Question: Examine 2 policies that the government could use to improve the international competitiveness of the UK economy.
International competitiveness is the ability of a country to compete with rival countries in terms of prices and/or quality. International competitiveness is, therefore, a key factor affecting foreign trade and the balance of payments.
One policy that the government could use is a real exchange rate devaluation. This would make the £ cheaper and the UK economy more internationally price competitive. Consumers outside the UK will find it cheaper to buy UK goods and services so UK exports will rise. Additionally, because the £ is devalued, it will be more expensive for UK consumers to import goods and services, so UK consumers will switch to buying more products from domestic UK firms.
However, as shown by the J-curve, an exchange rate devaluation would initially harm the UK’s balance of payments. After an exchange rate devaluation, the current account moves into a deficit in the short-run because of fixed contracts for exports and imports. Exports are cheaper and imports are dearer yet their volumes remain the same, so the current account initially moves towards a deficit. After contracts are renegotiated in the long-run, exports rise, imports fall and the current account moves towards a surplus
Additionally, the government could use supply-side polices to boost the UK’s international competitiveness. For example, the government could cut corporation tax on UK firms, increasing their profits. If UK firms then use these higher profits to invest in new technology then the UK economy would become more efficient. UK firms could then produce cheaper goods and, possibly, higher quality products with which they can better compete at the international level.
On the other hand, supply-side policies suffer from time lags. For instance, if UK firms are encouraged to increase investment then, in the short-run, AD will rise, inflation will rise, the UK economy loses international price competitiveness, exports become dearer and fall, imports become cheaper and rise. Furthermore, there is no guarantee that cutting corporation tax will even help boost the UK’s international competitiveness. This is because firms may use their higher profits to increase the pay of their managers and workers, causing consumption and AD to rise in the UK, raising UK inflation and reducing international competitiveness.