February 2014        

The euro and the balance of payments

The euro has worked well for the creditor (surplus) countries. Germany is the best example. The German mark would have risen in value if there was no euro, and this probably would have eliminated some of the surpluses.
      These surpluses enabled the Germans to buy assets abroad: for example, Lidl and Aldi have expanded throughout Europe. They return profits to Germany, and this increases the German surplus and the Irish deficit. This applies to the other creditor surplus countries: the Netherlands, Austria, Finland, Belgium, and Luxembourg.
      The Chinese are achieving similar results by keeping the value of their currency low. They have been able to buy up US government bonds, and mines in Africa and Australia, with the surpluses generated by this policy.
      Some countries in the euro area were winners in international trade, and some countries were losers. The winners had trade surpluses, and the losers had deficits. In table 1 the surpluses of the winning countries are shown as an average percentage over the periods 1990–99 and 2000–09, as well as the cumulative sum of their surpluses in the latter period.
Table 1: Average surplus or deficit as a percentage of GDP, creditor countries
1980–891990–992000–09Cumulative surpluses,
Population, 2009
Germany2.2  –1    3.8  €883.5 billion  81.757 million  
Netherlands3     4.1  6.5  €332.1 billion  16.612 million  
Belgium–0.4  3.9  4.3  €127.8 billion  10.883 million  
Austria–1.8  –2.1  2.2  €57.7 billion  8.388 million  
Finland–1.4  0.9  5.3  €45.2 billion  5.363 million  
Luxembourg15.9  12     9.7  €28.2 billion  508 million  
Average using population weights1.7  2.1  4.2  
Total €1,474.5 billion  123.511 million  
Note: Cyprus, Estonia and Malta adopted the euro in 2008, and Slovenia and Slovakia joined in 2007, and they are left out.

      It is important to remember that the euro is a fixed exchange-rate mechanism (in 1999 each currency was fixed against the euro), with no exit mechanism. This gives rise to the surpluses and deficits.
      Between 2000 and 2009 the euro was undervalued with respect to these creditor (surplus) countries. The cumulative sum of the surpluses is approximately €1½ trillion. Most of these surpluses would have arisen from trade with other euro countries.
      As Germany had the largest cumulative surplus—approximately €0.9 trillion—it is worth analysing what happened in Germany. The 1990s deficit for Germany is deceptive because of reunification. But the average surplus for the 1980s, 2.2 per cent, was much less than the 3.8 per cent of the euro era. If the 1980s rate had applied in the euro era, the cumulative surplus would have been €364 billion less.
      Since 2009 the surplus is approaching €200 billion per annum, which is twice the level of the period 2000–09.
      The Germans operated a beggar-my-neighbour policy by keeping tight control over wages. Gross wages in Germany in the first quarter of 2010 were 22 per cent higher on average than in the first quarter of 2000, while other labour costs were 19 per cent greater, according to the German Statistics Office. This was the lowest increase in twenty-two countries of the EU. The average increase in wages for the EU was 36 per cent, and other labour costs were also 36 per cent.
      This moderation in wages was facilitated—
      (1) by the system of “co-determination” in larger firms, whereby unions, as part of board structures, agreed to low wage increases;
      (2) the fact that more and more firms were able to opt out of industry-level agreements and were able set more flexible working time, which lowered costs and reduced wages;
      (3) the Hartz IV reforms, which cut welfare benefits and forced recipients to take low-paid, part-time or temporary jobs. The government provided benefits to top up their incomes. This enables employers to be more competitive, and they were able to hire short-term workers, and to fire them at will. There are now 1.3 million workers with these types of conditions.
      Adjusted wage share as a percentage of GDP in Germany fell from 66 per cent in 2000 to 64 per cent in 2010; adjusted share that went to capital increased from 34 per cent in 2000 to 36 per cent in 2010. So over the decade there was a major transfer from labour to capital in Germany.
      These factors made exports more competitive, and meant that workers’ demand for imports from other euro countries was reduced. As a consequence, German exports went up, and imports did not rise as fast. Exports from the deficit countries to Germany did not rise as fast.
      Exports reduced unemployment in Germany and increased unemployment in the countries that imported from Germany. The reduced imports into Germany meant that German firms could sell more, and this reduced unemployment. This had the opposite effect on unemployment in countries exporting to Germany.
      These surpluses increased Germany’s sway with the other creditor countries in the euro area and in the EU. They ended up in the private sector; and as this was foreign currency, they were able buy foreign assets directly, or they could invest in foreign financial instruments. Deutsche Bank was a conduit for German investors investing in foreign governments, foreign banks, and foreign companies. German companies could also invest directly abroad; banks such as Deutsche Bank and Commerzbank became involved in buying bonds issued by banks and governments in the deficit countries. Deutsche Bank, as well as banks such as Goldman Sachs, developed esoteric financial instruments with higher rates of return during this period, which led to the recession in 2008.
      The performance of France is shown in table 2. It had a small deficit in the euro era. It cannot be classed as a creditor country or a major deficit country, so it has a separate table.
Table 2: Average surplus or deficit as percentage of GDP, France
1980–891990–992000–09Cumulative surplus,
Population, 2009
–2.10.7–0.2–€59.4 billion64.824 million
      Table 3 shows the performance of the debtor (deficit) countries.
Table 3: Average surplus or deficit as percentage of GDP
1980–891990–992000–09Cumulative surpluses,
Population, 2009
Italy–1     1.3  –1     –€150 billion  60.483 million  
Spain–1.1  –1.8  –6.3  –€579 billion  48.073 million  
Greece–0.6  –1.7  –13.3  –€115.5 billion  11.308 million  
Portugal–8.1  –6.4  –9.7  –€149.1 billion  10.637 million  
Ireland–5.8  1.4  –2.2  €36.2 billion  4.476 million  
Average population weights–1.8  –0.3  –2.9  
Total –€1,030.3 billion  134.977 million  
Note: Cyprus, Estonia and Malta adopted the euro in 2008, and Slovenia and Slovakia adopted it in 2007, and they are left out.

