Commission publishes report on current account surpluses in the EU
1. The context
Macroeconomic imbalances in the euro area and in the EU expanded significantly in the run-up to the financial crisis. The imbalances manifested themselves in significant and persistent divergence in the current accounts of EU Member States. Although the current account of the euro area, as a whole, remained broadly balanced, current account deficits deteriorated significantly in some Member States, while surpluses increased substantially in others. From the macroeconomic viewpoint, the deficits in the euro area were thus financed by the surpluses in Germany, the Netherlands, Belgium, Finland, Austria and Luxembourg. Outside the monetary union, Denmark and Sweden also ran important surpluses. A similar accumulation of external imbalances was observed on a global scale. For example, the United States ran persistent current account deficits, while China and Japan registered persistent surpluses. Notwithstanding the intra-euro area rebalancing underway, the current account surpluses and deficits recorded by some EU countries are still high.
What is the aim of the report on current account surpluses?
The objective of this special analytical report is to analyse the persistently large current account surpluses in a number of Member States. In particular, the report explores whether the large surpluses in several EU Member States have been optimal from their own perspective, whether there is a link between surpluses and deficits in the euro area and whether there is a sustainable rebalancing in the euro area (and the EU) underway.
What is the current account?
The current account forms part of the balance of payments (together with the capital account and the financial account), which captures transactions between residents of a country and the rest of the world during a given period. The current account surplus or deficit corresponds to exports less imports plus the net income flow (like interest and dividends paid to and received from abroad) and net current transfers (like migrants' remittances).
The current account can also be calculated as the difference between domestic savings and investment. A surplus in the current account means that the country is generating more savings that it is investing domestically or, equivalently, that domestic income exceeds domestic consumption and domestic investment. This means that the country is investing abroad, exporting capital and, as a result, accumulating foreign assets (i.e. credits, FDI, etc.) vis-à-vis the rest of the world.
Which countries are analysed in the report?
The report focuses on eight EU Member States, six euro area Member States - Austria, Belgium, Germany, Finland, the Netherlands and Luxembourg - and two non-euro area countries - Sweden and Denmark. All have had relatively large current account surpluses over the past decade. The average surplus in these countries, as a group, was about 5% of GDP in 2007. Although there has been some reduction since 2008, surpluses remain relatively high. For 2012, the projections indicate an average surplus of 4% of GDP. However, it should be noted that there is a substantial heterogeneity among the eight countries. For example, since the onset of the crisis, surpluses have declined substantially in Austria, Belgium and Finland (the latter actually moved into a moderate deficit in 2011), but have remained high in Germany, Luxembourg and Sweden, and have even increased in Denmark and the Netherlands. The current account surplus as a share of GDP of the Netherlands is currently the largest in the EU, amounting to 9.2% in 2012 according to the Commission's autumn forecast.
Why is the report published now?
The surveillance processes in the Macroeconomic Imbalance Procedure (MIP) cover both current account deficits and surpluses (see last question). However, the nature, importance and urgency of the policy challenges differ significantly depending on the Member States concerned. Given vulnerabilities and the magnitude of the adjustment required, the need for policy action is particularly pressing in Member States showing persistently large current-account deficits and competitiveness losses. These might also be driven by market failures or policy settings that constrain domestic demand and investment opportunities. Such market or policy failures imply a misallocation of resources, which will entail welfare losses also in surplus countries. When this is the case, reforms that help strengthening domestic demand and growth potential can be welfare-enhancing for the Member State concerned. Therefore the debate on external imbalances and on appropriate policy reactions cannot focus only on deficit countries. In this special analytical report, the Commission services take a closer look at the drivers and policy implications of large and sustained current account surpluses.
Current account surpluses or deficits may or not constitute macroeconomic imbalances. Deficits and surpluses are a natural consequence of economic interactions between countries. They show to which extent a country relies on borrowing from the rest of the world or how much of its resources it lends abroad. They can often simply be the result of an appropriate allocation of savings, taking into account different investment opportunities across countries. Differences in economic prospects lead to differences in saving behaviour, with brighter expectations reducing the tendency of economic agents to save and hence contributing to the accumulation of deficits. In particular, countries with a rapidly ageing population may find it opportune to save today (i.e. run surpluses) to smooth consumption over time. Moreover, current account deficits and surpluses are part of the adjustment process in a monetary union.
Against this background it should be noted that some of the increase in the dispersion in the current account balances among EU countries since 1999 was a positive outcome of financial integration in the euro area and globally. However, some of the increase in current account surpluses and deficits may also reflect distortions due to inappropriate expectations, mispricing of risks or market distortions, or may be induced by misguided policy interventions or weaknesses in financial supervision. These market failures imply a misallocation of resources and a build-up of imbalances and vulnerabilities in both surplus and deficit countries. This misallocation of resources will entail welfare losses also in the surplus countries. In such cases, it would be in the self-interest of the surplus countries to address the market failures or correct their policy interventions, by removing the obstacles hampering their domestic demand.
Is there a link between current account surpluses in some countries and deficits in other countries?
Deficits and surpluses in the euro area (and the EU) are closely connected due to intensive cross-border trade and financial links. In particular, the savings of the surplus countries in excess of their own investment financed the deficits in other euro area countries. However, it is not possible to establish a causality between deficits and surpluses in any pair of countries. For example, there is no evidence that the export performance of the surplus countries crowded out the exports of the deficit countries.
