Germany's 'continental economy' - comparisons to the US, India and China

Data released by the German statistical service shows how much Germany, until this year the world's largest exporter, and still the second largest, relies on its European market - particularly in a period of severe economic downturn such as 2009.

Approximately three quarters of German exports were to European countries. 63% of all exported German goods were delivered to the member states of the European Union.

Asia, the second most important market for German export goods in 2009, trailed far behind with 14% of German exports. The US accounted for 10%.. Africa and Oceania (including Australia) accounted for only 2% and 1% of German exports.

In terms of imports Germany was almost equally Europe dominated. 71% of Germany's imports came from Europe, with 18% from Asia and 9% from the US. Goods from Africa and Oceania represented just 2% and 0.4%, of Germany's imports.

Germany's economy, in short, is not really a balanced 'international' one - in particular in an economic downturn. It is, in export terms in particular, a European continental economy with secondary add ons in Asia and the US.

What implications flow from this?

The first is to reinforce the decisiveness of preserving the Eurozone for Germany - as against somewhat facile talk that the Euro may split or disintegrate. Germany has by far the highest percentage of exports in GDP of any major economy - 47.1% on the eve of the international financial crisis in the 2nd quarter of 2008. This has increased hugely, from 28.0%, since the introduction of the Euro.

The fact that Germany is operating in a continental scale economy, Eurozone Europe, with a fixed exchange rate, allows it to gain or maintain tremendous economies of scale. Conversely introduction of unstable exchange rates,including the possibility for major European trading partners to carry out competitive devaluations, would almost certainly make it impossible for Germany to maintain such a high proportion of exports in its economy - that is it would greatly weaken the 'continental' scale of its economy. The Euro, in short, is not a 'monetary union' but a decisive mechanism for Germany to enjoy the advantages of a continental scale economy. As the gains are great German economic policy, being rational, can pay a major price to maintain the Euro - something to be kept in mind in the coming battles over debt in Greece, Portugal and Spain.

Second, the trade data casts an important light on the optimal size of a modern economy. It is well known that the world's largest and most productive economy, the US, has only a relatively small share of foreign trade in GDP. In the 2nd quarter of 2008, prior to the recent decline in world trade, exports accounted for 13.6% of US GDP and imports for 18.5% - evidently far below German levels. Exports of goods and services were only 5.7% of US GDP in 1929, 3.4% of US GDP in 1938, and 7.0% of US GDP in 1950.

The reason for the far more self-contained character of the US economy, of course, is the fact that it was the first continental scale integrated economy in history. The second continental scale economy was the USSR, which has since disintegrated, the third is China and the fourth is India. Germany's economic configuration is that of the single most important component of a continental scale economy attempting to come into existence in Europe. Whether it succeeds or not of course depends on the future course of European integration.

These parameters also cast a very interesting light on possible future dynamics of China's economy. China's economy is far more open than any economy of its scale has been historically. In real, that is parity purchasing power (PPP), terms China's has already been the second largest economy in the world for several years. In PPP terms China's economy is slightly over half the size of the US - on IMF calculations $7.9 trillion compared to $14.3 trillion. In terms of percentage of GDP, at official exchange rates, China's exports of goods and services peaked at 39.1% of GDP in 2006 - far exceeding the ratio of exports to GDP of the US. By 2008, under the impact of the upward movement in the exchange rate of the RMB, and the beginning of the international financial crisis, exports of goods and services had fallen slightly to 35.9% of China's GDP.

If China's exports in dollars are compared to a parity purchasing power figure for its GDP, however, then exports are only 20% of GDP. This is still above the figure for the US but not vastly so. It is entirely possible that as the size of China's GDP at official exchange rate grows towards US levels, both through economic growth and revaluation of the RMB, the percentage of exports in China's GDP will actually decrease. Unlike the historical pattern of most economies, which developed on the basis of their domestic markets and then expanded into exports, China may develop on the basis of exports and then statistically partially 'retreat' into a large scale domestic market. This would be a type of economic 'convergence' towards the type of $15 trillion GDP economy which is the scale represented by both the US and the EU.

