EU Economy
Germany in Eurozone benefits from consistent surpluses greater than China in proportion to GDP
By Michael Hennigan, Founder and Editor of Finfacts
Mar 11, 2011 - 8:43 AM

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Germany is in a position to secure for its economy consistent trade surpluses, greater even than those of China in proportion to GDP (gross domestic product), without the limitations of a compensatory mechanism working through currency appreciation, according to Domenico Lombardi, an economist at the Washington DC think-tank, the Brookings Institution.

The economist in a blog post on Thursday, said thanks to the imbalance, Germany has amplified the benefits for its economy following the introduction of the common currency. Never has this asymmetry been clearer than at the height of the euro crisis witnessed last year. The German economy benefitted from a hidden export subsidy as a result of a weaker euro.

Lombardi said as a result, the current fiscal consolidation in Europe will produce asymmetric effects. Germany is already compensating for the sustained decline in demand from its traditional commercial partners in the peripheral Eurozone by increasing its presence in emerging economies outside of Europe, while benefiting from the lack of a compensatory mechanism working through currency appreciation.

On the other hand, the economist says it is difficult for peripheral countries of the Eurozone to compensate for the reduction in internal demand with an increase in external demand: the capacity of these economies to penetrate emerging markets is much more limited. Their exports tend to be more similar in terms of technological content, which is relatively low, and the euro exchange rate, which is more onerous for these countries thanks to the Northern economies of the monetary union, represents an additional hardship. In this scenario, the refusal of the German economy to act as driver for the economic recovery of a crisis-struck Europe is especially problematic.

Looking forward, Lombardi says the Eurozone as a whole, including its "peripheral" economies, should ask: “what role will it play for itself and for the global economy in the years to come?” Will the Eurozone be a deflationary force or a supporting driver for global economic growth? He says this is a not-too-veiled concern that was presumably discussed by U.S. Treasury Secretary Timothy Geithner during his visit to Berlin earlier this week.

A paper, Trade Imbalances – Causes, Consequences and Policy Measures: Ifo’s Statement for the Camdessus Commission (pdf), published by the German Ifo institute for economic research at the University of Munich, with its president Prof. Hans Werner-Sinn among its authors, says  the low rate of income growth in the early years of the last decade, dampened German imports, while low prices stimulated German exports, both translating into a huge current account surplus.

Thus, Germany’s current account surplus resulted from the country’s weakness rather than being a sign of particular strength, as has sometimes been argued.

In the past few years, Germany was the world’s second-largest capital exporter after China. From 2002 to 2010, Germany had exported two thirds of its aggregate savings, some €1.05trn in total.

Only one-third was invested at home in factories, equipment, construction, roads, public buildings and the like. In recent years German net capital exports peaked just below €200bn annually.

The authors say intra-European capital flows could have been mitigated, had German banks shown more prudent investment behaviour. After all, four-fifths of German net capital exports were in the form of financial capital flows rather than direct investment. However, for various reasons, these banks shut their eyes to the potential sovereign state risk. One of these reasons was that they expected their clients to be bailed out by the community of states should a particular European state run into trouble. Another was a deficiency in the Basel system, under which banks did not have to impose any risk weights on government bonds and thus did not need equity against holding such bonds.

In fact, the Basel system had virtually imposed no constraints on banks lending to governments. This was a major reason why capital flows had been so excessive in Europe in recent years and why the European sovereign debt crisis eventually had to erupt.

Debt Sustainability

This week, we reported that the Irish debt to GDP ratio will rise to 113.5% in 2013 and much higher if the denominator is GNP.

Richest EU countries have the highest taxes; Irish tax burden will be as high as Denmark's by 2014

Irish National Debt: Public spending was 57.3% of GNP in 2009; Deficits in 2008-2013 will amount to €95bn

Ireland: GDP or GNP? Which is the better measure of economic performance?

On Thursday in Washington DC, Prof. Carmen M. Reinhart, of the Peterson Institute for International Economics, gave testimony to a House panel on the US debt crisis.

The economist is the co-author of the celebrated book on eight centuries of financial crises, This Time is Different.

Prof. Reinhart said that  in a paper written over a year ago with her c-oauthor Ken Rogoff from Harvard University, they examined the contemporaneous connection between debt and growth. She summarized some of the main findings of that paper and as well as recent related work and relevant studies from the International Monetary Fund (IMF) and European Central Bank (ECB).

"Our analysis was based on newly-compiled data on 44 countries spanning about 200 years. This amounts to 3,700 annual observations and covers a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances. The annual observations were grouped into four categories, according to the ratio of gross central government debt to GDP during that particular year: years when debt-to-GDP levels were below 30%; 30 to 60%; 60 to 90%; and above 90%. Recent observations in that top bracket come from Belgium, Greece, Italy, and Japan.

The main finding of that study is that the relationship between government debt and real GDP growth is weak for debt-to-GDP ratios below 90% of GDP. Above the threshold of 90%, however, median growth rates fall by 1%, and average growth falls considerably more. The threshold for public debt is similar in advanced and emerging economies and applies to both the post World War II period and as far back as the data permit (often well into the 1800s)."


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