Competitiveness at the end of the commodity boom
Today’s competitiveness landscape is the outcome of developments stemming from the global financial crisis which spread negative wealth shocks and contractionary effects from the United States to Europe and beyond.1 After reducing interest rates toward zero and all but exhausting the possibilities of conventional monetary policy to spur recovery, policymakers resorted to more unorthodox solutions. Central banks’ strategy of quantitative easing continues today, as they inflate their balance sheets and keep interest rates at record lows. This box explores the link between these well-known macro policies and diversification and competitiveness.
The end of the commodity super-cycle and the sharp drop in prices, mainly of oil and minerals but also of food and agricultural products, reveals a close relationship between commodity dependence and competitiveness and provides lessons going forward. As prices of commodities soared following the global financial crisis, reinforced by strong demand from a few large emerging markets known as the BRICs (Brazil, Russia, India, and China), the weight of commodities in the export baskets of commodity-rich economies increased. The continued strong growth of the BRIC economies, particularly China, reinforced the commodity super-cycle that had begun in 2000 after the long slump of the 1980s and 1990s.2 Close-to-zero interest rates in advanced economies induced large capital flows into emerging markets that went to these profitable commodity sectors. The dollar depreciation super-cycle was matched by currency appreciations that some claim produced Dutch disease phenomena in emerging markets. Commodity sectors attracted resources and manufacturing sectors found it harder to export and harder to attract investment.
The end of the commodity super-cycle, and in particular the pronounced fall in oil prices in response to increased supply of unconventional oil sources, especially in the United States, produced a large drop in the value of exports, current account deficits, government budget deficits, and large currency depreciations. As the US economy slowly recovered and monetary policy was expected to normalize, capital flows toward emerging markets fell. Many policymakers and analysts hoped that exchange rate depreciations would lead to increased exports of manufacturing goods. They soon realized that, for a variety of reasons—including depressed global trade in general, smaller real versus nominal depreciations, and the changing structure of global value chains and international trade—export elasticities had become smaller than they used to be (exports became less responsive to changes in the exchange rate).3
The key lesson learned, however, is that the process of starting to produce new goods in new sectors and managing to export them is hard. It requires having productivity levels beyond those achieved by commodity-exporting economies. Indeed, using the IMF Diversification Index, we find that more competitive economies also have more diversified export baskets, and more diversified economies are more competitive. The link between productivity and exports is well understood in the firm-level trade literature,4 and the relationship between diversification and productivity has been explored in Hausmann and Klinger (2006) and Juvenal and Santos Monteiro (2013), among others. Figure 1 shows the relationship between competitiveness and diversification.
The mechanism linking diversification and competitiveness comes via the effect of the fall in mineral and oil prices on the value of exports and on government deficits and inflation, which increases as a result of depreciation pass-through. In turn, as falling exports affect competitiveness through the deterioration of the macroeconomic environment, it is harder for new firms and new sectors to flourish. Additional mechanisms involve the incentives of cash-rich commodity exporters to make the investments and take the policy actions that would lead to increased competitiveness of alternative sectors.
These incentive effects are reflected in the composition of changes in the Index for net commodity exporters. Figure 2 shows the decomposition of changes in the GCI between 2008 and 2016. In particular, the business sophistication and innovation pillars fall for net exporters of commodities following the negative terms-of-trade shock.
On the other hand, net commodity importers have smaller changes in overall GCI scores when prices are lower, but no individual pillar drives the change.
The analysis suggests that competitiveness will not come from currency depreciations alone. Increasing productivity and creating the conditions for new growth sectors, based on emerging business models and technologies in the context of the Fourth Industrial Revolution, requires making progress on the competitiveness agenda that many economies neglected during their commodity-led growth period. The Global Competitiveness Report should serve as a tool to achieve this change.