“This German-bashing is getting tiresome. When Paul Krugman studied economics, he ranked at the top of his class. If his classmates bashed him for making them look bad by comparison, would he urge them to study harder? Would he give them lessons in how to study more efficiently? Or would he sabotage his own grades and lobby for grade inflation for his classmates?“ (anonymous comment in the NYT)
ItÂ´s time again: Germany is in the dock. It is accused of having too high current account surplus – and not for the first time. The American Ministry of Finance and the IMF denounce, the EU-Commission still wants to investigate. With their continuous surpluses, the Germans were not only like an axe upon the Euro, they also destabilised the world economy – along with the Chinese and Japanese. The charged German firms are unaware of having done anything wrong. They make an effort to make their products internationally competitive. A productivity-oriented wage and collective-bargaining policy and a strong flow of marketable innovations make German firms unpleasant competition on the world markets. They are particularly successful with their investment goods. Here in this country, mercantilist instruments that favour exports and hinder imports are applied not more than anywhere else. With the Euro, Germany has relinquished the instrument prone to manipulation – the exchange rate. No wonder that German employers, trade unionists and politicians now find the world a perplexing place. Should Germany be robbed of the fruits of its hard work by planned economy upper limits for current account surpluses?
Basics of the Balance of Payments
The dispute about balances in current accounts has escalated since the beginning of the Financial and Euro Crisis. Worldwide a few countries – Germany, China, Japan – generate persistent surpluses. In contrast, the USA have been accumulating huge deficits for a long time. This development can also be observed in the Eurozone. The greatest positive balance can be found in Germany, whereas the southern periphery still runs a deep deficit. The fear that the surplus countries live at the expenses of the deficit ones is widely spread. They extracted the demand. In countries who have a deficit in the current account unemployment rose. In fact, the intense discussion about current account balances is more a distribution problem rather than an allocation concerned one. Balances in the current accounts reflect that countries temporarily either export more goods than they import (surpluses) or import more than they export (deficits). In both cases economic actors have to adjust in the medium or long term. On the one hand, the strong industrial basis of the surplus countries with growing welfare erodes; on the other hand, growing financial needs of the deficit countries sooner or later require refinancing. In effect it is about deciding who should bear the costs of this adjustment – the surplus or the deficit countries?
It is hardly expedient to hold this debate about current accounts emotionally. A sober look at the accounts of the balance of payments is more helpful. If all transactions are fully recorded, the balance of payments is always even. This has consequences for the sub-accounts. Current accounts, capital accounts and foreign exchange balances can also be even or else be unbalanced. However, they have to add up to zero. From an accounting point of view, a balance in the current account can be described as follows – if the foreign exchange balance is even:
(Ex – Im) = (S – I) + (T – G).
A surplus of the private savings (S) over the private investments (I) contributes to exports (Ex) exceeding imports (Im), same as a surplus in taxes (T) over the government expenditure (G). Current account surpluses indicate that private households and the government save more than they spend. As the balance of payments has to be even, the capital account will have a deficit. The country is a net creditor against foreign countries. In case of countries with current account deficits it is just the opposite. These countries have to finance deficits in the current account via foreign countries. They get into net debt in foreign countries.
A surplus in a countryÂ´s current account can be accompanied by two utterly different constellations. On the one side, private domestic investments can remain behind private domestic savings. A part of the domestic savings looks for investment opportunities abroad. Surpluses in current accounts and deficits in capital accounts go hand in hand. On the other side, current account surpluses can come along with surpluses in the state budget. This occurs if the government “saves money“. Government expenditure for consumption and investments is lower than tax revenue. The government makes budget surpluses. The opposite case of current account deficits can either be accompanied by domestic investments that are greater than private domestic savings. In this case the country has a surplus in the capital account. Foreign savings finance the deficits in the current account. These savings can originate from private households or other states. Another possibility is the combination of current account and household deficits. Ever since at the beginning of the 1980s such a constellation arose in the USA, the term “twin-deficit“ has been established.
The economic policy dispute about current account balances was prompted by the different interpretations of the various constellations of current account balances, saving and investment balances and household balances. Some, above all the Germans, interpret current account surpluses as a strength of their firmsÂ´ international competitiveness and a relatively “economic“ governmental budgetary policy. Current account deficits are seen as competitive weakness of firms and consumption life “beyond its means“. Current account “commands“, capital account “obeys“. Some others, especially Eugen von Böhm-Bawerk (1914), are of the opinion that capital account “commands“ and current account “obeys“. According to that, capital flows finance not only trade transactions, but also increasingly develop an independent existence. On worldwide strongly integrated capital markets savings search for optimal return of investment of a diversified portfolio. In fact, international capital flows exceed the volume of international trade many times over. Current account does not play a dominant role anymore. Apparently, in times of globalised financial markets it is the capital account who often takes the “commanding“ role.
