Why doesn’t Europe have a large trade deficit?
Paul Krugman (hat tip: Greg Mankiw) points out that, for national savings (and investment) to affect the trade balance, it first has to affect the exchange rate. (In particular, if the US had a higher savings rate, the trade deficit wouldn’t fall unless the dollar depreciated further, so it is absurd to blame the weak dollar on the low savings rate.) One of the implications of this realization is that one can talk about the immediate causes of trade imbalances without mentioning national savings or investment: the cause has to be either in the (real) exchange rate or in the business cycle.
In terms of exchange rates, it’s pretty easy to see why the US has a large trade deficit today. (For now I’ll leave out the oil issue, though that’s part of the explanation.) The Asian countries (and China in particular) have become dramatically more productive over the past decade. Therefore their prices for traded goods have fallen dramatically, but they have not allowed their currencies to appreciate commensurately. Consequently, the dollar is overvalued (in real terms) relative to those currencies today. Ergo, the US has a trade deficit.
OK, so far it makes sense, but wait a minute: productivity growth in Europe has not been much faster than productivity growth in the US over the past decade. Prices of traded goods produced in Europe have not fallen. The euro has not, on balance, depreciated against the dollar. And Europe didn’t have a huge surplus with the US a decade ago (despite the booming US economy at the time). So if Asian goods are cheap today relative to US goods, then Asian goods must also be cheap relative to European goods. So why doesn’t Europe have a large trade deficit like the US?
If I get a chance, I’m going to download actual data on trade balances and exchange rates and see if I can figure this out. For now, though, it’s a puzzle. And it makes me wonder if we should start to get really worried about Europe’s trade balance now that the euro has appreciated dramatically against the dollar.
In terms of exchange rates, it’s pretty easy to see why the US has a large trade deficit today. (For now I’ll leave out the oil issue, though that’s part of the explanation.) The Asian countries (and China in particular) have become dramatically more productive over the past decade. Therefore their prices for traded goods have fallen dramatically, but they have not allowed their currencies to appreciate commensurately. Consequently, the dollar is overvalued (in real terms) relative to those currencies today. Ergo, the US has a trade deficit.
OK, so far it makes sense, but wait a minute: productivity growth in Europe has not been much faster than productivity growth in the US over the past decade. Prices of traded goods produced in Europe have not fallen. The euro has not, on balance, depreciated against the dollar. And Europe didn’t have a huge surplus with the US a decade ago (despite the booming US economy at the time). So if Asian goods are cheap today relative to US goods, then Asian goods must also be cheap relative to European goods. So why doesn’t Europe have a large trade deficit like the US?
If I get a chance, I’m going to download actual data on trade balances and exchange rates and see if I can figure this out. For now, though, it’s a puzzle. And it makes me wonder if we should start to get really worried about Europe’s trade balance now that the euro has appreciated dramatically against the dollar.
Labels: China, economics, exchange rates, international trade, macroeconomics, productivity, US economic outlook
posted by knzn at 11/11/2007 05:54:00 PM
19 Comments:
This suggests one obvious place to look. There's no indication that it is sustainable of course. You could ask the same question about Japan.
OK... for the sake of those in the audience who are a bit "slow", like me... Why should we care, again?What is this "trade balance" you speak of and why should I care? Because of the expected "correction" (whatever that is, again)? But if it's expected, as much as a random walk with drift can be, why worry? And please, no metaphors. Could we have this boil down to welfare?
knzn -- Europe does have a large and growing trade deficit. It is just masked by selection bias (the Eurozone is not Europe), and by one extraordinary large economy, Germany.
Take a look at the IMF's World Economic Outlook, Statistical Appendix. It's not as detailed as you might like, but you can put the pieces together. In Table A11, you can see that the Eurozone is expected to run a small very small current account deficit this year, 0.2% of GDP. So, no problem, right?
But, break things down a bit. Germany's running a surplus of 5.4% of GDP. Germany is 26% of Eurozone GDP, implying a CAD of about 2.2% for the Eurozone-without-Germany. Although there are several smaller surplus countries (go Luxemborg!), the big Eurozone economies besides Germany are all in the red, with Spain expected to run an extraordinary 9.8% of GDP 2007 CAD. Britain is very much "old industrialized Europe", but is not Eurozone. It's running a 3.5% current account deficit. If it were included with the Eurozone, the whole Eurozone est'd 2007 deficit would be about 0.08% GDP, or "old industrialized Europe ex-Germany" would be running a CAD of 2.5% GDP. Throw in emerging Europe, and the picture gets still worse. Eurozone+UK+Emerging Europe is expected to run a CAD of 1.8% of GDP. Ex-Germany, the aggregate CAD would be 3.4% of GDP. (Emerging Europe is particularly vulnerable, with an aggregate expected CAD of 7.3%.)
