November 14, 2019 Thieß Petersen

ROADMAP 2030: What Germany and Europe can do to reduce current account imbalances.

Last week we discussed Europe’s possible responses to growing protectionism . Current account deficits are an essential reason why countries are shutting themselves off economically. This post outlines five ways that countries can reduce those deficits (current account surpluses.)

Empirically, trade activities account for by far the most significant part of the current account balance (i.e., exports and imports, income payments, and transfers between countries.) That’s why changes in exports and imports are important in the development of the current account balance.

Germany has had high and rising current account surpluses since 2002. The EU has recorded such surpluses since 2011. The economy with the highest current account deficit in the world is the U.S. (see Figure 1).

With an export surplus, a country lives below its consumption possibilities because not all manufactured goods are consumed. They build up assets vis-à-vis other countries and raise domestic employment. For the government, this results in higher tax revenues.

A trade deficit has mirror-image consequences. With a deficit, a country takes protectionist measures to address challenges in the domestic economy. This can lead to a global protectionism race that reduces the export opportunities of all nations and causes unemployment to rise worldwide. Countries with an export surplus should, therefore, have an interest in reducing their export surplus.

5 Measures to reduce an export surplus

1 Increase domestic demand through wage growth

Higher wages enable workers to buy more domestic consumer goods. This is primarily the responsibility of the collective bargaining partners (the employers’ associations and the trade unions). The government, as an employer, could also advocate higher wages for employees in public sectors.

2 Dynamize the service sector

The starting point for this is the liberalization of existing access restrictions to the service sector. Their removal should lead to new jobs and an increase in productivity, which would be accompanied by an increase in wages and salaries. There would also be an increase in investment. Higher investments and an income-induced rise in consumer demand would reduce the export surplus by increasing domestic demand and imports.

3 Increase imports by reducing import restrictions

A traditional instrument for this is the dismantling of tariffs and non-tariff barriers to trade. It is also possible to reduce European subsidies in the agricultural sector. Subsidies represent a distortion of competition to the detriment of foreign suppliers. The reduction of subsidies would increase the competitive advantages of the remaining countries offering such products on the world market and increase their exports to Germany and the EU.

4 Increase public investment

In a number of areas, there are public needs that are not met by private investors due to insufficient private returns on investment: Transport infrastructure, network infrastructure, expansion of the education sector, basic research, and more. If the government increases its investments here, this increases domestic demand for goods and services and reduces the export surplus.

5 Tax measures to strengthen domestic demand

Reducing the tax burden and social security contributions would be conceivable, especially for low-income labor. This would increase domestic demand. A reduction in VAT rates can achieve the same effect. Finally, higher tax depreciation possibilities for private investment should be considered, leading to an increase in private investment.

What is needed to reduce export surpluses is not a reduction in exports but an increase in imports. Higher imports from Germany and the EU would boost economic development in the rest of the world. Hence, measures to restrict exports are not appropriate. They would not only reduce production and employment in Germany and the EU, but also in the countries from which German and other European export companies purchase their inputs.