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University of Economics in Prague Faculty of Finance and Accounting

Finance and Accounting

MASTER THESIS

Competitiveness of selected country in world markets

Author: Giyas Mustafayev

Supervisor: doc. Ing. Karel Brůna, Ph.D.

Academic Year: 2021

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Declaration of Authorship

The author hereby declares that he compiled this thesis independently, using only the listed resources and literature, and the thesis has not been used to obtain a different or the same degree.

The author grants to University of Economics in Prague permission to reproduce and to distribute copies of this thesis document in whole or in part.

Prague, date

Signature

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Acknowledgments

I would like to thank my supervisor doc. Ing. Karel Brůna, Ph.D. for his tremendous help, guidance and encouragement that he has given me throughout the process of writing this project.

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Abstract

This thesis analyzes Switzerland's competitiveness in regard to the other countries in the world. The paper provides a comparison in terms of macroeconomic indicators in comparison with the average indicator of the European Union and Germany. These countries were chosen to show the position of a non-EU country in relation to one of the most developed countries of the European Union - Germany. The aim of this work is to analyze the competitiveness of Switzerland on an international scale and to determine the causes of high competitiveness of this country.

The main research questions are the following: 1. What are the key indicators of the competitiveness of the country in the world markets? 2. What are the main reasons of high competitiveness of Switzerland in the world markets? 3. How has competitiveness of Switzerland changed in the last five years?

The main findings of the thesis is that Switzerland is keeping its high positions in international rating of the countries due to its high economic development, high level of development in IT sphere, in talents acquisition and other indicators.

Keywords

Competitiveness, Switzerland, World Competitiveness Ranking, Real exchange rate, unit labor costs, capital productivity, terms of trade, World Economic Forum.

JEL Classification B22, B27, E2, E42, E6

Keywords International trade, Macroeconomic aspects, General macroeconomic outlook

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Introduction

Competitiveness is a complex economic category that is not easily definable, measurable and has many levels that can be explored and monitored. It is possible to examine both the competitiveness of the company (its success in competition with other companies) and the entire state or regions. The result of the competitiveness analysis depends on the selected factors that are examined. It is possible to analyze GDP growth, unemployment, economic results or also inputs, costs, quantitative and qualitative factors. The method of data collection and evaluation can also influence the results of the analysis.

The country's success in international evaluation is influenced by many economic policy factors (monetary and fiscal policy, flexibility of factor markets, investment, tariff or non- tariff barriers to foreign trade), and can therefore be influenced.

This thesis analyzes Switzerland's competitiveness in regard to the other countries in the world. The paper provides a comparison in terms of macroeconomic indicators in comparison with the average indicator of the European Union and Germany. These countries were chosen to show the position of a non-EU country in relation to one of the most developed countries of the European Union – Germany.

The aim of this work is to analyze the competitiveness of Switzerland on an international scale and to determine the causes of high competitiveness of this country.

The main research questions are the following:

1. What are the key indicators of the competitiveness of the country in the world markets?

2. What are the main reasons of high competitiveness of Switzerland in the world markets?

3. How has competitiveness of Switzerland changed in the last five years?

The thesis consists of five chapters. The first chapter is an introduction and definition of the objectives of the work. The second chapter explains the theory of a country's competitiveness at the global level. Theories of relative and absolute advantage, as well as the theory of real

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The third chapter describes the methodology for analyzing competitiveness. Macroeconomic indicators are given, with the help of which the competitiveness of the country is determined, in particular, the level of productivity of work and capital, the real level of wages, the real exchange rate and indicators of foreign trade.

The fourth chapter provides synthetic indicators of competitiveness and a methodology for analyzing the World Competitiveness Index of countries.

The fifth chapter analyzes the competitiveness of Switzerland – an analysis of macroeconomic indicators and a comparison with Germany and the EU average, as well as an analysis of Switzerland's position in the ranking of countries according to the method of the World Competitiveness Index.

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1 Theory of competitiveness

Before we focus on the case study itself, it is necessary to define the concept of competitiveness. While this concept can be understood in a narrower and broader concept, therefore both concepts of competitiveness and their meaning can be mentioned in the work.

Furthermore, the economic view of the country's competitiveness will be presented, especially the theory of absolute and comparative advantages.

1.1 Microeconomic concept of competitiveness

Competitiveness at the microeconomic level is in general, understood as firms' ability to compete and operate in the market. Quantities such as labour and capital productivity, value-added, return on equity and assets, investments in technology, know-how, capital equipment, etc. point to high microeconomic competitiveness. Value-added is the value that each manufacturer adds to the value of the intermediate. The higher added value may be due to the more beneficial quality or uniqueness of the intermediary. By investing in technology, it is possible to acquire all the know-how, i.e. technical and technological knowledge, which is unknown or inaccessible to others, which gives a competitive advantage to the undertaking. Labour productivity means the added value that an individual worker produces at a given time. It is desirable to maximise this added value. The same principle explains Capital productivity. Labour productivity is increasing thanks to improved technology, skills and capitalisation. Competitiveness can be viewed static and dynamically, absolutely or relatively (Gugler, Chaiss, 2010).

A static view of business environment helps to find out the financial status of the company mainly in the short term, namely an analysis of the firm profitability or market share based on an indicator of profitability, e.g. the following calculation as return on assets (ROA) or return on equity (ROE), or proportional indicators used for listed firms on the stock exchange, as P/E ratio or P/BV ratio. Also, i tis necessary to mention EVA concept in terms of evaluation of the financial status. However, it must be realized, even the most profitable company with the largest market share in the sector may not maintain its position and competitiveness for a long time, for example, the firm is unable to innovate, its reaction to

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originality on products. It could also be a change in the technology which makes competitive and highly profitable company worse and worse in time.

Nowadays, a dynamic view of the business environment is preferred, based on an evolutionary sources analysis of competitive advantage over a long period. Flexibility and innovative activities are essential to maintain long-term competitiveness. A company can be competitive even with low flexibility when it can benefit from its competitive advantages.

