The Eurozone’s Coming Inflation Divide

ZURICH – Discussions within the European Central Bank’s Governing Council, which is poised to meet on April 7th, are about to get hot. The risk that rising inflation in emerging Asia could spill over into Europe will pit the Bank’s inflation hawks against those in favor of ensuring as fast a return to full employment as possible. But what may cause even greater dissension is a renewed clash of national interests as inflation rates within the eurozone diverge.

The underlying cause of this divergence is the much larger role that imports from China and other East Asian emerging economies play in the German or Belgian economies than in southern European countries. For example, Germany’s imports from China totaled roughly $63 billion in 2009, nearly equivalent to the imports from France, Greece, Italy, Portugal, and Spain combined.  And China’s trade significance, as a share of GDP, is nearly twice as great for Germany as it is for any of these countries.

In addition to this difference in the relative magnitude of imports, the benign price effect of low-cost import competition is much larger in Germany’s competitive retail landscape than in the more traditional, and uncompetitive, retail systems of Italy or Greece.

Overall, these structural economic disparities have led to vast differences in the ways that various eurozone members have benefited from the rise of cheap Asian imports over the last 15 years. Now that the era of cheap imports is waning, however, the effect on prices will be reversed, and those who benefited the most in the past may now suffer the most from Asian inflation.