An increase in domestic demand in the euro area surplus economies would improve the trade balance of countries with a deficit. Nevertheless, the impact on the rebalancing of the economic activity in the deficit economies should not be overestimated, because the increase in imports is spread among a large number of trading partners. For example, an increase in domestic demand of a big surplus country, such as Germany, has a much stronger impact on the exports of the neighbouring countries, including those with a surplus, rather than in the ‘peripheral’ economies of the eurozone.
What are the drivers behind large current account surpluses and deficits?
Most of the increases in the surpluses and deficits have been driven by financial flows, spurred by the convergence in interest rates following the introduction of the euro and by developments in the European and global financial markets. In the absence of adequate financial market macro-supervision, this resulted in credit-driven booms; reduction in savings and excessive investment in non-productive activities in the periphery; and excessive risk concentration in the financial system in the core countries.
Moreover, external shocks appear to have been more relevant for the intra-EU imbalances than is usually appreciated. These external shocks, such as the rapidly evolving competition from emerging countries, enlargement of the EU, increases in commodity prices, recycling of oil-producers' income and changes in the pattern of global demand had different impacts on individual Member States. For example, competition coming from China and other emerging economies has had substantial consequences on the export performance of EU economies. Though China directly competes with virtually all EU economies, changes in world trade appear to have affected the deficit countries more.
Should countries with high current account surpluses aim to reduce them?
Some of the surpluses recorded by certain EU countries are on the high side. There is no evidence pointing to a single specific market failure or misguided policy interventions, but there appear to be a number of structural features that might have contributed to the accumulation of surpluses. Structural reform would help strengthening domestic demand in the surplus countries and contribute to rebalancing. In particular, policy measures aimed at improving the functioning of specific sectors, such as services, financial intermediation (including mortgages) and other non-tradables would foster demand-based growth in the surplus countries. While these structural improvements are desirable in their own right, their positive spillovers on other euro area economies could be tangible.
To which extent is a "rebalancing" process already taking place?
The rebalancing inside the euro area and the EU is underway. So far, most adjustment has taken place on the side of the deficit countries, through deleveraging leading to reduction in consumption and investment, though the improvements in their competitiveness have also played a role. There has also been a reduction in surpluses, but it has been relatively modest until now. In fact, the current account surpluses (and especially trade surpluses) of the high-surplus countries with the high-deficit countries have dropped substantially, while the surpluses with non-EU countries have gone up. This suggests that the intra-EU rebalancing is not to the detriment of competitiveness of surplus countries vis-à-vis the rest of the world.
Favourable conditions for stronger domestic demand are in place in most surplus countries. From the euro area perspective, developments in two major surplus countries will be decisive. While wages are set to increase relatively more in Germany and the country is expected to reduce its surplus, subdued domestic demand combined with deleveraging needs are exerting upward pressure on the Dutch surplus.
What needs to be done in order to underpin the rebalancing process?
In a monetary union, the adjustment mechanism through relative costs and prices should be supported by sufficiently flexible product and labour markets that allow an efficient reallocation of resources.
Most surplus countries are currently experiencing relatively tight labour markets, so that one could expect a faster market-driven increase in wages in these countries. In a rebalancing context, policies with direct bearing on labour costs should be discussed in a coordinated manner. One has to distinguish between policies that aim at tackling problems with the functioning of the labour market from those that primarily aim to boost competitiveness. However, the rebalancing inside the euro area (and of the EU) can of course not consist of policies which undermine the competitiveness of the EU, of the euro area or even of individual Member States in the global economy, or the objective of price stability.
Moreover, overcoming financial fragmentation and the restoration of sound 'downhill' capital flows from the core towards the vulnerable countries in the euro area will be crucial to promote their recovery, which, in turn, is indispensable to achieve external balance as well as fiscal sustainability. Therefore, a key priority is to restore non-debt capital inflows used for productive purposes, for example in the form of FDI. Appropriate financial supervision, and the implementation of the recent decision on the single supervision mechanism (SSM), are key in this respect to ensure that savings are channelled to productive uses.
Should the euro area as a whole have a balanced current account?
In spite of the current account deficits and surpluses in individual Member States, the current account of the euro area and the EU as a whole has been broadly balanced. But it should be noted that the euro area (or the EU) current account does not need to be balanced. In fact, the structural characteristics of the euro area, including demography and relative level of prosperity, suggest that it could have a moderate surplus. The euro area is not a closed economy and the sum of its surpluses and deficits can substantially differ from zero. According to the Commission's autumn forecast, the current account surplus will amount to 1.1% of GDP in the euro area and to 0.4% in the EU in 2012, after 0.3% and 0.0% in 2011.
How will the Commission monitor current account surpluses in the future?
The Commission monitors current account surpluses and deficits under the Macroeconomic Imbalance Procedure (MIP), which was introduced in December 2011. Its aim is to identify, prevent and correct harmful imbalances by ensuring that appropriate policy responses are adopted in Member States in a coordinated manner. The issues that fall under the scope of the MIP are wider than the external accounts, but the current account deficits and surpluses feature prominently in the procedure. The starting point of each round of the MIP is an Alert Mechanism Report (AMR), in which the Commission identifies Member States whose macroeconomic situation needs further scrutiny through an in-depth review. The analysis in the AMR is based, inter alia, on a scoreboard of eleven macroeconomic indicators. One of them is the three-year average of the current account balance as a percentage of GDP, with an indicative threshold of +6% and -4%. The asymmetry reflects the fact that the risks in connection with current account deficits are higher than for current account surpluses.
It should be noted that there is substantial heterogeneity among the eight countries discussed in the report on current account surpluses. Although there are findings for the group of surplus countries as a whole, the conclusions drawn for each one of them do not always apply to the others.