Measuring dynamic competitiveness is not easy, but any long-standing firm can be considered as a long-term competitive firm because uncompetitive firms are shutting down and leaving the market. The best indicator of a company’s competitiveness is high brand value or branding. Such a company´s reputations contribute to higher margins, raise the highest quality human capital, and have greater bargaining power vis-à-vis the supplier (Zhuplev, 2014).

In Absolute terms, one can characterize a competitive firm by definition, capable of achieving positive economic results with limited labour and capital inputs. However, on the one hand, the problem is that it does not make it possible to compare the development with other similar firms within the industry, and the other hand, it does not express the structure of the firm and its circumstances, too. Therefore, one considers relative terms as more applicable since they capture both national and international market share. The acquisition, maintenance or increase of a firm's market share, on the national and international markets, can be achieved by applying a competitive advantage based on (Ordoñez de Pablos, 2014):

• the use of cost-cutting technologies and thus the price of the product offered at a given quality level (price competitiveness);

• achieving a higher quality of the product offered at a given price (qualitative competitiveness);

• to maintain a privileged market position, as a result, product differentiation and expanding into challenging markets.

The elementary preconditions for a company´s competitiveness stand on competitive advantages, determined quantitatively and qualitatively. As quantitative level can mention price or cost, increasing market share and labour and capital productivity. These

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quantitatively based competitive advantages are typically more likely for the Less-developed countries besides low wages, and undervalued domestic currencies result in low costs and consequently low prices. The qualitative level expresses the competitive advantages in areas, namely research and development, innovation capacity, know-how, technological progress, personnel policy, education, or focusing on knowledge workers and their increased performance. Also, it can be expressed by the level of customer care, which is at more high level in the economically developed countries (Fagerberg et al., 2004).

In the less-developed countries comes a gradual transition from quantitative-based competitiveness to qualitative-based, sustainable growth performance, which requires investment in capital and work. This leads to an increase in the productivity of the factors of production and consequently in the prices of the outputs sold, a rise in wages, which increases the income and living standards of the population. Not only is the economic level improving, but the price level is also rising, owing to both nominal appreciation of the domestic currency if compared to other developing country. There is a loss in price competitiveness caused by the price level increases. Reasons set out, the higher product price due to better quality and increased value-added. All this leads then to strengthens in non- price competitiveness. Desirably, the increasing non-price competitiveness is higher than the loss in price competitiveness. There is also a change in structure of product the country produces, which means that higher price is not the higher price of low developed product produced in the past, but high price of every developer and competitive product which is produced and exported now.

Another explanation is the Balass-Samuelson effect of wage contagion, which distinguishes between marketable and non-marketable goods in the economy. In the tradable sector, the growth in labour productivity compensates higher wages and values of tradable goods are stable. However, this leads to wage increases in the non-marketable sector with slower rising labour productivity, and prices of non-marketable goods are higher, e.g. the public sector raises wages to keep its employees. Also, it is necessary to add that non-tradable goods and services are consumed more that in the past as the qualitative level of the country is rising and people become richer and can buy more of these non-necessary products (Gunther McGrath, 2013).

Developed countries have a qualitatively based competitive advantage due to more advanced

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help to form the product uniqueness and imperfect substitutes. Both mentioned attributes are the primary requirement to maintain the company´s competitive advantage. The low level of the knowledge base causes the most substantial obstacle to competitive advantage increase in the Least developed countries. But these countries have an opportunity for technological catch-up based on technology takeover from developed countries, which depends on their absorption capabilities. The technological transfer takes place mainly through imports of physical capital, likewise lows of foreign direct investment. While it is true that the inflow of foreign direct investment is only an inflow of investment from a financial point of view, it must be realized that it forms the cornerstone for future technological transfers, e.g. the purchase of a domestic firm by foreign investors is often followed by the arrival of quality human or other physical capital. As a problem, knowledge-intensive segments are very rarely transmitted (Gunther McGrath, 2013).

1.2 Macroeconomic concept of competitiveness

In today’s globalized world, the importance of competitiveness at the macro-economic level, or the national or country level, cannot be ignored. That is a relatively new theme that has come to the forefront of the world economy over the last three decades. Many scientists have studied the national competitiveness of the economy. The first approach is external competitiveness, which looks at macroeconomic competitiveness through an export performance where a country becomes more or less competitive when its ability to sell on foreign markets improves or deteriorates due to price-cost factors (Balassa, 1965). Another indicator is ToT (Terms of Trade), which is a ratio of export and import prices of goods and services. Simple measurability is also an advantage by using the performance balance, comparative advantage indices etc. However, the lack of such an approach is that individual economies have different importance of foreign trade to aggregate demand, e.g. the US, which as a relatively closed economy, has the satisfying domestic market, and thus may not have an excess performance balance.

Many other authors stress the importance of exports to national competitiveness. Klemetti (1989) argues that national competitiveness is possible to define as the ability to compete in foreign trade, which helps sustain economic growth and employment rates. In other words, an increase in living standards is possible to achieve through a rise in gross output, which requires an increase in exports. For example, this strategy was part of the Chinese economic

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policy, but in a meanwhile they are reversing this policy to more domestic consumption.

Figueroa (1998) understands a country's competitiveness as gaining and maintaining market share in international markets. According to Fleming-Tsiang theory, a country's competitiveness will improve if global export markets increase compared to other countries (Tsiang, Fleming, 1956). Also, in this term it is possible to mention the concept of Revealed comparative advantage (RCA). It is based on the assumption that “patterns of trade among countries are governed by their relative differences in productivity. Although such productivity differences are difficult to observe, an RCA metric can be readily calculated using trade data to "reveal" such differences. While the metric can be used to provide a general indication and first approximation of a country's competitive export strengths, it should be noted that applied national measures which affect competitiveness such as tariffs, non-tariff measures, subsidies and others are not taken into account in the RCA metric”

(Uncstad, 2020).

