Spillover Effects of a Demand Boom in Northern Europe on Output and Employment in Southern Europe

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1 Spillover Effects of a Demand Boom in Northern Europe on Output and Employment in Southern Europe Oliver Picek 1 Enno Schröder 2 1 The New School for Social Research 2 The New School for Social Research, Institute for New Economic Thinking YSI workshop at the Eurozone and the Americas Conference at the LBJ Public Policy School, University of Texas, Austin, November 4, 2015

2 Outline Title and Outline 1 Two views on current account rebalancing in EMU Previous Work Our contribution 2 Impact analysis based on a multi-regional IO model Data 3 Main

3 Two views on current account rebalancing in EMU Previous Work Our contribution Two views on current account rebalancing in EMU The Bundesbank view Germany can contribute very little to growth, employment and trade balances in Southern Europe Bilateral trade flows small Germany trades with large number of countries A German expenditure boom diffuses The symmetric rebalancing view CA surplus countries: Stimulate domestic expenditure and inflate wages and prices CA deficit countries: Moderate expenditure and deflate Internal devaluation in deficit countries without expansion in surplus countries recession

4 Which view is accurate? Two views on current account rebalancing in EMU Previous Work Our contribution Previous work: EC (2012): multi-regional input-output model to estimate the size of spillover effects. Shock: 1% of final demand in Germany : improves trade balance of Spain, Italy and Portugal by about 0.02% (smaller for Greece). Problem 1: Computes only simple multipliers, multiplier always < 1 because of imports Problem 2: Germany only, not a coordinated stimulus in surplus countries Problem 3: What about a coordinated stimulus in all EU countries?

5 Two views on current account rebalancing in EMU Previous Work Our contribution Our contribution: Going beyond the Commission study 1 Close the model with respect to households: Allow for a Keynesian multiplier > 1 (a Keynesian consumption function) compute total multipliers (including induced effects of household consumption to higher income) 2 Distinguish between shocks to private consumption, public consumption, gross fixed capital formation, and domestic absorption (total final demand) 3 Estimate the effects of coordinated demand shocks in groups of countries, while the EC study focuses on Germany alone.

6 Impact analysis based on a multi-regional IO model Data Our method, IO analysis, has a few advantages A multi-regional input-output model takes into account interdependencies between industries in different regions (third-country multiplier effects and global value chains). Impact analysis allows estimation of the effect on output and employment of an exogenous shock to final demand Impact analysis based on a multi-regional model yields estimates of the size of spillover effects, i.e. the response of income and employment in one country triggered by a final demand shock in another country Size of spillover effects depends on: 1 Industrial structure 2 Size and composition of demand shock 3 Trade network of actual economies (not just bilateral trade flows!)

7 Data Title and Outline Impact analysis based on a multi-regional IO model Data Data from: World Input Output Database (WIOD) 35 Industries and 41 regions (40 countries and a model for the rest of the world) from , one table per year. Tables measure the flows of goods and services from industries to intermediate and final users, broken down by country of origin and by country of destination. Socioeconomic Accounts (SEA-WIOD): Auxiliary data necessary to close the model with respect to households (labor income, employment and hours worked by industry) 2009 Table for open and closed model, 2011 (latest available data) for open model.

8 Scenarios: Germany only I Main Scenario 1: Shock: Change in German final demand in the closed model of 1% for Germany: VA (GDP in basic prices): % Change in employment over labor force: % (reduction in unemployment if no change in labor force) Trade balance over GDP change: %

9 Scenarios: Germany only II Main Spillover effects of 1% shock to German final demand Trade balance in % of GDP, percentage point change Employment growth in % of civilian labor force GDP growth in % GRC ESP FRA FIN PRT ITA SWE DNK IRL BEL NLD AUT

10 Scenarios: Germany only III Main Spillover effects are highest for immediate neighbors Austria, Netherlands, Belgium similar and even higher for Eastern European countries in the German production network very small for all Southern European countries Take a 10% final demand change in Germany: Spain s GDP would increase by 0.54% (and that is in the closed model!). Italy s GDP would increase by 0.63% For comparison: 1.62% for Austria, 1.41% for the Netherlands, and 2.04% for the Czech Republic

11 Main Scenarios: The Northern Europeans expand I Scenario 2: The Northern European surplus countries eliminate their current account surplus Current account surpluses, according 3 year MA of MIP: Germany: 7% of GDP Netherlands: 11% of GDP Denmark: 6.4% of GDP Sweden: 6.9% of GDP Assume final demand changes of three times that magnitude for each Northern country, e.g. 21% of GDP for Germany

12 Main Scenarios: The Northern Europeans expand II VA GR in% D_Emp/CLF D_(TB/GDP) in% Austria Belgium Germany Spain Finland France Greece Ireland Italy Netherlands Portugal