Such a development would, of course, not be a retreat of China from globalisation - the absolute scale of China's exports, imports and inward and outward investment would continue to rise, but it casts the present rebalancing of China's economy towards domestic demand in not only a tactical but a strategic light. The only proviso that needs to be made, because of some confusions expressed in sections of the press, is that 'domestic demand' for China, as for every country, does not consist only of domestic consumption but also domestic investment. The present rise in the proportion of both domestic investment and domestic consumption in China's GDP, at the expense of its trade surplus, would constitute part of that process.

The process of 'globalisation' should therefore not hide the reality that the present is also an epoch of the integrated continental scale economy - with a common state to sustain a common currency, a unified budget, and the other features of an integrated economy. The US, China, and India have all created this, even if they are at different levels of economic development. Europe has not. Champions of 'national sovereignty' in Europe in fact lead their own nations towards decline. Whether Europe succeeds in creating a real integrated continental scale economy, or retreats into individual country units which are too small to be economically efficient in a modern world economy, will largely determine not only the continent's fate but that of the individual countries within it.

Germany's trade data shows the strength of the forces leading to the creation of a real European continental scale economy. The present parochial state of European politics - increasingly influenced by obsessions about banning minarets, immigrants, discussion of non-existent threats to ' convert Europe to Islam', and other forms of xenophobia and racism - leads the continent and the individual countries within it to decline.

It is a common pattern that a European country reached a peak of power followed by a prolonged period of fall - Italy in the 15th century, Spain in the 16th, Holland in the 17th, Britain in the 18th and 19th. Europe, which for several centuries was the world's most powerful continent, seems on the political level intent on pursuing the same path.

It remains to be seen whether the forces expressed in Germany's continental scale economy, and the parallel processes in other countries, can reverse the processes of decline which are expressing themselves in European politics.

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This article originally appeared on the blog Key Trends in Globalisation.

Memo to Martin Wolf - India and China show that to maintain support for globalisation reliance on 'trickle down' needs abandoning

In his blog from Davos Martin Wolf, chief economics commentator of the Financial Times, notes: 'I am listening to Lawrence Summers as I write. He has emphasised that we cannot maintain global integration if it is seen as a source of domestic disintegration. This tension - that between the global economy and domestic politics - is a central challenge of our time. It affects everything we try to do.'

Martin Wolf is a very strong supporter of global economic integration for reasons he set out in Why Globalisation Works and numerous other writings. The danger he warns against is that popular backlashes in favour of protectionism will undermine the process of global economic integration. In the US and a number of European countries popular sentiment in favour of protectionism has increased - although its effect on those who make economic policy, as regards the most important issues, is as yet far more limited.

For slightly different reasons to Martin Wolf this blog is also strongly in favour of the process of global economic integration and against protectionism. The reason for this is that division of labour, followed by investment, is the most powerful force in economic growth and in the modern era participation in increasing division of labour is necessarily international in scope. Preventing popular, indeed any, backlashes in favour of protectionism is therefore an important question.

In dealing with this issue Martin Wolf could reflect on the difference in sentiment between India and China on the one hand and the US and Europe on the other. In India a government pledged to take the country down the strategic path of integration in the international economy was re-elected with a convincing mandate. In China, as anyone who visits the country knows, popular support for the 'opening up process' (official terminology for the country's orientation towards globalisation) remains high. The contrast in popular mood between India and China on the one hand and the US and Europe on the other is therefore striking.

Part of this difference is, of course, the much more rapid growth of India's and China's economies compared to Europe and the US. However, simply rapid growth is not sufficient to maintain popular support for international economic integration - and while the US and European economies have been expanding less rapidly than India and China they were, prior to the current recession, still growing.

