Tuesday, July 29, 2014
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A Surplus of Controversy

CAMBRIDGE – When the US Treasury recently added its voice to the chorus of critics of Germany’s chronic current-account surplus, it underscored the deep disagreement over what, if anything, should be done about it. The critics want Germany to increase its contribution to global demand by importing more and exporting less. The Germans view the maintenance of strong balance sheets as essential to their country’s stabilizing role in Europe.

Both sides’ arguments will certainly receive a full airing at the spring meetings of the International Monetary Fund and the World Bank. Unfortunately, the debate has too often been informed more by ideology than facts.

The difference between what a country exports and imports can reflect myriad factors, including business cycles, demographics, investment opportunities, and economic diversification. It can also reflect the government’s penchant for running fiscal surpluses; after all, the current-account surplus, by definition, is the excess of public and private savings over investment.

During the first half of the 2000’s, US policymakers chose not to worry about sustained current-account deficits, which peaked at above 6% of GDP. They argued at first that the deficits merely reflected the world’s attraction to superior US investment opportunities, an odd position given that the US was not growing especially quickly compared to emerging markets.

Later, academic researchers identified more plausible reasons why the US might be able to run large deficits without great risk, as long as investors’ desire for diversification, safety, and liquidity sustained global demand for US assets. But policymakers should have recognized that even these better rationales had limits, and that massive sustained current-account deficits are often a blinking red signal of deeper problems – in this case, over-borrowing by households to finance home purchases.

In the case of Germany, of course, we are talking about surpluses, not deficits. And even though the surpluses exceed 6% of German national income and would seem to be on the same order of magnitude as pre-crisis US deficits, one must remember that the German economy is less than a quarter the size of the US (at market exchange rates).

However, as the Center for European Policy Studies’ Daniel Gros has pointed out, the issue is not simply Germany. Smaller northern European countries, including the Netherlands, Switzerland, Sweden, and Norway have been collectively running surpluses at least as large as Germany’s relative to national income, and, in absolute terms, their combined surpluses are even larger. So the issue obviously merits attention. But what is the cause, and is it related to policy?

Certainly, no one can criticize northern Europe for exchange-rate undervaluation. By almost any purchasing-power measure, the euro seems overvalued (and the Swiss franc even more so).

Keynesians look at these surpluses and say that the northern European countries should drive them down by running much larger fiscal deficits to boost domestic demand. They have a point, but they grossly overstate the case. Many studies have shown that changes in private savings and investment tend to offset partly the current-account effects of higher fiscal deficits.

For example, larger German fiscal deficits would hardly have been a decisive factor in Europe. Research by the IMF and others suggests that the demand spillovers from German fiscal policy to Europe are likely to be modest, particularly in the eurozone’s troubled countries, like Greece and Portugal. Germany trades with the entire world.

The European Commission has recently completed its own report on Germany’s surpluses, concluding that it is difficult to pin down the many factors underlying it, which of course is true. For example, Germany’s capital-goods exporters have benefited enormously from growth in China.

The Commission nonetheless argues persuasively that policies to promote public and private investment would tame the surpluses in the short term and strengthen German growth in the long term. One might add that there are still extensive impediments to competition in the service and retail sectors in many northern European countries. Removing them would increase consumption of all goods, including imports.

And Germany is right to point out that its strong balance sheet underpins Europe’s fragile stability today. Would European Central Bank President Mario Draghi’s vow in the summer of 2012 to do “whatever it takes” to save the euro have been nearly as effective if investors doubted Germany’s underlying financial strength and resolve?

At the same time, it is also true that Germany could have been more forthcoming and more liberal in using its balance sheet to defuse debt-overhang problems in periphery countries like Portugal and Greece, and perhaps even Ireland and Spain.

The bottom line is that large sustained external imbalances are something that global policymakers do need to monitor closely, because, as the US housing bust showed, they can be an indicator of problems that need to be investigated more deeply. And critics of the surplus countries are right that there are two sides to every balance, and that policies in both surplus and deficit countries should be subject to review. But it is wrong to believe that simplistic answers, such as more fiscal stimulus or more austerity, are a panacea; more often, the underlying problems relate to debt, structural rigidities, low investment, and weak competitiveness.

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  1. CommentedAlasdair MacLean

    The Germans have had surpluses long before the Euro. In fact, it is to do with their national psyche: the Westfalian house wife and all that. They had a lot of expense at the time of reunification but they got over it. So when they do come out of the Euro -what a day that will be-the Germans will just take on board that temporary problem and fix it. The rest will be left discussing what to do. Germany will get back to surpluses and the rest will be left still saying how much can we spend over GDP now that the Germans have gone. Remember inability to control spend was never a German problem but for the others it was.

