was to reduce at a stroke the competitiveness of peripheral countries in the internal market. To this poor start was added sustained loss of competitiveness, discussed in the previous section. The result, shown in figure 14, was inevitable: emergence of entrenched current account deficits for peripheral countries, matched by an equally entrenched current account surplus for Germany.
Care is obviously necessary in interpreting this picture. Greece, Portugal and Spain have run substantial balance of trade deficits, but they have also had significant surpluses on services. Ireland has followed the opposite path, again reflecting its own mode of integration into the eurozone based on higher investment, much of it directed to housing, and intensified labour flexibility. For all, inability to restrain nominal labour unit costs at German levels and, more fundamentally, inability to set productivity growth on a strongly rising path, resulted in current account deficits mirrored by surpluses for Germany. Note that two thirds of German trade is with the eurozone. Note also that the trade of the eurozone with the rest of the world is roughly in balance.
Fig. 14 Current account balance (percent GDP)
Source: IMF BOP
The euro and its attendant policy framework have become mechanisms ensuring German current account surpluses that derive mostly from the eurozone. Peripheral countries joined a monetary system that purported to create a new form of world money, thus signing away some of their competitiveness, while adopting policies that exacerbated the competitiveness gap. The beneficiary of this process has been Germany, because it has a larger economy with higher levels of productivity, and because it has been able to squeeze its own workers harder than others. Structural current account surpluses have been the only source of growth for the German economy during the last two decades. The euro is a ‘beggar-thy-neighbour’ policy for Germany, on condition that it beggars its own workers first.
Fig. 15 Capital and financial account (Net, $ bn)
Source: IMF BOP
Financial account: German FDI and bank lending to the periphery
Inevitably, the picture appears in reverse on the capital and financial account (fig. 15). Germany has exported capital on a large scale, while peripheral countries have been importing capital.
The financial account comprises fundamentally foreign direct investment (FDI), portfolio flows, and ‘other’ flows that are heavily driven by banks. The direction of aggregate flows between Germany and the periphery of the eurozone can be gauged from the composition of the German financial account (fig. 16).
The driving forces behind sustained capital exports by Germany since the introduction of the euro have been ‘other’ and FDI flows. Portfolio flows have been weaker, even turning inward for much of the 2000s. Put summarily, Germany has been recycling its current account surpluses as FDI and bank lending abroad. Bank lending peaked in 2007–8 and, as is shown below, this has been a vital element of the current sovereign debt crisis.
Fig. 16 Composition of German financial account (euro, bn)
Source: Bundesbank
The geographical direction of the recycling of surpluses is clear, once again, from the composition of German capital exports. The eurozone has been the main recipient of German FDI (fig. 17), while also competing with the non-euro part of the EU for German bank lending in the 2000s (fig. 18). Once the crisis of 2007–9 broke out, German banks restricted their lending to non-euro EU countries but continued to lend significantly to eurozone countries.
Fig. 17 German outward FDI by region (euro, bn)
Source: Bundesbank
To recap, international transactions of eurozone countries have been driven by the requirements and implications of monetary union. Peripheral countries have lost competitiveness relative to Germany because of initially high exchange rates as well as because of the ability of German employers to squeeze workers harder. The result has been a structural current account surplus for Germany, mirrored by structural current account deficits for peripheral countries. Consequently, German FDI and bank lending to the eurozone have increased significantly. ‘Other’ flows to peripheral countries rose rapidly in 2007–8 as the crisis unfolded, but then declined equally rapidly. That was the time when peripheral states were forced to appear in credit markets seeking funds.
Fig. 18 German ‘other’ outward flows by region (euro, bn)
Source: Bundesbank
5. RISING PUBLIC SECTOR BORROWING: DEALING WITH FAILED BANKS AND WORSENING RECESSION
The straitjacket on fiscal policy
The public sector of peripheral countries, and above all Greece, has been at the epicentre of the current turmoil. The reasons for this, however, are only partially related to the intrinsic weaknesses of the public sector in peripheral countries. The current crisis is due to the nature of monetary union, to the mode of integration of peripheral countries in the eurozone, and to the impact of the crisis of 2007–9. Public sector debt has become a focus for the tensions that have emanated from these sources for reasons discussed below.
It is apparent that the sovereign debt crisis has not been chiefly caused by state incompetence, inefficiency and the like. Eurozone states have been operating within the framework of the Stability and Growth Pact, the main components of which emerged already in the early 1990s with the Maastricht Treaty. The underlying logic has been that, if the euro was going to become a world reserve currency and means of payment, there had to be coherence of fiscal policy to match the single monetary policy. Rising public deficits and accumulating state debt would have reduced the international value of the euro. The Stability and Growth Pact is important to making the euro a competitor to the dollar.
In this respect, the EU has faced an inherent contradiction because it is an alliance of sovereign states. Sovereignty means little without power and ability to tax, always reflecting the social composition of particular countries. Therefore, a compromise was reached, in large measure imposed by the core countries. The Growth and Stability Pact has imposed the arbitrary limit of 60 percent national debt relative to GDP and an almost equally arbitrary limit of 3 percent for budget deficits that would hopefully prevent the level of public debt from rising. Fiscal policy was placed in a straitjacket that has tormented eurozone states for nearly two decades.
The Stability and Growth Pact represents a loss of sovereignty for eurozone states. However, not all states within the eurozone were created equal. The loss of sovereignty has been more severe for peripheral states, as has been repeatedly demonstrated when France or Italy have exceeded the presumed limits on deficits and debt. It is no surprise, therefore, that peripheral states have resorted to the weapons of the weak, that is, subterfuge and guile. Some of the techniques used to hide public debt have been ruinous to public accounts in the long run. Greece has led the way with persistent manipulation of national statistics throughout the 2000s as well as by striking barely legal deals with Goldman Sachs that presented public borrowing as a derivative transaction. Public–private transactions have also been widely deployed in the periphery to postpone expenditure into the future, typically at a loss to the public.
But
