Eva Srejber: Competition and growth
Speech by Ms Eva Srejber, Second Deputy Governor of the Sveriges Riksbank, to the Swedish
Taxpayers Association, Stockholm, 21 September 2001.
* * *
According to the Sveriges Riksbank Act, the objective of monetary policy is to safeguard the value of
money. The Riksbank has specified this in its inflation target, i.e. that CPI inflation should amount to
2 per cent with a deviation interval of plus/minus one percentage point. This means that when we
formulate monetary policy, we must take into account changes in a number of areas that affect price
trends, either directly or indirectly. I thought that I would comment on one of these areas today, namely
competition, and its effects on potential growth. This is an area that we are forced to consider when we
analyse the economy, as it is essential to assess potential growth when shaping monetary policy.
However, before I begin, I should like to make the point that I will not be discussing the current
monetary policy situation.
Growth is a constant central feature of monetary policy discussions, as demand in the economy in
relation to production capacity is crucial for determining whether inflationary bottlenecks arise or
whether we will underutilise the production potential. It is sometimes claimed that maintaining price
stability limits growth. This is incorrect. The limits are determined by the potential growth rate. We
must take into account the potential growth rate, even if we do not influence this by means of
monetary policy once price stability has been established. Correspondingly, we must take into account
changes in conditions for competition, as such changes can influence inflationary trends both directly
and indirectly. Any measures taken to strengthen potential growth come under other economic policy
than monetary policy. Such measures can include avoiding limits to competition that would lead to a
poorer allocation of resources.
The Swedish economy was showing very favourable growth until last winter. Today, now that growth
has slowed down, it may be worthwhile to remember that it is from this starting point that growth was
subdued. We can put it even further into perspective by comparing with the situation in the beginning
of the 1990s. Conditions then were very difficult and characterised by rising unemployment, a high
inflation rate and poor public finances. The situation was so strained that the government turned to the
academic world for advice and a report from the Economics Commission was delivered in spring
1993.1
This report, which is usually referred to as the Lindbeck Commission, contained no less than
113 proposals - many of them were controversial, which stimulated the debate of the day. The
Lindbeck Commission took the view that the crisis was based on problems in three fundamental areas;
stability, efficiency and growth. The proposals were also grouped into measures to create stability,
measures to increase efficiency in resource utilisation and measures to increase growth in the
economy.
Price and budget stability has been attained
If one reads this report today, one is struck by how many of these proposals have actually been
implemented. When it comes to measures for attaining macroeconomic stability, most of them have
been implemented and Sweden has for several years enjoyed low inflation and sound public finances.
Progress has also been made in the field of wage formation. With regard to measures to increase
efficiency and potential growth, the result of a survey of which proposals have been implemented
gains more mixed results. Important changes have been made in some areas; while in others very
little has happened.
If we look at developments during the eight years that have passed since 1993, the results are
heartening. The average growth rate during this period has amounted to 3.1 per cent. This is very
different from the average growth rate of 1.8 per cent that prevailed during the previous ten years. If
developments since 1993 had been limited to this 1.8 per cent, we would currently have a GDP level
around SEK 174 billion lower than now, i.e. more than eight per cent lower, and the situation would
have looked radically different in most areas. Open unemployment would be twice as high if one
1
"New terms for economics and politics", proposals from the Economics Commission, SOU 1993:16.
utilises the "Okun relation" - at approximately 8 per cent rather than roughly 4 per cent. It is doubtful,
however whether the Okun relation is relevant over such a long period of time. The greatest part of the
difference would probably have resulted in lower real wages, i.e. our disposable incomes would have
been substantially lower. It is possible to make many calculations of this nature, all of which illustrate
how differences in the growth rate provide very strong effects over a number of years.
There is therefore good reason to discuss which factors have contributed to this favourable
development. It will probably not be possible to agree on a definitive answer, but I believe it is likely
that the structural reforms implemented even before 1993 (in particular the tax reform of 1990/91) and
the proposals by the Economics Commission that were implemented have all contributed.
