Competitiveness,

Innovation and
Productivity:
Clearing up
the Confusion
Robert D. Atkinson
August 2013

The Information Technology

& Innovation Foundation
 COMPETITIVENESS, INNOVATION AND PRODUCTIVITY:
CLEARING UP THE CONFUSION

To listen to many economists, pundits and policymak-

ers discuss the economics of growth it would be easy
to be confused by the commonly used terms: com-
petitiveness, innovation and productivity. These terms
are often used almost interchangeably and with little
precise meaning. To remedy the situation, this policy NON-TRADED TRADED
memo defines these terms and explains how each is
important in driving economic prosperity. Thus competitiveness relates only to the economic
health of a region’s or nation’s traded sectors (for the
purpose of this memo, the term “region” shall refer to
COMPETITIVENESS both national and subnational economies). But how
do we define health? One definition is jobs. However, if
With the increased globalization of the econo-
one region’s traded sector is highly productive it could
my, the term competitiveness has become ubiq-
have fewer jobs than another region’s even if the first
uitous. But what does it actually mean? Most see
region is in fact more competitive. Another definition is
the term as synonymous with productivity. Har-
value-added—the amount of value that traded sector
vard’s Michael Porter states, “The only mean-
firms add to the inputs of production that they pur-
ingful concept of competitiveness at the national
chase. This is a closer definition, but fails to control for
level is productivity.”1 The World Economic Forum’s
the size of a region’s traded
Global Competitiveness Report defines competitive-
sector economy, i.e. the larg-
ness as “the set of institutions, policies, and factors If you listen to many
er the economy the larger
that determine the level of productivity of a coun- economists, pundits
the impact of the value
try.”2 And IMD’s World Competitiveness Yearbook and policymakers, it
added on competitiveness.
defines competitiveness similarly, but more broad- is easy to be confused
In addition, if a region has
ly, as how an “economy manages the totality of its by the commonly used
vastly more imports, even if
resources and competencies to increase the prosperity terms: competitiveness,
its traded sectors are pro-
of its population.”3 innovation and
ducing a large amount, its
economy is not holding its productivity.
But while these terms are related, competitiveness
own when it comes to com-
should not be equated with productivity or GDP growth.
petitiveness. But focusing
To see why, it’s important to differentiate between trad-
on trade deficits alone fails to account for the fact
ed and non-traded sector industries. A traded industry
that a region might run a surplus but do so by subsi-
is one where the firms sell a significant share of their
dizing its exporters (e.g., by manipulating its currency)
output outside a particular geographical area. For
or erecting barriers to importers (e.g., tariffs).
example, a printing firm in Michigan that sells printed
In this case, the trade surplus may not be a re-
material to customers across the United States would
flection of the true competitiveness of the region’s
be a traded firm from the perspective of the Michigan
traded sector firms, but rather a reflection of the
economy, but a non-traded firm from the perspective
extent of mercantilist aid the traded sector
of the U.S. economy. In contrast, a software firm in
firms receive.
Washington that sells software throughout the world
would be a traded firm from the state and national
The true definition of competitiveness is the ability of a
perspective.
region to export more in value added terms than it im-
ports. This calculation includes accounting for “terms
of trade” to reflect all government “discounts,” includ-
ing an artificially low currency, suppressed wages in

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 export sectors, artificially low taxes on traded sector
firms and direct subsidies to exports. It also controls
for both tariff and non-tariff barriers to imports.

Under this definition, a nation may run a large trade

surplus (one component of competitiveness), but if it
does so by providing large “discounts” to its exporters
or by restricting imports it would not be truly competi-
tive, for such policies would reduce its terms of trade by
requiring its residents to give up some of their income
to foreign consumers and/or pay higher prices for
foreign goods and services.

