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Wednesday, November 06, 2013

US and Germany trade blows over macro policy, but is Germany's export focus really to blame for the woes of the eurozone?

Another dispute arose last week between the US and Germany. This time on macroeconomics. Maybe not quite as glamorous (or controversial) as spying, but interesting nonetheless. The new disagreement was set off by the US Treasury’s semi-annual Report on International Economic and Exchange Rate Policies which said (and reiterated numerous times):
“Germany has maintained a large current account surplus throughout the euro area financial crisis...Germany’s anaemic pace of domestic demand growth and dependence on exports have hampered rebalancing at a time when many other euro-area countries have been under severe pressure to curb demand and compress imports in order to promote adjustment. The net result has been a deflationary bias for the euro area”.
Germany (unsurprisingly) took offence to this and hit back that its surplus was simply a result of competitiveness and global demand for German products.

Numerous commentators have weighed in to add to the criticism of Germany with Paul Krugman, Martin Wolf, the Atlantic and the Economist Free Exchange blog all lambasting Germany, albeit to varying to degrees. (See Bruegel here for a good round up). The WSJ's Richard Barley attempts to provide some much needed balance to the discussion.

The thrust of the argument is: Germany should boost domestic demand to provide a demand boost for the struggling eurozone economies (via imports). It should also allow wages and prices to rise (reflate) to reduce its advantage over these other countries, allowing them to take over some of Germany's market share.

So, who is in the right? We’ll leave that up to you to decide, but we do feel the debate has been rather one sided in its criticism of Germany. With that in mind, below are a few points to ponder.

1) Germany is not as big a source of demand for peripheral economies as assumed: As we have noted before, the assumption that if Germany imported more, the peripheral countries would benefit seems overstated. We have already pointed out that the eurozone and particularly the periphery make up a declining source of Germany’s trade.

Importantly, Germany is also a limited source of demand for these countries. In 2012 exports to Germany from Greece, Italy, Portugal and Spain amounted to 0.9%, 3%, 2.9% and 2.25% of their GDPs respectively. So, if Germany did boost its domestic demand and consumption only a small amount would filter through to imports from these countries and this would amount to a very small boost in GDP. To have any real impact then, Germany would consciously need to direct an increase in imports from these countries - not a realistic proposition. Also, keep in mind as well that it could do little to offset the massive collapse in domestic demand, investment and government spending which in many cases amount to double digit percentages of GDP.

2) ECB’s one-size-fits-all policy: As the Economist Free Exchange blog points out, the issue of reflating probably has as much to do with the ECB as it does with Germany. But as we have pointed out the ECB faces a tough time in tackling low growth and low inflation due to numerous technical, legal and political constraints. Furthermore, if Germany did start reflating quickly, with wages and prices going up, significant problems could be created for the ECB and its middle of the road, one-size-fits-all monetary policy. It would find it even harder to marry its single policy for a fast growing Germany and other countries.

3) Even if Germany became less competitive or exported less the periphery would not necessarily pick up the slack: Again as we noted before, Germany and the periphery have very different areas of expertise and specialisation – if Germany lost competitiveness due to reflating, the periphery may not fill the gap for cheap exports, particularly in manufactured and industrial goods. Chances are that emerging markets would reap the benefits or at least a large share of them. It's also worth noting that increasing wages may not be as simple a prospect as it sounds given that it cannot be done directly by the government and requires an agreement from both unions and businesses.

4) A less competitive eurozone:
This is a point the German government has raised previously and it has some merit. Although a German reflation would aid the adjustment in other countries (as the adjustment needed to become competitive relative to Germany would be less) the competitiveness of the eurozone as a bloc would be relatively decreased since the average unit labour cost would be higher. This can be offset somewhat by a weakened currency, but given that the ECB takes no specific action to influence the euro, it is far from guaranteed.

5) Germany has had an excess of savings for a decade: While Paul Krugman is right to point out that Germany has not always run a current account surplus, it has done so for nearly the entire time the euro has existed. So why was the excessive saving in Germany not an issue previously? Obviously, global demand has fallen and domestic demand in many periphery countries has collapsed, but previously German savings were heavily invested in the southern economies (through the banking system). This no longer happens, in a large part due to concerns over the stability of the euro and these countries economies and governments. This highlights the need to address the structural flaws in the euro, improve the business climate in these economies and create a banking union.

