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Mr. Herman Z Bennett, Mr. Julio Escolano, Ms. Stefania Fabrizio, Eva Gutiérrez, Mr. Iryna V. Ivaschenko, Mr. Bogdan Lissovolik, Marialuz Moreno-Badia, Mr. Werner Schule, Mr. Stephen Tokarick, Mr. Yuan Xiao, and Ziga Zarnic

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This collection of studies analyzes developments in nonprice external competitiveness of France, Greece, Italy, Portugal, and Spain. While France, Italy, and Portugal have experienced substantial export market share losses, Greece and Spain performed relatively well. Export market share losses appear associated with rigidities in resource allocation (sectoral, geographical, technological) relative to peers and lower productivity gains in high value-added sectors. Disaggregated analysis of goods and services export markets provides insights on aspects such as quality, market concentration, growth of destination markets, and geographical and sectoral diversification. Also, increased import penetration, offshoring and FDI could improve productivity and export performance.

The consensus view of the literature is that foreign direct investment (FDI) in general has a favorable impact on productivity and exports.2 FDI can be resource-seeking or market-seeking, and the former type boosts exports directly. But both types of FDI also have indirect impacts through positive externalities and spillover effects: they may bring capital and knowhow to domestic industries, have positive externalities on domestic companies through competition and reduced costs of inputs, and help host country exporters to gain access to foreign market. Although in theory FDI could adversely affect domestic producers by competing for markets and skilled employees, empirical evidence tends to support that the benefits of FDI significantly outweigh its costs for host countries.

Globalization has resulted in increasingly integrated markets across the world. As a result, competition may become tougher, and incumbent players may lose market share. Moreover, classical trade theory predicts a reduction in prices and margins, although the empirical evidence is mixed (see for example, Chen, Imbs, and Scott, 2004; and Boulhol, 2005). In the face of increasing competition, incumbent firms can adjust by increasing their productivity, and since this may prove difficult in mature industries, by diversifying toward markets with fewer competitors or higher-value-added products, where competition from new entrants could be weaker. However, shifts toward less competitive markets could indicate that exporting firms are not really adjusting but have been competed out of their traditional markets and forced to retreat into more protected but less profitable ones. Although all southern euro area five (SEA-5) countries have suffered a decline in their shares of world exports over the last decade (Figure V.1), it is not clear whether some adjustment has already taken place in response to the emergence of new global competitors.

Globalization is posing major challenges to the southern euro area (SEA-5) countries2—new products of better quality can be an alternative to increase their competitiveness. In this context, the main finding of this chapter is that product quality has not shown a marked improvement over the last decade. This slow progress appears associated with a loss of market share.

As a result of globalization, firms in countries around the world have been engaged in a “fragmentation” of the production process, i.e., breaking the production process into smaller tasks and carrying them out where they can be accomplished most cheaply. This process has been referred to as “outsourcing” and it can take a variety of forms. Outsourcing can take place domestically, as when a firm procures the services of an supplier who is located in the same country, or internationally, as when a foreign firm provides the service. When the latter occurs, it is termed “offshoring” and this practice has received a great deal of press attention in recent years because it is sometimes alleged that it leads to job losses in the home economy. Both domestic outsourcing and foreign outsourcing give rise to trade, either domestically between firms or internationally.

Mr. Bogdan Lissovolik, Mr. Julio Escolano, Ms. Stefania Fabrizio, Mr. Werner Schule, Mr. Herman Z Bennett, Mr. Stephen Tokarick, Mr. Yuan Xiao, Ms. Marialuz Moreno Badia, Miss Eva Gutierrez, and Mr. Iryna V. Ivaschenko

Exporting to fast-growing markets and sectors, especially in the current period of strong and varied world growth, is considered important for economic performance. For example, Arora and Vamvakidis (2004) showed that, controlling for convergence and other standard determinants, dynamic trading partners may substantially contribute to growth, with industrial countries particularly benefiting from trade with fast-growing developing countries. Recent literature also emphasizes the growth impact of export specialization (Plümper and Graff, 2001) compared to the more agnostic “traditional” view. And surging global export competition underscores the classic case for flexibility in reallocating to new, more promising, activities.2

Economic development is accompanied by increased specialization in services at the expense of industrial production. But while services account for over 60 percent of world production, they make up only 20 percent of world trade. International trade in services is limited by the nontradable nature of many services, which require physical interaction between producers and consumers. In addition, liberalization of trade in services has lagged with respect to liberalization of trade in goods. However, new technologies such as the internet facilitate the delivery of services, and increasing trade liberalization has created new opportunities for trade in services. Specialization in trade in services could result in improvements in the terms of trade; services prices typically grow faster than good prices and raises income as productivity in services exceeds productivity in manufacturing.

European companies compete more on differentiation, less on cost. Whereas 86 percent of them consider differentiation to be important, low cost is important for only 58 percent. Europe is focusing more and more on high value-added goods and services. Best of European Business competition survey, 2006

The common pattern of real appreciation observed during recent years in Greece, Italy, Portugal, and Spain has created concerns in policy and academic circles (Bini-Smaghi, 2007; EC, 2007; Roubini, 2007; and Papademos, 2007). It is argued that this real appreciation is associated with a loss of international competitiveness and could lead to a persistent period of slow growth, which has already materialized in the case of Italy and Portugal (Blanchard, 2006a and 2006b).

Imports increase consumer choices, exert competitive pressures on domestic producers, and facilitate industrial restructuring. In studies of cross-country differences in external performance, imports have drawn considerably less attention than exports, and typically have been assigned a passive role. For example, Allard, et al (2005) found imports to be largely determined by final demand while competitiveness has been playing a minor role. However, the benefits of imports are well known: they increase the supply of goods and services available to meet final demand, enable a national economy to bring forward consumption and investment, offer an enlarged product variety, and facilitate the global division of labor. This chapter looks at the role of imports in restructuring the economies of the five southern euro area (SEA-5) countries—France, Greece, Italy, Portugal, and Spain—and, for the purpose of comparison, the euro area average and Germany.