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S. Micossi: Balance-of-Payments Adjustment in the Eurozone

image-01/21/2016 - 12:35This policy contribution describes the unresolved adjustment problems confronting the eurozone, and places them in historical perspective by comparing developments in key real economic variables under EMU with those observed under the Bretton Woods system. The main finding is that the eurozone is afflicted by a strong deflationary bias and that, therefore, under current trends, deep economic and social strains will continue to project a dark cloud over its future survival.

Under Bretton Woods, the United States opened its domestic market to pull in net exports of its main partners, invested to improve its productivity and provided ample liquidity to grease the expansion of trade and the payment system. Throughout the period, US domestic demand was growing buoyantly; after the mid-1960s, the appreciation of the real exchange rate of the dollar was amplifying the room for expansion in the rest of the industrialised world. Thus, altogether, it comes as no surprise that the Bretton Woods system displays the best real economic performance amongst all exchange rate systems on record.

The eurozone, on the other hand, has been anchored to a country with stagnating or slowly growing domestic demand, a sharply depreciated real exchange rate and little contribution of stable long-term capital flows to the financing of the current account deficits in the rest of the area. Total factor productivity growth has been stagnant throughout the area and there has been little market opening beyond manufacturing, the source of the German competitive advantage. The services markets have remained closed, especially for the very important network utility services (energy, transport and communications), which are still organised on a national basis under tight national protection (and often public ownership of service providers). This market segmentation has been a main factor in explaining the sizeable delays in the adoption of IT technologies and the productivity shortfalls in the eurozone and the European Union relative to the United States. 

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This note was initially written for the CEPR project “Rebooting Europe” Step II, coordinated by Richard Baldwin and Francesco Giavazzi.