  2. CommentedWalter Gingery

    What utter rubbish! The point has been made endlessly that the Euro is in fact, as far as Germany concerned, under valued. To repeat a lesson that Rogoff seems to have forgotten (or perhaps he played hooky the year it was covered), the value of the Euro is an COMPOSITE of northern and southern European economies. Accordingly, the relative weakness of the South drags down the value of the Euro, which Germany takes advantage of in exporting its products. (The same applies to the rest of the Euro-North, and also to Sweden, because it pegs its currency to the Euro.)
    The utter mendacity of Rogoff's statement is revealed as soon as you ask Germany to exit the Euro. Oh, NO! Germans reply. We couldn't do that, the DMark would appreciate too much and our export economy would collapse.
    Precisely.
    And, by the way, so much for the argument about the supposedly superior quality of German products. Yes, German cars, etc., are superior, WHEN PRICED IN TODAY'S EUROS. But if Germany were to revert to the DMark, how well would they then compete? Competition is always based on more than the simple factor of quality; price, among others, must also be factored in -- always.
    Along these lines, it is highly relevant that production of VW's newest Golf model for the North American market is set to be at Puebla, Mexico, for the simple reason that -- even with vaunted German quality -- otherwise it would not be competitive.

      CommentedJose araujo

      And most of Germans exports are for EU and Euro countries, just imagine the impact if France products were 10% cheaper and German products 10% higher, that's a 20% differencial...

      CommentedWalter Gingery

      Follow the money. What other opinion, after all, could you expect from someone paid for by Deutsche Bank (see the introductory for Rogoff)?

  3. CommentedJose araujo

    I think K. Rogoff has a point, we cannot deny that, what he is forgetting is that it is Germany policy to generate a surplus, it’s not the consequence of a balanced policy.

    This is a Mercantilist view that has been proven wrong, time and time again, it generates imbalances in economies and it is not by definition a sustainable policy.

    History repeats itself, which in the case of Germany is particularly problematic, we have lived in mercantilist times before, with policies of laissez faire, and open free trade, which are the other side, or a more simpatic side, of the colonialist coin.

    Surplus running policies is a problem if what you aim is for the access to markets who provide resources and serve to dump your uncompetitive goods, and for that you push for deregulation and for fixed exchange rates (gold in the past, euros in the present).

    This error is magnified when it’s your policy to prevent inflation and you pursue a policy of internal labor depreciation that not only puts in check the competitive position of your colonies, but also prevent the increase for the demand of the colony goods.

    But what is more, by not allowing your economy to stay away for further specialization, and exploiting to full the comparatives advantages, you prevent innovation.

    Just take a deeper look at Germans economic tissue. How many Innovative companies are there, apart from SAP? Compare Germany to Korea, or China for instance on the new techs?

    By the way, Research and Rogoff usually means troubles. I honestly have problems with studies that propose that German’s inflation and fiscal deficits wouldn’t have a spillover effect over other European countries…

  4. CommentedFrank Hollenbeck

    Michael,
    first my article Germany's current account, "Germany’s “Dangerous” Current Account Surplus"
    Second, what I think of project syndicate articles such as Roggoff's article on inflation, " Why Keynesian Economists Don’t Understand Inflation". This article has been very popular and reprinted worldwide.
    As for your comment I will just quote myself:
    Paul Krugman jumped in with this beauty of a quote:

    The problem is that Germany has continued to maintain highly competitive labor costs and run huge surpluses since the bubble burst — and that in a depressed world economy, this makes Germany a significant part of the problem.
    Only in today’s surreal world of economic policy could being highly competitive be deemed detrimental!

  5. CommentedFernando Ferreira

    K. Rogoff paving the way for the non application of the Macroeconomic Imbalance Procedure ? what remind us of the EDP violation by Germany

  6. CommentedG. A. Pakela

    How is It that the German government is supposed to increase imports to stimulate world demand? German surpluses are based on the superior ability of German companies to manufacture pr0ducts that can be sold in foreign markets even with high labor costs and a strong euro. Similarly, German consumers make their own choices, individually. Exactly who is going to make them purchase products from other countries, and which countries would be the beneficiaries of German imports?

      CommentedJose araujo

      Well,first Germany activelly pursued anti-inflationary and wage controle policies, that messed with the normal stabilizators of a single currency area.

      Second, because the Euro acts like a fixed exchange rate, Germany is artificially competitive within the Euro area.

  7. CommentedChee-Heong Quah

    There should not be any governmental policies at all with regard to international balance of payments. Why? Consider the case of inter-state balance of payments or even inter-personal balance of payments. Should there be policies to correct policies of imbalances between individuals?
    Government policies are the cause to imbalances indeed.