13 Main Scenarios: The Northern Europeans expand III Interpretation of the North only expansion scenario: Non-negligible effect on Southern Europeans, but only because of the truly massive scale of final demand shocks in the North. Bundesbank view still intact Spain, Italy, Portugal and France: improves trade balance by around 1%

14 Main Scenarios: Coordinated final demand expansion I Scenario 3: Coordinated final demand expansion in EU-27 Relaxation in trade balance constraint of non-mip countries based on the previous scenario: 23 EU non-surplus countries change final demand by four times the trade balance (e.g. the TB in Italy had improved by 0.902%, therefore the Italian final demand shock is 5.412%. Scenario chosen to eliminate the trade balance gains of Southern Europeans and translate them into GDP and employment gains through domestic demand

15 Main Scenarios: Coordinated final demand expansion II VA GR in% D_Emp/CLF D_(TB/GDP) in% Austria Belgium Germany Spain Finland France Greece Ireland Italy Netherlands Portugal

16 Main Scenarios: Coordinated final demand expansion III Southern countries can use their improved trade balance to expand demand and not end up with a current account deficit! Italy s GDP increases by 8.9% instead of 2.1% Spain s GDP expands by 9.4% instead of 1.9%, with room for more expansion (TB still +0.2%) both countries with roughly a 0.8% worsening of the trade balance compared to the North only expansion scenario

17 Own effects I Title and Outline Main Why the large effects in the Coordinated final demand expansion scenario? Large domestic GDP and employment effects in the Southern countries due to increase in domestic demand, not sizeable spillover effects. The own multiplier (elasticity from 1% of domestic FD to x% of domestic GDP) for each country is much larger than the spillover effects from other countries. Countries are still fairly closed economies.

18 Own effects II Title and Outline Main Effect on GDP and employment 1% shock to domestic demand Employment growth in % of civilian labor force GDP growth in % IRL BEL NLD SWE DNK AUT FIN DEU FRA PRT ITA ESP GRC

19 Own effects III Title and Outline Main Effect on the trade balance 1% shock to domestic demand Trade balance in % of GDP, percentage point change IRL BEL AUT NLD SWE DEU PRT DNK FIN GRC ITA ESP FRA

20 I Title and Outline Main To an extent: We are all Bundesbankers now. 1 Spillover effects are very small: North cannot help the South directly by correcting the demand deficiency in the North. 2 The notion that Northern Europe and in particular Germany should run more expansionary policies in the common European interest is misleading. 3 About calls for higher wages we can t say much: We could say something about the direct demand effect of higher wages if we were to estimate how much consumption expenditure higher wages would bring about. Second channel missing: No change in competitiveness effect in the IO model. Would potentially increase the size of the effects in favor of the Southern European economies.

21 II Title and Outline Main 4 Does not invalidate helping the Southern countries: A Northern expansion would improve the trade balance of the Southern countries. Own-country multipliers in the closed model are large in the Southern countries Successful policies must target economic activity in the deficit countries directly 5 Policy proposals that are on the right track: Marshall plan for (Southern) Europe, Juncker Plan (times 10), IMK monetary financing proposal of investment, EU financed infrastructure investment in the South, transfers

22 Appendix A Appendix B: More Plots For Further Reading For Further Reading I To appear soon: Oliver Picek and Enno Schröder (2015): Spillover Effects of a Demand Boom in Northern Europe on Output and Employment in Southern Europe in: New School Working Paper Series Contact:

23 Appendix A Appendix B: More Plots Open vs. closed model: Multipliers Open model vs closed model Total truncated world output multipliers Simple world output multipliers

24 Appendix A Appendix B: More Plots Open vs. closed model: Multipliers Scenarios: The Northern Europeans expand I Second scenario: Current account surpluses, 3 year MA, according to MIP: Germany: 7% of GDP Netherlands: 11% of GDP Denmark: 6.4% of GDP Sweden: 6.9% of GDP Assume final demand changes of exactly that magnitude in those four current account surplus sinners

25 Appendix A Appendix B: More Plots Open vs. closed model: Multipliers Scenarios: The Northern Europeans expand II Spillover effects of final demand shocks in the North Shocks scaled to 100% of current account surplus (DEU, DNK, NLD, SWE) Trade balance in % of GDP, percentage point change Employment growth in % of civilian labor force GDP growth in % GRC ESP FRA ITA PRT FIN IRL AUT BEL

26 Appendix A Appendix B: More Plots Open vs. closed model: Multipliers Arguments you can use to cast doubt on the estimates An IO model is all linear: Economies of scale with a large shock? An IO model implies a Leontief production function no substitution effect No prices: No competitiveness effects through wage or non-wage cost, no exchange rate effects However: Where is a better model that gives you results at this level of detail (per country)?

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