The former BJP government in India achieved rapid economic growth but was tossed out of office by the electorate. Entirely rationally the population will not support globalisation if this merely yields higher GDP figures recorded in statistical works,. They will support globalisation only if it delivers better living standards for them. The majority of India's population considered the BJP's rapid economic growth had not delivered for them and therefore voted against the government.

The strategic concept of the new Congress government under Manmohan Singh was, and remains, 'inclusive growth'. It aimed at rapid growth, using global economic integration as a key means to achieve this, but did not rely on 'trickle down' to make sure the mass of the population shared in its benefits. Conscious programmes of redistribution of resources to rural areas, and less well off sections of the population, were part of the bedrock of 'inclusive growth'.

It is also notable in China that Hu Jintao's 'harmonious society' has included direct measures to redistribute the benefits of growth to those who were not previously perceived as having gained sufficiently. In China's stimulus package to confront the international financial crises, price reductions on consumer durables were targeted on rural areas, the government has reintroduced free education, a major expansion of the health care system is taking place, large scale investment is taking place in the less well off inland provinces etc.

In short, both India and China have abandoned 'trickle down' as the method of ensuring all share in the growth produced by international economic integration.

In the US and Europe, on the contrary, the movement has been towards greater reliance on unfettered free markets. The evidence shows, however, that unfettered operation of the market increases inequality sharply. The most notable result of this is that median wages in the US have relatively stagnated for two decades at the same time as relatively sustained economic growth occurred - it is necessary to look no further than this to understand populist backlashes in the US. In the US the gap in income and wealth between the bottom and top of society has widened greatly, as it has in Britain. The US and Britain by relying on 'trickle down', by the operation of the free market, have therefore sharply increased inequality - and, in the case of the US, deterioration of the economic situation for significant layers of the population has occurred.

India and China, in short, have abandoned 'tickle down' while the US and Europe have embraced it. In India and China support for strategic global economic integration remains high. In the US and Europe a backlash against it has developed.

Martin Wolf, in his entirely justified argument against the US and Europe embarking on protectionism, can therefore consider the contrast in the popular mood in India and China. It may indicate why, to maintain popular support for globalisation, the US and Europe also need to abandon reliance on 'trickle down'.

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This article originally appeared on the blog Key Trends in Globalisation.

Decline of the Rupee's exchange rate - India moves further towards the 'Asian growth model'

India was one of a number of countries that experienced major currency devaluation against the dollar during and after the international currency crisis. As the comparison to China, which pursued a policy of stabilising the RMB's exchange rate against the dollar after the outbreak of the financial crisis, is particularly interesting the movements of the RMB and the Indian Rupee against the dollar since 2000 are shown in Figure 1.

Figure 1

As may be seen the Rupee from 2000 up to September 2007 had a tendency to a weaker exchange rate than the RMB. But the difference was not extreme and in September 2007 the two currencies were essentially at parity in terms of exchange rate shifts with a roughly ten percent upward movement in exchange rate against the dollar compared to 2000.

After September 2007, however, a marked divergence between the exchange rate of the RMB and the Rupee began. The RMB first continued to rise and then stabilised, without falling, when the financial crisis began. The exchange rate of the Rupee, in contrast, start falling from September 2007 onwards and this accelerated as the financial crisis developed. The specific trends since the start of the financial crisis are shown in Figure 2.

Figure 2

Taking these movements together, between September 2007 and January 2010 the RMB rose by over 10% against the dollar while the Rupee fell by over 20% between September 2007 and its low point in March 2009. Even after recovery of the Rupee, at the beginning of January 2010 it was still more than 12% below its September 2007 level. As the RMB went up against the dollar in the same period this means that the Rupee has carried out an effective twenty per cent devaluation against the RMB since September 2007.