All of these are unverified quick calculations from data in Tables A11 and A12 (pp. 31-33) with weights taken from Table A (p. 7) of the WEO statistical abstract. (Please do double-check 'em.)
Whether or not it's reasonable to consider Europe-ex-Germany for some purposes is arguable. Certainly China ex-coastal-regions would probably be running a current account deficit as well. But, the nations of Europe are still distinct, labor mobility, while easier than the past is still limited and costly for most Europeans, and the political disunity of the continent combined with democratic politics and a shared currency (within the Eurozone) may put Europe in an awkward position if policy choices appropriate for Germany diverge greatly from those desired by the other economies. Rest-of-continent in deficit and Germany in surplus is a very different circumstance than a "balanced Europe".
Gabriel -- Perhaps in a more perfect world, macro wouldn't matter, and nations would be utterly superfluous in a seamless network of individuals and firms. But, empirically, there are such thing as national (and regional) economies, fluctuations of activity do tend to correlate within those groupings, and ones physical location relative to those fluctuations has a great deal of relevance to any individual's welfare.
As far as I know, in all models of international trade (all models of trade at any level and between any sorts of entities, however arbitrarily defined, really), trade must eventually balance. If a grouping is consistently importing more than it exports, at some point it will have to adjust. If that adjustment is gradual, there may be few welfare costs. But if that adjustment is sharp, well, ask citizens of many Asian countries about the change in welfare they experienced about a decade ago, when the persistent trade deficits of that region suddenly corrected.
In a world with clustering effects and few constraints on the movement of capital, adjustments are particularly likely to be sharp and painful. (Clustering effects imply that economies gain from specializing beyond what would be implied by fixed comparative advantage, so that economies dependent upon imports will be structurally ill-suited to retool quickly into tradables production. Free movement of capital means that groups that easily borrow to consume one day may find themselves unable to finance a meal on the next.)
Does this make sense? If you want to make a stochastic process of all this, it's not random walk with drift, it's random walk with mean reversion to trend. (Of course the walk isn't random to begin with, it's policy driven, but observing from outer space you might model it as random.) Mean reversion, in this case, can be painful. Better to stay close to the mean, or in the lingo, to avoid large imbalances (unless those imbalances are with high probability being used to prepare for the inevitable mean reversion via investment in future tradables capacity).
Simple explanation: The EU is far more protectionist than you (appear to) realize.
Trade and Exchange Rates:
I think Krugman is right to point out that trade balances are not corrected by immaculate transfer but I am not sure he is correct that exchange rates must be the driving force.
First, and most obviously are relative price movements. Suppose for example in our case that US produces chotchkes using manufactured goods from Asia and domestic retail.
Suppose that the price of domestic retail collapses. All else held equal the demand for Asian manufactured goods will rise.
Suppose instead in Europe the relative price of retail is kept high by a combination of labor laws and old infrastructure. The demand for Asian manufactured goods would be lower.
The key difference in these cases is not what happened to exchange rate but to domestic production that was complimentary to imports.
As a side note there is also the possibility that the US deficit could close without the size of exchange rate some are anticipating if the Engle curve tilts away from imports.
So suppose that Asian imports are rising quickly as a fraction of the chotchske feedstock, but chotchskes are declining as a percentage of consumption. There will be a turn around point where the deficit begins to retract even without an exchange rate movement.
From a recent press release:
"Through the first eight months of this year, the trade deficit is running at an annual rate of $708 billion, down 6.7 percent from last year's imbalance of $758.5 billion, which had been the fifth consecutive record deficit."
Compare to:
Pie Chart
"Current military includes Dept. of Defense ($585 billion), the military portion from other departments ($122 billion), and an unbudgeted estimate of supplemental appropriations ($20 billion). “Past military” represents veterans’ benefits plus 80% of the interest on the debt."
If we didn't spend vast amounts of money blowing things up or building things to blow things up we might either be able to fund needed social programs or keep debt down to levels required by economic expansion investment.
