Before we end this week of class, let's just see how exactly Europe could get out of the problem? Let's examine some of the alternatives. As you know, so far most European governments have been implementing very, very strong austerity policies but not everybody is happy about it. Let me offer you an alternative scenario. First of all, let's keep in mind that all of these European economies are very interconnected. So, for instance, of all of the exports of these various European countries, the 28 that are members of the European Union 68% of those exports go to another member of the trade block, another European country. Within the Euro Zone, which remember has a smaller number of countries, 19 compares to 28 for the European Union, 48% of the total exports of those 19 countries go to another Euro Zone country. In the NAFTA, the North American Free Trade Agreement among Mexico, Canada, and the United States, the correspondent figure is also 48%. If you consider Asia as a bloc, the number would be 49%. And if you consider Latin America as a bloc, the proportion of exports that Latin American countries send to other Latin american countries is 22%. So you can see on this table that, by far, the part of the world that is the most integrated is the European Union, with 68% of all exports going to another European country. That is to say exports that remain within the trade bloc. The second thing that I want to bring to your attention at this point, is how does the German economy in particular its exports compare to those of other European countries. I want to show you this chart in which you can see the overlap in terms of exports between Germany and all of the other members of the European Union. The higher the number on the vertical scale the more the exports of any one country overlap with also Germany. That is to say at the extreme right we have Austria, who's economy's very similar to Germany's. And as you can see upwards of 90% of the expose of Austria directly compete with those products that Germany makes. In the sense that the Austrians export the same kinds of products as Austria. But you can also see that Italy and Spain and several other European countries have overlaps in terms of exports by product with Germany that are also very high. Now, if we go to the left side of the chart, you will find countries such as Greece, or Cyprus or Ireland whose exports don't overlap that much with those from Germany. Because those are economies that are specialized in the different of set of products and services. So what I'm trying to convey to you here is that the fact that the German economy became so much more competitive than those of other European countries. It had a large impact, especially on the countries that on this chart are situated towards the right. That is to say, the ones that have a much higher degree of overlapping the exports with Germany. So, let me just then tell you, what is it that Europe could do differently to try to get out of this very difficult situation, with very slow growth and very high unemployment, as quickly as possible? First of all we need to establish one very important fact which is that the Euro, the Eurozone has been very good for the German economy. Why do I say this? Well, I say this for the reasons that I was explaining just a few minutes ago. Number one, about three-fifths of Germans exports go to the rest of the Eurozone and about half of Germany's trade surplus is generated in the rest of the Eurozone. The crisis in the periphery of the Eurozone, especially in Southern Europe, has essentially tended to depress the value of the Euro as a currency. If today we didn't have the Euro, and Germany had the German mark, the Deutsche Mark as its currency, the Deutsche Mark would probably be much stronger as a currency than the Euro. So in other words, German firms exploring their goods to other parts of the world like the US or Latin America or the Middle East or Asia have benefited from a weaker Europe. In general, large German firms are in favor of doing whatever it takes to make these Southern European economies grow again. And they're in favor in general of bailouts, why? Because they know that much of production, let's say of automobiles or chemicals is purchased by those southern European economies. Now the smaller and more medium sized farms in Germany, the so called Mittelstand companies, they're a little bit more skeptical about bailing out those southern European countries. Because these are typically companies that sell all over the world And they're much more competitive than the larger German firms. I would also like to add that since the introduction of the Euro in 1999, inflation in Germany has been lower than during the period that the country had the Deutsche Mark as its currency, that is to say between the years 1949 in 1998. So in other words the Euro has the deliver something that the German population wants which is relatively low inflation. As a result of this, I also like to bring your attention one very important fact which is that the reserves that the world keeps In Euros are greater than the reserves that the world use to keep. In Deutsche Marks, French francs and Dutch Guilders before the interaction of the Euro. That is to say that although confidence in the Euro has declined since the year 2010 even today, governments around the world feel confident enough to hold at least part of their reserves in the European common currency. So what is it that should be done or could be done in this situation to help these European economies get out of the crisis faster than through plain dramatic austerity measures. Well, I think very strongly, that in the short run there is two kinds of policies that European governments should implement. I think that the surplus economies and of course among them mainly Germany should provide a