6) You cannot have a currency with 17 Germanys: All the above said, you clearly cannot have a bloc of countries, which trades significantly with each other, all focused on creating an export model. Where would the demand come from? Clearly, Germany alone cannot provide it and being entirely reliant on external global demand is a risky strategy.

Other points to keep in mind include:
  •  An obvious point which seems to be missed is that, the current account deficits of these countries have decreased while Germany's surplus has not. If it was the flip side of these deficits then it would automatically fall. The relationship between the two has become detached as Germany and other countries have taken a more global outlook.
  • A weaker euro which is often also targeted in this type of debate would probably aid Germany more than others given its export base. This is linked to the impact looser ECB monetary policy which would probably weaken the euro - as such it seems strange for certain politicians to push for such action.
  • To be fair to the US, it is far from alone in raising this point - the IMF and Commission have both mentioned it. That said, a singular country, even one the size of the US, commenting on another’s economic policy is different to an international institution or private sector commentator doing so.
  • Germany is also not alone in coming in for flak, as has been happening for some time, the US also hits out at China's excessively weak currency.
  • Martin Wolf makes a wider point, that Germany is hampering global demand. This seems more valid since it is increasingly turning away from trade with its euro partners to elsewhere.
We have pointed out many time that imbalances are a big problem in the eurozone. There is no doubt some rebalancing is needed. The Economist Free Exchange blog makes a good point, that this can be done through reforms such as tax cuts and opening up markets which would not impact competitiveness directly but would boost demand. There is also no doubt that Germany's and the eurozone's handling of the crisis has been less than stellar, as we ourselves have noted many times.

That said, pushing much of the blame onto Germany's current account surplus seems a bit misguided. Some correction is needed but it alone is far from enough to have a sizeable impact in reversing the crisis. That is exactly why more concrete progress on the banking union, structural reforms and reducing the democratic deficit is needed in the eurozone.


Anonymous said...

The simple answer, which you seem to ignore, is to break up the Euro and allow individual nation states to pursue their own currency adjustments. Alternatively, recognize that a single currency can only be optimized for the aggregate, and let the periphery suffer. Mass migration to the core would progressively solve the problem. There is a reason why South Dakota is empty. In a federal US dollar system, it makes no sense to go there in large numbers. Equally, the same applies to much of Italy, Spain, Greece, etc.

Jesper said...

Suppose there was country with a noticeable difference between north and south, then it might be possible to look at it and see how much merit the US argument has.

Italy is such a country. It has even had fiscal transfers (the argument about 'optimal currency area' theory...) for decades and the south of Italy is still lagging.
Is the north of Italy to blame for the problems in the south of Italy? Not enough money being transferred to the south? Or could the explanation be something else entirely?

& the theory that a banking union would improve things in the south... How much has that affected the divide in Italy since the north and south of Italy has in effect had a banking union for decades?

Rollo said...

It is not a question of German effort to be to blame. It is the euro which is the problem. It is too weak for the German economy, accustomed as it is to good housekeeping and hard work and restraint; It is far too strong for the other economies, who cannot compete. We weaken our currencies with QE; the Germans have no need for this, the euro is kept too low by joining the DM to the drachma, lira, peseta, franc. As long as this persists, the divergence between weak and strong econoimies will increase.

Anonymous said...

As well as contradicting itself, this blog is economically illiterate.

Anonymous said...

Why not give all German family's a voucher for a holiday to Southern Europe??

Open Europe blog team said...

Thanks for your feedback @Annymous 11.17 - would you care to elaborate?

Anonymous said...

It would appear that only the Netherlands and China are negative trade balances for Germany, and given their hold on the euro it's no wonder that the other eurozone nations are suffering to give Germany what it wants. They lost the war but have won the peace it seems. The simple answer is of course to either dismantle the euro, or to throw germany out of it entirely.

Ian Campbell said...

At 58% of German exports going to the EZ there is much demand going iwithin the EU for German goods. This would much lower if the exchange rate for German goods were not so low. It is low because of that foolish construct - the €.

The imbalances would not exist without it. So we should not be having this conversation - and the more other members recognise this and speak up the sooner the € project will be recognized for the folly it is.

We should not be starting from here.

Henri Erti said...

Breaking the Euro-zone apart would return Europe back to the days of mutual competitive devaluations. The Euro has been particularly successful in disciplining reckless monetary policies and therefore, we need to have faith in the common currency.

Previously in the midst of decline in output, nations could easily avoid necessary structural reforms by just devaluing their national currency. With the Euro, nation states actually need to make comprehensive adjustments in order to maintain real competitiveness.

