Non-price competitiveness factors and export performance: The case of Spain in the context of the Euro area
Empirical evidence suggests that internal non-price/cost factors dominate over strictly price/cost elements in determining the external competitiveness of the five largest EA economies. Building on this observation, internal devaluation policies are likely to have only a limited impact on restoring competitiveness compared to those aimed at strengthening capitalization and providing the right incentives for exporters.
Abstract: This paper examines, for the five largest euro area economies – Germany, France, Italy, Spain and the Netherlands (EA5) –, the evolution of the leading price/cost (internal) competitiveness indicators, and the association between them and export performance. First, we show that the most prominent price/cost competitiveness indicators have oscillated with different orders of magnitude in the five countries. The smallest oscillations correspond to Germany and the Netherlands, and the highest (more than four times higher) to Italy. We also show that although Italy and Spain have had similar trajectories up to 2008, Spain appears to have recovered by the end of 2015 virtually all of the cost-competitiveness lost between 2000 and 2008, while in Italy what is left to recover exceeds the corrections made so far. Concerning the association of these internal developments with the behaviour of exports, this paper finds, in line with previous literature, that the link appears to be rather weak. This suggests that other, non-price/cost factors are more important for export growth. To the extent that this hypothesis could be proved, policies in support of competitiveness should rebalance priorities away from internal devaluations and incentivize the capitalization of the EA5 economies with more important challenges, in particular in Spain.
The competitiveness of an economy is a key economic policy priority. In the wake of the 2008 economic and financial crisis the issue is even more central, particularly for the European Union (EU) and the Euro area (EA) countries. The European Commission and EA economic establishment in its flagship policy paper to revitalize the European Union identified the task of “boosting competitiveness” as the most urgent one (Five Presidents Report, 2015).
However, beyond its prominence in the policy debate, there is no unequivocal way of understanding the competitiveness of an economy, but rather there are two basic approaches: internal and external competitiveness (Draghi, 2012). This distinction is not only academic, but also holds significant policy relevance.
For example, in the case of Spain, the fourth largest economy in the EA, both concepts of competitiveness have evolved in opposite directions since the 
introduction of the euro in 1999. By most standards of measurement, internal (price-cost) competitiveness has deteriorated while the external (export-related) has improved. This is known as the “Spanish paradox” and it is likely to be the manifestation of a deeper dual economic structure in the country. A handful of very competitive, internationally-oriented firms coexist with a larger set of smaller, more troubled, inward-looking ones. As the price-cost indicators tend to over-represent the latter ones, these indicators become less reliable[1].
The textbook approach suggests that improvements in internal competitiveness translate into gains of external competitiveness: by reducing wages, cheaper products are sold better in international markets. This rationale, as simple as it might seem, has guided a fair share of policy interventions in the EA in the wake of the crisis.
In this paper, we examine this link for the five largest EA economies: Germany, France, Italy, Spain and the Netherlands (EA5). The following section introduces the different types of deflators for the real effective exchange rates. Then, the article examines how they have evolved in the EA5 between 2000 and 2015. Subsequently, we disaggregate the variation of export shares in the EA5 into two components, one related to cost competitiveness and the other related to non-cost competitiveness. The final section provides a conclusion.
Real effective exchange rates (REER)
Competitiveness is, by definition, a relative notion; firms, countries or regions are more or less competitive than their counterparts. The leading competitiveness indicator of an economy is the real effective exchange rate (REER). It is a generalization of the nominal exchange rate, which is the rate (or price) at which currencies are exchanged. The real effective exchange rate intends to capture the real price of a country’s currency, i.e. its relative price in terms of the currencies of its principal trading partners.
Formally, the REER of a country is defined as the weighted geometric average of the nominal exchange rate rates of the country’s main trading partners employing a particular deflator. That is, for a given country, if there is a set i=1,..., n of trading partners; ei, the exchange rate; Pi* , the deflator; ωi , the weight associated to trade partner i (a function of imports and exports), then the real effective exchange rate is,
See Giordano and Zollino (2016) and the references therein, for further details.
The REER is thus an approximation to the effective, relative price of the exports of one country in terms of the exports of its more relevant international competitors. Constructed in this way, increases in a country’s REER (or, REER appreciations) imply a loss in competitiveness –its products or services become more expensive relative to its trading partners.
There are several versions of the REER because there are several ways to deflate and compare currencies. Depending on the type of relative deflator  in the equation above, whether it is a price or a cost, the REER is price– or cost-based.
The European Commission provides five of the most widely used deflators and in this article we will limit our attention to those.
  • Harmonised index of consumer prices (HICP) deflator. This deflator includes goods and services but it covers only consumer goods. So it does not take into account differences in the prices of capital and intermediate goods across countries.
  • Price deflator of the GDP at market prices (GDP). This deflator includes goods and services and all levels of activity. However, they are not fully comparable across countries due to the different national measurement of services activities.
  • Price deflator of exports of goods and services (EXPGS). This deflator follows the same logic of the previous, with the same limitations, but it covers only the exports of goods and services.
  • Nominal unit wage cost for the manufacturing sector (NUWC-M) deflator. This deflator takes into account differences across countries in the ratio between productivity and total compensation per employee in the manufacturing sector. This deflator does not take into account other costs of production, such as the cost of intermediate inputs or the firms’ mark-ups.
  • Nominal unit labour cost for the total economy (NULC-TE) deflator. This deflator is an adaptation of the previous one but covering all sectors of the economy.
A price-based REER (deflated by HICP, GDP or EXPGS) increases when the corresponding measure of domestic inflation is larger than the average inflation in the trading partners. A cost-based REER (deflated by NUWC-M or NULC-TE) increases in a country when either labour costs become higher, labour productivity decreases, or both, with respect to the trading partners.
The evolution of price-cost competitiveness indicators in the EA
For the particular case of the EA countries, the nominal exchange rate between member countries has remained constant since the adoption of the euro in 1999. However, EA countries’ real effective exchange rates have diverged for the afore-mentioned reasons: inflation rates, wages and labour productivity have had idiosyncratic dynamics in each country.