Most of the international financial crises that haveoccurred over the last 200 years were the result of strains created by the recycling of capitalfrom countries with high savings to those with low savings. The currentEuropean crisis is a case in point. For nearly a decade, capital fromhigh-savings countries like Germany flowed to low-savings countries like Spain.The resulting build-up in debt created its own constraints, and now Europe’seconomy is forced to rebalance.
If the rebalancing takes place only in Spain and otherlow-savings countries, the result, as John Maynard Keynes warned 80 years ago,must be much higher unemployment. Whether unemployment remains confined tocountries like Spain, or eventually migrates to those like Germany, depends onwhether the former remain in the euro.
Although the relative savings positions of Germany andSpain seem to confirm cultural stereotypes, national savings rates have littleto do with cultural proclivities. Instead, theylargely reflect policies at home and abroad that determine householdconsumption rates.
A country’s overall consumption rate is, of course, theflip side of its savings rate. Apart from demographics,which change slowly, three factors largely explain differences in nationalconsumption rates.
First and foremost is the share of national income thathouseholds retain. In countries like the United States, where households keep alarge share of what they produce, consumption rates tend to be high relative toGDP. In countries like China and Germany, however, where businesses and thegovernment retain a disproportionate share, household consumption rates may becorrespondingly low.
The second factor is income inequality. As people becomericher, their consumption grows more slowly than their wealth. As inequalityrises, consumption rates generally drop and savings rates generally rise.
Finally, there is households’ willingness to borrow toincrease consumption, which is usually driven by perceptions about trends inhousehold wealth. In Spain, for example, as the value of stocks, bonds, andreal estate soared prior to 2008, Spaniards took advantage of their growingwealth to borrow to increase consumption.
But this is not the whole story. Consumption rates can alsobe driven by foreign policies that affect these three factors. For example, anagreement in the late 1990’s among the German government, corporations, andlabor unions, which was aimed at generating domestic employment by restrainingthe wage share of GDP, automatically forced up the country’s savings rate.Germany’s large trade deficits in the decade before 2000 subsequently swung to large surpluses, which were balanced by corresponding deficits in countries like Spain.
As Spain’s tradable-goods sector contracted in response tothe expansion in Germany, it could respond in one of only three ways. First,Spain could refuse to accept the trade deficits, either by implementingprotectionist measures or by devaluing its currency. Second, it could absorbexcess German savings by letting unemployment rise as local manufacturers firedworkers (because rising unemployment forces down the savings rate). Finally,Spaniards could borrow excess German savings and increase consumption andinvestment.
Of course, Spain could not legally choose the first option,owing to its EU and eurozone membership, and, not surprisingly, was reluctantto choose the second. This left only the third option. Spaniards borrowedheavily prior to the crisis to increase both consumption and investment, withmuch of the latter channeled into wasteful real-estate and infrastructureprojects.
This continued until 2007-2008, when Spanish debt levelsbecame excessive. But, as long as Germany does not absorb its excess savingsand accommodate the desired rise in Spanish savings, Spain is still faced withthe same options. Once borrowing is no longer possible, Spain must eitherintervene in trade – which implies leaving the eurozone – or accept many moreyears of high unemployment until wages are driven down sufficiently to producethe equivalent of currency devaluation.
This is the key point. Low-savings countries cannot easilyadjust without an equivalent adjustment in high-savings countries, becausetheir low savings rates may have been caused by high savings abroad. After all,savings and investment must be in balance globally, and if policy distortionscause savings in one country to rise faster than investment, the reverse mustoccur elsewhere in the world.
In other words, savings rates in Spain and other deficitcountries in Europe had to drop once policy distortions forced up Germany’ssavings rate. In theory, excess German savings could have left Europe; but,given high Asian savings that already had to be absorbed, mainly by the US, andthe constraints imposed by the euro, it was almost inevitable that excessGerman savings would be exported to other European countries.
Germany should care about Spain’s difficulty in adjusting,because the resulting rise in European unemployment will be absorbed mostly bySpain unless the Spanish government accelerates the adjustment process byleaving the eurozone and devaluing. In that case, Germany would bear the brunt of the rise in unemployment.
There should be nothing surprising about this. Once deficitcountries take aggressive measures, it is usually trade-surplus countries thatsuffer the most from international crises caused by trade and capital flowimbalances. As political tensions in low-savings countries grow, so will therisk of these countries abandoning the euro, causing the price that Germanywill pay for its distorted savings rate to rise.