National competitiveness cannot be based solely on export performance, however, there are other factors, such as microeconomic decision-making, other economic structures belonging to neither micro – nor macro-economic, and political-economic interests. Today, therefore, the so-called aggregate concept of macroeconomic competitiveness prevails, with stress on increasing the income of the population rather than just export performance. However, this must not be achieved at the expense of unsustainable rising private or public sector debt. A country with a high standard of living, determined by high productivity, can be considered a competitive economy, and it is its continued growth that is necessary to achieve favourable results from macroeconomic indicators such as GDP growth, employment etc. This approach is generally close to external competitiveness because today, practically all economies are open, and the external sector is a standard part of their overall supply and demand.

According to Porter (1990), the company´s microeconomic competitive advantages and the industrial sector, in international comparison, are transferred to the macroeconomic level. It is the productivity of an economy that determines a country's standard of living because only that allows high wages, a strong currency, and a satisfactory return on capital. Dollar and Wolff (1993, p. 227) see a country as competitive if it is successful in international trade because of better technology and quality while maintaining high incomes and wages.

According to their theory, countries with low incomes or cheap labour to be considered uncompetitive, even though their businesses can successfully trade on the international

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development, i.e. a country with cheap labour and low wages cannot suddenly jump to a group of countries with high earnings and incomes. Hence, it is suitable to regard as competitive such countries that are not only able to maintain high incomes and wages but are also able to increase the pensions of their populations.

Corden (1994, p. 323) argues the ability to increase productivity, and maintain the rate of increase in employment, express a country´s competitiveness. A prerequisite for achieving high competitiveness is profitability, which cannot be easily defined or measured. Since each country has specific capital requirements, it is not possible to compare capital investment profits of different countries, indeed. The term 'capital requirements' means primarily the conditions for foreign investors to enter the market, including the profitability of individual areas in the country. When evaluating investment opportunities, each investor considers barriers to entry into the equity market, the conditions for income taxation in a given country and the return on investment.

Another interpretation of competitiveness at a national level, considered the most systematic, is the definition given by Trabold (1995), which highlights the following key features:

• ability to sell (exportability),

• ability to attract,

• ability to adapt,

• ability to make money.

The ability to sell (exportability) expresses whether a country has improved or deteriorated in its export performance domestically or abroad. The ability to attract is due to the likelihood of attracting investment in the form of financial or physical capital, where the most important requirement is a high level of profitability and a business environment. Another significant factor is the capacity to adapt not only to the political proceeding but also to a change in the economic system as a whole, i.e. it depends on the economic environment of the country.

Knowledge links both the lower and upper ranks. The ability to affect region competitiveness thus depends on the ability to acquire and manage the knowledge base. Earning capacity is a general indicator of national competitiveness and views other competences more as factors.

In another perspective, earning ability can be seen as the main objective of competitiveness

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because it raises a country's standard of living and uses GDP per capita as the elementary indicator to measure it (Trabold, 1995).

Garelli (1997, 2006) says that the GDP indicator, and its adjusted form in purchasing power parity, as well, is not an appropriate indicator to explain national competitiveness because GDP and its sub-components are not only a consequence of national competitiveness but can also be the cause of it. If a country has a competitive advantage in a particular area, which makes it able to produce products with higher added-value, this contributes to an increase in the income of the population and results in high GDP. Rich economy countries with a high standard of living have, for example, better education systems and better economic conditions that can lead to new competitive advantages, and thus high GDP can be a cause of competitiveness. Moreover, GDP does not include the primary income balance which captures profits from domestic production factors abroad, or costs from the foreign production factor in the domestic economy. It further estimates the size of the black or shadow economy and the added value generated by households during fulfilling household chores. Another fact is that part of the income comes from non-renewable natural resources, and part of the earnings is from past accumulated assets. Also, which is very important, GDP does not include the very important factor as the impact of production on nature, effect of air and water pollution.

The aim of national competitiveness is thus undoubtedly to maintain or raise a country's standard of living, which is determined primarily by its high productivity. One of the key factors is the economic factor, i.e. the ability to earn, to raise incomes or pensions of residents or to keep them high, but this must not be achieved at the expense of unsustainable rising private or public sector debt. In other words, i. e. the capability of the country to create an economic environment that promotes the creation of high added values. However, it is necessary to take into account not only economic factors, but also social aspects such as freedom of choice, health and life expectancy, education, and choice. It is not surprising that quality education contributes to high productivity, and that openness or tolerance to different views and cultures contributes to innovativeness, research and development. Garelli (2006) highlights the same he argues that competitiveness is not limited to productivity or profit because a country cannot prosper in the long term unless it uses its wealth to provide adequate health and education infrastructure to its citizens. This broader theory seems to be growing in importance in today's civilized world, where the goal of any democratic state is

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measure it but suffers from a lack of objectivity by including qualitative factors (Krugman, 1994). When assessing competitiveness, it is significant to note that this is a relative expression of a competitive advantage over other countries or groups of countries.

1.3 Theory of absolute and comparative advantages within international trade

Absolute advantage and comparative advantage are concepts based on the technological superiority of one country over another. According to Adam Smith (1776), Absolute advantage means higher productivity or lower costs for one country than for another.

However, the absolute disadvantage of one country does not necessarily pose a worse position in international trade. David Ricardo's comparative advantage (1817) means that a country only needs to have a relative advantage over another country or higher relative productivity.

Technological differences in the two countries are the essential source of the movement of goods across national borders. This a dynamic view, so the advantage can change over time, for example, because of business practices and government policies. It deals with capital employed and education system. Highly industrialized countries have more capital sources and special technologies in production like machines and software (Satya Dev Gupta, 2015).

A man or a country has a comparative advantage in an activity in which he or it is better than in other activities. In the context of international cooperation, even if the overall production of certain goods is moving to ‘worse’ conditions, regardless, it can lead to improvement.

Satya Dev Gupta (2015) states in his report that there are several reasons why a country may have an advantage when exporting goods to another country. The main ones are technological superiority (already mentioned above in terms of absolute and comparative advantage), resource availability, demand model and trade policy.

