Outcomes matter: Do aggregate economic profit outcomes align with established metrics about national business environments?

To examine whether it is worthwhile adding economic profit to the analytical repertoire, we draw on three well-known indices of country-level performance – IMD’s World Competitiveness, the WEF’s Global Competitiveness, and the World Bank’s Ease of Doing Business. These measures link national competitiveness/ease of doing business to the set of institutions, infrastructure, and policies that determine the level of productivity of a country. Here we discuss three of the findings from comparing each metric with our national economic profit measure:

1. Countries that score higher in terms of competitiveness also tend to generate higher economic profit (EP) margins. While EP/revenue has a moderate positive (Spearman) correlation with both the IMD and the WEF scores (0.28 and 0.38 respectively), these are significantly weaker than the correlation between the two competitiveness scores (0.83). Looking at the supply side of economies through the economic profit lens enables us to identify countries that clearly depart from their evaluation by established metrics. First, large emerging markets (e.g., India, Russia, South Africa) except for China tend to generate higher EP margins than traditional metrics predict. Second, G7 countries with similar business environments present a large discrepancy in terms of economic profitability. For WEF scores near 80, Figure 1 displays EP margins of almost the entire range: from Canada (0.3%) to Sweden (4.9%).

2. Once the national business environment is set up right, labor productivity (EP/worker) explodes – resembling a hockey stick relation. Initially, labor productivity, which we define as economic profit per worker, strongly depends on institutional components. However, after the business environment reaches a certain stage of development enabling efficient economic activity (scores ~70-80), our productivity measure clearly departs from existing metrics. Countries at the productivity frontier such as Switzerland, Sweden, Netherlands, and the United States, do not owe their success exclusively to the right business environment. What sets them apart is a better combination of factors, technology, and expertise. Recalling our economic profit definition that adds back voluntary expenses, high labor productivity reflects, amongst others, high spending on R&D and restructuring per worker, which in turn will boost labor productivity further.

3. Between 2015 and 2019, labor productivity (EP/worker) of the median country improved by ~50%, while business environment scores increased by not more than 7%. Only a few countries demonstrated increased supply-side metric scores with unchanged or negative labor productivity growth, highlighting in general the co-movement of these measures. EP, however, has a much broader scale than existing measures that are limited to a scale from 1 to 100, enabling policymakers and other stakeholders to identify more subtle changes. Spain, for instance, had clear improvements in terms of EP/worker (plus 400%), starting from a negative EP in 2015 (minus 230 USD per worker), reflecting perhaps the long-lasting effects of the financial crisis and housing bubble collapse. The improved performance, however, only translated into a 13% increase in the WEF score, while the IMD and WB scores did not truly capture this development.

While governments can shape the national business environment, they should also care about corporate outcomes. Our aggregate economic profit measure can be used to generate metrics that indicate whether business environment improvements are translating into sufficient value creation.