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Post writer: HUMU

Relationship between International Competitiveness and the Cost of Capital and How Investment Opportunities are Affected by Interest Rate Differences
Introduction
International competitiveness is the ability of a country to compete under free and fair international markets, while maintaining and expanding its citizen’s real incomes. A country’s competitiveness mainly depends on its ability to ensure that the growth rate of its productivity is equal to or greater than those of its major competitors. The growth rate of productivity is positively related to the rate of investment on innovation in a country (Pires, 2014).
Firms can raise funds for investment internally or externally. They also have increasing flexibility to decide where they can raise public equity capital and where they can list or trade their securities. The cost of using funds internally is the returns forgone when those funds are invested externally. The cost of external funds is the minimum rate of return lenders will need to invest their capital in a firm (Salvatore, 2012: 640). The key variable in determining a country’s ability to compete for domestic or international mobile capital is the cost of capital. Tax changes in the United States, if not matched by changes in Canada, can adversely affect the Canadian economy.  For instance, concerns were raised that the tax base of corporate income taxes will be eroded in Canada, when the basic corporate tax rate was lowered in the United States from 46 to 34 percent in 1986 (Shoven and Topper, 1992: 217). This paper evaluates the relationship between international competitiveness and the cost of capital. It also discusses how differences in interest rates between countries can lead to investment opportunities.

Relationship between International Competitiveness and the Cost of Capital
According to the Martine Durand and Claude Giorno (n.d.), one of the key determinants of competitiveness of a country is the cost of capital in that country.
There is generally a direct relationship between the cost of capital in a country and how competitive that country is in the international market. Economists have argued that countries that greatly regulate their labour markets and businesses are less competitive because they tend to have higher cost of capital relative to others. For example, a country will be less attractive to international businesses if it is difficult for firms to gain planning regulations to expand factories.  The World Bank produces a list of countries where it is easier to do business due to the degree of regulation, flexibility of labour markets and protection of private property. The top 5 countries on this list are Singapore, Hong Kong, New Zealand, the United States and Denmark. These countries are very competitive because they have very flexible labour markets; low levels of regulation and provide high protection for private property (Doing Business, 2013:8). Therefore, the cost of doing business is very low in those countries.
The following are some few costs that determine the competitiveness of doing business in countries. Ceteris paribus, the higher these costs are in a country, the lower the competitiveness and investment opportunities in that country (Agenda, 2006:1-4; Economics Help, 2012):
€¢    Underwriting fees €“ The lower these fees are in a country, the more attractive it is to do business in that country’s stock market. Germany, France and the UK have similar costs which are relatively lower than those on NASDAQ and the NYSE. Underwriting fees account for about 3-4% of receipts in Europe and 6.5-7% in the US.
€¢    Corporate governance regulation €“ regulation reduces or eliminates incentives for firms to be efficient and may in fact lead to higher costs of capital. One of the leading or highly attractive countries in this category is the UK.
€¢    Trading costs and liquidity €“ The more liquid it is to do business and the less trading cost there is in a country, the more opportunities there will be for investment in a country, all things being equal.
€¢    Professional fees, listing fees and other direct costs €“ The higher the fees, the lower the attractiveness for investment.
The cost of capital is also determined by transportation costs. For example, it is argued that the competitiveness of the UK is greatly undermined by bottlenecks in transportation like limited capacity of the London airport and traffic jams on its major roads