Given that India runs, relative to the size of its economy, a containable balance of payments deficit, which in 2008 was 2.7% of GDP, no substantive internationally destabilising consequences flow from the devaluation of the Rupee against either the dollar or the RMB. What will be significant however will be to see whether this clear devaluation of the Rupee against the RMB alters the relative dynamics of India's and China's economies.

As this blog has noted on a number of occasions the long term effect of India's economic reforms has been to shift it decisively towards the 'Asian growth model' - that is to a very strong increase in savings and investment rates. Indian Prime Minister Manmohan Singh has consciously supported this policy.

The decline of the exchange rate of the Rupee moves India further towards adoption of the 'Asian growth model'. This is because for countries such as South Korea and China a second component of their economic strategy, alongside high rates of savings and investment, was to maintain a low exchange rate in order to boost exports.

Contrary to accusations to the contrary this did not necessarily mean running a large trade surplus, as this depended on developments such as the rate of growth of the economy which helped determine whether imports rose equally - for example China's large trade surplus appeared only in 2005 and is now declining, while South Korea at various times has run large trade deficits. The low exchange rate policy, however, did ensure a rapid development of the share of exports in the economy, allowing economies of scale from production for the international market and other benefits to be achieved. The fact that India was more cut off from the international division of labour compared to is east Asian competitors, that is its share of exports and imports in the economy was relatively low, was an achilles heel.

Having achieved a level of savings and investment which is currently higher than South Korea and the other former East Asian tigers, and is not far behind China, the logical next step for India is to adopt a low exchange rate policy to stimulate exports still further. The changes in the Rupees exchange rate in the last period give the opportunity to achieve this. It remains to be seen whether they will be consolidated.

In addition to the importance for India itself there is an international significance of India's further shift towards a policy of a high savings and high investment coupled with a low exchange rate to stimulate exports. For this, as noted, is precisely the 'Asian growth model'. The fact that the world's second most populous country, soon to become its first, is moving with success further towards such a model has clear implications. Far from the 'Asian growth model' moving to its end after the financial crisis, as some commentators have claimed, it is spreading further.

Watching the exchange rate of the Rupee, and its effect on India's economic performance, is becoming a highly important international issue.

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This article originally appeared on the blog Key Trends in Globalisation.

The convulsion in world trade

This blog has analysed on several occasions that the current decline in financial markets, including share prices, has continued for 17 months to match in rapidity that after 1929 – i.e. the most severe recorded.

As may be seen from Figure 1 the rise in share prices on Wall Street in the trading week 9-13 March week did not break out of this declining trend. The shift so far has simply moved the rate of descent closer to the declining trendline that has been operating since October 2007 following several weeks of more precipitate than average falls.

Figure 1

As may be seen from the comparison in Figure 2 the rate of descent of the Dow Jones Industrial Average since October 2007 continues to be as rapid as in 1929 - i.e. it greatly exceeds in speed any other major share decline, apart from 1929, seen since the beginning of the 20th century.

Figure 2

Considering the relation between the financial decline and the productive economy, an article on this blog earlier this month also noted that, for the major industrialised economies, the annualised rate of decline in exports in the last three months has actually been more rapid than in 1929.

The latest statistical data released by the Organisation for Economic Co-operation and Development (OECD) for world trade up to December 2008, with data for more recent months in a few cases, allows the calculation of a picture for a wider range of countries that confirms this trend in striking fashion.

Due to the extremely rapid shift in the situation three indicators have been calculated for exports – the actual year on year decline to December 2008, the actual decline in exports since the peak month for each country or area last year, and the change during the three months to December 2008 on an annualised basis.

In order to give a historical scale of comparison the decline of US exports, in current prices, was 22.5% in 1929-30, 32.7% in 1930-31, 32.4% in 1931-32 and 4.0% in 1932-33 after which partial export recovery commenced - i.e. the most rapid annual rate of decline of US exports in the Great Depression, and the most rapid on record to date, was 32.7% in 1930-31. By 1933 US exports had fallen 66.2% below their 1929 level.

