Why doesn’t Europe have a large trade deficit? (Part 2)
The first rule of this game is that you’re not allowed to answer, “Because Europe has a high savings rate.” The whole point of Paul Krugman’s post to which I linked in Part 1 (as well as this 1995 Krugman piece to which he links therein) is that there has to be some mechanism by which a higher savings rate leads to a smaller trade deficit (or a surplus). The usual mechanism is the exchange rate, but in this case, the dollar has not appreciated against the euro. (It has depreciated in nominal terms and probably mildly depreciated in real terms also.) You can’t just say that when people save more, they buy fewer imports: if this were the only mechanism, then an increased savings rate would necessarily lead to a huge recession, because people would also buy fewer domestic products. Once the central bank and the financial markets make the necessary adjustments to avoid that recession, they increase the demand for imports again, and we’re back where we started. Unless something else – such as the value of the currency – changes.
I’m somewhat disappointed that I haven’t yet seen an answer that is both convincing and conventional. Apparently, there is no easy story that explains the divergence in trade balances between the US and Europe. (When I say Europe, BTW, I mean the Euro Zone – since I’m speaking with reference to exchange rates. Steve Waldman points out that there is diversity within the Euro Zone, with Germany running a surplus and most of the others running deficits. At a pinch, I’ll make this whole discussion about Germany and say, “Why does Germany still have a trade surplus?”)
There were a couple of interesting unconventional answers that involve complementarity. Karl Smith (in a comment that he develops more fully on his own blog) suggests a complementarity between Asian production and US distribution. In this story, the major cause of the US trade deficit is what might be called the “Wal-Mart effect.” Imports have become cheap to buy in the US, not so much because they have become cheap to produce in Asia, but because US retailers have learned to operate on thinner margins. European retailers, on the other hand, have not.
A couple of people hinted at another possible complementarity: between European (i.e., German) exports and the Asian production process. If the Asian (Chinese) investment boom has created a specific demand for European (German) capital goods, then the resulting export demand could outweigh the effect of euro’s appreciation. It’s not entirely clear to me why it wouldn’t also create a demand for (presumably cheaper) US capital goods, but then I know very little about the details, so perhaps US capital goods just aren’t the kind that China needs.
Some people suggested various things, such as European protectionism and the VAT, that might help explain why Europe has in general had a stronger trade balance than the US, but as far as I can tell, they don’t explain why the US has developed a trade deficit over the past decade and Europe hasn’t. The VAT was there a decade ago, when the euro was weaker and Asia was less productive, so why didn’t Europe have a large trade surplus at that time?
Gabriel M. asks why it all matters. He wants the answer to boil down to welfare. Steve Waldman gives an answer which may help satisfy Gabriel. As for me, I don’t have an answer that boils down to welfare, because in this case I’m one of the agents trying to form my own expectations about exchange rates. The observation that the US is importing a lot more than it is exporting, and the presumed unwillingness of people outside the US to keep sending goods to the US without eventually receiving something in exchange, suggests to me that the dollar is overvalued. The fact that a similar argument cannot be made for Europe suggests that the euro is undervalued against the dollar. But I’m troubled because there is a piece of the puzzle that doesn’t seem to fit.
I’m somewhat disappointed that I haven’t yet seen an answer that is both convincing and conventional. Apparently, there is no easy story that explains the divergence in trade balances between the US and Europe. (When I say Europe, BTW, I mean the Euro Zone – since I’m speaking with reference to exchange rates. Steve Waldman points out that there is diversity within the Euro Zone, with Germany running a surplus and most of the others running deficits. At a pinch, I’ll make this whole discussion about Germany and say, “Why does Germany still have a trade surplus?”)
There were a couple of interesting unconventional answers that involve complementarity. Karl Smith (in a comment that he develops more fully on his own blog) suggests a complementarity between Asian production and US distribution. In this story, the major cause of the US trade deficit is what might be called the “Wal-Mart effect.” Imports have become cheap to buy in the US, not so much because they have become cheap to produce in Asia, but because US retailers have learned to operate on thinner margins. European retailers, on the other hand, have not.
A couple of people hinted at another possible complementarity: between European (i.e., German) exports and the Asian production process. If the Asian (Chinese) investment boom has created a specific demand for European (German) capital goods, then the resulting export demand could outweigh the effect of euro’s appreciation. It’s not entirely clear to me why it wouldn’t also create a demand for (presumably cheaper) US capital goods, but then I know very little about the details, so perhaps US capital goods just aren’t the kind that China needs.
Some people suggested various things, such as European protectionism and the VAT, that might help explain why Europe has in general had a stronger trade balance than the US, but as far as I can tell, they don’t explain why the US has developed a trade deficit over the past decade and Europe hasn’t. The VAT was there a decade ago, when the euro was weaker and Asia was less productive, so why didn’t Europe have a large trade surplus at that time?
Gabriel M. asks why it all matters. He wants the answer to boil down to welfare. Steve Waldman gives an answer which may help satisfy Gabriel. As for me, I don’t have an answer that boils down to welfare, because in this case I’m one of the agents trying to form my own expectations about exchange rates. The observation that the US is importing a lot more than it is exporting, and the presumed unwillingness of people outside the US to keep sending goods to the US without eventually receiving something in exchange, suggests to me that the dollar is overvalued. The fact that a similar argument cannot be made for Europe suggests that the euro is undervalued against the dollar. But I’m troubled because there is a piece of the puzzle that doesn’t seem to fit.