We can see this by looking at past trends in the

U.S. trade deficit. While the rise in the relative price
of imports brought about A COMPETITIVE ECONOMY IS ONE WITH A
through the lower val- TRADE SURPLUS, FEW BARRIERS TO IMPORTS,
The true definition of ue of the dollar in the
competitiveness is the AND LIMITED “DISCOUNTS” TO EXPORTERS.
last half of the 1980s
ability of a region to export helped reduce the U.S.
more in value added terms So how does productivity fit into competitiveness? Pro-
trade deficit; it also re- ductivity growth can enable competitiveness, especial-
than it imports. duced the U.S. terms ly if it is concentrated in traded sectors, which lowers
of trade (the United costs and enables firms to sell more in global markets
States could buy fewer without relying on government provided discounts. But
imports for the same quantity of exports). Therefore, productivity growth can also be relatively unrelated
U.S. competitiveness was unchanged even as the to competitiveness if it is concentrated in non-traded
trade deficit declined. Likewise, the fact that the United sectors. Imagine a nation with strong productivity
States runs a massive trade deficit today but many of growth but almost all of it in non-traded sectors like
its trading partners run surpluses by means of massive grocery stores, electric utilities and nursing homes. Cer-
“discounting” and import blocking means that we tainly incomes would go up as relative prices in these
cannot determine with certainty that the U.S. economy sectors fall, but firms in traded sectors would only see
is uncompetitive. modest reductions in their costs based on the extent of
purchased inputs from non-traded firms.
In fact, despite numerous studies claiming to compare
national competitiveness, no study to date has fully
accounted for export discounting and import restrict- INNOVATION
ing. While data exists on trade balances for virtually
all nations, data on the extent of export discounts and While competitiveness is almost always incorrectly
import restricting (especially through non-tariff barri- equated with productivity, innovation is usually de-
ers) are difficult to obtain. Despite this, at a cursory fined more accurately, although usually too narrowly.
level, it would appear that nations like Austria, Germa- Many see innovation as only technological in nature,
ny, and Sweden would be on a list of competitive econ- resulting in shiny new products like Apple’s iPad or
omies (they run trade surpluses while also having Boeing’s 787 Dreamliner. Still others believe innovation
relatively high wages and limited discounts). In con- pertains only to the research and development (R&D)
trast, nations like China (too much discounting) and activity occurring at universities, national laboratories,
the United States (too large a trade deficit even when and corporations.
accounting for foreign subsidies) would likely
not make the list of competitive economies.

INNOVATION

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 While this is all true, it is much too limiting in scope. Despite this, many analysts still use the term incorrect-
The Organization for Economic Cooperation and De- ly. For example, some argue that moving jobs to China
velopment properly defines innovation more broadly as and lowering wages raises productivity because it lowers
“the implementation of a new or significantly improved prices. But while these actions might reduce prices, lower
product (that is, a physical good or service), process, a prices are not the definition of productivity. In fact, moving
new marketing method, or a new organizational method jobs to China might actually decrease productivity since
in business practices, workplace organization, or exter- firms in China use fewer machines and are less efficiently
nal relations.”4 Innovations can arise at many different organized than firms in the United States.
points in the development process, including concep-
tion, R&D, transfer (the shift of the “technology” to the To understand the sources of productivity, it’s important to
production organization), production and deployment understand that economies have three ways to grow over
or marketplace usage. the medium and long term: growth in workers, growth in
productivity across-the-board and growth in the share of
However, even when innovation is defined properly, activity in high-productivity industries. The first, growth in
many equate it with competitiveness and/or produc- the number of workers, is a non-sustainable strategy and
tivity. For example, Bloomberg includes productivity more importantly does nothing to increase productivity or
as one of its seven variables for ranking the 50 most per-capita income growth. America would clearly enjoy
innovative nations.5 But while innovation is related to a larger GDP if the number of workers increased ten
productivity, and for that matter competitiveness, it percent, but the average income of workers would not
is not synonymous. There are many innovations that necessarily increase.
have little to do with productivity or competitiveness.
For example, the innovation of the smart electric grid THE THREE SOURCES OF
will help boost electric util- ECONOMIC GROWTH
ity productivity, but will
While innovation is related
do little to boost compet-
to productivity, and for that
itiveness as electric utility 1. GROWTH IN
matter competitiveness, it
services are not typically in- WORKERS
is not synonymous.
ternationally traded. Like-
wise, while the develop-
ment of a new technology to enable better weather
prediction would boost quality of life, it would also 2. PRODUCTIVITY
not directly affect productivity. In contrast, the IN ALL INDUSTRIES
creation of a new drug, a new kind of airplane
or a faster computer chip would not only enhance
traded sector industry competitiveness, it would
also improve quality of life and/or productivity. 3. GROWTH OF HIGH
So while innovation can increase productivity and PRODUCTIVITY INDUSTRIES
competitiveness, it is not synonymous with either.