Within the framework of resource availability, we are talking about a situation where a country does not have an advantage in technological maturity but can profit from the fact that it has the most natural resources. The state has a comparative advantage in that goods, for which production it uses relatively abundantly available resources in that country (Heckscher, 1919; Ohlin, 1933). For example, to make furniture, it takes a lot of wood. A country with the largest forest area on its territory will have a comparative advantage over

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other countries. Countries with large amounts of human or knowledge capital will have a similar convenience (Satya Dev Gupta, 2015). As well, countries, which are producers of crude oil and gas and export this commodity to other countries, have also great competitive advantages.

In his essay, Linder (1961) explores the effect of demand within a country on comparative advantage. His work proves that high demand for certain goods in a determinate country leads, by specialization in production, to gradually improving technology, technological processes and production. Therefore, the average quality of demand will consist of different quality grades of various products. The country gains a comparative advantage over a country where demand is not so high.

The final reason for the comparative advantages (and disadvantages) Satya Dev Gupta (2015) presents the national policy. Industrial policies such as production subsidies, tax preferences, antitrust policies are often applied to gain an advantage over another state.

Fiscal policy measures usually aim to favour domestic products and services at the cost of undermining import options. International agreements have a clear positive impact on the promotion of international trade. The World Trade Organisation (WTO) said: Since the General Agreement on Tariffs and Trade began in Geneva in 1948, world trade in goods has increased 16-fold and should increase 22-fold by 1998. Trade is now growing about three times faster than the production of goods. Global exports of goods and services are currently worth more than $6 trillion (WTO, 1998, p. 1). Support of reducing regional disparities states that reducing regional disparities, promoting small and medium-sized enterprises and also fostering development and research, all these factors pose suitable prerequisites for labor productivity growth and economic competitiveness.

It is also necessary to mention Exchange rate policy in terms of comparative advantages.

Exchange rate of the country plays a very significant role in the competitiveness of the national production. For example, China had policy of undervaluation of Chinese Yuan, which meant de facto higher competitiveness of Chinese products on the World’s market and this led to the increase of demand on Chinese production and services.

The term „comparative advantage“ is accompanied by another one, namely “competitive advantage”. Neary (2003) seeks to explain the difference between these terms and views comparative advantage as the substantial determinant of international trade. Competitive

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production, but it involves a convenience to the whole country. Therefore, considered as an advantage of the sum of the country's companies, which, through lower obstacles to market entry, has better initial conditions, thereby stimulating entrepreneurship, increasing firms, which provides, in total, an advantage over foreign competition (Neary, 2003).

Another view of competitive advantage brings Porter (1990), the theory bases on a case study to identify factors that encourage national firms to achieve a high share of world markets in their industries. Porter (1990) states that national prosperity is not inherited, and does not derive from its labour fund, interest rates, or currency value. A country's competitiveness depends on its capacity to innovate. Companies gain an advantage over the best competitors in the world through pressure and challenge. They take advantage of strong domestic competitors, aggressive domestic suppliers and demanding local customers.

Differences in national values, culture, economic structures, institutions and history contribute to competitive success. There are significant differences in competitiveness patterns in each country; no nation can or will be competitive in all or even most industrial sectors. Finally, nations succeed in certain industries because their home environment is the most predictable, dynamic and challenging (Porter, 1990, p. 73).

The relationship between comparative advantage and competitive advantage displays Chart 1. The first part of the Chart 1 shows the elements influencing the country´s comparative advantage, namely, the already discussed amenities of physical capital, policies to promote international trade, technology and demand within the country. These all factors belong to the national level. By contrast, the competitive advantage factors based on Porter´s examination (1990) are company-specific factors, i.e. monitored at the microeconomic level.

First and foremost, there are resources that companies can benefit from comparative advantage and can convert them to their competitive advantage, supply – and demand-driven innovation strategies, and the business environment in the economy. Strengths within comparative and competitive advantage are subsequently mutually reinforcing and are the basis for national conveniences in international trade.

1.4 Theory of the Real Value Added on a country level

The value-added of an industry or named as gross domestic product GDB-by – industry, as well, means the benefit of the private sector or government measures to overall GDP. Value- added is dwelled by the following factors, compensation of employees, taxes on production,

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imports fewer grants, and gross operating excess. The value-added calculation presents the difference between an industry’s gross output (i.e. encompassing revenue or incomes and other operational results, commodity taxes, and inventory change), and the cost of its intermediate inputs (here belongs, for instance, energy, unprocessed materials, semi- processed goods, and services obtained from all sources) (BEA.gov, 2020).

According to the World bank (2021) “industry attributes to ISIC divisions 10-45 and includes the work (ISIC divisions 15-37). It refers to value added in mining, manufacturing (also reported as a separate subgroup), construction, electricity, water, and gas”. Value added is the net output of a sector after counting up all the production of goods and services nationwide in a determined period (i. e. outputs) and deducting intermediate inputs. Into its calculation do not enter deductions for depreciation of fabricated assets or depletion, and degradation of natural resources. The origin of value added is regulated by the International Standard Industrial Classification (ISIC), revision 3 or 4.

By preference, standard accounting and financial report analysis of companies should determine the industrial output. However, in most developing countries such company overview is rare, so original financial report results must be deduced by using a suitable indicator. The choice of element sampling, which may be the company (where responses may be based on financial records) or the organization (where production units may be recorded separately), also influences the data quality. Furthermore, much industrial production is structured in unincorporated or owner-operated ventures that are not subsumed by reviews target at the formal sector. Even, in large branches of industries, where ordinary reviews are more commonly, evasion of excise and other taxes, and making a secret of income reduce the value-added appraises. Such problems become more intense as countries move from state control of industry to private business because new firms and growing numbers of established firms fail to report. According to the System of National Accounts, the output should cover all such unreported activity together with the rate of illegal activities and other undeclared, unofficial, or not so usual operations. Data on these activities need to be composed using techniques other than traditional reviews of companies.

Gross domestic product (GDP) determines the sum of value in which all its producers participate. Value-added means, the volume of the gross production, except the value of intermediate goods and services used for production, without calculating the fixed

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on products) or output prices (involving net taxes on products paid by production companies but besides sales or value-added taxes). Both terms exclude transport cost, accounted especially by producers, independently in the invoice. Purchaser prices determine GDP.

