Part 2: The Mercedes and the Feta Cheese
As we have seen in part 1, debt in the periphery of the Eurozone has climbed to allegedly unsustainable levels as a consequence of the crisis more than as a cause of it. So if it’s not debt, then what are the underlying causes of the fault lines in Europe? Part 2 of this note will explore the consequences of productivity imbalances within the members of a monetary union.
As a reminder of the basics, when a country’s products are demanded and its exports rise, the demand for that country’s currency rises and the currency appreciates. The currency’s appreciation acts as a counter balance for that country’s goods becoming too desirable: they become too expensive. Now once the countries in the Eurozone decided to get together and form a common currency, the value of that currency they agreed is close to an average of the original currencies it is formed of. So Germany was now trading with a currency that is cheaper than its original Deutch Mark, and Greece was now trading with a currency that is more expensive that its original Drachma. The effect this has is that German products become comparatively cheaper to what they should be, and Greek products become more expensive. Once this happens, Germany starts to exports much more, and its economy booms while Greece’s economy plummets.
This is clearly shown in the below graph that shows the evolution of current accounts (to simplify, think of current accounts as net exports) between Germany and the GIPSI, from the inception of the Euro in 1999.
Now suddenly your vacation in Greece becomes so much more expensive than what it’s worth, and you decide to go to Turkey instead. Take a look at the following graph of the evolution of tourism in Greece and Turkey since the inception of the Euro.
The German Structural Reforms
The above paragraph shows the impact that a common currency has on net exports. It explains how original imbalances in productivity or product quality translate in imbalances of exports and imports, but is it worthwhile to explore the reasons for the original productivity and quality imbalance. Germany’s current high levels of productivity and low production cost are results of years of efforts started with Helmut Kohl and perpetuated by Gerhard Schroder and Angela Merkel, and these could be the subject of another article. It is worthwhile to take a look at the following graph that shows the unit cost of labor (inversely proportional to productivity) in Germany and Spain.
It looks like what is happening is that Germany worked hard for years to attain the level of productivity they are at now, and is expecting the same from its European counterparts, in very different circumstances than the ones it went through.
To be continued