Link Between International Competitiveness and Inflation

Readers Question: If British industry was to become uncompetitive it would have the following adverse effects on the economy : one of them is a higher level of inflation. How to explain that ?

If British industry becomes uncompetitive it means that basically, the UK’s cost of production is rising faster than our international competitors. For example, we may become uncompetitive because wage costs are rising and this is leading to higher inflation.

So in a way, the two are linked, we are becoming uncompetitive because of rising costs of production. Also if we become uncompetitive, there will be less demand for British goods and hence Sterling, and so this would cause a devaluation in the value of the Pound. Devaluation tends to cause inflation because:

  1. Rising cost of import prices (imported inflation)
  2. Rising aggregate demand (demand pull inflation)
  3. Less incentives to cut costs

Fixed Exchange Rates

  • For countries with permanently fixed exchange rates, such as countries in the Euro, the inflation rate is very important for determining competitiveness.
  • For example, If inflation in Italy is higher than other Euro countries, they can’t devalue, so their exports will become less competitive.
  • If the UK became uncompetitive, then the Pound would devalue to restore competitiveness.
Related

International competitiveness

By on June 8th, 2008

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