Productivity, exchange rates, and competitive advantage

Abstract

PurposeThe purpose of this paper is to contextualize a productivity contest between a local manufacturer versus a foreign one, both of whom sell an identical product in the local market, within the two companies' respective economies. The intent is to delineate the conditions under which one firm gains a competitive advantage over the other.Design/methodology/approachThe purchasing power parity model is reformulated to account for differential rates of macroeconomic productivity gain in the two countries. The implications of these differential rates vis‐à‐vis the productivity contest between the local and foreign manufacturer are then explored.FindingsTo gain a competitive advantage over its foreign rival, the local firm must achieve a net productivity improvement relative to its (local) economy that surpasses the net productivity improvement of the foreign rival relative to its (foreign) economy. Thus, the local firm stands in a rivalrous relationship not solely with its foreign competitor but also with the average firm in its very own (local) economy and in a complementary relationship with the average firm in the foreign economy. The foregoing is shown to be a generalization of the Dutch disease phenomenon and to imply that national efforts to attain competitive advantage are self‐contradictory.Practical implicationsIn its productivity contest with its foreign rival, the local firm's management should not focus myopically on a comparison of the two firms' rates of net productivity improvement. Rather, the focus should be on the two firms' differential rates of net productivity improvement relative to their respective economies.Originality/valueThe main conclusions of this paper, which derive from the effect of productivity changes on exchange rates, are both stark and original. A firm is engaged in a productivity contest with the average firm in its own economy. Thus, national efforts to enhance productivity are counter productive to a firm whose productivity improvement lags behind that of the average domestic firm.