Balance of Payments in the European Periphery Assignment Help
Introduction:
The article by Hale (2013) focuses on the factors which have resulted in the balance of payment crisis in the European periphery countries of Greece, Italy, Ireland, Portugal & Spain (GIIPS). As explained in the article, the current account deficit is caused by excess of imports over exports and excess of consumption and investment over production. This Current Account Deficit (CAD), coupled with the Financial Account imbalances, forces the country to borrow. Persistent deficits further increase imports, lead to excessive government spending and excessive lending by the financial sector. This leads to excessive investment as compared to savings. This deficit is funded by private-sector through direct or portfolio investment, and sovereign lending. Both the lenders, governments and the financial sector, borrow from abroad leading to a vicious cycle. This is either automatically corrected by exchange rate fluctuations or a currency crisis where the foreign exchange reserves are depleted and the country cannot borrow any more. This leads to a sudden and large devaluation of the currency, further accelerated by speculators who take advantage of the country’s inability to support the currency. A lower value currency leads to inflation and drop in wages, and more capital outflows to repay debt. Inflow is obviously reduced as the currency value is falling. The articles states that these adjustments are more pronounced in economies where the debt burden is more.
In the European Union, creation of the common currency Euro reduced trade costs and boosted trade. However, labor costs increased relatively more in the peripheral countries. Germany produced surpluses and increased the deficits in GIIPS. To fund this deficit, private capital flowed from other EU countries into GIIPS. Over time, these deficits ceased to be funded by private capital flows as the repaying capability of these countries came into question due to lower credit ratings. However, instead of a crisis, these deficits began to be funded by government debt (European Central bank and central banks of other EU countries) through cross border transfers. On the Balance of payments sheet, it resulted in accumulation of negative balances on the official foreign reserves account of GIIPS. This support of the governments / banks helped the countries avoid a currency crisis. However, adjustments in other aspects of the macro economy, which are inevitable, are being made. Lower wages, higher inflation are some of the symptoms of this ongoing socially and politically painful correction. As per the article, these adjustments have lead to increased competitiveness of the countries, albeit through a different route. The article points out that the CAD of GIIPS has shrunk. The wages have fallen but not as much as they did during the Asian financial crisis. Thus the fall has been cushioned because GIIPS had access to the EU funds to support their CADs. Of course, the problems of the sovereign debt are still to be addressed.
Evaluation
The article clearly explains the inter-linkages and nuances between the long term macroeconomic trends and the balance-of-payments situation of individual nations. It highlights that the automatic or natural corrections in the exchange rate lead to adjustments in the components of the balance of payments, leading to a balance over the long term. However, artificial protection of the exchange rate may lead to delaying the adjustments.
The article correctly traces the chain of events leading to the balance of payment crisis in the GIIPS. This is in line with the theoritical factors which influence the balance of payments. While aspects like exports and imports were dependent more on the relative poor economic conditions in these countries, the capital flows were majorly a consequence of the requirement to fund the resulting CADs. The negative foreign exchange reserves added to the balance of payment crisis. All these factors were majorly influenced by the artificially high value of the currency (the Euro) for these economies.
However, as mentioned in Warner (2013), the shrinking of the CADs is not due to inherent strengths of the economies of these countries. In fact, lower imports are a results of lower domestic demand due to inherent weaknesses. The exports are still lower than the pre-crisis levels, and the increase is not as robust as it should be to signal any significant improvement in competitiveness. Further, the decrease in wages is more of a result of lower employment opportunities rather than a proper adjustment. In effect, fewer workers are doing the same amount of work. The wage adjustments are more pronounced in the public sector where it is relatively easier to control the wages. Further, the increased competitiveness of the economies like Spain have made it difficult to lower the wages any further. Also, there are signs of a bifurcated labor market where new jobs are at lower rate and existing jobs are highly protected. Importantly, the lower wage rates lead to shrinking of the economy. Further, as these adjustments are more fiscal in nature, the competitiveness is not being increased (e.g. through higher taxation).
Thus, the apparent cushioning of the fall cannot be considered as a great positive for the GIIPS as the access to government / EU bank funds has not addressed the underlying problems. As mentioned in Pabst (2013), the banking and sovereign crisis has an underlying balance-of-payments crisis stemming from trade imbalances between surplus core countries and deficit peripheral countries. This has more to do with different levels of competitiveness and productivity due to differences in private and public investments. However, the intra-EU funding has definitely helped in delaying the inevitable adjustments.
To conclude, the balance-of-payments account is a result of various macroeconomic forces prevalent in the economies of nations and the world. All components of the balance-of-payments equation have to be addressed in a measured and timely manner to achieve sustained stability over the long term. Simply funding the deficit leads to aberrations in other parts of the economy which leads to deepening of the crisis. This makes the solutions more complex. European Union is unique in the sense that balance of payments of the component countries is strongly influenced by the relative health of their economies. Inability of the member countries to adjust the exchange rate to the health of their economies makes matters difficult.
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Reference
Hale, Galina (2013), ‘Balance Of Payments In The European Periphery’, FRBSF Economic Letter, 2013-01, January 14, 2013, FRBSF:San Fransisco, viewed 15 May 2013, http://www.frbsf.org/publications/economics/letter/2013/el2013-01.pdf
Warner, Jeremey (2013), ‘Europeans must face up to prospect of massive debt restructuring’, The Telegraph 13 May 2013, viewed 15 May 2013, http://www.telegraph.co.uk/finance/comment/jeremy-warner/10055044/Europeans
must-face-up-to-prospect-of-massive-debt-restructuring.html
Pabst, Dr. Adrian (2013), Wild World:Interview with Dr. Adrian Pabst, Crisis of Capitalism, Identity & Finance, 01 May 2013, Russian International Affairs Council: Moscow, viewed 15 May 2013, http://russiancouncil.ru/en/blogs/casingpoint/?id_4=464
