Tomorrow's Challenges
Ref: TC047-19

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Institutions and social openness unlock competitiveness

By Adjunct Professor Christos CabolisChristos Cabolis and José Caballero

The international economic system is being shaped by the rise of inward-looking governments, scepticism about globalization, the closing of borders, and the spectre of war, trade or otherwise. This political and economic uncertainty greatly affects competitiveness – a nation’s capacity to foster sustainable value creation, prosperity and wellbeing.

The role of institutions and social openness

How do countries navigate this environment? Competitiveness, as measured by the IMD World Competitiveness ranking, can help us understand the factors behind the economic success of a country. In the short and medium-term, annual GDP and productivity growth rates (included in the Economic Performance and the Business Efficiency factors) provide a clear picture of the value generation potential of an economy. The long-term drivers of a country’s prosperity also include fundamental dimensions such as institutions, social and human capital, health and environment (measured by the Government Efficiency and Infrastructure factors).

Findings from our global rankings survey show that strong institutions, aided by key societal factors, support competitiveness, even in times of uncertainty.

Institutions

Fluctuations in global markets due to instability in the international political landscape and trade relations have affected competitiveness globally in 2019. As a counter-balance, a strong institutional framework provides the stability necessary for businesses to invest and innovate, ensuring a higher quality of life for citizens.

Table 1 presents the top and under performers in several aspects of institutional quality. Economies that rank in the top 3 in these indicators, place in the top quarter of the overall competitiveness ranking. Conversely, countries that rank in the bottom 3 in these institutional aspects, rank in the bottom quarter of the overall ranking. For example, Singapore, Hong Kong and the UAE top the legal and regulatory indicator, and rank in the top 5 of the overall ranking. The most underperforming economies in this indicator – Greece, Croatia and Venezuela – rank 58th, 60th and 63rd in competitiveness. Government policy transparency is topped by Finland, Denmark and Norway, which rank 15th, 8th and 11th in the overall ranking. The underperformers in transparency – Slovak Republic, Mongolia and Venezuela – rank 53rd, 62nd and 63rd in the competitiveness ranking.

Table 1. Top and under performers in institutional framework, indicator level

Figure 1 further highlights the role of institutions through government policy adaptability and stability. The first chart shows how high scoring economies in policy adaptability such as Singapore and Norway rank high in the competitiveness ranking. Countries that score low in policy adaptability, such as Argentina and Brazil, place low in the overall ranking. Similarly, as shown in the second chart, high levels of political stability are associated with higher competitiveness levels.

Figure 1.  Adaptability of government policy (correlation coefficient -0.75), risk of political instability (correlation coefficient -0.79) and competitiveness

There is a strong positive association between the institutional framework sub-factor and the overall competitiveness ranking (Figure 2). The Institutional Framework subfactor (a component of Government Efficiency) can explain 86% of the variation of the overall competitiveness in 2019 (R-squared=0.86, observations=63). The higher a country ranks for institutional framework, the higher its overall position. For example, Switzerland, the Netherlands, Norway and Denmark rank in the top 10 in both dimensions. Argentina, Brazil and Mongolia are in the bottom 10 for both.

Figure 2. Institutional framework sub-factor and the overall competitiveness ranking (correlation coefficient 0.93)

This relationship has become stronger over time. Figure 3 shows that the correlation between the institutional framework sub-factor and the overall competitiveness ranking has increased from 0.912 in the 2005-2009 period, to 0.917 in 2010-2014 and to 0.933 in 2015-2019. Figure 3 also shows that the correlation between government efficiency and competitiveness, despite some fluctuations, has increased over time (0.895 in 2015-2019).

Figure 3. Correlation between institutional framework sub-factor and the overall competitiveness ranking 2005-2019

Social factors

Institutions do not function in a vacuum. Social conditions are essential for their effectiveness. Society’s openness, for example, is important in influencing competitiveness trends. Figure 4 shows the positive relationship between attitudes towards globalization and the overall competitiveness ranking. Economies with positive attitudes towards globalization rank higher for competitiveness – for example, Ireland and Sweden. Figure 4 also shows that social cohesion has a positive relationship with competitiveness – for example, Denmark and Sweden.

Figure 4. Attitudes towards globalization (correlation coefficient -0.65), social cohesion (correlation coefficient -0.76) and the overall competitiveness ranking

Conclusion

Some countries fare better than others amid high levels of geopolitical and economic uncertainty in global markets. Economies with strong competitiveness levels feature high quality institutions and open societies, which act as safeguard against uncertainty.      

Uncertainty is likely to continue to challenge countries in their drive toward competitiveness. Strong institutions and open societies will be essential to mitigate this impact by providing a predictable context for investment, innovation, and value creation.

Find out more about the recently released IMD World Competitiveness Yearbook

By Chief Economist and Head of Operations at the IMD World Competitiveness Center Christos Cabolis, and José Caballero

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