German current balance of payments in the euro area asymmetry

Sottotitolo: 
Merkel's government has never considered the hypothesis of an expansive fiscal policy. However, one can ask why the hypothesis of higher wage growth has not been taken into account.

In 2016, the euro-zone (EZ) had a trade balance of 472.5 billion euro; 50.5% is due to Germany, which has a 29.2% share of GDP. So while EZ the surplus of trade balance is +4.4%, the German figure is 7.6%. German trade balance accounts for more than 90% of the current account balance (8.3% in 2016), well above the 6% limit set by the macroeconomic imbalance procedures. As one can imagine, therefore, since Obama time, in the US there is a critical judgment on the economic policy of EZ, due in large measure to German decisions. A critical judgment which turned, with Trump, into open hostility.

In the nineties, Germany had been in deficit of current account balances due to unification, and this had created a strong concern in the German ruling class. The wage compression policy implemented with the early 2000s had a role in the competitiveness gains compared to the other EZ countries, bringing the balance surplus at levels never before reached.

A recent study by the Institute for Macroeconomic Policy (IMK)  (1) addresses an interesting question , wondering what would happen if between 2001 and 2015 the average wage was 1% higher than the actual one. The answer is that there would have been a reduction in the balance of current account, but the surplus would still be beyond the 6% limit.
More specifically, the highest average wage would have led to a higher level of export prices, hence a certain loss of competitiveness, but this would lead to a higher gains, not less. In fact, the reduction in exported quantities would have been lower than the increase in prices (the elasticity is less than unity), so the overall effect would be, on the export side, that of an increased revenue. On the other hand there would be a certain increase in the volume of imports, so the trade balance would fall, but to a very limited extent (-6.4%).

However, this effect only depends on the change in export-import prices (the relative-price effect). But it must be considered also the effects of the change in the distribution of income, with growth in wages and hence consumption. Not only that, but this leads to an increase in tax revenue, which, being additional revenue, could result in higher public spending, for example, for investments, and in any case there would be a slight improvement in the public budget surplus of three billion. In this case, there would be a greater fall in the current account surplus (-14% in 2015), mainly through an increase in imports; an effect which obviously would benefit other European countries.
Nevertheless, the current account balance would remain at around 7.2% of GDP, well above the 6% limit. So the conclusion of the study is that to further reduce the current account surplus, the fiscal stimulus would have to be significantly stronger, abandoning the target of the German government's budget balance.

Obviously, Merkel's government has never considered the hypothesis of an expansive fiscal policy. However, one can ask why the hypothesis of higher wage growth, such as that assumed by the IMK study, has not been taken into account. Maintaining the level of the public budget, and using only the higher tax revenues, would have result in a greater employment by 3%, higher consumption by 8.4%; not only, but gross profits would have grown 8.5% as a result of GDP growth (+3.7%).

The obvious question that can be asked is why a policy oriented towards greater wage growth, with results in which all parties earn (a win-win case), has not been carried out by German governments. Perhaps because this would have led to a change in the income distribution in favor of the wage earners? It seem to me very hard to believe. In fact, the wage share would have increased, but by a modest extent (2.4%).

The answer is rather to be found in the economic policy lines that all the right-wing formations in Europe have formulated: to focus on exports by squeezing domestic demand, particularly that of public consumption, but also private ones, and liberalize the labor market; The Spanish case is the perfect example. But this kind of policy can succeed in a country (with serious consequences on income distribution), not all over Europe. For some time, both the ECB and the European Commission are questioning the low wage dynamics that could fuel consumption and even inflation, which is still too low. But this is the result of the chosen policies. By changing policies, one would notice that the mystery of missing wage growth could be solved.

 [1]Gustac Horn et. al., The Role of Nominal Wages in Trade and Curren Account surpluses. An econometric analysis for Germany, June 2017

Ruggero Paladini

Economist - Professor of "Scienza delle Finanze" at University "La Sapienza" Roma; Member of the Economic Board of Insight - ruggero.paladini@uniroma1.it

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