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Wednesday, August 14, 2013

German growth leads the eurozone out of recession but can it really lead the eurozone out of its crisis?

As has been widely covered today, the eurozone exited recession in the second quarter of this year, growing by 0.3% (over expectations of 0.2%).

We posted our thoughts on this expected ‘turnaround’ in the eurozone a couple of weeks ago, so we won’t rehash them. Needless to say the figures are a positive but there is still plenty of negative data around (unemployment, bank lending to real economy, consumer confidence), so European leaders should refrain from getting overexcited.

The key point for us remains this issue of divergence. It’s worth noting that Germany and France played a significant role in pulling the eurozone average growth up. There also seems to be a prevailing logic that German growth can play a big role in pulling the eurozone out of its crisis. As we have noted before we’re fairly sceptical of this idea for a couple of reasons.

There are two mechanisms through which German growth could in theory help boost struggling eurozone countries:
  • Firstly by boosting German demand for imports from these countries significantly.
  • Secondly by moving Germany away from its export model (possibly through decreased competiveness) allow these countries to fill that gap and export more.
1. Boosting imports
 
(Data up to end of 2012, however imports from eurozone countries have continued to decline in 2013)

As we have discussed before, and as the graph above shows (click to enlarge), German imports from peripheral eurozone countries have decreased substantially with only Italy featuring as one of Germany’s top ten trading partners. Furthermore, imports from other EU countries have declined to 56% of total imports – with the eurozone accounting for approximately 38% of this and peripheral eurozone states a small part of this. 

Therefore, even if GDP and consumption are growing quickly in Germany it’s not entirely clear that this would have a significant knock on effect on the countries that need it most.  The Netherlands, France and Italy are the most likely to see some boost. The IMF itself noted recently that using fiscal policy to boost Germany GDP would provide limited help for the eurozone. It ultimately also depends where Germany’s economic growth comes from, if driven by its own exports or government spending the impact would be even further limited.

2. Providing space for the periphery to boost exports

The theory here is that Germany ‘reflates’ allow wages and unit labour costs to grow and focuses its economy more on domestic consumption and investment rather than exports. This allows for the other eurozone economies to step in and export more, not least because they look relatively more competitive.


However, as the graphs above show (via UBS, click to enlarge), in many cases the struggling peripheral countries do not export the same goods as Germany (transport equipment, electrical equipment, chemicals), although there is some overlap on food and financial services. In any case, it’s far from clear that the struggling peripheral countries would be able to step into any breach left by Germany (particularly with heavy competition from emerging markets). Furthermore, many German exports used component parts from elsewhere in the EU, so decreasing them could actually have negative knock-on impact in certain sectors.

Another point worth keeping in mind is that a rapidly growing Germany would put added strain on the one-size-fits-all policy of the ECB. With the ECB now forecasting that interest rates will stay low for some time, if Germany continues along this growth path it may not be too long before the Bundesbank becomes concerned about the monetary policy being too lax.

It almost goes without saying that strong German growth is a good thing for the eurozone generally (breeds confidence and helps encourage investment) and strong economic growth should be the target for all countries. However, as the points above demonstrate, this does not mean it will be enough to drag the eurozone out of its crisis (i.e. it may be necessary but it is far from sufficient) and is certainly no panacea. The key issues to address remain the structural flaws in the eurozone and the lack of competitiveness within many of the peripheral economies.

12 comments:

Rik said...

1. Looks almost too good to be true. Hard to see where eg France's 2.0% annual growth is coming from. It is simply not in line with other data. Would be nice to see where the growth is coming from, sectors and that kind of stuff.
See with which figures the ECB comes up and if this continues this way.

2. Anyway like in the US it looks like a recovery outside mainstreat.

3. More and more noise that the books look to be cooked (see eg ZeroHedge in Greece. Related: also btw mentioning the fact that the shortages in the social funds are not accounted for in the Greek deficit.

4. Anyway it still means that the countries forming the EZ combined are still a huge drag on the worldeconomy. But hopefully a smaller one than expected.
And the EZ basically is organised more as seperate countries than one big total and seen from that angle still half of them or more are in recession.
Markets however likely see it more as one area. More than the facts on the ground really permit anyway.

5. Like with Greece-Russia gasprices it is clear that there are a lot of structural problems. One being as OE mentiones here that the economic basics in some countries simply not give the possibility to grow exports quickly but that first imvestments are required to build up the capacity.
Another one that devaluation in trade deficit countries with huge necessary imports (energy mainly) is also a problem.

