Is Internal Devaluation Enough for Europe? Probably Not, Very Unlikely…No
The IMF produced an interesting paper, “Euro Area Export Performance and Competitiveness“, that could have policy implications for the effectiveness of internal devaluation on intra-Euro area export demand. As I interpret Table 1, page 13, intra-Euro area exports are less sensitive to foreign demand (like German demand for Spanish exports, for example) and more sensitive to measures of ‘competitiveness’ than are extra-Euro area exports.
One could argue the following: these results demonstrate that internal devaluation has a better chance of working for trade within the Euro area than it would for other countries that aren’t part of a single-currency union. The policy implication is that gained relative competitiveness via fiscal austerity in Spain, Greece, and Ireland has a fighting chance to produce a positive growth outcome. (If you want to skip to the end of this article, I present another interpretation of the results.)
We are seeing some evidence already of the link between internal devaluation and the rebalancing of trade within the Euro area (data link). The chart below illustrates the shift in the trade balances on a rolling 12-month basis and as a share of GDP across key Euro area countries (click to enlarge).
Generally, the healthy rebalancing is occurring on a trended basis. The intra-Euro area trade deficit is worsening in some of the core countries, like France and even Germany, and improving in key Periphery countries, most notably Spain and Greece. This is what is supposed to happen: capital moves away from the Periphery and into the core, eventually driving the trade flows to a healthier and more sustainable flux.
However, there’s another way to read the results of Table 1 (page 13): the elasticities of real export volume with respect to the real exchange rate (i.e., measures of competitiveness, and however you measure it) are all less than one (except for one case). That means, for each 1% increase in relative competitiveness, export volume rises by less than 1% – and in some cases a lot less than 1%.
Simply put: the Periphery countries need an inordinate amount of internal devaluation and fiscal austerity to derive sufficient real export growth. Without the strong impetus to global demand, the necessary internal devaluation then becomes ‘infernal’.
I haven’t quantified this result; but the illustration above suggests that much more is needed. Furthermore, with global growth slowing – the IMF just today lowered its growth forecast - I’d say the Periphery countries will be showing some serious ‘economic holes’ in coming quarters.
This post originally appeared at News N Economics and is reproduced here with permission.
