Northern Europe’s Drag on the World Economy

The difference, it was argued, was monetary union. So long as the eurozone as a whole was relatively balanced, Germany’s surpluses were considered irrelevant – just as, say, Texas’s surpluses have never been considered an issue in the United States. Chinese surpluses, by contrast, were seen as a cause of global imbalances.

This argument is correct in the sense that it is the current-account surplus or deficit of a monetary union as a whole that can be expected to have exchange-rate implications. And, unlike China, Germany no longer has a “national” exchange rate that can adjust in response to its current-account surplus. These factors – together with the lack of trade data for regions within countries – have led economists only rarely to consider countries’ internal surpluses or deficits.

But, in net terms, a region within a country – or, like Germany, a country or sub-region within a monetary union – still “subtracts” from national and global aggregate demand if it exports more than it imports. Witness how expenditure cuts by US state governments – many of which are constitutionally required to balance their budgets – frustrated, to some degree, America’s massive federal-government stimulus in 2010-2011.

For this reason, it is relevant to ask whether a country as large as Germany – or even a large state like California or Texas – augments or depletes global aggregate demand. (In fact, as sovereign countries, California and Texas would have been the world’s 12th and 14th largest economies, respectively, in 2012 – ahead of the Netherlands, Mexico, and South Korea.)

That question is all the more important, because the Netherlands and Austria, two of Germany’s Northern European eurozone neighbors, continue to run current-account surpluses, while the Southern European crisis countries have reversed their previously large deficits, as austerity has squeezed domestic demand and made room for an increase in exports. As a result, the eurozone as a whole will produce a surplus close to $260 billion this year, which represents a new global imbalance that is more directly comparable to China’s in the past decade.

Europe’s non-eurozone surplus countries – Sweden, Denmark, Switzerland, and Norway (all of which tie their exchange rates to the euro to some degree) – magnify this global imbalance. Northern Europe – including these four countries and Germany, the Netherlands, and Austria – is running a massive current-account surplus of about $550 billion. Meanwhile, China’s surplus is unlikely to exceed $150 billion this year. In fact, the highest level that China’s annual surplus has ever reached was around $400 billion in 2007-2008 – when the US was poised to introduce trade sanctions against the country, because it viewed this imbalance as a threat to the stability of the US and the world economy.

What is most problematic about the eurozone’s situation is that unemployment in some of the crisis countries – Spain and Greece – remains above 20%. These countries are trying to achieve a difficult “internal devaluation” – that is, a reduction in their domestic unit labor costs relative to the eurozone’s stronger economies – while the overall eurozone surplus caused by Northern Europe puts upward pressure on the exchange rate, undermining their competitiveness outside the monetary union.

Spain and Greece have managed to achieve an internal devaluation of about 5% this year vis-À-vis Germany, but their competitiveness vis-À-vis the US and dollar-linked countries has not improved, because the euro has appreciated by more than 5% against the dollar. And, indeed, the euro should appreciate, because the eurozone as a whole is now running a large current-account surplus.

One can only pity the Southern European countries. They should almost thank the French for their inability to impose effective austerity measures and thereby still run a small current-account deficit, which has prevented the eurozone surplus from becoming even larger.

But an abundance of pity alone will not help. Northern European countries, which have ample room to increase wages and implement expansionary policies, must do so. This would directly benefit Northern European citizens themselves, while helping to keep the euro down and stimulate growth and adjustment in Southern Europe and the global economy as a whole.