Judge still out.

jon livesey said...

It's very much a subjective judgement, but a lot depends on what you think the EU is for.

If you think that the idea behind the EU was that free trade in a single market would decrease economic disparities in Europe, then it has failed because those disparities have become worse, not better, and show no sign of improving.

If you had to sum up the experience of the euro in the past decade and a half, you would have to say that the traditionally prudent countries, such as Germany, persisted with their traditional permanent semi-austerity, with low wage levels and low nominal wage settlements, and improved their competitiveness.

Meanwhile, the nations that historically depended on periodic devaluations of a national currency to adapt to high wage and price inflation, continued to act as if they could devalue, and accepted high nominal wage settlements that eroded their competitiveness.

Before 1999, the outcome would have been an upward currency revaluation in Greater Germany and devaluation along the periphery, but membership in the euro prevents that, leading to internal deflation.

Internal deflation "works" in some sense, but it is socially very unjust, because most of the pain of internal deflation falls on wage earners who in many cases didn't benefit much from the previous bubble-like growth.

So we are now entering a new period in eurozone history, in which domestic demand is permanently impaired along the periphery, while lack of competitiveness in the periphery sucks in exports from Greater Germany, leading to a boom there.

There are really only two possible futures. One is where the eurozone Governments manage to hold the thing together, and the EU becomes a place of more or less permanent depression along the periphery with high growth in the core, freezing all of Europe's historical imbalances in place.

The other possible future is one in which voters in the periphery react by electing more and more extreme political parties, as they did in the Thirties, until finally nationalistic forces overpower European forces, and the EU breaks up, more or less in the same way that Thirties Europe abandoned negotiation and concensus in favour of nationalism.

I can't prove it, but I think that within a year, we will all look back on this week's "finally out of recession" as a bit of a sick joke.

c said...

More wishful thinking! First let's deal with the inescapable truth, our trading with the EU has and continues to remain in deficit and is in fact hampering our own embryonic and fragile recovery.

As Philip Aldrick pointed out in the Daily Telegraph less than a week ago our trade with the EU, a deficit which in June increased alarmingly from £4.6 billion to £5.4 billion! If it had not been for the burden our membership of the EU imposes on all of us our trade surplus would have been the lowest for many  years!

Jeremy Warner's perceptive comments in Today's Telegraph blows a hole in the spurious claim of recovery!

"Take the latest example. For some years now, Mr Rehn has been repeatedly declaring the eurozone crisis over, only to be proved consistently wrong. So wrong, in fact, that he has become a standing joke. Indeed, you have been able to set your watch by him. Every time Mr Rehn opens his mouth to claim final vindication of the policies the European Commission is imposing on Europe's dispossessed, you kind of know that the storm is about to break out anew".

"And now he's done it again. "The data…supports, in my view, the fundamentals of our crisis response: a policy mix where building a stability culture and pursuing structural reforms supportive of growth and jobs go hand in hand", he said in response to news that the eurozone has finally emerged from recession".

"He's joking, right? Indeed he must be, and by going just a little bit too far in his claims, he's given the game away. It was good while it lasted, but now we know that even Mr Rehn cannot believe in what he says, for otherwise he surely would have tempered his remarks with a few caveats".


Rollo said...

Of course a German recovery will not help the Eurozone victims. The problem is the huge disparity between the different economies and cultures. The gap between Germany and some of the weaker countries is widening, as one grows and the others shrink. So the problem will continue to worsen.

Anonymous said...

Simple answer No it can't it seems that the reporters are pleased that the overall growth is 0.3% but as Germany France and Portugal are above that it means that the other nations are still negative, but that isn't mentioned. The euro is still a basket case and the eurozone is still in trouble.

Denis Cooper said...

Off-topic, I haven't seen this reported in the UK mass media:

http://www.spiegel.de/international/germany/anti-euro-party-alternative-for-germany-faces-violent-threats-from-left-wing-activists-a-916531.html

"Hard Knocks for Anti-Euro Party"

"In recent weeks, AfD campaigners have received threatening phone calls, been subjected to verbal abuse and - in some cases - physical attacks."

Well, that's how the Nazis suppressed public opposition in 1930's, by being more effective thugs than their left wing opponents, and now it seems that German left wing, supposedly "anti-fascist", extremists, are adopting the same tactics as the Nazis.

