By Franz Nauschnigg
What can be done to help the “crisis economies” of southern Europe reduce their external deficits? The debate is often presented as a conflict between the deficit-burdened PIIGS – Portugal, Italy, Ireland, Greece, and Spain – and the euro zone’s current-account-surplus countries, particularly Germany. But a new and more important imbalance has emerged in recent years: the PIIGS’ trade and services deficits with China, which suggest a possible solution to southern Europe’s economic malaise – a stronger renminbi.
Until 2004, the PIIGS’ biggest trade and services deficits were with the rest of the euro zone. But in 2005, their combined deficit with the rest of the world, at €37.2 billion ($48.6 billion), exceeded their combined deficit with other euro members by more than €4 billion. Then, in 2008, before the worst of the global financial crisis hit, the PIIGS’ global deficit reached a record-high €116.5 billion, of which €34.8 billion was with China, surpassing their deficit with Germany for the first time – by more than €2 billion (see chart).
Crucially, though the PIIGS’ combined deficit with Germany, the euro zone, and the world narrowed substantially over the next four years, their deficit with China remained huge – at €33 billion in 2010 and €29 billion in 2011.
Two key factors help to explain how this situation came about. The first was the euro’s rapid appreciation against the renminbi in the early 2000’s. The euro rose from an average rate of ¥7.4 in 2001 to ¥10.4 in 2007, before depreciating to ¥7.8 by August 2012. This happened in part because the renminbi was tracking the US dollar, which had fallen dramatically against the euro in 2002-2004.
As a result of the euro’s sharp nominal appreciation, the euro zone as a whole became less competitive. The impact was felt particularly strongly in the PIIGS, whose booming economies were attracting huge capital inflows that drove up inflation and wages.
The adverse effect on competitiveness was compounded by a second development. Southern European economies, heavily dependent on their textiles, clothing, and footwear sectors, began to face intense competition from cheaper Chinese imports. According to research published by the International Monetary Fund, China’s textile exports were largely responsible for huge trade deficits in Portugal, Italy, Greece, and Spain. By contrast, the current accounts of Germany, Finland, Austria, and France were far less affected, owing to their greater strength in export sectors, such as machinery, in which China was relatively weak.
Other IMF research has also noted that, in addition to the rise of China, the integration of Central and Eastern Europe and higher oil prices affected euro zone economies’ trading positions in different ways, with the PIIGS among the hardest hit.
The worst has been avoided, because the euro zone’s current-account-surplus countries have financed the PIIGS’ external deficits, despite their significant trade imbalances with the rest of the world. Investors from outside the euro zone simply increased their claims on Germany, France, and other surplus economies.
But what can euro zone policymakers do to help? Low interest rates, high debts, and wide deficits leave little margin for further monetary or fiscal expansion. Pressure to moderate wages can go only so far; indeed, it can be counterproductive insofar as it dampens domestic demand and thus raises the risk of recession.
The crisis economies might, however, find it easier to make the necessary external adjustments under three conditions: stronger external demand, a less onerous financing environment, and a weaker euro. Much of this could be achieved with a revaluation of the renminbi against the euro and the currencies of other major trading partners.
This would provide southern Europe’s economies with an essential boost to external demand while leaving them room to shrink their fiscal and external deficits. Indeed, it was stronger external demand that allowed Germany to reduce its fiscal deficit in recent years.
It may make sense for euro zone policymakers to focus on the difficulties that weak external demand and Chinese exports have created for southern Europe. In these circumstances, a weaker euro could help a weakened Europe.
Franz Nauschnigg is head of division, European affairs and international financial organizations at the Austrian National Bank. The views expressed are only those of the author.
Copyright: Project Syndicate, 2013.
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