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Home Publications Blogs Beat the Press China and the Euro Zone: Beggaring Neighbors

China and the Euro Zone: Beggaring Neighbors

Sunday, 03 November 2013 16:26

Paul Krugman is wrongly beating up on the euro zone for its current account surplus, showing that it is now larger than China's. The problem with the comparison is that China is an extremely fast growing developing country. This is the sort of place that in the good old days we expected to run trade deficits.

The euro zone on the other hand is a bloc of slow growing rich countries. We would expect them to be running trade surpluses. This does not negate the fact that the euro zone could and should be doing much more to stimulate its economy with larger budget deficits and more aggressive monetary policy, but that fact that it has a larger trade surplus with the rest of the world than China really doesn't tell us much of anything.



I'm not gratuitously beating up on Krugman here, there is a real point. If a country is growing rapidly, like China, we would expect it would have a high return on capital. On the other hand, the return on capital is likely to be lower in the slow growing rich countries. This means that we should see a flow of capital from rich countries to developing countries. That would imply a trade surplus for the rich countries and a trade deficit for developing countries.

Another way to think about this is that the developing countries need to both build up their capital stocks at the same time that they continue to feed and house their people. By running trade deficits with rich countries, they can get the extra goods and services that allows them to do both simultaneously.

In reality, the capital flows from rich to poor countries have been at best uneven. This is a case where the real world has stubbornly resisted the textbook story. To my mind this is an indictment of the international financial system which has not generally accommodated this flow of capital from rich countries to poor countries. This is quite evident in the most recent reversal, which followed the botched bailout by the IMF-U.S. Treasury form the East Asian financial crisis in 1997. 

But if we could somehow get things right and create a mechanism whereby excess capital in the EU and other rich countries helped finance investment in the developing world, that would be a good thing. This is why showing that the EU has a larger trade surplus than China does not necessarily mean that the EU is a bad actor in the world (although it is). 


Further Note:

Reference to EU changed to euro zone -- thanks folks.

Comments (9)Add Comment
A bit unfair
written by Anonyrat, November 03, 2013 3:58
A bit harsh, maybe, calling the Krugman out on one statement that "doesn't tell us much of anything"?
written by watermelonpunch, November 03, 2013 11:07
The Krugman must be called out, because the likes of me, and probably others, wouldn't have immediately realized that the comparison between China & the EU isn't a telling one.

That said... at what point do we stop calling China a "developing country"?
written by sherparick, November 04, 2013 8:32
The Eurozone is not all of a piece. Eastern Europe and Greece are more like developing countries than the developed ones like France, Germany, Scandinavia, and the BENELUX. Italy is split between a developed North and a 3rd World South, while Spain and Portugal had structural economic problems that joining the Eurozone did not solve. Putting these ill matched economies into a Monetary Union was a recipe for problems. And Germany, is benefiting directly from the weak Euro in the sense it is exporting the problem of solving the periphery's problems through exports. Krugman is wrong to suggest that Germany's policies are having a direct impact on the U.S. current account deficit, which is mostly China and Oil, per Calculated Risk, but his overall point that Germany, and the House Republicans, fetish about budget deficits and austerity in a time of economic contraction is insane.
written by AlanInAZ, November 04, 2013 9:42
We want Germany to spend more, so that it provides a market for other countries and stops adding so much to the world’s excess savings. The last thing European debtors, or anyone else for that matter, should demand is that Germany put on a hair shirt.

So please, Germany, live it up.

The above quote from Krugman's blog summarizes the point I think he was trying to emphasize with the chart. The chart does highlight the amount that Germany's surplus is overwhelming the balances of the many other Euro countries.
The Euro Area is not the EU
written by Mark A. Sadowski, November 04, 2013 10:41
Krugman's post is on the current account balance of the Euro Area, not the EU. All of the 17 member states of the Euro Area are in the EU but 11 of the 28 member states of the EU are not in the Euro Area. Many people make this error but almost all of them are not economists who should know better.
written by watermelonpunch, November 04, 2013 1:59
Dean Baker wrote:
I'm not gratuitously beating up on Krugman here

I would've never thought that the case in regards to the Krugman.

However, I would not begrudge someone if they enjoyed some shadenfreude regarding some of the other columnists who turn up on Beat the Press blog, on a regular basis, for being wrong. The Krugman doesn't seem to really fit that criteria.

And I, for one, have a great respect for professionals who are as willing to critique friends as well as foes, in service of accurate information.
In a culture where social connections trump qualifications & expertise on a regular basis, I think being willing to go against that flow is a sign of huge integrity much missing in our society.
written by AlanInAZ, November 04, 2013 2:09
Today's column by Krugman puts meat on the bone. Dean may disagree but I don't think the chart was meaningless.

Rewrite the textbook, not the international financial system
written by Sustainable Gains, November 04, 2013 2:37
"This is a case where the real world has stubbornly resisted the textbook story."

… and this is another good example of why economics is not a science.

When the real world doesn't agree with the textbook, it's the textbook that has to change. Not "the international financial system".

I don't think anyone can argue that China has spend 30 years on the wrong path to growth and development. And yet China has almost-consistently run a trade surplus since the 1980s:


So what's wrong with the textbook analysis?

If real-world capital were dollars, or gold, then it might make sense for developed nations to run surpluses, accumulate capital, and then invest that capital in developing markets where the return would be higher. (That would certainly be nice for the investing class in the developed nations, wouldn't it?)

But real-world capital is "surplus of production over consumption", and a dollar is just a unit of measurement, not an actual surplus that can be used to generate new production. The way a nation obtains an actual surplus is by producing more than it consumes, and one way to get there is by running a trade surplus.

Looking at other historical data, the U.S. itself was also a strong trade-surplus nation during its "developing economy" years in the 1800s, through the 1950s, as well.
written by JSeydl, November 04, 2013 8:18
Sustainable Gains, the textbook is not technically wrong. It refers to a system of floating exchange rates. We hardly have such a system today.

Also, the textbook is a positive description of what will happen under certain conditions. It's not a normative one. You could make the case that welfare gains for the global economy would be higher if we had the textbook story play out. But that's a long-run welfare gain. In the short-run, China would almost certainly be hurt if it let it's exchange rate float. Its economy - and especially its service sector - just isn't set up to accommodate the massive boost in domestic demand that would be needed from a devaluation. So China will readjust at its own pace. That is the political reality, unfortunately.

Finally, on the issue of Europe, it should (and indeed must) be noted that the improvement in the current account has been due to a collapse in domestic investment, not a more competitive trade position. The CA equals S-I in theory. S has increased slightly over the past few years, while I has collapsed. This is not a good story. Long-term damage is being done the longer I stays depressed. Europe would be far better off in the short run if it ran CA deficits if they mean an investment recovery.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.