A more efficient economy
One interesting condition is that total factor productivity really took off in 1993 and that it thereafter
developed more strongly than it had during the previous decades. Total factor productivity concerns
the quality of available resources and how efficiently we utilise them, and in this respect developments
show a marked improvement. From the mid-1980s up to 1993, there was in general terms no increase
at all in factor productivity, which means that the limited increase in productivity that arose was due to
investment, i.e. to an increase in capital intensity. From 1993 onwards, the relationship has been
reversed. We have had an impressive annual increase in factor productivity of per cent2, while capital
intensity has increased by a modest 0.1%.
The fact that this change began in the same year that the Economics Commission presented its
proposals is probably mainly coincidence, but the fact that a macroeconomic stabilisation has a rapid
and enduring effect on the development of productivity has been proved by the economist Easterly,
amongst others. That is to say, the combination of price and budget stability is an important
explanation of developments in total factor productivity. It is probably due to stable prices providing a
better information value in relative prices, which improves the allocation of resources. The combination
of price stability and budget stability also increases willingness in the household sector and corporate
sector to make long-term decisions.
If we consider other factors that stimulate the rise in total factor productivity, there are a number of
changes that play a central role. In general, one tends to seek explanations for increasing factor
productivity among factors such as technological developments, education, competence and
incentives among the labour force, allocation of resources in society, as well as between and within
branches and companies. There is therefore a large group of possible factors, but many of these are
connected to general incentives behind the transformation and to the capacity to utilise technological
progress in the world around us.
The allocation of resources in society includes an area where important changes were implemented
mainly before the days of the Lindbeck Commission. I am referring to the deregulation of the financial
markets and the development of these in recent years. A number of international studies indicate that
a deregulated and well-functioning financial market clearly stimulates the development of factor
productivity.
With regard to a more efficient use of the labour force, several changes have been implemented that
have probably stimulated development. These include reforms in the pension system, the tax system
and the social insurance system. The burden of taxation has been subdued and the economic return
on higher education has increased - in particular in technical education. In addition, wage formation
has been improved, which should have been facilitated by the monetary policy focus on price stability.
At the same time, the pressure on companies to use resources efficiently has increased during the
1990s. Tougher competitive pressure as a result of both increased internationalisation and
deregulation in a number of sectors has increased the need for companies to economise with scant
resources. Less wastefulness with resources means that labour force and capital are employed in
other areas, where they can better contribute to the national economy. The development of investment
is another factor that may have contributed, even if capital intensity has increased at a very slow rate.
One factor that has not contributed to a long-term improvement in resource allocation is the
development of the exchange rate. The devaluations in the 1970s and 1980s have been followed by a
floating exchange rate, but with an undervalued Swedish krona. The longer the krona remains
undervalued, the greater the risk of bad investments being made in domestic businesses. I do not
intend to go into these issues in greater detail here and now, but would nevertheless like to point out
that undesirable effects on business can arise through a misaligned currency giving flawed relative
prices. Companies may make decisions regarding investment and employment on the basis of these
relative prices. The foremost risk here is that too many resources will be drawn to the export sector
and to the import competition sector before there is a return to the equilibrium exchange rate and to
corresponding relative prices. At that point, the resources overinvested in these sectors will be
transferred to other sectors. We know from previous structural changes in, for instance, shipping, steel
manufacture and the property sector, that such a development would result in considerable costs to
the real economy. One should not underestimate the importance for welfare of a correctly valued
Swedish krona.
Openness is important
Factor productivity is also affected by a country's capacity to utilise technological progress in the
outside world. This capacity in turn depends on how open the country is to impulses from outside,
which is determined by the barriers that exist to ideas, goods, services and production factors moving
freely across the borders. A number of studies have shown that countries, which are more open have
a greater capacity to imitate technological progress. The capacity to renew regulatory frameworks and
institutions to enable the country to embrace change is an important part of this openness.
Obstacles to ideas, goods, services and production factors moving freely across borders have
declined during the 1990s, partly thanks to our membership of the EU, and it is reasonable to assume
that this has had a positive effect on factor productivity. For a small country like Sweden,
internationalisation and increased international competition are expected to lead to particularly
favourable productivity effects. Various measures indicate a marked increase in the degree of
internationalisation in the Swedish economy. Both the import share and the export share have risen,
which means that trade and the degree of specialisation have increased. Moreover, foreign direct
investment in Sweden has multiplied and it is mainly direct investment from EU countries that has
increased.
