By Fortune Editors
September 27, 2011

By Dinesh Paliwal, CEO of Harman International

FORTUNE — As global markets continue to see-saw on the verge of another recession, central banks across the world face a difficult balancing act of monetary policy. Massive injections of stimulus funds have been deployed in many cases, creating outstanding balances of sovereign debt that may take decades to resolve. Other banks are hinting at reduced stimulus funding and higher interest rates, fueling fears that sudden inflation could damage the economic recovery.

Although imperfect, these central bank actions have been helpful in moderating the severity of economic cycles over time. However, more recently, some bankers have adopted policies intended not to moderate but rather to manipulate domestic currency exchange rates and gain advantage on the global playing field. This “currency war,” although far different from its military namesake, has equally significant implications for free-market global trade.

Many economists cite China, which relies heavily on exports to fuel its fast-growing economy, as a key influencer in the currency imbalance. According to these economists, the nation has long followed a policy of injecting large sums of money into its economy and buying debt from other nations. This has the effect of undervaluing the Chinese yuan compared to other currencies, and lowering the relative cost of Chinese goods shipped abroad. Other nations, which seek to sell their own goods to China, face higher relative export prices as a result.

Ironically, China’s monetary policies have not been successful in controlling domestic inflation, as both wages and consumer prices are rising steadily. According to recent IMF data, consumer prices in China increased 5% in 2010 compared to about 1.6% in the U.S. and euro zone. Chinese wages and skilled worker wage expectations are growing even more rapidly, as the country approaches a Lewisian Turning Point-type phenomenon – the economic theory named after Arthur Lewis where demand for labor begins to outpace the available supply.

There is much debate among economists as to whether Western nations should counter China’s monetary policy by deflating their own currencies. Although this might temporarily reduce the cost of goods exported from the West, the resulting debt would further weaken their balance sheets and pass the consequences of short-term thinking to future generations.

I am baffled by many Western politicians who continually blame low-cost imported goods for their own economic challenges. How many of these individuals would wish upon their hard-working constituents a rapid increase in the price of products ranging from televisions to tennis shoes? Like it or not, we are all hooked on the attractive prices of these imports, driven in part by the phenomenon of emerging markets.

I believe the answer to this complex economic challenge lies in focusing on a troika of principles: education, innovation, and productivity.

To its credit, China has far outpaced many Western nations by equipping its citizens with higher education, allowing them to accept new job responsibilities. An astounding 97% of Chinese students who enroll in the nation’s colleges or universities go on to complete at least a Bachelor’s Degree. In the U.S., just over half of enrolled students earn their diplomas, while most Western European nations have a completion rate around 40%. This ratio must improve.

With regard to innovation, the playing field is somewhat more level across the global marketplace. Today’s remarkable technologies are open to all for exploitation, but the winners will be those who think outside the box by listening to customers, collaborating, and delivering beyond expectations. China, for instance, has been evolving from being an imitator to a real innovator.

This brings me to the final critical pillar of success for multinational companies – productivity. Many Western nations have made significant gains through automation and operational excellence, while emerging markets rely on ever-increasing numbers of workers. Each will improve their competitive position only by examining every element of operations to make existing resources more efficient, and to deliver real value at lower cost.

The global “currency wars” are likely here to stay, due to the fine line between legitimate monetary balancing and sometimes self-serving trade manipulation. But these artificial mechanisms lack tangible or lasting value. The real competitive advantage will come to countries and companies who differentiate their offerings through education, innovation and productivity.

Dinesh Paliwal, is the CEO, president and chairman of Harman International, a global manufacturer of audio and electronic equipment.


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