Trump and Merkel’s latest clash over German trade policy revives a decade-long economic power struggle within Europe. Germany’s export is booming: is it a problem? Should Berlin invest more?
German Chancellor Angela Merkel and U.S. President Donald Trump at their joint press conference in the White House in Washington, D.C, on March 17, 2017. Both look happy. Picture: Wikimedia.
The G7 – a summit of the world superpowers – is generally nothing more than a display of political harmony and big smiles. Rarely anything new is added to the world’s agenda and few problems are ticked off from it.
This was before Donald, of course. The unpredictable American President managed to turn a useless event into a potentially destabilizing one. The picturesque Italian town of Taormina, which hosted this year’s G7, made for the perfect stage for the clash between Trump and German Chancellor Angela Merkel.
The bone of contention was trade policy. The American President reportedly told European Council’s President Tusk: “Look at the millions of cars that they are selling in the United States. It’s horrible. We’ll stop it”. He then added that “Germans are bad. Very bad”. What made them “bad” is their export surplus, which reached eight percent of GDP on February.
This was not the first time the American administration openly criticized Germany’s trade policy. On the 1st of February this year, Peter Navarro, head of the US’s National Trade Council, accused Germany of currency manipulation and of exploiting its trade partners. He called the euro “an implicit Deutsche Mark”, claiming that Germany is unfairly benefitting from a “grossly undervalued” currency.
Although the usual childishly aggressive tone Trump uses in his statements seems to cast some doubts on the validity of his claims, the controversy of the German current account surplus is far from trivial or unfounded. For years, the European Commission, echoed by the former Italian PM Matteo Renzi, has been arguing Germany should reduce its gargantuan surplus and/or start investing more. Moreover, the German surplus is a vivid reminder of the imbalances that led to the Eurozone crisis in 2010.
Before delving into the issue, a brief word about this indicator may be helpful, since it will probably receive some more attention as the protectionist narrative gains traction and the misplaced antagonism between “deficit” and “surplus” countries paves the way for new political instability.
The current account (very) roughly indicates how well a country is doing in the international trade arena. It is computed for each country as the difference between its exports and imports of goods and services, but can also be interpreted as the difference between how much a country (both government and private sector) has invested against how much it has saved. What is important to note is that, the current account is by construction influenced by very different factors. For instance, a deficit might be the result of a country financing productive investment with foreign funds; it may also be the sign of low competitiveness or of weak demand in partner countries.
Deficits and Surpluses: A nightmare from the not-too-distant past
So why is the German current account surplus a problem for the Eurozone? First of all, the roots of the 2011 Eurozone sovereign debt crisis can be traced back to the divergence of current accounts between core (i.e. Germany, France, Netherlands) and periphery countries (i.e. Italy, Spain, Portugal and Greece), so the German surplus is a vivid reminder of the euro debacle. Indeed, the countries that faced the highest social cost during the crisis were all running current account deficits between 2000 and 2008.
It all started with the introduction of the euro, which reduced interest rates differentials between countries after the Maastricht Treaty assured investors of the solidity of the new EMU (Economic and Monetary Union) architecture. Cheap credit from Europe’s core flooded the periphery and was channelled to the non-traded sector of the economy, inflating asset bubbles, as in Spain. As investments in the Mediterranean countries boomed, so did their current account deficits that reached an average of minus 10 per cent in 2007.
All this came to an end when the financial crisis hit and these flows abruptly terminated in what has been defined as a ‘sudden stop’ crisis. Foreign investors stopped lending to periphery’s banks and governments; risk premiums skyrocketed and growth stalled for the following 3 years giving rise to the never-ending Eurocrisis. The fact that Germany’s current account has remained at the same level since then, could indeed be a worrying sign.
Against this view, one might rightly assert that the current situation is not the same as it was five years ago. Periphery countries have closed the gap with the Nordic ones, reaching balanced current accounts or even surpluses. Unfortunately, this happened at the expense of a robust reduction in their domestic demands and employment levels. In other words, without the possibility of devaluing the euro and becoming more attractive, Mediterranean countries simply reduced their imports and production. In Spain the unemployment rate has reached an unsettling 20 per cent, while Italians are now as rich as they were 17 years ago.
The level of social tension in these southern European countries can help explain the IMF’s and EC’s pressure on the German government to reduce its current account through an expansionary fiscal policy. The idea is that if Berlin starts investing instead of lending, Rome and Madrid will benefit as well through increased exports. At the same time, above average German growth would push up the still sluggish EU inflation and steer the periphery away from the spectre of deflation.
Let us imagine that the mighty German Minister of Finances, Wolfgang Schauble, were to decide one day that the times of the balanced budget are over. Would a spike in German public investments be enough to kick-start the Mediterranean countries? I believe there are some reasons why this might not be the case.
A one-off increase in export (following the a hypothetical new German spending) for periphery countries, even if marginally beneficial, could hardly be seen as panacea to the more fundamental problem of the EMU architecture, namely: core and periphery production structures are still very different from each other, with countries such as Spain and Greece that are not keeping up with the pace of technological development.
Moreover, sharing the same currency with Germany, which disproportionately influences European demand (or the lack thereof) and inflation has undoubtedly made things more difficult for southern Europe. However, the primary cause of the high social cost, borne since the financial crisis, is the lack of convergence in production structures since the introduction of the euro. The growth of a developed economy hugely depends on what it is able to produce, which technology it uses and with whom it competes.
If we rank products and countries based on complexity and export share respectively, the north/south divide is clear: among all the periphery countries only Italy appears among the top five exporters of the ninth most complex product, while Germany is the second most complex economy in the world.
More than 20 percent of Spain’, Italy’ and Portugal’s export structure is devoted to low technology manufactures, against the 10 and 12 percent of Germany and France. Productivity gaps between core and periphery remained at high levels, effectively delineating a two-velocity Europe with a single currency. This makes the Union vulnerable to asymmetric responses to trade and financial shocks. Unfortunately, this is a structural problem that an increase in German demand alone cannot solve.
In fact, under certain conditions, further German spending might even be counterproductive. If, for example, Germany were to follow the European Commission’s suggestion of increasing investment on infrastructures and research, then the gap between north and south would only widen further.
To conclude, the real question is how to facilitate technological development in periphery countries. Subscribing to the view, implicit in all protectionist arguments, that trade is a zero-sum game is a non-starter.