Relationship between Interest Rates and Investment Opportunities
Interest rates are the rates at which debtors (borrowers) pay interest for the use of money borrowed from a creditor (ender) for a specific time period. Interest rates are usually called the cost of money. One of the main determinants of interest rates is inflation. For example, lenders insist on being compensated with higher interest rates for losing the purchasing power of their money when inflation is high (or expected to be high). Investment and output can also be reduced (but unemployment increased) when interest rates are high because high interest rates increase the cost of borrowing.
However, interest rates may move down or up even if inflation (or expected inflation) does not change. A booming economy, for example, attracts businesses that are willing to pay high interest rates because they can find investment opportunities to profit from money they borrow. Central banks of countries also adjust interest rates, through the use of monetary policy, to either stimulate spending or borrowing to boost their economies or to encourage saving if the economy is expanding too fast.
Investment opportunities are significantly affected by changes in interest rates. The Bank of Canada can affect the amount of dollars borrowed or spent by businesses and Canadians if it raises it lowers interest rates. When interest rates fall, the cost of borrowing falls and it becomes very attractive to invest. This increases the potential for businesses to be profitable and further increases opportunities for investment. For example, the Bank of Canada lowered the interest rate to 1% in September 2010 during the global economic downturn to stimulate borrowing, investment and the economy. This has stimulated domestic investment in the mortgage, bonds, stocks and other industries as well as increase exports by 4.2%. Consequently, the Canadian economy grew by about 3.1% in 2013. Now that most of the goals of the monetary have almost been achieved, interest rates are expected to increase by about 0.5% in 2015 (CBCNews/Business, 2014).
Therefore, differences in the rates of interests from one country to another can lead to different investment opportunities. All things being equal, countries with lower interest rates will generally attract more investment opportunities that those with higher rates and vice versa.

Conclusion
Interest rates are one of the key determinants of the cost of capital in a country. The higher interest rates are the higher the cost to borrow (of capital) and the higher the cost of doing business. Differences in interest rates between countries can lead to differences in investments opportunities in those countries. There is an inverse relation between the cost of capital in a country and that country’s international competitiveness. Ceteris paribus, the higher the cost of capital in a country, the less attractive it is to do business in that country and the less competitive that country will be in the international market. Therefore, the key variable in determining a country’s ability to compete for domestic or international mobile capital is the cost of capital.
References
Agenda (2006) The cost of raising capital: an international comparison. July, pp.1-4[Online]. Available from: http://www.oxera.com/Oxera/media/Oxera/downloads/Agenda/Cost-of-raising-capital.pdf?ext=.pdf(Accessed 25 September 2014)
CBCNews/Business ( 2014) Bank of Canada holds key interest rate at 1%:
Benchmark rate has stayed the same for 4 years, September [Online]. Available from:
http://www.cbc.ca/news/business/bank-of-canada-holds-key-interest-rate-at-1-1.2754145 (Accessed 26 September 2014)
Doing Business (2014) Understanding Regulations for Small and Medium-Size Enterprises. October [Online/Blog]. Available from:http://www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual-Reports/English/DB14-Full-Report.pdf (Accessed 25 September 2014)
Durand, M.  and Giorno, C. (n.d.) Indicators of International Competitiveness: Conceptual Aspects and Evaluation. General Economics and Balance of Payments Divisions, pp.147- 197 [Online]. Available from:https://www1.oecd.org/eco/outlook/33841783.pdf (Accessed 26 September 2014)
Economics Help Blog (2012) Factors that determine international competitiveness 3rd October [Online/Blog]. Available from: http://econ.economicshelp.org/2007/06/what-determines-international.html (Accessed 25 September 2014)
Pires, A. J. G. (2014) Beyond Trade Costs: Firms’ Endogenous Access to International Markets. Journal of Industry, Competition and Trade, June, 14(2), pp. 229-57 [Online]. Available from:
http://download.springer.com.ezproxy.liv.ac.uk/static/pdf/827/art%253A10.1007%252Fs10842-013-0158-9.pdf?auth66=1411867761_36ea5b678991aa63cdd56fe34d138fb8&ext=.pdf (Accessed 25 September 2014)

Salvatore, D. (2012) Managerial economics in a global economy. 7th ed. New York: Oxford University Press.

Shoven, J. B and Topper, M.  (1992) The Cost of Capital in Canada, the United States, and Japan.  National Bureau of Economic Research, January, pp.219-235 [Online]. Available atwww.nber.org/chapters/c7483.pdf (Accessed 26 September 2014)