I am glad I found this site because I have some really basic questions about this subject matter:
1. Isn't it better to have a cheap currency? You get to export more and bring in more money. A cheap currency hurts if you travel outside the country, but on the other hand, you have more money to spend because you export more.
2. Why has the US followed a strong dollar policy? It seems Japan has had the right idea by keeping their currency cheap.
To be honest, I am a molecular biologist, not an economist, and I don't really understand what is going on. It seems like currencies are like the weather, you adjust what you are going to do that day, but you still continue life as normal. If you have an expensive currency you move money around. If you have a cheap currency, you manufacture and export. I prefer the security that making things provides. For instance, if a really big war or other event happens I would rather be an arsenal than a bank; the US rather than Luxemborg.
Can someone answer my questions?
I have to concur with jwalker. Europe is a bunch of trade isolationists. They don't let citizens choose whether Chinese products are of a high enough quality to purchase, the governments tell their citizens what is good for them and what is not.
If European's were as selfless as they proclaim to be, they'd lift tariffs on food and let Africa rise out of misery. But alas, Europeans are selfish Marxists.
VAT
It changes the effective exchange rate. A country that relied 100% on VAT taxes imports but not exports. A country that relied 100% on income taxes taxes exports but not imports. I have said this over and over but nobody takes any notice.
From steve waldman's first post, it seems the question should be "Why doesn't Germany have a large trade deficit?"
From Morgan Stanley last year, "productivity in Germany has been running at about a 1.7% y-o-y clip over the five quarters ending in 2Q06. While that pales in comparison to a much more vigorous US productivity revival, it does represent a marked acceleration from the anemic 0.7% annualized German productivity trend evident over the 1998 to 2004 period." True, German is the powerhouse of Europe, but productivity growth doesn't seem to be the answer.
Perhaps it is protectionism, either explicitly in policy or implicitly via consumer selection bias. If it is the latter, I would expect the Eurozone deficit to grow as the quality of Chinese imports improves.
-z-
Zoltan...
Why do you think that economy wide productivity measures (hairy as they are) are relevant. All that is relevant is unit labour cost in the tradables sector.
I'll have to think about all this, but one thing I should note: I don't think protectionism (or the VAT) is a sufficient explanation, unless it has changed significantly over the past decade. The question isn't really, "Why hasn't Europe had a large trade deficit in general?" but "Why hasn't Europe (or Germany, in particular) developed a large trade deficit over the past decade, as the currency has had a real appreciation vs. Asian currencies?"
knzn,
Well, traditionally Germany is an export nation. Just remember who invented the "Made in Germany" trademark in the late 19th century. :)
And that´s true not only for big companies but for middle-size companies too.
More to the point though...
Look at what we export:
% of exports in 2006
18.6% cars and car parts
14.6% machinery and equipment
13.4% chemical products
Followed by
steel/ metals including parts and
equipment for power generation. Accounting for roughly another 15%.
(All according to the German Statistical Office).
Add medical equipment, electronics, food, rubber and plastics (in this order) and you´ve got pretty much all the main export branches of Germany.
All of these are products you can sell during a booming world economy. Think factory equipment for China for example.
If you´ve got a reputation for quality and reliability you might even be able to justify somewhat higher prices...
Falling unit labour costs (i.e. relative inflation), high savings rates?
If you take the point of view that the trade deficit is driven by the domestic savings-investment gap it is very simple why the US has a large trade deficit and Europe has a surplus. The US trade deficit is a reflection of the US needs to imports large volumes of foreign savings to fill the domestic savings-investment gap while Europe has a savings-investment surplus and exports capital. If this is the fundamental driving force and all the other economic variables adjust to accommodate this determinate it is obvious why the US has a deficit and Europe does not.
You can't answer the question by looking at differences in savings rates, because that's where the discussion began. (In particular, see Paul Krugman's post to which I link above, as well as this piece of his from 1995, to which he links.) There is no "immaculate transfer": the differences in savings rates would have to affect some other variable(s), which would in turn affect the trade deficit. Usually, the other variable that economists identify is the exchange rate. However, it does not appear that the dollar has appreciated (even in real terms) against the euro. The question I'm trying to ask is, "What is the other variable in this case?"
Germany primarily exports high quality high cost products specilized equipment, autos turbines and medical equipment. However a weaker dollar should hit Germany's exports. It takes only a few jets to swing the balance of trade.
this is right good analysis
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