OECD (2001) defines that “value added at basic prices is calculated from the production value plus subsidies on products less the purchases of goods and services (other than those purchased for resale in the same condition) plus or minus the change in stocks of raw materials and consumables less other taxes on products which are linked to turnover but not deductible. It represents the value added by the various factor inputs in the operating activities of the unit concerned”.

1.5 Terms of trade as a competitiveness measure

According to OECD (2021), “terms of trade are defined as the ratio between the index of export prices and the index of import prices. If the export prices increase more than the import prices, a country has a positive term of trade, as for the same number of exports, it can purchase more imports”.

Terms of trade (ToT) are used in international comparison for the effect of foreign trade on the domestic economy. In essence, it is the development of the ratio of export and import prices, i.e. the ratio of price indices. The countries must strive to improve this indicator. As long as the price for imported goods is lower than the price for export goods, people in the state can afford to buy more goods and are at a relative advantage. This means that their terms of trade are better. When the prices of import goods are higher than the prices of domestic goods and export prices, the terms of trade are worsened.

In mathematical form, according to export and import prices, the formula of terms of trade looks like this:

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The ITT shows the terms of trade index, the Iex export price index and the Iim import price index. The importance of terms of trade in macroeconomics is their development, trend and real national economic impacts (Economicsonline.co.uk, 2020). If the index of terms of trade

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acquires positive values, or exceeds the value of 100, the growth rate of export prices increases compared to the growth rate of import prices, and these are positive terms of trade and vice versa. It is possible to calculate the index by the inverse ratio, when it is necessary to take into account that values that exceed the value of 100 tend to worsen the terms of trade.

Over time, the terms of trade have changed and adjusted, shaping their names as well as formulas for calculations. Therefore, there are many different concepts used, both in foreign trade and for cross-sectoral comparisons of given economies. The most frequently used indicators of terms of trade include commodity, factor, income, gross barter and territorial terms of trade.

Factor terms of trade

In addition to the development of prices in foreign trade, this type also takes into account the development of productivity. For example, if the terms of trade deteriorate due to falling export prices, this does not necessarily mean a reduction in available resources. At the same time, the benefits of increased productivity in the domestic country are shared by foreign countries, because part of the production goes to them. In the domestic economy, however, consumption is growing. These terms of trade can be further divided into one-factor and two-factor.

The method of calculating the index of a one-factor terms of trade (Itt, f) can be expressed using the following formula (Economicsconcepts.com, 2020):

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where Iex stands for export price index, Iim stands for import price index, fex stands for productivity development index in export industries. The difference between the productivity index and the commodity terms of trade index is actually obtained by foreign countries.

For the calculation of two-factor terms of trade, it is difficult to obtain the necessary data and their economic interpretation is often complex. Two-factor terms of trade use

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commodities to express the exchange rate between the service of the factor of production per unit time in a given country and the service of the factor of production in another country.

Income terms of trade

This indicator is obtained by adjusting commodity terms of trade for the physical volume of exports. It is based on the assumption that an increase in the relative price of exports leading to an improvement in commodity terms of trade may mean a reduction in export demand in a given country. A decline in total exports may lead to a reduction in the country's import capacity. The formula for calculating the income exchange rate index (Itt, d) is the following (Economicsconcepts.com, 2020):

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where Iex stands for the export price index, Iim stands for the import price index, Qex stands for the index of the physical volume of exports.

Gross barter terms of trade

If the ratio of the physical quantity of imports of one commodity to the physical quantity of exports of another commodity is given, it is an indicator of the gross barter terms of trade.

They are used mainly when exchanging goods for goods. If the value of exports is equal to the value of imports, the index of these relations can be calculated according to the following formula:

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where Itt, GB denotes the index of the gross barter terms of trade, Qim the physical volume of imports, Qex the physical volume of exports. The higher the value of the index, the more advantageous the exchange is for the given economy, because for its export of a given commodity it obtains a larger quantity of imports of another commodity.

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Territorial terms of trade

If the ratio of commodity terms of trade achieved in relation to selected countries is compared with the relations achieved on the basic market, these are territorial terms of trade.

The main market for a given economy is chosen as the basic market, which is determined, for example, by the size of foreign trade turnover. If the values of the index of territorial terms of trade are greater than 100, then the country imported a larger physical volume of goods the same physical volume of exports due to the fact that prices in the foreign trade of the economy differed from basic market prices in trade with selected countries.

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2 Measuring country's competitiveness through macroeconomic factors

For a short time, the development of price-cost indicators plays a key role, where lower costs come to light at lower prices. Thus, it is possible to maintain or strengthen the external competitiveness of the country of interest. However, to its full extent, the country’s competitiveness aims to raise living standards and public well-being in general. The achieving of much wealth by way of higher incomes or wages is an essential part of socio- economic factors. Wage growth increases costs and thus prices, which negatively affect the cost-cost sources of the competitive advantage of the monitored country, if they are not accompanied by growth in labor productivity. Indicators include price developments, unit labor costs, labor productivity and the real exchange rate. Labor productivity are measured by total gross value divided by population of the country.

2.1 Price indicators

Monitoring of price development is one of the basic indicators of macroeconomic analysis when examining national competitiveness in individual countries. However, the problem is often in choosing the right price index. It is not appropriate to use the Consumer Price Index (CPI), which contains only final products in the form of consumer goods. Firstly, goods can be imported and secondly, in today's globalized world, the importance of added value or semi-finished products is growing. Another disadvantage that reduces its explanatory power is the influence of taxes and traders' margins. The GDP deflator has the advantage over the CPI of covering the whole economy. The main disadvantage of both indicators is that they include both tradeable and non-tradeable goods. However, the question is how exactly to understand the division of the internationally tradable and non-tradable sectors, because the prices of non-tradable goods affect the costs of producers producing tradable goods (Corporate Finance Institute, 2020).