The German "Green Youth" who are highlighted as being at the forefront of this violence are cousins of the Young Greens in the UK, both of their parent national parties being affiliated to the European Green Party:

http://en.wikipedia.org/wiki/European_Green_Party#Member_parties

I wondered whether the solitary Green MP Caroline Lucas really wanted to be even indirectly associated with this scum in Germany, and so I've emailed to ask her what she thinks about it.

jon livesey said...

The two methods mentioned in the column are not the only ways Germany could help the rest of Europe. If you look at 1930's Depression era migration within the US, you find some startling facts.

In the period 1930-40 the population of some depressed "dust bowl" middle America counties declined by as much as 25%, while the populations of other states grew. In the case of California and Florida some counties grew by 75% and quite a few by 25-50%.

Translated to Europe this means Greek migrating the Germany to find work, and German companies opening branches in Greece to take advantage of cheap labour.

Of course, this isn't going to happen in Europe on anything like the American scale. For cultural reasons, Greeks aren't going to be moving en masse to Germany any time soon - I don't blame them; I wouldn't either - and Germany would be seen as exploiting Greece, in ways we would hardly claim that California would "exploit" Oklahoma.

I think that the mere fact that a pretty obvious solution isn't likely to happen is just more evidence that the eurozone put the cart firmly before the horse. They needed to wait for Europe to become culturally ready for a single currency, and instead they tried to force the pace by introducing the single currency before its time.

Anonymous said...

Even more interesting by reading Portuguese newspapers and analysing the data, is that the growth there was mainly because the new austerity measures were put on hold due to some constitutional issues. And that allowed people to consume enough to stop the internal aggregate demand from falling further and couple with some exports rise in refined oil products.
Sounds exactly the kind of paradigm that Germany won't like to hear for the remainder of the EZ. But the fact is that austerity is killing slowly the Eurozone. The sooner Germany realizes this the better for them. A EZ breakout could be even more probable if the expectations for a "recovery" turn out to be short-lived and panic will run throw the whole EZ.

JL

Rik said...

@Denis
Idiotic lefties throwing eggs etc at AfD will only help AfD. Simply the way it works. Being despised by people your potential voter base despises is a very good marketing strategy for a newcomer/populist. Especially if throwing things and treaths are involved.
Hard to see however it will bring them over the 5%. They are still around 3% and German polls are not as crap as the UK and US ones. They might gain something on the effect that people will not state they vote for them in polls, but that will likely be marginal. Wilders who is much more extreme had something like 20% extra.
And didnot have the 5% problem. Which likely will lead to strategic voting as the left and right block are very close to each other and a lot of people think Steinbruck is a complete idiot. Which they might want to keep from power.

Jon this is widely discussed in academic papers at the time of setting up the EZ. It was simply ignored. Keywords optimal monetary union (currency area) probably.
Anyway Greece is not cheap by any measure compared to its competition. It might be cheaper than Germany but Germany has 200 other countries it could take and 10s of those are considerably more attractive. To begin with nearly the complete former East block. And wages have gone down but the other costs have not.
Next to being as far as possible from the homemarket with crap and expensive logistics.
Greece is simply uncompetitive in general and not only on wages.

jon livesey said...

"Jon this is widely discussed in academic papers at the time of setting up the EZ."

Thanks Rik, but it was widely discussed in non-academic circles as well. One reason I feel a bit vindicated by what's going on is that I predicted the outcome in some detail twenty years ago in discussions on netnews.

Tony Maher said...

The point isn't the proportion of Germany's imports coming from the periphery but the proportion of their exports which go to Germany.

The expansion of German domestic demand can double the periphery's export value without bringing these countries into the top ten of importers to Germany.

Poland, Czech & Slovakia don't feature in the top ten either but Germany is by far and away their biggest customer.

Derick @ TeleTrade said...

From the core of my heart I believe that there is no economic rationale for Germany to be in Eurozone because it is the only country (or may be one of the many countries) that is doing fairly well economically. Look at the economic affairs of any other country in the zone and you will find distress and nothing else. In fact, the pathetic situation of the Euro is also because most countries are fairing badly. So, why should Germany be a part of a currency whose fate is not even dependent upon its own economic performance? This is high time that it comes out of the shamble, have a grip on the its own currency, may be the old Deutsche Mark, make its currency acquire momentum and reap the gain.