How Euro Area Trade with the Rest of the World Contributed to the Euro Crisis

by Ferdi De Ville

Right at the time that the euro crisis had begun (to the relief of decision makers) to retreat from the front pages of newspapers, in Belgium the Ford Genk tragedy happened. The decision of the Ford Europe board to close the plant in the Flemish province of Limburg, making 10.000 workers redundant, and move the production to Valencia, has many links with the euro crisis. First, the overproduction problem in the automotive industry, which may be structural in the end, has been worsened dramatically by the crisis. In difficult times, many people postpone the purchase of a car, and especially of big cars such as the models that were made in Genk. Second, according to some, the decision by Ford to close the Genk plant and move the production to Valencia is due to the lower wage costs in Spain. While this can be disputed, as the labour share in the cost of producing a car is very limited, it is indeed the case that the labour cost in Spain has quite substantially decreased since the crisis (with around 5%), and hiring and firing has been made easier. Successfully: Spanish exports are up 23.6% since the beginning of the crisis, according to Deutsche bank. Third, the harsh decision (and ruthless style of communicating it) has been seen as exemplary for the current power of multinational corporations that operate on an international scale, over governments and trade unions in Europe that still play (in the case of states at least still in fiscal and social matters) on the national level.
This only by way of introduction and to point out that the subject of this post is more topical than might appear at first sight. I want to highlight an interesting IMF research paper that handles on the role of external trade imbalances in the euro crisis.

It has been recognized by many prominent observers (e.g. Martin Wolf, Paul Krugman, Paul De Grauwe and Fritz W. Scharpf) that the (im)balance of payments problem in the euro area was the decisive factor in the euro crisis. Mostly, this accumulation of current account imbalances in the euro area has been explained as an endogenous process – as a vicious spiral caused by the one-size-fits-none interest rate of the European Central Bank. This in turn led to housing, financial and consumption bubbles in the peripheral countries and to divergent inflation and wage developments between the peripheral and core countries (especially Germany where real wages declined between the time of adoption of the euro and the crisis).

The IMF working paper now shows that the current account deficits of peripheral countries are to a large extent the consequence of external trade shocks, actually more than of internal trade flows. However, all is connected in the euro crisis. The authors note that ‘in particular, the rise of China generated strong demand for machinery and equipment goods exported by Germany while exports from euro area debtor countries were displaced from their foreign markets by Chinese exports’. Moreover, the higher oil prices and delocalisation of (parts of) firms to emerging Europe worsened the situation of peripheral economies while benefitting the German economy and outwardly integrated German machinery and equipment exporters in particular. To complete the circle, the worsening competitiveness situation in peripheral economies was compounded by the appreciating euro, but this was for some time sustainable through easy financing, in part thanks to interest in euro area financial assets because of this appreciation. However, international investors did not buy peripheral states’ bonds directly. These were purchased by core euro area countries’ banks, contributing to the enormous intra-euro area liabilities of the peripheral countries when the crisis erupted.

This important study not only shows that an important accessory to the euro crisis has hitherto been neglected: external trade. But this also questions an important part of the recovery and future growth strategy of the euro area and the European Union in general: to export itself out of the crisis (and towards sustainable growth). If an important problem of the peripheral countries in the past decade has been that it has a competitive production structure vis-à-vis China (while Germany and other core countries have a complementary economic fabric), than a policy of simply increasing exports to China and other emerging economies cannot be a solution for the troubled euro area countries. It is illusive (and undesirable) that these countries can compete on price with emerging economies any time soon. So if we want the peripheral economies, and Greece and Portugal in particular, to become export-oriented growth poles within the EU the coming years and decades to allow them to compensate for this crisis, we should not focus on their price competitiveness problem (alone). These countries need targeted investment in the export sectors of the future. It has been said repeatedly that, also taking into account the countries’ comparative climate advantages, the renewable energy sector is a first candidate.

Hopefully, besides the other important recent finding by the IMF that the fiscal multiplier in advanced economies is much larger than assumed (and, consequently, austerity is much more damaging to output in the near term than believed), this analysis will lead to a rethink of the euro crisis approach, and of the policy towards peripheral economies in particular. Together with the Ford Genk catastrophe, it also compels us to think more critically about the EU’s external trade policies. And finally, both should for the umpteenth time be an irresistible wake-up call to at last develop Social Europe.

Dr Ferdi De Ville is assistant professor at the Centre for EU Studies, Department of Political Science, Ghent University where he teaches and writes on economic and monetary union and the euro crisis.