Another indicator used is the Producer Price Index (PPI). It is a cost index that captures the development of the price of inputs in a given sector. More precisely, these are the prices of the outputs of a certain sector, which are used as inputs for other sectors, or for the industry

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itself. Its specification by sector makes it possible to monitor individual sectors, where there is main interest in industries that create internationally tradable products. This is because even semi-finished products are now internationally traded. It also makes it possible to monitor price developments in the agricultural sector, especially for countries that focus on agricultural products (IMF, 2004).

It is considered more appropriate to use the foreign trade index (𝐼𝑇𝑇), which is defined by the ratio of the export price index (𝑃𝐸𝑋) to the import price index (𝑃𝐼𝑀). This is an important indicator reflecting the structure of foreign trade and its efficiency (IMF, 2004).

𝑃𝐸𝑋

𝐼𝑇𝑇 = (5) 𝑃𝐼𝑀

The index may deteriorate (i.e., fall) in the inflationary period, when foreign import prices rise faster than foreign export prices. Inflation, especially if the domestic price level rises faster than abroad, can lead to, or cause a nominal depreciation of the domestic currency - making imports more expensive and disadvantaging domestic exporters. The deterioration of this indicator means that a given country must cover the same volume of real imports with a larger volume of real exports. The negative income effect leading to a decrease in real gross disposable income, which ultimately reduces consumption and the living standards of the population in the monitored economy, cannot be neglected either.

2.2 Wages and income measurement of competitiveness

Another factor needed to analyze while describing country’s competitiveness, are wages and population income. There is an indicator of real gross disposable income and the real wage indicator that show the living level in the country.

Real gross disposable income consists of gross domestic product (𝐺𝐷𝑃), which is adjusted for the income effect of changes in foreign terms of trade (𝑇𝑇), the balance of primary income (𝐵𝑃𝐼) and the balance of secondary income (𝐵𝑆𝐼). The balance of primary incomes records payments of income from domestic factors of production abroad, or expenditures

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income records cash and non-cash current transfers between residents and non-residents (Worldbank, 2021).

Transition economies are characterized by the fact that the higher rate of investment compared to the rate of savings is satisfied by the inflow of not only foreign direct investment, but all forms of capital (foreign savings), which causes a deficit in the balance of primary incomes, i.e. that the profits or income from investments will not remain in the domestic economy, but flow to foreign investors. The favorable development of foreign terms of trade (faster growth of export prices) leads to a positive income effect increasing the income of entities in the domestic economy and contributes to improving the living standards of the population. An increase in export prices occurs when a given economy produces final products or semi-finished products with greater added value due to significant scientific and technical progress or improvements in other quality features. The branding also has a positive effect on foreign terms of trade, where economic entities with a high brand value contribute significantly to higher export prices, thanks to their reputation under the assumption of high quality or uniqueness. However, it is essential that the owners of the increased added value or branding are domestic entities. It is the creation of desirable institutional conditions for business and support in suitable non-economic areas (eg education) that can be considered key for the country's transition to a phase of expanding advanced economy (Mandel, 2008).

The main barrier for post-transitional economies is therefore the lack or non-existence of a global brand, or the absence of a socio-economic environment supporting its emergence and development. Post – transitional economies are able to work as a supplier of final products for major global brands, or intermediates, but do not own these brands. This will cause the vast majority of income to go to foreign owners of these brands or added value. If the improvement in the external terms of trade and its favorable income effect outweigh the negative impact of the primary income deficit, then this leads to an increase in real gross disposable income. It is therefore a key factor for a capital-importing country to become a capital-exporting country, leading to a shift from a negative primary income balance to a positive balance, and consequently to a further increase in domestic income and an improvement in the country's standard of living (MDPI, 2019).

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The other indicator is the real wage indicator. This definition refers to the salary expressed in respect of subsistence and the services from which the worker is paid. It indicates the amount of consumer goods that the worker is able to obtain, as well as the services that the worker can buy for his nominal wage (which is measured in the amount of money that the worker receives). The value of the real wage depends on several aspects, for example, on the size of the nominal wage, the price level that corresponds to consumer items and the level of service prices, on the tax level and burdens on the wages of the employees.

2.3 Unit labor costs

The main sources of competitiveness include the productivity of a given economy, which is measured by the value of goods and services per unit of inputs. Productivity, as one of the factors of economic value added, expresses the efficiency and effectiveness with which production factors are used in production. Productivity of production factors is divided into labor productivity and capital productivity.

2.3.1 Labor productivity

The indicator represents the effectiveness of the work factor over time in the production of a given output. Paradoxically, labor productivity only partially reflects the personal capacities of workers. This distortion is caused by changes in capital employed, intermediate goods, technical and organizational changes, returns to scale, utilization, and, last but not least, erroneous measurements. In general, the relationship for calculating labor productivity can be written in two ways. The first relates the amount of work involved to the gross output.

𝐿𝑎𝑏𝑜𝑟 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 =gross output index

labor input index (6),

The second equation works with added value:

𝐿𝑎𝑏𝑜𝑟 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑣𝑖𝑡𝑦 =𝑣𝑎𝑙𝑢𝑒 𝑎𝑑𝑑𝑒𝑑 𝑖𝑛𝑑𝑒𝑥

labor input index (7)

Where Gross output index means “a measure of an industry's sales or receipts, which can include sales to final users in the economy (GDP) or sales to other industries (intermediate

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Labor input index is measured as “either the number of workers employed or the number of hours they worked during a given time period“. (BLS.gov, 2020)

The disadvantage of calculation (6) is the fact that it includes intermediates. If the company is able to outsource in the production process, resp. to replace the unit of labor by intermediate products, labor productivity increases artificially. Thus, productivity growth also depends on how the ratio of labor involved to intermediate products changes. The calculation (6) therefore examines how many units of labor are needed to produce a certain physical output. These data can be used in the analysis of labor intensity of production in the company or industry (OECD, 2001).

