Mercantilist arguments in the Union
Pablo Balsinde // 20 February 2017
Over the last few years, prominent economists, think tanks and business newspapers have come to the consensus that Germany’s trade surplus is a problem for both European and non-European economies. Ranging from The Economist to the Centre for European Reform and to Ben Bernanke, they all argue that, by encompassing widely different economies, the common European currency makes German goods artificially cheap and crowds out other European manufacturing, like that of Spain or Italy. They claim that, without the Euro, exchange rates would reflect the higher demand for German goods. Germany’s currency would appreciate, and Southern European currencies would depreciate, reducing the former’s trade surplus and the latter’s trade deficit. However, while partially true, these kinds of arguments effectively rely on zero sum views on trade, are too politically guided and place too much focus on trade balances when, as Adam smith claimed in The Wealth of Nations, “Nothing can be more absurd than this whole doctrine of the balance of trade” (Smith, 1776: Book IV, Chapter 3).
Germany’s current account balance as a percentage of GDP is currently around 8% and constitutes the largest trade surplus out of any major world economy. While Germany’s trade surplus has been significantly increasing since the twin recessions of 2008 and 2011, it has come to be seen as the main cause for the political and economic division between northern and southern Europe. Economists like Yanis Varoufakis, for example, diagnose a “structural” difference between surplus and deficit nations, and pinpoint this perceived distinction as the basis for the region’s economic ills. However, these arguments miss the crucial fact that most of the German surplus comes from trade outside of the European Union (e.g. with China and the U.S.) and the surplus with Eurozone countries has become negligible to the point where the previous argument on exchange rates becomes null.
Former Federal Reserve chairman Ben Bernanke, acknowledges this point, yet he maintains that it is largely irrelevant to his argument because the German surplus displaces other Eurozone exports to third countries, both directly and by making the Euro stronger than it would otherwise be. He argues that the persistent German surplus with the rest of the world appreciates the euro, and consequently crowds out exports from other countries. This claim ignores the fact that the Euro today is at the same level it was in 2003, when Eurozone countries where growing appropriately. Regardless, central to his argument is the claim that the surplus is caused by consumption in Germany not being high enough, which, in turn, is caused by policies that deliberately reduce internal demand, like running a budget surplus and keeping wages artificially low. In early 2014, the Centre for European Reform stressed this latter point, arguing that after a decade of wage restraint (due to deep labour market reforms), the German real exchange rate was strongly undervalued relative to the rest of the Eurozone.
It is true that Germany pushed wages down in the first decade of the century, although it is not clear that there was anything ‘artificial’ about this. Keeping in mind that Germany suffered from chronically high unemployment at the end of the last century, it should become clear that a period of wage restraint is a correction, not a distortion. Moreover, since the recession – which is the period critics are concerned with – OECD data shows that wages increased dramatically by all measures. On top of this, in 2015, the German government instated a minimum wage of €8.50, which is set to rise to €8.84 per hour this year. This is much higher than minimum wages in southern economies.
Either way, it is hard to measure whether the ‘crowding out’ is actually happening. One would have to take into account whether German and Mediterranean exporters compete in the same markets in terms of quality of product and geography of market.
Even though Germany’s surplus is astronomical, and some of the critics’ policy recommendations would be beneficial for the country and therefore the Union (like encouraging capital investment and liberalising start-ups and the services industry), they are misguided in placing too much emphasis on the supposed inherent evil of trade surpluses. Much in the same manner in which Trump sees America’s trade deficit with Mexico as harmful, these critics are guided by the general perception that Germany has utilised the European Union to push forward their neo-mercantilist agenda. If trade surpluses were really what we were worried about, we would discuss the policies of countries that also have significant ones, like the Netherlands or Belgium.
Whilst the accusations against the Germans are to some extent true, they distract us from other countries’ unwillingness to reform their economies. In this respect the difference between Spain and Italy is striking. On the one hand, since the 2011-2012 crisis the Spanish government implemented crucial reforms regarding the labour market and the financial industry that pushed the economy out of the recession. Although these reforms were highly controversial and imperfect, Spain is currently the fastest growing large economy in Europe, and its trade deficit declined by more than 30% last year. At the same time, Italy has struggled to implement structural reforms, and now finds itself constantly in a state of impending crises with very little room for fiscal policy.
The argument could be made that Germany and many other European countries are breaking the Macroeconomic Imbalance Procedure, a European law put in place in 2011 to control risky economic developments, which sets a limit of 6% on the trade surplus any country can have. However, if we hold Germany and the rest of surplus economies to this rule, we would also have to hold the deficit economies (which still includes Spain, for example) to the Maastricht fiscal rules, which limit deficits to 3% of a country’s GDP. This lack of economic rule enforcement shows how politically tied economic relations have become. Although Germany’s trade account is a dynamic we should keep in mind, it should not become a tool for fear mongering against the country, assigning it all the blame and forgetting about the reforms that are necessary in the rest of the Union.