The Role of External Demand in the Eurozone

The argument is widely heard in Europe and elsewhere: If only Greece and other struggling eurozone countries could let their currency depreciate, as other collapsing economies have done when hit by debt crises—in Asia and Latin America, for example. Such a step would in theory boost demand for these countries' exports, limit their imports, and make it easier to lower their debts.

Greece, Spain, Portugal, Italy, and other European countries wedded to the euro can't take that step, of course, without suffering a major disruption. But the view that a currency devaluation would offer a way out for Greece or other countries is in any case based on a simple fallacy. Just because eurozone members share their currency, the euro, with their eurozone neighbors does not prevent them from benefiting from the increased external demand for their goods driven by a decline in the euro itself.

The euro is not a global currency,¹ and anything individual eurozone members sell outside the eurozone (and associated countries in the "Greater Euro Area," which peg their currencies to the euro) will benefit in terms of price competitiveness from a decline in the euro. That decline, especially against the dollar, has been under way since the global financial crisis began, and its slide is accelerating.

As late as December 2009, the bilateral $/€ was around $1.50/€, whereas today it hovers just above $1.20/€. The euro has, in other words declined by roughly 20 percent against the US dollar over the last six months. For those eurozone members that sell their goods globally, this matters a lot.

Table 1 illustrates how much the decline in the euro matters to individual members of the euro. It shows the share of each country's goods that are exported outside the eurozone. For the sake of comprehensive coverage, table 1 also includes 1) the other members of the EU-27, 2) the export shares outside the euro area, plus the four EU members—Denmark, Estonia, Latvia, and Lithuania—currently inside the narrow band of the European Exchange Rate Mechanism (ERM2), which are essentially pegged to the euro;and 3) the share of exports outside the "Greater Euro Area," which include the euro area itself, the four ERM2 countries, and all other territories that use the euro (or are pegged to it) and for which detailed trade data are available. These territories include the Danish dependencies; the Faroe Islands and Greenland; French overseas territories French Polynesia, New Caledonia, and St. Pierre and Miquelon; Netherlands Antilles, Gibraltar, Montenegro, and Kosovo. The latter two countries have unilaterally adopted the euro, while being outside the European Union itself.²

Table 1 shows how the share of exports that go outside the eurozone varies greatly from just 28 percent in Luxembourg to fully 70 percent in Finland. Among the eurozone countries, those with the largest share of exports going outside the eurozone are perhaps not surprising. The three largest economies in the eurozone send more than half of their exports outside the eurozone, with Germany at 57 percent, making it the most global exporter. Table 1 also illustrates that adding the ERM2 countries and other territories that use the euro makes relatively little difference. The "Greater Euro Area" is largely equal to the euro area itself.

On average about half of eurozone exports go to countries outside the "Greater Euro Area." This means that broadly speaking eurozone countries can count on a boost to half their exports from a decline in the euro, relative to countries that have their own currencies. Membership in the euro does have costs resulting from "foregone external demand" within the euro zone.  But that loss is far from total and indeed leaves plenty of room for exports to boost eurozone growth through a weaker euro.

The conclusion is inescapable: Membership in a regional currency union clearly narrows the scope of  external demand in boosting economic growth, but not as much for countries that export outside their own currency area. Or put in another way, if a country makes something that countries all around the world really want to buy, membership of a regional currency union is far less of a constraint on its ability to overcome its barriers to growth.

This is illustrated in column 5 far to the right in table 1, which shows eurozone members' exports outside the "Greater Euro Area" as a share of their GDP in 2008. In other words, column 5 shows the importance of exports for  eurozone members, controlling for their membership in the eurozone. The results are striking.

Within the eurozone the range of "extra–euro export intensities" goes from 4 percent of GDP in Greece to fully 38 percent of GDP in Slovakia.

Note that this is very bad news for Greece. It cannot benefit from a decline in the euro simply because it just does not export enough outside the "Greater Euro Area" (4 percent of GDP). Consequently, with such a low export share, Greece will find it extremely difficult to export itself out of its current economic malaise. In 2008 Greece exported for more than $500 million worth in just four categories: light petroleum distillates, medicines, fresh fish, and "other,"³ and shipped more than $1 billion worth of goods to just seven trading partners (ranked): Italy, Germany, Bulgaria, Cyprus,the United States, the United Kingdom, and Romania.⁴ Other troubled low extra–Greater Eurozone exporters, such as Spain and Portugal, face similar if less acute troubles.

The same dismal facts dispel any notion that Greece in the longer-term would be better off outside the eurozone. Simply but harshly put, Greece does not export many goods that the world wants, so the gains a country like Greece will ever realize from even a large real devaluation through the introduction of a "New Drachma" would be minuscule.⁵

On the other hand, for the Northern and Eastern eurozone members with large extra–Greater eurozone export shares of GDP—such as Germany on 23 percent, Slovakia at 38 percent, or the Netherlands on 26 percent of GDP, the potential external demand gains from a large depreciation of the euro will be large. External demand, in other words, is a factor that is widening already serious intra-eurozone differences in economic growth.

Finally, it is worth comparing the world's three continental-size economies—the eurozone, China, and the United States—in terms of their export intensity. This is done at the bottom of table 1. Here it can be seen how the eurozone "extra–Greater eurozone export intensity" in 2008 was 16 percent of GDP, just half of China's 32 percent, but almost double the level of only 9 percent for the United States.

In other words, the eurozone as a whole is likely to get a far bigger external demand boost from a decline in the euro than America would realize from a decline in the US dollar. Or put in different terms, even if  in the unlikely event that President Obama were to succeed with his new National Export Initiative and double US exports in 5 years, the boost would probably not even make the US economy as export intensive as the eurozone as a whole is right now.⁶

This analysis does not take into account the fact that the US dollar remains the global anchor currency in which many commodities and other parts of global trade are transacted. The global role of the dollar thus makes it even harder for the US economy to gain any significant external demand boost from a decline in the US dollar. It seems likely that having the global anchor currency is more important for external demand than membership of a regional currency union.

In sum, for external demand to be a meaningful contributor to domestic economic growth after a large depreciation of a country's currency, what matters is whether you make BMWs or Hummers, not really whether you share your currency with your neighbors.
Notes

1. The perpetuation among economists of the view that eurozone membership eliminates the option for member states to gain from external demand is perplexing. Perhaps years of indoctrination and reliance on oversimplified theoretical trade models operating in a two-country/two-commodity world (where any currency union of course by definition would be global in reach) is partly to blame.

2. In addition to these countries and territories, Andorra, the Principality of Monaco, the Republic of San Marino, the Vatican City State, and the French overseas departments of Guadeloupe, French Guyana, Martinique, and Réunion use the euro. No trade data however is available for these. See the European Commission website, "The euro outside the euro area."

3. Data from the UN Comtrade Database. The four HS six-digit commodity codes in question are 271019, 999999, 300490, and 030269.

4. Total Greek goods exports in 2008 were just $25bn, with about half accounted for by the listed top-7. Exports to the top-Greek export market in Italy amounted to $2.9 billion.

5. Total Greek export intensity (all goods exports/GDP) is just 7 percent of GDP—far lower than any other eurozone member. See "Europe's Huge €120 Billion Gamble" for a discussion about why Greece will also not see many benefits from leaving the euro in terms of exports of its principal services—tourism and shipping.

6. This is due to the fact that US GDP will also grow over the 5-year period, offsetting some of the potential export gains. In 2008 with roughly comparable GDP levels, the United States exported $1.3 trillion worth of goods, while the eurozone shipped $2.2 trillion of goods outside the Greater eurozone. See White House press release for details of the National Export Initiative.