The second calculation (7) replaces gross output with value added. Labor productivity measured in this way is less prone to change in the ratio of labor involved and intermediate products. If a company replaces a unit of labor with intermediate products, labor productivity increases, but at the same time the value-added index decreases. The resulting effect of intermediates on the examined labor productivity is therefore smaller, ideally none. Value- added productivity can be linked to economic growth at national level. It can provide economists with information on which industry is most contributing to this growth.

Productivity calculated in this way is also important from the point of view of fiscal policy, especially when negotiating wages (OECD, 2001).

The advantage of both calculations (6) and (7) is their simplicity and easy economic interpretation. The disadvantages are the various factors already mentioned (capital, organizational structure, etc.), which enter into the calculation and distort the resulting productivity indicator. In practice, this means that two manufacturers may show different labor productivity, even if they have the same production technology. The difference in productivity may arise, for example, from one of the producers using capital more intensively, due to the different prices of this factor of production between producers (Syverson, 2011).

2.3.2 Capital productivity

The productivity of capital represents the efficiency by which capital is used in generating physical output over a period of time. This concept must be distinguished from the term rate of return on capital. The latter represents a ratio that measures the profitability of invested capital. It is therefore primarily the company's or country’s efficiency in generating profit.

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As with the labor factor, capital productivity can be calculated in two basic ways. The first calculation (8) contains in the numerator the amount of gross output.

𝐺𝑟𝑜𝑠𝑠 𝑜𝑢𝑡𝑝𝑢𝑡 𝑖𝑛𝑑𝑒𝑥

𝑇𝑜𝑡𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑚𝑝𝑙𝑜𝑦𝑒𝑑 (8)

The second calculation (9) of the amount of capital involved relates to value added. The already mentioned advantages and disadvantages associated with the method of added value and gross output apply. Even in this case, the productivity of capital calculated on the basis of value added is less sensitive to the substitution of capital by intermediate products.

𝑉𝑎𝑙𝑢𝑒 𝑎𝑑𝑑𝑒𝑑 𝑖𝑛𝑑𝑒𝑥

𝑇𝑜𝑡𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑚𝑝𝑙𝑜𝑦𝑒𝑑 (9)

Capital productivity increases when gross output growth is associated with declining price of capital. The same conclusions apply as for labor productivity. When calculating, it is not possible to abstract from influences such as economies of scale, technical changes, deviations or measurement errors that may affect the development of the indicator. In the case of technological progress, capital quality increases, which is reflected in better quality capital services. If better capital goods are able to provide more capital services, then, with the same rate of output growth, they imply a reduction in capital productivity (OECD, 2001).

This can only happen if new and technologically better capital is not used efficiently in production.

From an economic point of view, capital productivity can capture changes, for example, in the form of output growth, which can be achieved at a lower price of capital than in the case of its alternative use.

2.3.3 Unit labor costs

The most commonly used indicator to monitor the source of competitiveness is unit labor costs (ULC), which are linked to labor costs and labor productivity. Unit capital costs (UCC) can be monitored on the same principle.

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Accoring to the OECD, the “unit labour costs are often viewed as broad mesures of (international) price competitivness. They are defined as the average cost of labour per unit of output produced. They can be expressed as the ratio of total labour compensation per hour worked to outpu per hour worked”. (OECD, 2021)

The compensations that are paid to workers can include both wages and benefits, such as retierment contributions or health insurance.

Basically, the increase in hourly compensation tend to increase unit labour costs. On the other hand, increases in output per hour worked tend to reduce the ULC.

The ULC can be calculated by using these two following formulas.

𝑈𝐿𝐶 =𝐶𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑜𝑛

𝑂𝑢𝑡𝑝𝑢𝑡 𝑜𝑟 𝑈𝐿𝐶 =

𝐶𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑜𝑛

⁄𝐻𝑜𝑢𝑟 𝑂𝑢𝑡𝑝𝑢𝑡

⁄𝐻𝑜𝑢𝑟 (10) (11)

Final result can also be written in two possible forms, which are per integers or integers relative to time period (hourly labour cost).

In nominal terms, unit labor costs are the ratio between the nominal average wage (𝑤𝑛) and average labor productivity (𝐴𝐿𝑃). Average labor productivity is defined as the ratio of value added in real terms (𝑉𝐴𝑟) and number of employees (𝐿). Value added in real terms is the ratio between its nominal expression (𝑉𝐴𝑛) and the price index (𝑃). Nominal GDP (𝐻𝐷𝑃𝑛) is the sum of value added in nominal terms over a period. Growth 𝑈𝐿𝐶𝑛 means that the monitored country loses its price competitiveness through faster growth of nominal wages than labor productivity. The decline in value added or GDP ceteris paribus is pushing for growth 𝑈𝐿𝐶𝑛. Another case leading to a loss of price competitiveness is a situation where nominal wages and employment are growing faster than value added. It is clear that a country with high labor costs can be competitive with countries with low labor costs if it has a favorable relationship between labor costs and labor productivity and between the exchange rate of the compared countries.

In real terms, unit labor costs are a ratio of 𝑈𝐿𝐶𝑛 to price index. This is the share of wages in the generated income, the rest of which is the remuneration to the owners of capital. This indicator has nothing to do with the examination of competitiveness and only shows the distribution of income between workers (employees) and owners. As a result of faster

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growth of real wages than labor productivity, the business may be closed by the owner due to declining profitability, resp. default of the firm, and not a loss of price competitiveness.

Real ULC can also influence foreign capital inflow that does not see profit opportunity investing in the country that distributes too much to employees.

However, empirical observations from Kaldor (1978) confirm another fact. The strongest economic growth after World War II had the countries with the highest growth in unit labor costs, i.e. that economies with higher growth in unit labor costs gained a higher market share (the so-called Kaldor paradox). A decrease in price competitiveness by growth 𝑈𝐿𝐶𝑛 may not lead to a decrease in overall competitiveness. Kaldor's paradox can be explained as a situation where technological and production capacity exceeds the importance of prices. But this is the situation about the change of the structure of the economy, which is more oriented on services than on production. But at the same time, Kaldor paradox does not take into account if ULS increase is safe for the economy and if it does not cause huge indebtedness of the companies in the economy (Fagerberg, 2004).