Considering first the OECD area as a whole, and the situation in the European region, the data is set out in Table 1. As can be seen for the OECD region as a whole exports have already declined by over 30% since their peak in April 2008 - essentially equaling the rates of decline of the worst year of the 1930s. The annualised rate of decline in three months up to December 2008 was an astonishing 64%.

For the major G7 economies the decline was only slightly less severe - with a decline of 26.9% since the peak in July and an annualised rate of decline of 57.8% in the three months to December 2008.

Within the Euro area the annualised rate of decline for the three months to December 2008 was 50.4% and for the OECD European region, which includes some East European states, the annualised rate of decline was 67.0%.

It may therefore be clearly said that in the field of trade, as in that of financial markets, the current decline is full comparable in speed of descent to the onset of the Great Depression. The difference, so far, is not in the speed of fall but in its duration. The decline in exports after 1929 continued for four years whereas so far the current decline has been occurring for a year.

Table 1

Turning to individual countries, Table 2 shows the figures for the largest OECD economies - the G7. As may be seen all have seen declines in exports of over 25% since their peak levels last year and in the three months to December 2008 all witnessed annualised rates of decline of more than 50%.

In short, the precipitate decline in world trade, at 1930s rates of descent, is not confined to smaller economies but fully affects the largest ones.

Table 2

Table 3 shows the rates of decline of exports for the non-G7 European OECD states. As may be seen with the exception of two small economies, Luxemburg and Ireland, which have done better than others, all OECD European countries have seen actual export declines of at least 25% and annualised rates of decline of 50% or more.

It is possible that the rate of decline for Spain, an incredible 99.7% annualised rate in the three months to December 2008, is a statistical freak or error but the annualised rates of decline for Sweden, Poland, and Norway are almost as severe - respectively, 79.1%, 82,8%, and 83.1%. Such rates may rightly be characterised not as decline but of collapse of exports in at least the short term.

Table 3

Turning to non-European economies, the data is set out in Table 4. Again, with the exception of the small economies of Iceland and New Zealand, the highly publicised decline of Chinese exports by 22.3% since their peak last year, and at an annualised rate of 53.0% in the three months to December, are themselves actually significantly smaller than for other countries. Mexico and South Korea have already seen actual declines of exports of over 30% and South Africa and Turkey have seen falls of over 40%. The annualised rates of decline of exports for South Korea, Brazil, Indonesia, South Africa, and Turkey - at 70.7%, 72.4%, 78.2%, 82.1%, and 90.1% respectively - are clearly catastrophic.

Table 4

Countries for which OECD data is available for January confirm continuation of the same trend – as shown in Table 5. The chief difference is that with the extra month the actual declines in exports, as opposed to only the annualised rates of fall, have become more serious.

The actual falls recorded from the maximum levels of exports are 29.8% for Switzerland, 41.1% for South Africa, 41.4% for Sweden, 46.3% for Norway and 47.5% for Turkey. There is nothing in this pattern which indicates results for other countries are likely to show an improved tendency.

Table 5

Summarising the above data, of the 34 countries studied 14 had annualised rates of decline of exports of more than 70% and 20 had rates of decline of more than 60%. The widely publicised reports of declines of exports in the last three months of last year such as the annualised 51.9% for Japan, 53.0% for China, or 54.0% for the US, which attracted much publicity, are actually modest compared to the falls in most countries.

While the annualised rates of decline show the extremely striking implosion of world trade during the last three months of 2008 an annualised rate, naturally, indicates an, in this case extremely severe, tendency. What is equally disturbing is the factual falls in exports recorded from the maximum levels last year. Seven countries registered actual falls in exports of more than 40% and 19 of more than 30%.

It should be noted that trade today plays a more significant role in the world economy than at the onset of the 1929 crisis. Exports in an economy with relatively low exposure to trade such as the US now account for 12% of US GDP compared to 7% in 1929 - the figures for most countries are of course much higher. The result of any continuation of such rapid rates of decline of trade therefore, all other things being equal, would be more severe than in 1929.