  8. Portrait of Michael Heller

    CommentedMichael Heller


    What I like about Ken Rogoff’s latest Project Syndicate oped is that it simplifies the core problem expertly (with high probability of accuracy) and constructively:

    a) It identifies one among several symptoms of an economic system imbalance (in this case, the excessive or the problematic current account imbalance). But it notes that the relationships between the symptoms are too complex to understand fully.

    b) It explores the possible causes of the system disequilibrium briefly enough to surmise with high probability of accuracy that there are several causes, and the causes may be interacting. In other words, there are some known unknowns. The complexity and multiplicity of causes is made evident.

    c) It concludes that even without being able definitively or precisely to understand the symptoms or to identify the *causes* of disequilibrium, it does remain possible to be relatively certain about effective *solutions* to underlying disequilibrium.

    (An economist with good understanding of economic history will be familiar with the general components of repeatedly tried-and-tested structural means of restrengthening the equilibrium forces after a disequilibrium shock.)

    d) It identifies three broad policy approaches which are currently dominant in discussion of policy solution to the known complex disequilibrium -- fiscal stimulus, austerity, structural reform.

    e) It concludes that it is a crude error to rely exclusively on either of two currently dominant approaches, which for convenience are labelled ‘Keynesian’ (fiscal demand management) and ‘Austerity’ (fiscal retrenchment).

    f) Instead, based on apparently sound understanding of core economic system dynamics, Rogoff concludes that ‘the underlying problems relate to debt, structural rigidities, low investment, and weak competitiveness”. I conclude from this that Rogoff is reasserting the case for renewed focus on structural reform which will restore market competitiveness, fiscal balance, and economically productive public investment. Very Schumpeterian.

    What I find in Rogoff’s short article is a concise plea for a more determined move toward structural reform, which can still be usefully assisted at the margin by tinkering with fiscal stimulus and austerity. Currently I think the main national units of the world economy might still be stuck down the obverse path. Are they not merely tinkering with (hard) structural reform while devoting priority attention to (easy) stimulus and/or austerity? Fiddling while Rome burns.

    Reminder - Of the three broad policy approaches currently on offer, structural reform is the most neglected, the most politically difficult to implement, the one most closely aligned with sound Schumpeterian thinking, and the one most likely to bring national economies and the world economy back into the neighbourhood of equilibrium In Time to avert the more dangerous conflagration scenario in which two separate fires -- financial crises and geopolitical crises -- meet somewhere near to the (e.g. Asia-Pacific or Central-Europe) bellicosity zone of a current account surplus/deficit inflection point.

    Thank you,
    http://michaelgheller.blogspot.com.au
    Heller Economic History Entertainments

      Portrait of Michael Heller

      CommentedMichael Heller

      Nonsense Frank! You haven’t named your famous “classical economist”, and forgot to take into account the market approval ratings which the “world’s smartest students” voluntarily give their teacher every year.

      I agree the issue of trade balance could be superfluous if all is rosy in the market place. But like all other variables in an economic system current accounts can reflect distortions in the absence of market freedoms. My point -- consistent with ‘classical economics’ -- is simply that there are numerous hard to identify and hard to understand symptoms and causes of disequilibrium, one of which can be the current account balance. It is blindingly obvious that the ‘system’ (global or national) has experienced conditions of disequilibrium. Structural reform, if defined as reform that restores a range of market freedoms, uniquely claims (rightly or wrongly) to restore all ‘balances’ rather than just one or two ‘balances’. See:

      http://www.project-syndicate.org/blog/the-structural-problem-of-depression-by-michael-heller

      http://www.project-syndicate.org/blog/the-good-times-might-never-come

      These two Project Syndicate publications might help you see the reasons why structural reform has been essential in recent times. That is the issue. Let’s keep a balanced view of system balance, and not rashly or rudely rubbish positive contributions.

      CommentedFrank Hollenbeck

      What absolute nonsense....do I have a structural problem because i run a current account surplus with my employer...or should I run to the supermarket and demand that the manager buy more of my economics services because I am running a structural deficit with the supermarket? Problem today is that we have economists like Rogoff teaching the world's smartest students popular misconceptions that were previously ridiculed by the classical economist.

  9. CommentedFrank Hollenbeck

    the entire article is talking about Germany's current account surplus....seems that the authors has forgotten that Germany no longer has its own currency...you know why we don't complain about Florida's current account surplus or deficit ( not measured). The reason is because when you are a region there are too many transactions that will be missed so that a surplus or deficit is meaningless. ...as for his statement on the overvalued euro or Swiss franc..see my article " the Euro is not overvalued (nor is any other currency)"

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