This paper discusses five indicators of competitiveness: real exchange rates based on consumer price indices, export unit values in manufacturing, normalized unit labor costs in manufacturing, the relative price of traded to nontraded goods, and the ratio of normalized unit labor costs to value-added deflators in manufacturing. It discusses how each of these measures is associated with changes in a country’s balance of trade in goods and nonfactor services, changes which are relevant for an assessment of competitiveness, and examines how each of these indicators is related to each other. The conclusion reached in this part of the paper is that each indicator of competitiveness possesses shortcomings, and that no one indicator provides an unambiguous assessment of competitiveness. In fact, reliance on competitiveness indicators should only form part of any assessment of the appropriateness of a country’s exchange rate, given the many limitations inherent in the construction of these indicators. The paper suggests that competitiveness indicators should be used in conjunction with other indicators in order to obtain an assessment of competitiveness that is as complete as possible.
Given this fact, the paper examines the empirical performance of three of the indicators (real exchange rates based on consumer price indices, export unit values in manufacturing, and normalized unit labor costs in manufacturing). The empirical analysis shows that none of the indicators works well uniformly across countries. It is impossible to unequivocally recommend one indicator above all others to explain both import and export flows at all levels of aggregation in every G-7 country. Because movements in real exchange rates may be dominated by volatility in the nominal rate. Therefore, no one indicator may be elevated to the status of the best indicator.
From a policy point of view, the implications are clear--in examining an issue as complex as trade competitiveness, the use of competitiveness indicators should form only part of the analysis.