Bootle & Co turn back the European clock in 22 ticks
How the core economies managed before the euro
A Capital Economics' analyst team comprising Roger Bootle, Jonathan Loynes and Jennifer McKeown have published a detailed note on Europe in which they challenge the common perception that the eurozone's core economies are inherently dependent on exports and would struggle to grow outside the single currency
The trio turn back the clock and take a look at how these economies performed in the 30 years before the euro and draw on some hopeful signs should the euro break-up. They highlight that on the whole, they grew much more strongly and their relative strength was related to
domestic demand, not net exports. This suggests that after a break-up, they might be able to rely on domestic spending to grow rather than aggressively cutting costs to improve their competitiveness.
The following 22 graphs outline the rationale behind their thinking.
The importance of the core economies
Taken together, the eurozone’s core countries
(Germany, France, the Netherlands, Austria,
Belgium and Finland) make up 9% of global GDP. That’s almost half the size of the US and one and a half times the size of Japan.
Economic performance since 1999
In recent years at least, conventional wisdom has it that the euro-zone’s core countries have relied heavily on exports to grow (particularly those to elsewhere in the euro-zone) while their consumer sectors have been very weak. The reliance on net exports is true of Germany, the Netherlands and Austria, as Chart 2 shows, but not really of Finland, France or Belgium.
Germany, the Netherlands and Austria have achieved this strong net export performance despite the fact that they all entered the euro at high, uncompetitive exchange rates. The Netherlands has benefitted from the presence of the large port of Rotterdam, into which it has invested heavily, and from the increased global trade volumes which have flowed increasingly through that port.
But both Austria and Germany have instead
improved their price competitiveness by reducing
their relative unit labour costs so that their real
exchange rates have depreciated. While Austria
has achieved this through a combination of
stronger productivity growth and weaker wage
growth than the euro-zone average, Germany’s
real depreciation has entirely reflected wage
That wage restraint has meant more than a decade of weak consumer spending growth.
Chart 5 shows that investment growth has also
been weak in Germany, the Netherlands and
Austria. This might have been another way in
which firms have attempted to reduce their costs, cut prices and compete effectively in international markets. But needless to say, such a strategy could come at the cost of growth in the longer run.
Economic performance before 1999
To think about how the core economies might
cope after a euro-zone break up, the most obvious benchmark is their performance before the euro existed. Charts 6 and 7 (next slide) show that all of them typically grew at much stronger rates in the decades before the euro’s inception than they have since, which clearly casts considerable doubt on the idea that they would struggle to grow without the euro.
So just how did they achieve that growth? None of these economies were great net exporters. Charts 8 and 9 (next slide) show that they typically ran smaller current account surpluses before the euro than they have since – in some cases they ran deficits.
The relatively unspectacular performance of net
exports before euro membership in some cases
reflected the fact that the core countries’
exchange rates were appreciating. This was
particularly true for Germany, as Chart 10 shows. To illustrate the point, when the Deutsche Mark was introduced in 1948 there were roughly 13 to the UK pound. But by the end of 1998 there were only about one and a half. Austria and the Netherlands also saw their exchange rates appreciate pretty sharply between 1970 and the mid-1990s.
Unlike the situation since 1999, German firms did not respond to the rise in the exchange rate by cutting their labour costs to improve
competitiveness. Indeed, Chart 11 shows that
German wage growth was actually quite strong
throughout this period, particularly in the 1970s.
In other core economies, the shift in workers’
fortunes has been less dramatic, but it has occurred nonetheless. Charts 11 and 12 (next slide) show that all of the core economies had far stronger wage growth in the 1970s and 1980s than they have recently.
Accordingly, labour’s share of total income used
to be far higher (and the profit share
correspondingly lower) in Germany than it is
now. Chart 13 shows that the labour share began
to fall in 1980, but the decline accelerated rapidly
after the euro’s inception.
This stronger wage growth meant that consumer
spending growth was also typically stronger than it has been for the past decade. (See Charts 14 and [next slide] 15) In Germany in particular, the conventional view that consumer spending growth has always been weak is not correct.
What’s more, note that the relative strength of
consumer spending growth before the euro did not come at the expense of much weaker investment growth. Charts 16 and 17 (next slide) show that, despite the fact that firms’ wage costs were increasingly more rapidly and profits’ share of income was lower, investment growth was typically stronger before the euro’s inception than it has been since.
Admittedly, if there has been some cultural shift that has led to weaker domestic spending since 1999, then it might be difficult to reverse this and return to the strong spending growth of the past. It is often said that German consumers, in particular, have become increasingly cautious in recent years.
However, there is little evidence to support that view. Chart 18 shows that the German household saving rate is high. So in other words, consumers there are relatively cautious. But it is considerably lower now than it was in the 1970s when consumer spending was growing strongly. Indeed, all of the core countries with the exception of France have seen their household saving rates fall since they joined the euro. So if anything, households seem to have become less frugal in recent years.
Similarly, if the relative strength of domestic
spending before the euro was achieved through
irresponsible monetary or fiscal policy, then
perhaps it would be unwise to attempt to repeat it. But again, there is little evidence for that. Charts 19 and 20 (next slide) show that interest rates in all of the core economies were far higher before the euro’s introduction that they have been since.
Admittedly, the core countries’ governments
typically ran budget deficits in the 30 years before the euro’s introduction. But Charts 21 and 22 (next slide) show that (apart from in Belgium and the Netherlands in the 1980s) those deficits were not typically much larger than those that have prevailed since the euro’s inception. This suggests that the relative strength of domestic spending before the euro was related to some natural or structural process rather than an artificial or temporary policy stimulus.
The euro-zone’s core countries managed very well before the euro – indeed, they grew more strongly than they have since its inception. And the relative strength of growth at that time was related to domestic spending rather than net exports.
There is no evidence to suggest that the strength of domestic spending before the euro was 'artificially' or culturally generated. Instead, it
seems likely that it was something about the
underlying structure of these economies that
encouraged (or allowed) their firms and
households to spend more freely.
Of course, in its immediate aftermath, a eurozone break-up could be very damaging to the core economies and we have discussed these effects in previous research. But our analysis here suggests that it need not be too harmful in the long run.
Rather than trying to compete with the peripheral economies’ exports (at a time when their relative costs would be falling rapidly), the core economies could implement reforms to boost their domestic spending.