China and the Euro Zone: Beggaring Neighbors

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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.

 

Addendum:

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.