PRODUCTIVITY
The second—the across-the-board “growth effect”—
occurs when a region’s productivity increases not by
Productivity is perhaps the most straightforward
higher productivity industry sectors becoming a larger
and easily defined of the three factors. Productivity
share of the economy, but by all sectors, low and high
is economic output per unit of input. The unit of
productivity ones alike, getting more productive. For
input can be labor hours (labor productivity) or all
PRODUCTIVITY:
production factors including labor, machines and
example, retail trade, banking, health care and auto-
mobile manufacturing all increasing their productivity.
energy (total factor of productivity).
This across-the-board process can happen two ways: if
all the firms in an industry increase their productivity or
if the low-productivity firms in an industry lose market
OUTPUT UNIT OF = PRODUCTIVITY share to high-productivity firms in the industry (e.g.,
INPUT smaller less productive “bricks and mortar” bookstores
go out of business because consumers prefer to buy

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 e-books). This process of change within industries But which productivity strategy—the growth effect or
occurs in all sectors but is not the major way industries the shift effect—is the better path to higher produc-
become productive. One study found that plant turn- tivity? The answer depends in part on the size of the
over from entry and exit contributes 15 to 25 percent economy and to a lesser degree on the type of sec-
of Canadian manufacturing labor productivity growth, tor. The larger the economy, the more important the
with the other 75 to 85 percent coming from individual growth effect is since relatively lower shares of large
firms becoming more productive.6 economies’ output are in traded sectors. Moreover,
the more local-serving the sector is, the greater the
importance of the growth effect. To understand why,
consider an automobile
factory in a small city. If
The lion’s share of
its managers install a new
productivity growth in
computer-aided man-
most nations comes not
ufacturing system and
from changing the sectoral
raise the plant’s produc-
mix to higher-productivity
tivity (the growth effect),
industries, but from all
a large share of the ben-
industries, even low-
efits will flow to the firm’s
productivity ones, boosting
customers around the
their productivity.
nation and even around
the world in the form of
lower prices. The city will benefit only to the extent
that its residents buy cars from that factory, if some
of the increases in productivity go to higher wages or
if the factory is able to employ more workers. In gen-
THE“GROWTH EFFECT” OCCURS WHEN eral, even though most nations, especially developing
ALL OR MOST INDUSTRIES BECOME nations like Brazil, China and India, have focused their
MORE PRODUCTIVE industrial policies on boosting productivity by changing
their industrial mix, the lion’s share of productivity
The third, the “shift effect,” occurs when the mix of growth in most nations comes not from changing the
low and high-productivity industries, as opposed to sectoral mix to higher-productivity industries, but from
firms, in a region changes. For example, if a developing all industries, even low-productivity ones, boosting
nation loses 500 agricultural jobs (which in developing their productivity.7
nations normally have low productivity) and gains 500
software jobs (which normally have higher productivi- IMPLICATIONS FOR POLICY
ty), overall productivity would increase.
So if competitiveness, innovation and productivity
are separate but interrelated, which is most import-
ant for a region’s economic well-being? As discussed
above, this depends in part on the size of the region.
In general, however, productivity is the most important
determinant of a region’s overall per-capita income.
-500 +500 Yet, it would be a mistake to conclude that economies
THE “SHIFT EFFECT” OCCURS WHEN can ignore innovation or competitiveness. Spurring
HIGH PRODUCTIVITY INDUSTRIES innovation can help productivity and competitive-
GROW FASTER THAN LOW ness. And innovation means that future goods and
PRODUCTIVITY INDUSTRIES services will not only be cheaper but better. Spurring
competitiveness is important as well. Without com-
petitive sectors, a nation’s standard of living will be

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 lower since it will have to give up more production to To date, no nation has adequately articulated the
pay for its imports. Moreover, as highlighted in Inno- differences between these three factors and in turn
vation Economics: The Race for Global Advantage, developed distinct, stand-alone competitiveness,
a weak traded sector can have spillover effects on innovation and productivity strategies. Rather, nations
the overall economy, distorting investment patterns tend to meld these together assuming that success in
and limiting growth 8. Competitive weakness also one will lead to success in another. But this is a recipe
creates a stiff headwind that other components of for underperformance. To truly succeed in today’s technol-
growth (e.g., non-traded sector innovation and pro- ogy-driven, global economy nations need to develop three
ductivity) must struggle to overcome. In fact, this distinct strategies: one for success in innovation, one for
competitive weakness explains many of the current international competitiveness and one for productivity. Not
problems faced by the U.S. and European economies. only will this lead to success in each of the three realms, it
will lead to reinforcing policies that benefit all three factors
The bottom line is: nations need to have well-articu- and drive economic prosperity and quality of life.
lated and distinct strategies addressing competitive-
ness, innovation and productivity. No one strategy can
effectively address all three factors.