The transmission mechanisms of the financial crisis into the productive economy are also made clear by such trends. As has been noted previously, initially in the present crisis there was a disjunction between the decline in financial markets, which was of 1929 magnitude, and the situation of the productive economy - which was of a severe but not equivalent decline. As such a disjunction is highly unlikely to continue either financial markets would recover, having overshot on the downside, or the trends and statistics in the productive economy would be shown to have been a lagging indicator and they would adjust downwards to the tendencies indicated in financial markets.

The extraordinarily powerful falls in world exports shown in the latest figures for all major economies indicate that the decline in trade is operating as a key mechanism by which the crisis revealed in financial markets is beginning to affect the productive economy. It may now be said that in two areas of the world economy, financial markets and trade, rates of decline are fully comparable to 1929 scale. How powerful the transmission mechanisms from the international sector are into domestic economies must clearly be carefully studied. The duration of the crisis is also critical - the so far unique severity of 1929 was not only due to the rapidity of the fall but by its duration. The decline in US trade and GDP in the 1930s continued for four years whereas the current decline in financial markets has lasted 17 months, the decline in trade slightly under one year, and the fall in GDP approximately six months.

Nevertheless quite sufficient data are now in to say with certainty that in the last three months of 2008 a convulsion in world trade occurred. The extreme rapidity of the fall in world trade, as with the situation in financial markets, confirms that the benchmark for present analyses must be not only post-World War II recessions but also 1929 itself.

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This article originally appeared on Key Trends in Globalisation

Notes to Tables - peak month for exports in 2008

1. Peak January 2008
2. Peak March 2008
3. Peak April 2008
4. Peak May 2008
5. Peak June 2008
6. Peak July 2008
7. Peak August 2008
8. Peak September 2008

India and China

The international financial crisis is shaking up and reshaping many economic relationships. One at the top of that list should certainly be economic relations between India and China.

The complementarity of the two countries in the present international financial situation is evident. India has naturally been affected by the international financial crisis but its economy is still continuing to perform strongly compared to almost all other countries - while GDP growth is almost certain to have decelerated from the 7.6% year on year year increase recorded in the third quarter, India will continue to be one of the few major economies experiencing economic growth this year and India's industrial production in December was down only 2.0% year on year, which is far superior to current performance in most countries. India's macro-economic fundamentals, particularly its high savings and investment rates, continue to be strong. China continues to register economic growth and its savings and investment rates are the highest in the world.

In short, India and China will be the world's two best performing major economies in 2009 and therefore able to offer more favourable markets for each other than almost any other combination of countries.

The Indian government, however, is quite open about the fact that India cannot finance alone all the infrastructure investment it requires to sustain its rapid economic growth at present – short term and medium term project requirements by themselves amount to over $250 billion. Meanwhile India's budget deficit of 6% of GDP limits the room for manoeuvre of the government in publicly funded infrastructure development.

China, however, is not only very strong financially but also has highly experienced companies capable of leading infrastructure projects. Simultaneously India has areas of great strengths where it has achieved leads over China – in a number of service sectors led, of course, by software in which China can benefit from Indian expertise. The two economies, in short, have developed significant complementarities. Discussions between India and China governments on economic issues would therefore seem to be a high priority.

The main obstacle to this at present would seem to be circles in the US which are seeking to create tensions between India and China for political purposes and some short sighted figures in India who are prepared to go along with such an agenda. The US is, however, in no position to aid India economically or to undertake the scale of infrastructure and other economic development which India requires to sustain its growth rate. Tension between India and China therefore damages India even more than China.

Economic relations between the world's two most rapidly growing major economies will therefore be a matter of great interest during the current financial turmoil.

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This article appeared on the blog Key Trends in Globalisation.