Kirkegaard: Why a Weaker Euro Would Not Help Greece
The argument is widely heard in Europe and elsewhere: If only Greece and other struggling euro-zone countries could let their currency depreciate, as other collapsing economies have done when hit by debt crises – in Asia and Latin America, for example. Such a step would in theory boost demand for these countries’ exports, limit their imports and make it easier to lower their debts.
Greece, Spain, Portugal, Italy and other European countries wedded to the euro can’t take that step, of course, without suffering a major disruption. But the view that a currency devaluation would offer a way out for Greece or other countries is in any case based on a simple fallacy. Just because euro-zone members share their currency, the euro, with their euro-zone neighbors does not prevent them from benefiting from the increased external demand for their goods driven by a decline in the euro itself.
The euro is not a global currency, and anything individual euro-zone members sell outside the euro-zone (and associated countries in the “Greater Euro Area,” which peg their currencies to the euro) will benefit in terms of price competitiveness from a decline in the euro. That decline, especially against the dollar, has been under way since the global financial crisis began and its slide is accelerating.
As late as December 2009, the bilateral $/€ was around $1.50/€, whereas today it hovers just above $1.20/€. The euro has, in other words declined by roughly 20 percent against the U.S. dollar over the last six months. For those euro-zone members that sell their goods globally, this matters a lot.
Table 1 illustrates how much the decline in the euro matters to individual members of the euro. (Click here for a larger table >>>).
Table 1 shows how the share of exports that go outside the euro zone varies greatly from just 28 percent in Luxembourg to fully 70 percent in Finland. Among the euro-zone countries, those with the largest share of exports going outside the euro zone are perhaps not surprising. The three largest economies in the euro-zone send more than half of their exports outside the euro-zone, with Germany at 57 percent, making it the most global exporter. Table 1 also illustrates that adding the ERM2 countries and other territories that use the euro makes relatively little difference. The “Greater Euro Area” is largely equal to the euro-area itself.
On average about half of euro-zone exports go to countries outside the “Greater Euro Area.” This means that broadly speaking euro-zone countries can count on a boost to half their exports from a decline in the euro, relative to countries that have their own currencies. Membership in the euro does have costs resulting from “foregone external demand” within the euro zone. But that loss is far from total and indeed leaves plenty of room for exports to boost euro-zone growth through a weaker euro.
The conclusion is inescapable: Membership in a regional currency union clearly narrows the scope of external demand in boosting economic growth, but not as much for countries that export outside their own currency area. Or put in another way, if a country makes something that countries all around the world really want to buy, membership of a regional currency union is far less of a constraint on its ability to overcome its barriers to growth.
This is illustrated in column 5 far to the right in table 1, which shows euro-zone members’ exports outside the “Greater Euro Area” as a share of their GDP in 2008. In other words, column 5 shows the importance of exports in euro-zone members, controlling for their membership of the euro. The results are striking.
Within the euro-zone the range of “extra-euro export intensities” goes from 4 percent of GDP in Greece to fully 38 percent of GDP in Slovakia.
Note that this is very bad news for Greece. It cannot benefit from a decline in the euro simply because it just does not export enough outside the “Greater Euro Area” (4 percent of GDP). Consequently, with such a low export share, Greece will find it extremely difficult to export itself out of its current economic malaise. In 2008 Greece exported for more than $500 million worth in just four categories: light petroleum distillates, medicines, fresh fish and “other,” and shipped more than $1 billion worth of goods to just seven trading partners (ranked); Italy, Germany, Bulgaria, Cyprus, U.S., U.K. and Romania. Other troubled low-extra-Greater Euro-zone exporters, such as Spain and Portugal, face similar if less acute troubles.
The same dismal facts dispel any notion that Greece in the longer-term would be better off outside the euro-zone. Simply but harshly put, Greece does not export many goods that the world wants, so the gains a country like Greece will ever realize from even a large real devaluation through the introduction of a “New Drachma” would be minuscule. Moreover, with large services exports only in tourism (vulnerable to the social unrest which is guaranteed to follow an abandonment of the euro) and shipping (transacted mostly in US$), Greece could furthermore also not expect much of a boost to its services sector exports from leaving the euro-zone.
On the other hand, for the Northern and Eastern euro-zone members with large extra-Greater euro-zone export shares of GDP – such as Germany on 23 percent, Slovakia at 38 percent or the Netherlands on 26 percent of GDP, the potential external demand gains from a large depreciation of the euro will be large. External demand, in other words, is a factor that is widening already serious intra-euro-zone differences in economic growth.
Finally, it is worth comparing the world’s three continental-size economies — the euro-zone, China and the United States — in terms of their export intensity. This is done at the bottom of table 1. Here it can be seen how the euro-zone “extra-Greater euro-zone export intensity” in 2008 was 16 percent of GDP, just half of China’s 32 percent, but almost double the level of only 9 percent for the United States.
In other words, the euro-zone as a whole is likely to get a far bigger external demand boost from a decline in the euro than America would realize from a decline in the US dollar. Or put in different terms, even if in the unlikely event that President Obama were to succeed with his new National Export Initiative and double U.S. exports in 5 years, the boost would probably not even make the U.S. economy as export intensive as the euro-zone as a whole is right now.
This analysis does not take into account the fact that the U.S. dollar remains the global anchor currency in which many commodities and other parts of global trade are transacted. The global role of the dollar thus makes it even harder for the U.S. economy to gain any significant external demand boost from a decline in the U.S. dollar. It seems likely that having the global anchor currency is more important for external demand than membership of a regional currency union.
In sum, for external demand to be a meaningful contributor to domestic economic growth after a large depreciation of a country’s currency, what matters is whether you make BMWs or you make Hummers, not really whether you share your currency with your neighbors.
Jacob Funk Kirkegaard has been a research fellow at the Institute since 2002. Before joining the Institute, he worked with the Danish Ministry of Defense, the United Nations in Iraq, and in the private financial sector.