February 19, 2010The elimination of intra-euro-area imbalances implies very high adjustment costs for countries on the euro-area periphery. A change in German philosophy could help ease the transition. If, instead, Germany chooses to maintain the status quo, it may have to get used to periodically bailing weaker nations out.
With Europe’s leaders pledging to stand by Greece—provided it delivers on its fiscal promises—some stability has returned to peripheral euro-area bond markets. But very little has been done to address the fundamental imbalances that led to the upheaval in the first place. The conventional wisdom suggests that the fault for these imbalances lies with Greece and the other peripheral countries. In reality, it is not so simple. Indeed, it is not unreasonable to argue that Germany should accept some responsibility for the current predicament.
Since the introduction of the euro in 1999, the overall current account position of the euro area has never been very far from balance—it has ranged from a surplus of 0.8% of GDP to a deficit of 1.5% of GDP. But these numbers mask major imbalances within the euro area itself.
Digging beneath the surface, we find that Germany was actually running a small current account deficit in 1999 (Display 1). At the same time, the other core euro area countries (Austria, Belgium, France and the Netherlands) were running a modest collective surplus, while the periphery (Greece, Ireland, Italy, Portugal and Spain) was very close to balance.
Things have changed dramatically since then. In particular, there has been a huge deterioration in the combined current account position of the periphery. The counterpart of this has been the emergence of a large German surplus.
How can we explain this? A key factor has been very strong demand growth in the periphery countries, either as a result of credit-fueled housing booms or easy fiscal policy. But this has been exacerbated by developments in Germany, especially the stagnation of consumer spending and the, related, weakness of wage growth.
After a brief spurt of growth around the time the euro was introduced, German consumer spending has grown very slowly (Display 2).The cumulative gain since the first quarter of 2001 has been just 1.6% (equal to 0.2% per annum), depriving the other euro-area countries of support from their most important trading partner.
One reason why consumption has been so weak is that wage growth has been very subdued. Since 2001, compensation per employee has risen by just 7% in Germany, far lower than the 34% rise seen in the rest of the euro area (Display 3). It is worth noting that US compensation has also risen by about 30% over this period, making Germany a clear outlier.
To continue reading, go here. (c) Alliance Bernstein
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