Challenges Arising When a Country Loses Its Competitiveness

Question

(b) Discuss the potential challenges that might arise when a country loses its competitiveness. [15]

Answer

Trade competitiveness is a country’s ability to sell its goods and services abroad, determined by price and non-price factors. When it falls, two macroeconomic challenges follow — negative actual growth and rising unemployment. My thesis is that the rise in unemployment is the greater challenge, because it threatens the economy’s long-run productive capacity in a way that a short-run fall in output does not.

Fall in actual economic growth. When competitiveness falls, foreign buyers are less willing to buy the country’s exports, so export revenue ( $X$ ) and net exports fall, worsening the balance of trade. Falling competitiveness also lowers investor confidence and the marginal efficiency of investment, reducing investment ( $I$ ). As both are components of aggregate demand, AD falls, and through the reverse multiplier real national income falls by a multiple of the initial fall in injections.

Negative actual growth: falling net exports and investment shift AD₀ left to AD₁ in the Keynesian range, lowering real national output from Y₀ to Y₁ — negative actual economic growth.

Rise in demand-deficient and structural unemployment. As AD falls, firms face an unplanned build-up of inventory, cut output and hire fewer factors. Since labour is a derived demand, demand-deficient unemployment rises. In addition, workers retrenched from declining export industries may lack the skills for rising industries — a skills mismatch — raising structural unemployment.

Judgement. The rise in unemployment is the greater challenge. Left unaddressed, prolonged unemployment erodes productive capacity: the long-term unemployed lose their skills, and a loss of competitiveness can drive a brain drain as high-skilled workers emigrate for better opportunities, compounding the damage and risking negative potential growth. Structural unemployment in particular is slow to reverse, depending on the rate at which retrained workers are re-absorbed. Negative actual growth, by contrast, is comparatively easy to reverse in the short run with expansionary fiscal or monetary policy, and so poses a smaller challenge. The central danger of lost competitiveness is therefore not the immediate fall in output but the durable harm to the economy’s capacity through unemployment.