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Causes and Consequences of Economic Imbalances: Comparison of US-Asia and Europe

Masterarbeit 2012 83 Seiten

BWL - Allgemeines


Table of Contents


List of Figures

List of Tables

List of Abbreviations

1. Introduction
1.1 Problem and Objective
1.2 Methodology and Theory Approach

2. Key Indicators of Imbalances
2.1 Overview of Economic Imbalances
2.2 Balance of Payments US-Asia
2.3 Balance of Payments of Europe
2.4 Comparison of Debt Structure

3. Causes of Imbalances
3.1 Economic Growth and Competitiveness
3.2 Saving-/Investment Rate
3.3 Financial Markets
3.4 National Policies

4. Consequences of Imbalances on the Economy
4.1 Benefits of Economic Imbalances
4.2 Costs of Economic Imbalances
4.3 Implications of US financial crisis
4.4 Implications of European Economic Crisis

5. Measures to overcome Imbalances
5.1 Exchange Rate as a Stabilizer
5.2 Alternative Balancing Channels
5.3 Budget as a Stabilizer
5.4 Financial Assistance

6. Author’s Comment

7. Conclusion





In the past ten years, huge economic imbalances among US-Asia as well as eurozone countries have built up. Since huge economic imbalances have led to numerous crisis situations in the past, the goal of this paper is to find out if economic imbalances are sustainable or if they need to be rebalanced? And what role do distinct national policies play?

The author is going to compare the imbalances of US-China with the intra-euro imbalances of Germany, Spain and Italy. In the first chapter, the historical development of the economic imbalances is presented in order to point out the unprecedented height of the mentioned imbalances. Not only the current account is being analyzed, but also the debt structure of the mentioned countries is presented since it shows how vulnerable a country is towards economic changes. Prior to the crisis, debt was mainly composed of private debt whereas afterwards it was partly turned into public debt. In the third chapter, the author is analyzing the causes of imbalances by presenting the development of the competitiveness, the saving-/investment rates, the financial markets as well as the different national policies. It is shown that distinct national policies were the underlying causes for the development of such high economic imbalances.

After having seen the historical development as well as the causes, the author describes the possible costs and benefits of having imbalances as well as the implications of the global financial crisis and the current European crisis. Due to the increasing globalization, the financial crisis spread fast and led to huge losses and decreasing investor’s trust in European countries. This resulted in the European crisis which subsequently could also endanger the global economy.

Because of the huge crisis’ impact, traditional and alternative balancing channels are discussed in the following chapter. Despite supporting measures such as restrictive fiscal policies and financial assistance, Europe is still suffering from an economic downturn whereas the US returned to a slow economic recovery. At the end, the author concludes that global imbalances need to be rebalanced in order not to avoid reaching an unsustainable level. The occurring as well as rebalancing of economic imbalances highly depend on distinct national policies. Unless the international coordination and cooperation increases, economic imbalances will continue to occur and will lead to economic crises when reaching an unsustainable level.

List of Figures

Figure 1 Global Current Account Balances as % of World GDP 1990-2011

Figure 2 US-China Current Account Balances as % of GDP 1990-2011

Figure 3 Euro Area Current Account Balances as % of GDP 1990-2011

Figure 4 Sectoral Financial Balances as share of GDP, USA 1990-2011

Figure 5 Sectoral Financial Balances as share of GDP, Spain 1990-2011

Figure 6 Real GDP Growth Rates in % 1990-2011

Figure 7 CPI-based Real Effective Exchange Rates 1994-2011 (2000=100)

Figure 8 CPI-based Real Effective Exchange Rates 1994-2011 (1999=100)

Figure 9 Net Foreign Debtors and Net Foreign Creditors in $billion 2010 18 Figure 10 Gross National Saving Rates as % of GDP 1990-2011

Figure 11 Banks’ Exposures to Public Sectors as % of Capital 2010

Figure 12 Long-term Interest Rates (10-year Government Bonds) 1993-2011

Figure 13 Sectoral Financial Balances Development in % of GDP 2007-2009

Figure 14 Banks’ Exposures to the Debt of PIIGS in €billion in 2011

Figure 15 Nominal Exchange Rate ¥ and € relative to the US dollar 2000-2011

Figure 16 Key Interest Rates in % per year 2000-2011

Figure 17 Wage Development - Current and Constant Prices in NCU 2000-2011

Figure 18 Net Migration Rate Germany, Spain, Italy 2000-2010

Figure 19 Fiscal Stimulus Packages as % of GDP in 2008-2009

Figure 20 Comparison of Real GDP Growth 2006, 2009 and 2011

List of Tables

Table 1 Development of the Global Financial Crisis 2007-2010

Table 2 Development of the European Economic Crisis 2009-2012

Table 3 European Austerity Programs announced in 2010 and 2011

Table 4 Monetary Policy after the Financial Crisis 2008-2012

Table 5 Functioning of Alternative Balancing Channels

Table 6 Current Economic Development 1st Quarter 2012

Table 7 Scenario Analysis based on Policy Choices

List of Abbreviations

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1. Introduction

1.1 Problem and Objective

“The economic health of every country is a proper matter of concern to all its neighbors, near and far.”

