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Wednesday, May 1, 2013

More on the Current Account Cookie Jar Dilemma

The current account cookie jar dilemma even has religious dimensions

Returning to the Sinn-Soros debate at project-syndicate, it's obvious that even highly trained economists like Sinn do not seem to fully understand the fallacy of composition when applied to international economics.

Germany's dilemma is the following. Germany would like to keep its export surplus growth model, which means she wants to maintain  the over 5% current account surplus-to-GDP ratio she has achieved over the last decade. At the same time, by wage deflation, 'structural reforms' and austerity, she wants the Eurozone peripheral countries to improve their 'competitiveness' without Germany making any contributions to a unit-wage-cost rebalancing on her side (except contributing to the minimum bailouts necessary to prevent the periphery from collapsing completely).

But what does increasing 'competitiveness' mean in international economics? Raising exports faster than imports (in the most generous sense, including services and tourism), i.e., moving into current account surplus. Now the sum total of all countries' current accounts must be zero, by definition, so this is a zero-sum game. So if e.g. Spain moves into surplus, somebody else has to move into deficit. If Spain's gain in 'competitiveness' does not come at the expense of Germany (say by exporting more wind turbines, automotive parts and Mediterranean holidays to Germans than Mercedes and machines she imports from Germany), where will this gain come from? From China, the USA, Abenomics Japan? Certainly possible, but even Germany runs a bilateral current account deficit with China at the moment, so I don't think this likely. Some of it will have to come from a reduction in Germany's current account surplus with the rest of the EZ (which still accounts for more than 40% of her trade).

But the ultimate guiding principle of German policy remains defending her current account surplus at all costs (in the name of hard-won competitiveness - see Bundesbank president Jens Weidmann's 2012 rebalancing speech at the BIS for the clearest statement of this obsession). People like Weidmann and Sinn seem to implicitly think a rebalancing of EZ current accounts can come entirely at the expense of the rest of the world (something I already hypothesized back in 2011 in my blog "What does Germany want..."), but I think this is completely unrealistic. Some of it will have to come at the expense of Germany's current account surplus (though that does not necessarily mean at the expense of her people's welfare - quite the contrary, this can be income enhancing, even mutually - income is not a zero-sum game).

In contrast, Sinn's one-sided competitiveness adjustment policy calls for lowering Spain's prices and wages by 20-30%! In view of the well-known downward nominal wage rigidity, this would call for inconceivable mass unemployment ('structural reforms' are a delusional euphemism when we are talking about such unprecedented wage deflation) to accomplish. But even if, using some kind of wage-setting magic wand (such as a devaluation used to represent), we could accomplish this overnight, the resulting domestic demand collapse due to debt-deflation and the high multiplier would erase Spain as a viable economy long before exports could pick up enough to make up the difference. Plus all of the mobile, educated skilled workers would have fled the country by then (which is already happening). So Spain's ultimate productive basis - her human capital - would have been destroyed in the process. This reminds me of US strategy during the Vietnam War - "we had to destroy them to save them."

So either I am crazy or Sinn and Weidmann can't do the maths and let go of some cookies for the common good.

For more economists' views on the current account adjustment issue, see e.g.:

Hans-Werner Sinn, Akos Valentinyi, "European imbalances".

Alexandr Hobza, Stefan Zeugner, "Current-account surpluses in the Eurozone: Should they be reduced?"

Michael Pettis, The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy, 2013

Peter Temin and David Vines, The Leaderless Economy:
Why the World Economic System Fell Apart and How to Fix It, 2013

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