The Competitiveness Gap: The True Cause of the Global Recession

Here most economists and policy makers continue to assert that the 2008 Great Recession was caused by the collapse of the housing bubble, and that budget belt tightening alone is the best medicine needed to revive a sluggish economy. However, as we showed in Innovation Economics: The Race for Global Advantage, the housing bubble was not the cause, it was the effect. For in the last decade, many western countries, including Britain, Greece, Ireland, Italy, Spain, and the United States, began to fall behind in global competitiveness, losing production and jobs to developing nations, like China and India. With companies losing markets and moving production overseas, the demand for real investment capital to build new factories, buy new machines, and power the creation of new ideas shrank. And rather than downsize in the face of reduced demand for their services, banks and other financial institutions gambled on risky mortgages, funneling money into the Ponzi scheme of housing.

Furthermore, these countries, including Great Britain, began to lose the engineering, product development and technological capacity that go with a strong industrial base. Of the ten major industrial nations, Britain and the United States lost a significantly greater share of their manufacturing jobs than other nations. In both countries, as well as in Italy and Spain, industrial production was actually lower at the end of 2010 than it was at the beginning of the decade.

Without vibrant and competitive global industries, national economies will wither, as we are seeing so clearly in Italy and Spain. In contrast, when countries are winning, or at least not losing innovation ground, investment is stable or growing, jobs are more plentiful, and real wages (and demand) are increasing. We see this in nations like Austria, Germany, and the Nordics which field a team of vibrant global competitors. The lesson should be clear to policymakers: It’s impossible to obtain robust economic growth without a vibrant and competitive traded sector (e.g., manufacturing, creative industries, software, etc.).

Fortunately, all is not doom and gloom, at least for Europe. Prime Minister Cameron’s potential reform package is one of several steps being taken to increase competitiveness on the continent. Many European nations, as well as the EU, are making new commitments to support research and development in order to spur the creation of new industries and the revitalization of existing ones. And many are expanding high tech tax incentives, as the U.K. has done in expanding its R&D tax credit and putting in place a new “patent box” incentive. And finally, many European nations have recently announced comprehensive innovation strategies that seek to enhance investment in high-tech industries, promote new product development, and develop a higher skilled work force.

In contrast, America remains stuck between 19th century laissez-faire advocates on the right and 20th century social democrats on the left, and has been unable to take these centrist, pragmatic steps.However, for Europe and the U.K. to thrive will require them to work in close cooperation with the United States and international institutions such as the World Bank and World Trade Organization to more vigorously fight what can be called a new “innovation mercantilism”—the practice by nations like Brazil, China, and India of putting in place a host of unfair and protectionist policies to gain advantage in the industry specialties of Europe and America.

Hopefully, Cameron’s call to action will serve as the spark needed to create not only robust action in Britain, but an international mandate for real reforms that can allow all nations to participate in the innovation economy.

Image credit: Wikimedia Commons User robertsharp