The European Council on Foreign Relations

€ view: good and bad news on current account imbalances

Date: 17th April 2012  |  Author: Sebastian Dullien,

Categories: € View,
Tags: debt , debt, greece, spain, unemployment, euro crisis

I spent the second half of last week at the conference of the Institute for New Economic Thinking (INET) in Berlin. The central policy topic was – of course – again the euro-crisis. While the vast majority of speakers agreed that the crisis was much more than a simple fiscal solvency crisis (in contrast to what sometimes has been discussed in some German media), there was disagreement on the question how the underlying balance-of-payment crisis could be solved. Interestingly, there were already vastly different claims on what really is going on at the moment in terms of adjustment in the euro periphery. While one speaker claimed that “unit labour costs in Spain continue to rise more quickly than in Germany” another speaker claimed that “in the 2.5 years since the onset of the crisis, Spain has regained already a third of the competitiveness lost in the decade before”.

In fact, the question of balance-of-payment adjustment is central to the future of the euro zone, possibly more important than a few basis points in spreads between German bunds and Spanish or Italian bonds. Only if imbalances in the current account and in competitiveness eventually adjust back to equilibrium, can the euro can survive. Otherwise, the euro area would need large and permanent transfers from the normally growing North to a South with structurally high unemployment in the magnitude of several hundred billions euro per year. While we have seen such a transfer dependence in East Germany over the past 20 years, it probably would not be sustainable at the European level.

The good news: Looking at the economic data in the euro area, things are actually much more promising than the skeptics believe. As this analysis from BBVA shows (and the data used is in line with that from official sources such as the IMF and the EU commission), there already has been quite some adjustment in a number of countries. It is reasonably well known that Ireland has corrected a large share of its overshooting in unit labour costs and this is also already reflected in the Irish current account which has turned from deficit into surplus. But also Spain is making large progress. Nominal unit labour costs in fact have already fallen by almost 5 percent since early 2008 while German unit labour costs have increased during that period quite strongly (graph 11 on p. 15 in the BBVA paper). Also the Spanish current account deficit is closing quickly, forecast at slightly more than 2 percent of GDP for 2012 by the OECD – a significant improvement against the roughly 10 percent recorded in 2007.

In addition, as Sven Giegold pointed out at the INET conference, this data might actually understate the underlying adjustment. At the same time as the competitiveness has increased, the periphery countries’ energy bill has increased sharply as oil prices have risen more strongly than the quantity of energy imports has contracted. If one looks at the non-energy or constant oil-price current account (which arguably are better indicators of the underlying changes in price competitiveness), improvements are more pronounces in all crisis countries.

Is this adjustment going to continue? In my eyes, there are some positive signs: Already last year, nominal wages in Germany with a rate not been seen for a decade or so. German unit labour costs increased by 1.4 percent and hence more strongly than in the crisis countries in the periphery. In addition, the current wage round in Germany promises to yield wage increases significantly above those seen in the past decade. In addition, wages in the crisis countries will stagnate or even fall. Taken all this together will lead to some more correction of current account imbalances 2012 and in the next years.

So, is everything well in Euroland then? Unfortunately, no. The sceptics have a point: While the adjustment has started, it will still take a very long time. While the UNCTAD chief economist Heiner Flassbeck’s claim at the INET conference that it will take “10 to 15 years even if wages grew by 5 percent in Germany until imbalances are corrected” in my eyes is excessive, even a much shorter period i.e. of five years seems to be unbearable. Unemployment already stands at more than 20 percent in Spain with almost one in two young Spaniards being out of work. Add to this that decent GDP growth will not return as soon as the relative overvaluation is corrected, but only when the crisis countries have gained significant cost advantage beyond the equilibrium so that export growth can compensate for weak domestic demand, and we will almost certainly get a lost decade in the periphery. This is problematic for two reasons: First, this weak growth implies continuing fiscal solvency problems with the Spanish debt-to-GDP ratio predictably rising quickly above 100 percent of GDP. Second, it remains to be seen how much long-term mass unemployment the political system of Spain, Portugal and Ireland can bear before we will see much more serious social tensions, unrest or even a revolution.

I know that making comparisons with the 1930s in Germany is always treacherous. However, as I am looking out of the window of the INET conference location here at the Berlin Brandenburg gate, I cannot help thinking about the catastrophe for Europe which was triggered roughly 80 years ago by the mass unemployment here in Germany which ultimately paved Hitler’s road to power.