Problems of Current Account Balances
Regarding the question which sub-account dominates, the answer is not “either or“. In the short term, either current account or capital account might set the tone. Already in the medium term “both“ is the answer. Current and capital account interact. Generally the following applies: identities do not tell you anything about causalities. This is also valid for the sub-accounts of the balance of payments. The development of sub-accounts is not the result of a collective master plan. Millionfold individual consumer, entrepreneur and voter (politicians) decisions are the true drivers. Â Â Â Nationally different preferences regarding price level stability influence a countryÂ´s international competitiveness. A rather strong preference for price level stability generally improves competitiveness. Current account surpluses arise. If society aging varies, increasingly aging countries have a stronger preference for future consumption. They are more likely to invest their savings abroad. Capital account deficits arise. Finally, countries can also differ in their inter-generative preferences. A strong preference for a pleasant life “on tick“ leads to current account deficits and capital account surpluses.
It would be only a matter of chance, if the sub-accounts were even. Balances in the sub-accounts are more the rule than the exception. But in principle, uneven sub-accounts are economically speaking not a problem. This, however, requires flexible relative prices. Exchange rates are important flexible prices. If one lets them develop freely, one does not only see the trees of the successful grow into the sky. They also avoid the economically footsore ones rotting in hell forever. The balance of payments evens out. Sub-account balances are still possible, although they donÂ´t pose insurmountable problems. Difficulties only arise when the mechanism of exchange rates is turned off. This is generally the case in a system of fixed exchange rates or a common currency, like the EMU. Necessary structural adjustments in countries and balances of payments then have to take place through internal appreciation and depreciation. In countries with current account surpluses higher wages and pay scales sooner or later lead almost automatically to increasing unit labour costs. For countries with current account deficits this is harder. In their case, downwards inflexible wages and prices often hinder the process of internal depreciation.
Persistently high bilateral balances in countriesÂ´ current accounts are unimaginable without the existence of the Euro. First, it contributed to their existence, and now it prevents its disappearance. The Euro was involved in the increase of current account surpluses of some countries and the really explosive surge of deficits of others.Â Due to the Euro differences in interest rates between centre and periphery eroded as risk premiums decreased. In the periphery, incentives to indebt increased, whereas the willingness to invest savings there grew. Capital flowed from north to south. Capital accounts in the south reached a surplus; northern ones ended up in deficit. Not only did this initiate a process of strong economic growth in the periphery, but also these countriesÂ´ current accounts went into deeper deficit. Capital accounts pushed current accounts. This development was possible, since politics regards the Euro as a “community of common destiny“ (Schicksalsgemeinschaft). Hence, investors got the indication that in case of doubt, the liability exclusion agreed in Maastricht might not even be worth the paper itÂ´s written on. Risk premiums disappeared; capital flowed from central north to peripheral south. The later trouble of high bilateral balances in current accounts was born.
The Euro also prevents the adjustment of distorted bilateral current account balances of the Euro countries. It becomes the stumbling block of the process of internal depreciation of deficit countries. The hope that the Euro becomes a catalytic converter for flexible relative prices did not come true. The Euro was supposed to build up massive pressure in order to initiate structural reforms. Monetary policy of the ECB focussed strictly on price stability and effective liability exclusion among the members should have forced overdue structural reforms. The way through internal appreciation and depreciation should have been paved. This did not happen. Governments suspended the “no bailout“ clause; the ECB carried out an unrestrained “monetary fiscal policy“. No wonder that structural reforms in countries with current account deficits came to a halt. Gigantic monetary and fiscal rescue packages cement traditional sectoral structures. Current account balances harden. But this is not all. The peripheryÂ´s economic weakness lowers the external value of the Euro. However, this improves international competitiveness of the German economy more than the one of other members. German current account balances keep growing.
Solution of the Problems
The break of the Maastricht Treaty by the governments – community of liability – and the behaviour of the ECB in breach of the Treaty – monetary fiscal policy – further distort the bilateral current account balances. The balances increase social unease and discord in Europe. Deficit countries are concerned that surplus countries “take the bread from their mouth“ regarding demand. This would be detrimental to both economic growth and employment. In contrast, surplus countries fear for their old “business model“. Their mostly export-dependent industrial sectors would lose their dynamic. This would neither be good for economic growth nor for employment. The exciting question remains how this conflict between surplus and deficit countries shall be solved. Who should bear the costs of adjustment? Under consideration are a market economy and a planned economy alternative. By suggesting concrete upper limits for current account balances, the USA, the IMF and the EU-Commission rely on a planned economy approach. Such a strategy should be turned down without any “ifs and buts“. Individual freedom of decision making for consumers, entrepreneurs and voters (politicians) would be eliminated. It would be more appropriate to put market mechanisms of the sub-accountsÂ´ adjustments into force again.