      The euro was overvalued with respect to the debtor (deficit) countries.
      Greece’s deficit increased dramatically, from less than 2 per cent per annum in the 1990s to over 12 per cent during the 2000 decade. It is a similar story with Portugal and Spain. It is clear from a trade viewpoint that the euro has been bad for these countries, and it seems likely with hindsight that these countries should not have joined the euro.
      Ireland did not have as dramatic a trade swing but, like Spain, had a banking crisis and a fiscal crisis after 2008.

Solutions to the imbalances

      1. The creditor countries could expand demand or increase wages. This would lead to extra imports from the debtor countries and go some way towards solving their deficits. The Germans object to this, because it might cause inflation in Germany. It also smacks of Keynesian economics, and the Germans are now in the neo-liberal camp and believe that governments should not interfere in markets.
      2. The deficit countries could retain the euro but pursue a policy of “internal devaluation.”
      (a) This means cutting wages in the economy to make exports cheaper and domestic goods more competitive against imports. But the creditor countries are dominated by large companies, and it will be difficult for the deficit countries (excluding Italy, where most firms are small) to expand output to compete with these.
      (b) Lower wages lead to less consumption, and this leads to a contraction in the economy. If it is assumed that investment remains the same, and the effect of a is greater than that of b, the economy contracts (negative economic growth and higher unemployment). This has happened here since 2008. This lowers imports and reduces the balance of payments deficit.
      (c) Other incomes may be unaffected—for example doctors, lawyers, and pharmacists—and profits will rise. This is unfair, as only one sector (employees) have their incomes reduced.
      (The present situation in Ireland is complicated by the need to meet the Maastricht criterion of a maximum ratio of deficit to GDP of 3 per cent. This has led to reduced expenditure and increased taxation, which reduces demand further in the economy, reduces growth, and increases unemployment. The present Government emphasises cuts in expenditure (two-thirds), which affect low-income households most, over tax increases (one third), which affect higher-income households. This is austerity.
      3. The deficit countries could abandon the euro and devalue their currencies. This would increase exports and reduce imports in time. Thus the deficit would be cut. But the foreign portion of government debt would increase, and so would the interest on it.
      4. The possibility of a return to the exchange-rate mechanism is most unlikely, but this would lead to adjustments being undertaken in a more orderly fashion, without the major dislocations that are occurring under the euro regime.
      From all this it can be seen that the euro area is divided into surplus and deficit countries. The inclusion of the deficit (weak) economies brings down the value of the euro and creates surpluses in the surplus countries. The inclusion of the surplus (strong) economies increases the value of the euro and creates deficits in the deficit countries.
      It should also be noted that the population of the deficit countries—135 million—is greater than that of the surplus countries—124 million—yet policy seems to be run by and for the surplus countries.

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