Thursday, 28 June 2012

Euro Area: Would expansionary policies in the core benefit the periphery ?

One broadly suggested policy response to the depression plaguing the “peripheral” Euro-area countries wants the “core” countries to raise wages and try to boost private final consumption. According to proponents of this policy path this would boost growth in  peripheral countries and ease their pain.

I do not wish to comment on how feasible something like that is neither on whether it constitutes a morally right or wrong policy response since it is a highly politicized issue. What I would like to try and comment on is whether such a policy has the capacity to produce the desired results. 

As anyone that has cast even a shifting glance to trade data for Euro-Area countries must have noticed, in most cases the importance of intra-Euro-Area trade is diminishing. 
As the trade channel will be the transmission mechanism through which potential benefits of this policy will spillover to the periphery, here is the chunk of imports for Germany and the Netherlands (the two larger core Euro-Area markets) that come from the Euro-Area.

source: Eurostat, own calculations

As one can see from the chart, for both countries, the Euro-Area share of their imports is diminishing fast.

Hence, one question that I cannot help but ask is, should this suggested policy move were to materialize, would it have the envisaged results?

Although, when new demand is created one cannot accurately predict where it will be channeled to, the chart above conveys two crystal clear messages. First, the share of core countries imports stemming from the Euro-Area is decreasing and second, for both the countries featured in the chart, the said share currently lies below 40%. Hence, such a policy would first and foremost benefit non-Euro-Area countries and not the periphery.

The other side of the coin is to look at the direction of peripheral countries exports’ flows. Here’s the chart.

source: Eurostat, own calculations

It seems that according to this metric, out of the three countries featured in the chart, Spain stands to benefit more, followed by Italy, while out of the three, Greece would reap the less benefits.

This particular data point makes, always in my humble opinion, implementation of such a policy mix even more unlikely, since should a proposed policy be likely to produce uneven  results and distribute potential benefits asymmetrically doesn’t this make it less desirable? 

Finally, one last point that questions the extent that such a policy would be beneficial to the peripheral countries is the fact that private consumption (and not exports) represents the lion share of their GDP. What’s more in all peripheral countries (Greece, Ireland, Italy, and Spain) the external sector is not large enough to compensate for plummeting domestic demand. The next graph portrays that pretty vividly.

source: Eurostat

According to this metric as well, potential benefits would once more be the least for my native Greece, whose external sector is miniscule. 

To wrap this up, the policy proposition which claims that should core Euro-Area countries implement expansionary policies this would have major beneficial effects on the periphery, leaves a lot to be desired in my humble opinion. One cannot control where newly-created demand from incremental final private consumption will be channeled to. On the other hand one could control where incremental public consumption would flow but how possible is something like that happening in such an international environment? I do not claim that this policy will lack any expansionary effects, I just think that there are other policy alternatives that would give policymakers more bang for their buck (or Euro if one wants to be literal)…

P.S. Here's the chart about private final consumption.

source: Eurostat

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