stimulus. You see, Germany not only has a very large trade surplus, in addition, Germany has a balanced budget, something very few countries in the world have. What this means is that the German government has a lot of capacity to borrow and to spend that money. And the purpose of that would be that at least some of that spending would spill over into the southern European economies. Because most likely they would purchase some goods and services from those economies, and that would provide a stimulus. The other very important thing that a surplus economy should do is let workers enjoy higher wages. And this is what Germany started to do in the year 2011 and 2012, in part as a result of a new government coalition between the Christian Democrats and the Social Democrats so the more pro business and the more pro labor parties in Germany. One of the conditions for that coalition government that the social democrats imposed was that wages should go up. And wages going up in Germany of course means that their companies and their products lose a little bit of competitiveness. But it's helpful, because of course with the extra money those workers in Germany are likely to purchase at least some goods and some services from the southern European countries, thus all framed those economies a stimulus as well. And I think there's another very important policy too but for the last two or three years, roughly speaking since the year 2014 has been embraced by the Europeans Central Bank which is to allow for slightly higher inflation in Euro. Why is this important? Well, it's important because if you remember, inflation favors the holders or debt. It has become very difficult for the governments in Southern Europe to keep up with their servicing of the debt, paying the principle and the interest on their debt. Slightly higher inflation, a few decimal points would help those governments that are up to their ears in debt. But that's a policy that a European central bank would have to implement, and that it has started to implement in the form of purchases of bonds and other types of securities. Not only to help individual countries in Europe with their debt burden but also to allow for a slightly higher rate of inflation. I often get the question what should Germany and the rest of Europe do about the southern economies? About Portugal, Spain, Italy and Greece? And for me the answer is quite simple, Europe should do three things. The first is to allow for a slightly higher inflation rate. Why is that the case? Well, when you have a lot of debt, inflation helps you get out of problem. I'm not asking for, 5% or 8% inflation, I'm just asking for 0.2% or 0.3% more inflation than what's currently the case throughout the US zone. Number two, Germany should increase wages. That's going to help the Southern periphery, because the Germans buy goods and services From Portugal, from Spain, from Italy, from Greece. Germany can afford a wage increase because over the last 15 years, productivity in Germany has grown faster than wages. And number three, Germany should not balance its budget so early. You see the German economy can borrow at real negative interest rates, that includes the government. That's because a lot of members would like to put their money in the place that is relatively safe. So they're willing to give Germany, let's say 100 euros, only to get return about 98 of those euros, or 99 of those euros. That's called the real interest rate that is negative. With a balanced budget then Germany contributes to the procyclical policies that are essentially producing more recession, are producing a shrinkage of GAP throughout Europe. What Germany should do is invest more. And the government, the German government can certainly make a difference. Beginning with the medium term, let's say three, or four, or five years down the road, if you really want the Euro zone to work as an economy with a single currency, then I strongly believe, along with many other economists and political scientists, that Europe needs to put in place three kinds of institutions. It is to have a much greater degree of fiscal coordination and perhaps a fiscal union in the future. That would mean merging the national treasuries, that would mean having a European wide tax structure. The second thing that would need to be in place is a banking union. And happily Europe has taken a few steps in this direction since the year 2015. Now the so called systemic banking institutions in Europe are supervised by the European Central Bank and that's a very important step in terms of making sure that sovereign risk and bank risk are kept separate in job especially for those banks that are deemed to be systemic. That is to say that they operations are complex enough and affect enough countries from the Euro zone to deserve supervision of the European level. And lastly, I have already been telling you about this aspect for the last few minutes If the Euro is to survive as a single currency, the Euro zone needs to have a single labor market. This is really important. A single currency cannot work when some countries have 20% unemployment and others just 5%. It's very important to create a conditions under which people with look for jobs, for the best jobs available. Not just within their respective home countries or rather throughout the entire union. So these analysis brings our third week of class to an end we have looked at global economic and financial imbalances. We have tried to get a census to what the future might bring in terms of the relationship between the US and China. And also in terms of trade blocs in the world, the NAFTA, the European Union. And lastly we have analyzed Monetary Unions. And we have looked in depth at the Euro zone which seemed to be a great experiment at first but over the last few years has become a major liability.
