Why the anchor dragging down the European economy isn’t Athens -- it’s Berlin.
- By Patrick ChovanecPatrick Chovanec is chief strategist and managing director at Silvercrest Asset Management and is an adjunct professor at Columbia University’s School of International and Public Affairs.
Last year, Germany racked up a record trade surplus of 217 billion euros ($246 billion), second only to China in global export dominance. To some, this made Germany a bright spot in an otherwise anemic eurozone economy — a “growth driver,” as the German finance minister, Wolfgang Schäuble, puts it. In fact, Germany’s chronic trade surpluses lie at the heart of Europe’s problems; far from boosting the global economy, they are dragging it down. The best way to end this perverse situation is for Germany to leave the eurozone.
Germans usually respond to such charges with a kind of hurt confusion. We run trade surpluses, they patiently explain, because we are simply much more competitive than most of our trading partners. Can you blame us, they ask, if the world prefers to buy superior German goods (and has nothing we want in return)? So goes the argument: The rest of the world just needs to up its game, get its house in order, and become a bit more like Germany. In the meantime, don’t hate us ‘cuz we’re beautiful….
Contrary to popular mythology, however, there’s absolutely no reason why being “competitive” should mean running a trade surplus. As far back as 1817, the economist David Ricardo pointed out that the optimal basis for trade is comparative, not absolute, advantage. In other words, even if a country is better at everything, it should export what it is best at and import what it is less better at. Having an across-the-board advantage does not imply that it makes good economic sense to produce everything yourself, much less to sell more than you want in return. Or, to put it a bit differently, there’s no inherent reason why earning more can’t mean spending more, on consuming both public and private goods, as well as investing in future productive capacity.
Trade surpluses take place when a country chooses to spend less than it produces — when it has excess savings, beyond its domestic need for credit. It lends that excess savings abroad, financing another country’s ability to spend more than it produces and, by running a trade deficit, purchase the lender’s excess production. It’s true that a highly productive country might have the wherewithal to conjure up excess savings, while a less productive country might be inclined to borrow rather than scrape up the savings it needs. But fundamentally, trade imbalances arise not from competitive advantage but from choices about how much to save and where that savings should be deployed — at home or abroad.
Does it ever make sense to run trade imbalances? Sure it does. In the 19th century, Britain’s Industrial Revolution enabled it to reap vast earnings from expanded output, some of which it invested in the United States. The money lent to a rapidly growing American economy generated higher returns than it would have back home, while creating a market for British-made goods. The potential productivity gains made it a win-win: It made sense for the Americans to borrow and for the British to lend. But the case also highlights something that’s easy to forget: Running a trade surplus means financing someone else’s trade deficit.
The eurozone crisis is often called a debt crisis. But, in fact, Europe as a whole did not have an external debt problem, but an internal one: German surpluses and mounting debt in Europe’s periphery were two sides of the same coin. Germans saved (a lot), and the single currency induced them — rather than save less or invest it at home — to lend it to their eurozone trading partners, which used the money to buy German goods. By 2007, Germany’s trade surplus had reached 195 billion euros, three-fifths of which came from inside the eurozone. Berlin might call this “thrift,” but it’s hard to argue that Germany’s excess savings, which its banks often struggled to put to use, were well invested. Instead, they gave Germans the illusion of prosperity, trading real work (reflected in GDP) for paper IOUs that might never be repaid.
Something needed to change, but what? Normally, each country would pursue its own monetary policy, relying on exchange rate adjustments to shift the locus of demand from those that could not afford it to those that could. Under a single currency, though, this could not happen. Instead, Europe’s debtors were forced to slash demand, through a combination of fiscal austerity and debt deleveraging. Their trade deficits with Germany fell dramatically — but by buying less, not selling more. All of the so-called PIIGS (Portugal, Ireland, Italy, Greece, and Spain) saw their total trade with Germany shrink — in the case of Greece and Ireland, by more than one-third. So, to the extent Europe rebalanced, it did so at the cost of growth.
The eurozone was caught in a trap. Its countries needed to move in two separate directions, but under a single currency, they could only move in lock step. A Europe that lived within its means meant a Germany that continued to save more than it spent, rather than driving much-needed demand. Monetary easing — and a weaker euro — merely redirects Europe’s internal imbalances outward. Germany’s trade surplus with the United States exploded (up 49 percent from 2007 to 2013), and deficits with China and Japan collapsed (by negative 71 percent and negative 78 percent respectively). Meanwhile, Germany’s trade balance with Brazil and South Korea flipped from deficit to surplus.
Since 2012, virtually all of the eurozone’s net GDP growth, on an annual basis, has come from net exports — further testament to the weakness of domestic European demand as a driver of growth. It’s doubtful, however, whether relying on Americans to pile on more debt — and risk going the way of Greece — is really a reliable strategy. In principle, narrowing Europe’s trade deficit with China makes more sense. But in practice, this has consisted less in tapping China’s mass consumer market than in selling machinery and luxury goods into China’s credit-fueled investment boom, which itself is predicated on maintaining an outsized trade surplus with the United States. The issue isn’t — as it’s so often framed — what’s fair, but what’s sustainable. And Americans playing the world’s consumer of last resort, by borrowing to live beyond their means, isn’t sustainable.
So what should be done? The best solution — and the least likely to be adopted — is for Germany to leave the euro and let a reintroduced Deutsche mark appreciate. Here, the experience of the 1985 Plaza Accord offers some encouragement. While a stronger yen made barely a dent in Japan’s structural trade surplus, German behavior proved far more responsive to the incentives embodied in a stronger mark.
In the past year, German politicians have proved far more willing to try boosting demand by raising the minimum wage, cutting the retirement age, and increasing pensions — moves that may work, but risk harming productivity, which is ultimately the source of Germany’s capacity to consume. Perversely, those same politicians refuse to cut taxes or boost public spending, which in 2014 resulted in Germany posting its first balanced federal budget since 1969, a year earlier than planned. To most Germans, any suggestion that they should relax this fiscal discipline smacks of Greek-style profligacy, but there’s another way to think about it. The excess savings are already there; the only question is where to lend it all. Borrowing it domestically to drive a genuine European recovery might be preferable to (once again) throwing it at foreigners to buy things they really can’t afford.
With an aging population, perhaps it’s understandable why Germans want to save. But there is no inherent reason to direct that savings abroad when there is a far more crying need to deploy it at home. The “growth” Germany generates by funding unsustainable trade imbalances — inside and outside the eurozone — is an illusion. It is growth that is borrowed, for only a while. For Germany, and for the world, it’s a bad trade.
Photo credit: TOBIAS SCHWARZ/AFP/Getty Images
*Correction, Feb. 20, 2015: The Plaza Accord was signed in 1985. An earlier version of this article mistakenly said the year was 1986.