Ishaan Gupta

BSc Economics, University College London

Source: Author's own animation

The EU is a troubled block, with Germany (and much more recently France under Macron) trying hard to tie the loose strings. There were many moments when it seemed evident that the block would fall apart, yet somehow it managed to claw its way back, always tethering on the edge. One stark example was the coronavirus pandemic, threatening to rip right through this unity and ensnare the ever widening North-South gap. Yet again, it was the two countries standing tall, as the EU passed the landmark €750 billion rescue package, getting a grip of the knot just when it was starting to unravel. This is not a one-off incident, but the EU’s history is punctuated with several instances, where its largest economy has always ended up throwing its hat in the middle to put at bay any disenchantments.

Why then, one may be pressed to ask, is Germany so concerned about the survival of EU? It may indeed be a deep sense of moral responsibility, but one will be naive to ignore the existence of any other motive.

At $3.95 trillion, Germany is the world’s 4th largest economy. In a country with a flourishing manufacturing sector and a limited (and fast-ageing) domestic market, much of this success is attributed to robust exports, seen in a current account surplus equalling 8% of its GDP. This is where the Euro and the EU at large comes into play, and assumes significant importance for Germany. For any export based strategy to reach fruition, a favourable exchange rate is very important. In fact, much of the reason behind Japanese economy’s fall from grace is attributed to the sharp appreciation witnessed in the Yen. Euro, by being the common currency of 19 countries, saves Germany from experiencing just that.

In 1999, when the Euro was devised, Germany was suffering economic difficulties and thus its Deutschmark was significantly below its real value, while other countries like Spain, Greece and Italy inflated their respective currencies in lieu of undue optimism (Ezrati, M 2018). Thus when the Euro was adopted, the real exchange rate for Germany fell by almost 23%, while that for other countries rose by an average of 7%, instantly lending the former a competitive advantage. Post the 2008 crisis and its lingering aftermaths felt by most European economies, the Euro got further depreciated against the dollar, enhancing Germany’s competitive advantage globally.

Bertelsmann Stiftung (2013), wrote a policy paper stimulating the effects of a German exit from the Euro monetary union. According to him, such an exit would have four main repercussions:

  1. Higher transaction costs due to conversion rates and currency fluctuation. He estimated this to amount to 0.5% of the German GDP.

  2. Lower level of price transparency, which could potentially increase inflation by an average of .13%.

  3. Lower interest rates up to 0.5% (This was the only benefit accruing from the exit)

  4. An appreciated currency, as discussed above.

Based on these factors, he produced the following estimate of the effect on Germany’s real GDP growth, if a monetary exit did happen.

Source: Stiftung (2013)

But the positive effects of the Euro go much further. Germany has maintained a high current account surplus, while constantly managing a fiscal surplus of around 2%, in an economy with a savings surplus of over 6%.

As shown by the equations above, there are two ways for a savings surplus to be utilised. One by financing a fiscal deficit (G-T) and the other by financing a current account surplus (ie having a capital account deficit in the balance of payments). Germany was able to channelise the entirety of its saving surplus in financing its current account surplus, thus allowing it to maintain a surplus in its fiscal accounts. Japan, for instance, an economy of a similar size as Germany’s and a similarly outsized dependence on exports (current account surplus of 6%), is currently running some of the highest fiscal deficits at 3%, as it was unable to utilise its savings efficiently in investing abroad (Wolf, M 2019).

Germany’s success and Japan’s failure in this respect is rested, in no mean part, rests on the shoulder of the Euro. When compared to the Japanese Yen, the Euro has a much lower volatility. Lower volatility in exchange rates not only reduces transaction costs (as noted above) but also helps reduce uncertainty and allows firms to make clearer decisions about future investments abroad, thus allowing a capital account deficit.

Stiftung’s model estimated a total loss of €1.2 trillion for Germany, till 2025, if it were to abandon the Euro in favour of an individual currency. That is 30.4% of Germany’s current GDP! Given this, it is no wonder then that the Euro has played a crucial role in pivoting Germany as a global manufacturing giant, and giving it the economic heft it currently enjoys.

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