Although the increasing international openness has been pronounced in Sweden with, for instance, a
rise of 13 percentage points in the export share of GDP during the 1990s, there are several smaller
countries that have shown an even more rapid increase in the equivalent figures. This reflects the
globalised world in which we live, and does not reduce the significance of openness for the
development of factor productivity.
Internationalisation has thus contributed to ensuring that an increasing percentage of trade and
industry is exposed to competition. Increased competition means that companies must become more
efficient and cost-conscious, which in turn should have a positive effect on productivity. In addition, a
new competition act came into force in Sweden in 1993, containing an expressed prohibition of
co-operation between companies that limits competition, as well as a ban on the misuse of a dominant
position. There has also been deregulation in a number of areas. For instance, government
monopolies have been abolished and freedom to establish businesses has been introduced with
regard to, for instance, transport, communication and energy.
Changed conditions for competition thus affect productivity growth, but they can also affect price
trends in a more direct manner. Despite the fact that we gained much tougher competition legislation
in 1993, it appears that developments in this field are moving rather slowly. Swedish prices continue to
lie at a higher level than those in other countries in most areas, without this being fully explained by
differences in VAT rates and wages. Increased competition could contribute to a convergence of price
levels.
High food prices
Swedish food prices were, for instance, more than 18 per cent higher than the average prices in the
EU in 19983. The difference has declined somewhat since then, but apparently at a very slow rate. If
one regards 1998 prices in current terms with the aid of HICP development since then, one finds that
we probably still have approximately 17.5 percentage points of the 18 percentage point difference in
food prices.
Another field in which competition appears to be weak is the construction sector, and in particular the
construction materials sector. This area is characterised by a high company concentration with
considerable entry barriers to new companies and weak import competition. With regard to prices for
construction materials, one can also see a much more rapid price rise than for other industrial
products over a number of years, which may indicate rising profit margins or considerable inefficiency
in resource utilisation.
In some further fields, such as telecommunications services and electricity, deregulation had a
pronounced dampening effect on price development for some time. This is no longer the case. The
most recent statistics available indicate price increases of 7 per cent and 20 per cent respectively for
these areas. In addition, Telia has announced a large rise in its subscriber fees with effect from
October. I therefore see it as natural that there are investigations underway and planned into
competition conditions in these markets.
Vested interests versus consumer interests
Although we have thus achieved improvements in certain areas, it appears to me that the description
in the Economics Commission's report of 1993 (page 10) still applies to large parts of the economy.
"It is evident that a number of important markets in the Swedish economy function poorly and that this
leads to considerable wastefulness with resources and to large costs for the national economy. The
Commission's assessment is that the fundamental reason is the lack of competition in Swedish trade
and industry. One indicator of the lack of competition is that prices on a large number of goods are
much higher in Sweden than in other countries. Other indicators are the many public regulations of the
market, the agreements between companies that limit competition and the monopoly-like market
structure in many sectors. The limitations to competition are a clear example of how vested interests
dominate over general consumer interests."
More recently, this type of question has arisen with regard, for instance, to the EU Commission's
revelations of price collaboration between the airline companies SAS and Maersk. From an economic
perspective, these are important questions that motivate a broad discussion. From a monetary policy
perspective, an influence on price developments from changed conditions for competition is one of
several important areas that we at the Riksbank must consider, as the potential growth rate depends
on how effectively resources are allocated.
To summarise, there has been considerable change in the Swedish economy in recent times. The
external framework is currently characterised by significant fiscal and monetary stability, which
facilitates planning and decision-making by both households and companies. These fundamental
conditions, together with a pronounced increase in openness towards the outside world give reason to
expect a continued favourable development in productivity.
At the same time, one should remember that several markets in Sweden still show clear signs of poor
competition. This involves considerable cost. The various parts of the economy are connected, which
often means that a strengthening of the weaker parts is even more important to the economy as a
whole than to the effects on a particular branch or sector. It is exactly this - the complementarity of the
economy4 - which makes it particularly important to deal with our weak links and to listen with humility
to the proposals of the OECD and IMF, for instance. It is often easier to identify problems if one can
see things with a little perspective. I believe that the Swedish economy has considerable unutilised
potential for a strong growth if we concentrate on it, if we all work together to make our joint cake
grow.