2.4 Real Exchange rate

According to the relative version of the purchasing power parity theory, the appreciation of the real exchange rate leads to a loss of international competitiveness of domestic exporters.

The reason for real appreciation may be the nominal appreciation of the exchange rate or a faster growth of the domestic price level than the foreign one. However, real appreciation can also be a consequence of growth in labor productivity and quality of domestic production, and therefore it is appropriate to first determine the equilibrium appreciation trend of the real exchange rate and then monitor the appreciation deviations of the real exchange rate from this equilibrium trend.

As well as it was in the case of wages, exchange rate has also two forms in which can be expressed – nominal and real, and it is very important to diferentiate between them.

The real exchange rate (R) is defined as ratio of the price level abroad and the domestic price level, where the foreign price level is converted into domestic currency units via the current

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𝑅 = ^𝐸.𝑃∗

𝑃 , (12)

where P* is the foreign price level, and the domestic price level is denoted as P and E represents the nominal expression of exchange rate (CNB, 2021). Decrease in R means appreciation of the real exchange rate, whereas an increase expresses depreciation.

2.5 Indicators on the basis of payment balance

The payment balance of the country shows economic transactions between the domestic and foreign economies. It is about providing basic information on external relations from a flow point of view, while the country's investment position abroad provides information from a stock point of view. The development of the balance of payments affects key macroeconomic variables but is also influenced by them.

For example, GDP, employment, level of prices of goods and services, interest rates and exchange rates. When examining business performance, it does not make sense to monitor the overall balance of payments, but its individual accounts, especially the cumulative current account balance and sub-balances. These balances are problematic in that they are far too general and fail to reveal various structural factors affecting a country's competitiveness. For example, a stable or balanced net export may be due to growing exports of products with high added value requiring high scientific and technical complexity and growing imports of products with lower qualification and technological intensity.

Another important indicator is rate of increase / decrease of export / import. Countries that lost competitiveness are those where the rate of increase of the export is lower than the rate of increase of the import (in the long run).

Exports also depend on the size of foreign demand for the production of the domestic economy. This depends on the size of the income of the demanding economy and the relative price of foreign goods to the domestic price. This brings us to another important determinant of the development of foreign trade, which is the exchange rate. Most countries strive to keep the domestic currency as weak as possible. The reason is the effort to increase the country's competitiveness, improve the trade balance and replenish foreign exchange reserves. In general, therefore, there is an effort to reduce the domestic interest rate. These interventions in the currency market were also introduced, inter alia, to support domestic exporters. It is often the exporting companies that have a strong influence on the government

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in this regard. However, the importance of a weakening of the domestic currency loses its meaning if countries compete with each other precisely by deliberately weakening their currencies to support their exports. This situation is often referred to as currency war, or competitive devaluation.

National competitiveness is the degree of a nation's ability to produce goods and services that stand the test of the international market, while increasing the real incomes of its citizens in free and fair market conditions. International competitiveness is most often measurable using the real effective exchange rate (REER), which is based on a comparison of the domestic and foreign price levels expressed in one currency. Therefore, if the domestic price level grows more slowly than the foreign one, the country's price competitiveness increases for the NEER remaining the same.

𝑅𝐸𝐸𝑅 =^{𝑁𝐸𝐸𝑅 ×𝑃}^𝑧

𝑃𝐷 (13)

REER – real effective exchange rate NEER – Nominal effective exchange rate Pz – price level of foreign countries Pd – domestic price level

The real effective exchange rate calculated in this way is a dimensionless number that indicates the number of consumer baskets that can be purchased in the domestic economy for a value corresponding to one consumer basket purchased in foreign economies. Smaller purchasing power of the domestic currency against foreign currencies is indicated by values greater than 1.

Another way to support the export of goods and services of domestic exporters is to influence the real effective exchange rate (REER), which was described above. REER can be affected either by a change in the domestic or foreign price level or by a change in the nominal exchange rate.

The importance of the financial market cannot be overlooked, especially in today's

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account must be monitored for its partial breakdown, especially foreign direct investment, which captures the acquisition of at least 10 % of the share capital (or voting rights) by buying shares or reinvesting profits, but also long-term loans from the parent company to its subsidiaries or foreign branches. For transition economies, it is important that the current account deficit, which may be due to a performance deficit or a primary income deficit, be financed by non-debt capital inflows. This just motivates subjects in the economy to use factors of production more efficiently and realize potential economic growth.

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3 Synthetic competitiveness indicators

According to Loo (2012), “the most respected organizations dealing with the assessment of nation's competitiveness at the global level are the World Economic Forum (WEF) and the Institute for Management Development (IMD)”. Both institutions are from Switzerland – based institutions and use macro and microeconomic concepts¹ to study the efficiency of the public and private sector as well as the overall infrastructure that forms and affects national competitiveness.

The Organization for Economic Co-operation and Development (OECD) can be cited as another organization that provides indicators for assessing countries' competitiveness.

Many empirical studies analyze countries' global competitiveness based on international and reputable indexes. Another group of authors compares the competitiveness of countries as measured by the Global Competitiveness Index (GCI) and World Competitiveness Rankings (WCR) scores and their positions in the world ranking. As reported by Loo (2012), the WEF’s Global Competitiveness Report (GCR) releases the annual Global Competitiveness Index (GCI) that awards a rank to each of the 12 pillars and culminating in the rank of the nation. The IMD’s World Competitiveness Yearbook (WCY) releases the annual rankings of nations based on four key measurements. As a distinction between these two annual reports, Loo sums up the fact that the WEF focuses on the role of government in ensuring the rising standard of living of its citizens, IMD proposes cooperation between governments and businesses to manage resources for sustainable progress (Loo, 2012).

The next chapter, it will deal precisely with the WEF's competitiveness measurements.

3.1 Methodology based on the principle of the World Economic Forum (WEF)

Not only macroeconomics and trade indicators have a significant role in competitiveness of the country. There are numbers of other soft and hard indicators that play a significant role in measuring the rating of the country in the World. That is why international organizations