Latvia’s Competitiveness before and after the Crisis

Konstantins BenkovskisMarch 1, 2012

Outline

• Discrepancies between different competitiveness indicators for Latvia

• Drawbacks of traditional REER indicators• How to assess non-price competitiveness?

o

Theoretical frameworko

Dynamics in price and non-price competitiveness in Latvia

• Conclusions

REER shows losses in competitiveness before crisis and gains afterwards

Different real effective exchange rates of Latvia (1999 = 100)

Source: Eurostat Source: Bank of Latvia

Latvia quickly regained competitiveness by closing wage-productivity gap

Real wage and productivity index (2005Q1=100)

Source: Central Statistical Bureau of Latvia, Bank of Latvia calculations

Does market shares dynamics contradict the previous conclusions?

• Despite significant real appreciation signalled by REER indicators, nominal and real shares of Latvia’s exports have a stable upward trend

• Do traditional REER indicators capture all the relevant competitiveness issues?

Source: UN Comtrade, Eurostat, Bank of Latvia calculations

Drawbacks of traditional REER: unit labour costs is not the whole story

Source: Central Statistical Bureau of Latvia, Bank of Latvia calculations

• Profit margins of exporters (difference between export prices and ULC) can change as well:• Profit margins decreased

before the crisis, partly offsetting competitiveness losses

• After the crisis profit margins are on an increasing trend

Further drawbacks of traditional REER

• Structural issues are not captured:o

Differences in export structure are not taken into account

o

Need to analyse competitiveness at disaggregated level

• Focusing on price competitivenesso

Some measures are adjusted for quality (e.g. CPI-based)

o

However, many other important factors left aside (e.g. taste, image of brands)

o

Need to also consider non-price competitiveness issues

How to evaluate non-price competitiveness?

• We have trade data on a very disaggregated level:o

prices (unit values, euro/kg)

o

volumes (kg)

• Why shouldn’t we combine both sources instead of focusing just on one?o

If real market share improves when relative export price is increasing, it gives us some clue about non-price factors

• Consistent theoretical framework needed

Theoretical framework Consumer’s utility function

• First-level CES utility function (imports and domestic good)

• Second-level CES utility function (different imported goods)

• Third-level CES utility function (different varieties of a good)

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∑ γγγ

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elasticity of substitution between products

elasticity of substitution between varieties

quality or taste parameter

set of goods

set of countries

Theoretical framework Change of a relative price in a single market

• Relative price of a good g imported from country k relative to other origins:

1. Traditional relative price index – increase denotes worsening price competitiveness

2. Adjustment for changes in monopoly power of exporters. If set of partner countries is increasing, relative price index increase as well

3. Adjustment for changes in quality or taste. Rise in relative quality or taste decrease relative price index and improve competitiveness

1 2 3

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Source: K. Benkovskis, J. Woerz (2012) “Evaluation of Non-Price Competitiveness of Exports from Central and Eastern European Countries”, Bank of Latvia working paper, forthcoming.

Theoretical framework How to estimate quality/taste parameter?

• After solving utility maximization problem:

• Relative quality or taste depends on relative prices and relative volumes of sales

• It also depends on elasticity of substitutiono

relative quantities are not important for perfect competition

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gkt

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g xx

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ln1lnln1σσ benchmark country

relative prices (UVX) relative quantities (kg)

Database and coverage Eurostat Comext data

• Eurostat Comexto

Import data for all 27 EU countries

o

8-digit CN classification level• approx. 10 000 products

o

1999 to 2010, annual datao

50 main partner countries

• All EU countries, US, Japan, China, India, Brazil, Canada, Russia etc.

• Therefore, we are assessing competitiveness of Latvia on EU marketo

Still analysing the most part of Latvia’s exports (67.2% in 2010)

Price competitiveness of Latvia’s exports to EU

• Aggregated export price-based REER shows lower appreciation – profit margins matters

• After evaluation of relative export prices on every importing market (27 countries, ~10000 products), overall index obtained by weighting according to Latvia’s export structure

• Disaggregated export price-based REER shows even lower appreciation and losses in price competitivenesso

Price competitiveness is better for main export products of Latvia

Source: K. Benkovskis, J. Woerz (2012) “Evaluation of Non-Price Competitiveness of Exports from Central and Eastern European Countries”, Bank of Latvia working paper, forthcoming.

Price and non-price competitiveness of Latvia’s exports to EU

• Taking into account non- price competitiveness factors changes the perception of Latvia’s performance

• Competitiveness of Latvia’s exporters on the EU market significantly improved:o

Quality and taste for Latvia’s products increased faster then one for our rivals

Source: K. Benkovskis, J. Woerz (2012) “Evaluation of Non-Price Competitiveness of Exports from Central and Eastern European Countries”, Bank of Latvia working paper, forthcoming.

Conclusions

• Do not stick only to simple aggregate indiceso

REER shows losses in competitiveness before crisis and gains afterwards

o

Market shares of Latvia’s exports contradicts it, showing stable upward trend

• Use in-depth disaggregated analysis, when possibleo

Price competitiveness of Latvia’s exports worsened only marginally

o

Non-price competitiveness factors (quality, taste) have a significant positive contribution

o

Overall, competitiveness of Latvia’s exporters on the EU market improved before, as well as after the crisis