Labels: China, economics, exchange rates, international trade, macroeconomics, productivity, US economic outlook
posted by knzn at 11/15/2007 05:37:00 PM
6 Comments:
Some of the mystery comes from looking at aggregate figures and making the tacit assumption that they are enough to determine behaviour when further thought would make it clear that different industries will respond to changes differently.
So what are the differences? It doesn't have to be only one thing.
Productivity growth figures tend to be calculated in local currency terms and compared either directly or in PPP terms which might well miss important compositional developments so getting 2% better at making machine tools might be more important for trade than being 3% more efficient at running retail outlets.
I don't think that VAT is so very different to sales tax and the US is not manifestly less protectionist than the EU. BMW, for example, must pay penalties for the failure to meet the CAFE standards yet remains a major exporter to the US. More compelling is higher tax on oil so consumption and therefore imports have been lower.
The EU is also less centralised than the US so individual states must each attempt to balance their books. Effectively each of the 27 states must live with the same constraints as the US as a whole so assuming the US is pushing the envelope only a few states in the EU will be in the same boat and aggregate imbalances should be lower.
There has also been considerable indirect labour cost flexibility obtained through the admission of new member states -- in effect it can be as efficient to import Romanian labour as it would be to import goods from China. US hostility to Mexicans might dampen this effect or the US might have played the same trump earlier.
Finally, the European market is much more fragmented than the US so even without considering different tax rates and the like, institutions are smaller and therefore may not have economies of scale available to them which would lessen the advantages of importing or outsourcing and lead to slower uptake and lower deficits.
Knzn, I don't think I have an "answer," but I think you're on the right track looking at the *mix* of imports and exports. And I don't mean it's just a measurement problem. I would start with the excellent Worldmapper maps of financial imports and exports vs real goods and vs royalties imports and exports. I don't know how to draw conclusions, except that Europe's and America's exports are mostly intangible (financial and royalties) and Asia is mostly "real goods." Also compare the size of agricultural exports by region under the "Food" tab -- perhaps European and US subsidies
have something to do with it.
Link:
http://www.worldmapper.org/textindex/text_services.html
Let me suggest a related question that might open up a productive line of inquiry: Why is it that China has to accumulate large quantities of dollar assets to preserve the USD-RMB exchange rate, but doesn't need to accumulate large holdings of Euro denominated assets to keep the RMB from appreciating drastically against the Euro?
Answer that and I think the answer to the other question will become clear.
Okay, let´s try an answer.
Since I am a German, let´s consider Germany. Maybe justified since it´s the biggest Eurozone economy and the largest Eurozone export nation.
If I want to describe the situation of Germany in the last few years, I´d say:
Strong exports but pretty stagnant domestic market/consumer spending. I´m pretty sure that if German consumer spending would be more like French, British or American consumer spending, the Eurozone would have a large trade deficit.
Now why is consumer spending in Germany flat?
Several reasons according to German economists:
1) The aftereffects of German reunification in late 1990 and the entry of an overvalued Deutschmark into the Euro weakened German companies. As a result wages were pretty stagnant for years on end. Not to mention that unemployment did rise significantly.
2) Rising unemployment led to higher federal budget deficits. Which led to reforms lowering unemployment benefits.
3) Take 1) and 2) and people were/are unsure about the future. Couple that with offical advise about why people should save more money because the German "social security benefits" will have to be lowered/stay flat somewhat in the future. Which led to a household savings rate of 10+%.
4) Oh, and Germany didn´t have a housing boom. Denying German consumers another chance of feeling rich. :)
5) German companies regained their competitiveness in the early 2000s. Unemployment rates though only went down in 2005/2006.
6) At which point our politicians raised the VAT from 16% to 19% (January 1, 2007). Not to mention reducing tax benefits for first home owners plus reducing some other tax benefits. To balance the budget, you understand.
(To be fair, they made their plans in 2005. When the budget deficit was still around 3% of GDP. I blame them for not changing their plans during 2006).
In short, you´ll see a German export economy highly competitive (according to some studies production costs per unit actually went down in Germany) while the German consumer is still feeling insecure. The current high price of oil, food and the disturbing financial news aren´t helping. :)
P.S. I looked at some Eurostat statistics (exports to countries outside the EU up to 2005). All of the large Eurozone countries have (varying) trade deficits with Norway and Russia (oil and natural gas), China and Japan. Unlike other Eurozone countries back then, Germany did have a large trade surplus with the USA and even a small trade surplus with OPEC countries.
Summary:
Europe/the Eurozone got one large country with a highly competitive export economy. And at the same time, consumer spending in that country is stagnant. So trade surpluses in that country (Germany) are rising, balancing somewhat the trade deficits of other Eurozone countries.
detlef1961, I think you're violating my rule #1. To say that Germany has weak consumer spending is essentially equivalent to saying that it has a high savings rate. But there's no immaculate transfer that goes from a high savings rate to a trade surplus. Normally, a high savings rate results in a trade surplus because it weakens the currency (as the central bank must keep interest rates low, and thereby keep the currency unattractive, in order to generate enough aggregate demand to compensate for the weak consumer spending and prevent a recession). But the German currency (the euro) doesn't seem to be weak (particularly not when compared to the recent past).
The inmaculate transfer from a higher spending rate into higher exports does exist. Just suppose you are an entrepreneur in a low-consuming country. Where would you be likely to invest, in export-generating activity (machinery for China and luxury products for the Middle East) or in the domestic market? That's what happened to Germany.
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