Anonymous said...

As the first anonymous contributor, but not one of the subsequent anonymous contributors, I realize we have a chimaera of opinions under the same banner. Let me say that my reference to the US should, if expanded, make the point that the US expanded from near emptiness under the rule of a single currency. There was relatively little misallocation of population, and the current demographic distributions of the US still reflect, to a remarkable extent , the history of settlement under a common currency regime. Europe, by contrast has large amounts of capital invested in demographic distributions that, in today's economic terms, make little sense. Italy has been cited as an example where the problem is chronic. The south does indeed pose challenges, and encouraging migration to the north would produce a new economic equilibrium. Recognizing and addressing demographic maldistribution is always going to be profoundly disruptive and painful, but that is what truly free labour markets will move to optimise.

Anonymous said...

I should have said "truly free labour markets will move to reduce".

Anonymous said...

This article really seems to miss the point. Saying that peripheral Europe does not compete directly with Germany is a straw man argument. Presumably they did not compete directly with Germany when the Euro was introduced, yet its introduction has coincided with the enormous increase in deficits in peripheral Europe. According to your line of argument this should not have happened because their trade with Germany is limited and what they produce is very different.

Rollo said...

This rather proves my point:
According to figures released by the German national statistics office DESTATIS this morning, Germany’s trade surplus hit a record high of €20.4bn in September. Compared to September 2012, German exports increased by 3.6% to €94.7bn, while imports fell by 0.3% to €74.3bn.
Reuters Deutschland Handeslblatt Spiegel FAZ Süddeutsche

Rik said...

If you look at the stuff the South is producing for possible exports and their cost level there simply is a huge mismatch.
Low added value/ few high end products and a cost (wages, taxes, RE, regulation, energy etc) which is 'worldtop'.

This is the real measure of competitiveness. Not the macro thingy most are using for convenience. All the guys or gals wanting to sell abroad that face competition from other countries there.
And Europe's South is extremely poor there. Majority of their products compete with nearly everybody else , including a lot of those with 300 Euro monthly wages. Exception probably only the North of Italy. Rest is simply completely overexpensive economic crap.

And bringing down the Germanies to that level is easy to predict as far as the consequences are concerned.
Not going to happen anyway. No better way to commit political suicide for a German politician. So unrealistic to say the least.

The problem is that you cannot manufacture relatively simple stuff for the worldmarket at a pricelevel that is double of that of some of your main competitors.

Anyway the EU is at the end of the day a group of seperate countries that each trade on the worldmarket. Bringing the Euro somewhat down will not solve the problem in the South. They are clearly simply looking fior an easy scapegoat.
Japan shows that import dependent but not export pricing power countries (like basically the whole South) leads short term to bigger trade gaps. Energy has to be imported whatever happens and the holes are plugged with imports lateron.
This is not a really good looking worldmarket for export growth (worldgrowth is very low at the moment). It is so much easier to frow yourself in a growing market.
And a few others as well. It is not simply 1 Euro less German surplus equals 1 Euro more in the South. Considerably more complicated.

Mark A. Sadowski said...

"Furthermore, if Germany did start reflating quickly, with wages and prices going up, significant problems could be created for the ECB and its middle of the road, one-size-fits-all monetary policy. It would find it even harder to marry its single policy for a fast growing Germany and other countries."

On the contrary, more expansionary monetary policy would be a relatively painless way to bring the competitiveness of Germany and the Euro Area periphery into alignment. German workers would get higher wages and unenployed Spanish workers would get jobs. Krugman explained very clearly how this would work:


It's a win-win solution unless you like the idea of keeping German wages low and Spanish workers unemployed.

Anonymous said...

"Previously in the midst of decline in output, nations could easily avoid necessary structural reforms by just devaluing their national currency."

A Rehnplicant phrase for sure and devoid of any intellectual rigour.

Everytime I read or hear a European savant mention structural reforms it's all about dismantling the welfare state or vague excuses to address the lack of a true economic and fiscal union. Or even worse, since some of the countries who are targeted for "structural reforms" they have already done so and the situation stays the same.
Sounds we have a cauldron for long term EC dismantle.


Rik said...

You simply miss the point that competitiveness is a worldwide game and the policies suggested are purely intra EZ.
In other words like what we see now extra spending power in Germany will mainly be used for buying stuff from others than the Greeces and Italies of this world.

Rollo said...

What a silly expression, @one size fits all'. What is meant is 'one size fits none'.