COMPETITIVENESS INNOVATION PRODUCTIVITY

STRATEGY STRATEGY STRATEGY

NATIONS NEED WELL-ARTICULATED

AND DISTINCT COMPETITIVENESS,
INNOVATION AND PRODUCTIVITY STRATEGIES

A traded sector competitiveness strategy should focus

specifically on targeted policies—including trade, tax,
talent and technology polices—that improve the inter-
national competitiveness of a region’s traded sector
industries.9 An innovation strategy should focus on the
barriers to innovation (e.g., regulatory) and the needed
support systems (e.g., investment in R&D, support for
technology transfer and STEM education) that can
spur more innovation in all three major sectors of an
economy (for profit, non-profit and government).10
Finally, a productivity strategy should examine all
major industries and functions in an economy to
determine the barriers to growth and the policies
that can promote both the growth and shift effects.
This includes support for the development of “plat-
form” technologies, such as broadband, smart
grids and health IT. While all three strategies are
related they are also distinct enough that they de-
serve to be considered separately by policymakers.

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 ENDNOTES

1. Michael E. Porter, “The Competitive Advantage of ACKNOWLEDGEMENTS

Nations,” Harvard Business Review, March 1990, http:// The author wishes to thank the following
hbr.org/1990/03/the-competitive-advantage-of-nations/ar/1.
individuals for providing input: Kathryn
2. Klaus Schwab, “Global Competitiveness Report 2012- Angstadt, Will Dube, Stephen Ezell, Alex
2013” (World Economic Forum, September 2012), Key, and Ben Miller. Any errors or omissions
http://reports.weforum.org/global-competitiveness- are the author’s alone.
report-2012-2013.

3. “World Competitiveness Yearbook 2012” (IMD World

ABOUT THE AUTHOR
Competitiveness Center, May 2012), Dr. Robert Atkinson is the president of
http://www.imd.org/wcc/wcy-world-competitiveness- the Information Technology and Innovation
yearbook. Foundation. He is also the author of the books
4. “Ministerial Report on the OECD Innovation Strategy”
Innovation Economics: The Race for Global
(Organization for Economic Cooperation and Development, Advantage (Yale University Press, 2012) and
March 2010), http://www.oecd.org/sti/45326349.pdf. The Past and Future of America’s Economy:
Long Waves of Innovation that Power Cycles
5. “50 Most Innovative Countries,” Bloomberg, February
2013, http://www.bloomberg.com/slideshow/2013-02-
of Growth (Edward Elgar, 2005). Dr. Atkinson
01/50-most-innovative-countries.html#slide50. received his Ph.D. in City and Regional
Planning from the University of North Carolina
6. John R. Baldwin and Wulong Gu, “Plant Turnover at Chapel Hill in 1989.
and Productivity Growth in Canadian Manufacturing”
(Statistics Canada, April 2003), http://www.statcan.gc.ca/
pub/11f0019m/11f0019m2003193-eng.pdf. ABOUT ITIF
The Information Technology and
7. James Manyika et al., “How to Compete and Grow: A Innovation Foundation (ITIF) is a
Sector Guide to Policy” (McKinsey & Company, March
2010), http://www.mckinsey.com/insights/economic_
Washington, D.C.-based think tank at the
studies/how_to_compete_and_grow. cutting edge of designing innovation strategies
and technology policies to create economic
8. Robert D. Atkinson and Stephen J. Ezell, Innovation opportunities and improve quality of life in the
Economics: The Race for Global Advantage ( New Haven:
Yale University Press, 2012). http://globalinnovationrace.
United States and around the world. Founded
com/ in 2006, ITIF is a 501(c) 3 nonprofit,
non-partisan organization that documents the
9. James Manyika et al., “How to Compete and Grow: A beneficial role technology plays in our lives
Sector Guide to Policy” (McKinsey & Company, March
2010), http://www.mckinsey.com/insights/economic_
and provides pragmatic ideas for improving
studies/how_to_compete_and_grow. technology-driven productivity, boosting
competitiveness, and meeting today’s global
10. James Manyika et al., “How to Compete and Grow: challenges through innovation.
A Sector Guide to Policy” (McKinsey & Company, March
2010), http://www.mckinsey.com/insights/economic_
studies/how_to_compete_and_grow. FOR MORE INFORMATION VISIT WWW.ITIF.ORG.

GRAPHIC ATTRIBUTIONS
Bohdan Burmich, Adam Heller, Luis Prado, Jon Trillana,
Nicolò Bertoncin, all from The Noun Project.

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