Necessary internal adjustment works via real unit labour costs. This is the way surplus countries take. An increase of employment makes wages and pay scales rise almost automatically, international competitiveness decreases, current account surpluses melt down. This development can be observed in Germany as well. However, price elasticity of demand of German investment goods is rather low. Hence, it will take a while. A lot more challenging is the way via decreasing unit labour costs in deficit countries. Considering the two possibilities “better or cheaper“, in the short term only the latter remains. Nevertheless, nominal wages and commodity prices only decline if they succeed in closing channels through which collective bargainers pass on burdens connected to employment policy on to third parties. Without structural reforms this is not possible. First, the way through shifting to social security systems has to be obstructed. This calls for higher rather than lower age limits. Second, more flexibility has to be introduced on labour markets. Wage agreements closer to firms and less strict dismissal protection are indispensable. Third, governmental debt has to be restricted. Without austerity this cannot be achieved. Members have to comply again with the Maastricht Treaty without any “ifs and buts“. Debt limits can be of help, a community of liability must not exist.
This does not exclude support for deficit countries. With the implementation of the European Stability Mechanism (ESM) the members of the EMU have closed a gap. The “fiscal rescue package“ should serve as “support for balance of payments“. This temporary aid is linked to a contribution on the part of the needy ones. Requested are sustainable austerity measures and comprehensive structural reforms. Despite the right approach, reforms so far have not been sufficient. This particularly applies for the southern periphery including Italy and France. Although unit labour costs there have decreased as well, commodity prices decline very slowly, in fact, until now they did so only in Greece. It is still a long way to go to notable international competitiveness of the problem countries. Nevertheless, a rigorous reform policy stretches to the limits of democratic institutions of these countries. If they are reached, only the possibility to leave the EMU at least temporarily remains.Â This is a long and thorny road. Not only does the accumulated real debt burden in foreign countries remain. Dwindling commodity prices will increase it further. It is also an illusion to think that by using depreciation one could avoid austerity policy and hard structural reforms. Burdens originating from these reforms cannot be financed by third parties anymore, but have to be borne by oneself.
The argument about current account balances is a substantial distribution conflict. Surplus and deficit countries quarrel because both want to pass on the burden of structural change to the respective other one. In Europe, in particular the successful “German business model“ is the one being pilloried. Several things indicate that even in Germany sectoral structures are not undistorted. The export-dependent industrial sector plays a too important role, whereas the services sector a far too small one. This is also due to the fact that services here are still strongly regulated. All parties involved in Europe would benefit from Germany succeeding to regulate the services sector. With less regulative competitive restraints especially for freelance services and network industries one would kill three birds with one stone. First, domestic employment and economic growth would benefit, second, sectoral distortions would be reduced and third, the German high structural current accounts would be equalised. With an accelerated deregulation policy of the third sector, politics can relax the balance of payments crisis in the EMU already in the medium term and clear the way for structural change in the long term towards a knowledge-based economy.
The hectic pace of the EU-Commission shows: ItÂ´s getting serious regarding finances in the EMU. Payday is coming closer. The debate about current account balances forms the scenery. Behind the scenes it is all about who should pay for the outrageously expensive experiment of the Euro. Deficit countries point the finger at surplus countries. Already today fiscal and monetary rescue packages finance a considerable amount of the deficits. This puts taxpayers of surplus countries financially at stake. Deficit countries would like to keep it that way. Surplus countries see it differently. They point at the deficit countries. Those who have lived beyond their means have to take responsibility for it. Surplus countries want to help temporarily only if the deficit countries save money and do their structural homework. Hence, fronts are clear-cut. The majority of deficit countries has been captivated by the abstruse idea of reducing the competitiveness of surplus countries. It wants to kill the goose that lays golden eggs. This planned economy strategy does not solve the distribution conflict. Instead, it makes Europe poorer. It is high time to block this road to serfdom.
Dieser Beitrag ist die englische Version von “Deutschland auf der Anklagebank – Der Euro verzerrt die Leistungsbilanzsalden“, der am 15. November in “Wirtschaftliche Freiheit” erschienen ist. Er wurde von Julia Schreiber übersetzt. Herzlichen Dank!