-Franklin D. Roosevelt[1]

This quotation reflects the importance of economic imbalances for the global economic environment. As seen in the past, huge economic imbalances of emerging countries have resulted in a number of crises such as the Mexican tequila crisis, Asian crisis or the Argentine crisis. In the past ten years, major economic imbalances have been concentrating among a small number of countries. The main deficit countries such as USA and Spain have been mirrored by current account surplus countries in Asia, Middle East as well as in Europe. Already in 2004, the persistency and growing size of the global imbalances have led to the speculation about a disorderly unwinding in the future. In 2007, the global financial crisis started in USA and rapidly spread across major economies due to the high financial integration. Out of the financial crisis, the current eurozone crisis developed which is posing a major threat to the global economy.[2]

“Global imbalances can be defined as widening external positions of systemically important economies that reflect distortions or entail risks for the global economy.”[3] External positions are shown in the current accounts which show huge deficits or surpluses caused by distortions or/and pose a risk for the global economy. Distortions can arise due to policy decisions taken by the public or private sector. The current account development of a single European country does not fit the definition, but a country’s possible contagion effect in case of a crisis and the overall European development is systemically important and poses a significant risk to the global economy. Hence, in the author’s point-of-view the current account development from US-Asia as well as the intra-euro economic imbalances can be considered as global imbalances.

According to Blanchard and Milesi-Ferretti (2011), global imbalances can be considered as good or bad for the global economy. In the optimistic point-of-view, it may be desirable to hold economic imbalances in a globalized world, e.g. to counteract inefficiencies in the national economy. In contrast to that, in the pessimistic view imbalances increase the risks of economic crises and therefore, can be regarded as the underlying causes of economic crises.

Global imbalances not only include the trade flows but also capital flows resulting in a country’s level of external indebtedness. The US is said to have more time than Europe to recover from crisis’ impacts due to lower borrowing costs. European borrowing costs significantly diverged since the financial crisis and resulted in huge borrowing costs for current account deficit countries. Therefore, this thesis is going to compare the causes and consequences of the US-Asian and European economic imbalances and discuss possible ways to rebalance. Under consideration of the optimistic and pessimistic view, the goal is to find out if global imbalances are sustainable or is it necessary to rebalance? How do distinct national policies impact the occurrence and rebalancing process of economic imbalances?

1.2 Methodology and Theory Approach

As mentioned in the definition of global imbalances, policy interventions can lead to distortions in external positions which may pose a risk to the economy. Those policy interventions include foreign exchange interventions, macroeconomic as well as structural policies and regulations of national financial markets and can be based on a misjudgment of the current trade and financial circumstances.[4] This thesis will try to answer the research questions by applying the Polanyian Dynamics theory since it takes into consideration the importance of distinct national policies. According to Karl Polanyi[5], a Hungarian political economist, the Great Depression was not just an economic crisis but the result of deliberate policy decision on a national level which caused unintended consequences. In other words, there is a conflict between democratization, i.e. following national goals, and economic liberalization in the form of open markets for goods and money. The latter entails that distinct national policies directly impact the economic development of the nation itself as well as other countries. In addition to that, the market outcome is usually not in favor of the participants and leads to the market dictating the development, e.g. resulting in national taxpayers bearing the losses in case of a crisis. By dictating the conditions, the economic sphere weakens the democratic character of a nation.[6]

Therefore, the causes and consequences of global imbalances on the economy will be analyzed under consideration of national policies’ influence. In order to be able to answer the research questions the thesis’ methodology is mainly based on a qualitative approach using the Polanyian Dynamics theory. The deductive and descriptive analysis will be conducted with the help of secondary data and will be based on chosen countries. Since China has been playing a major role in the building up of global imbalances, it will be examined throughout the thesis. Concerning Europe, Spain, Italy and Germany will be taken as examples since all three of them are economically very important countries in the eurozone and have been heavily discussed since the start of the European economic crisis. Concerning the data collection, the thesis will be concentrated on the development until the end of 2011 in order to ensure the data comparability. Only a few important European policy choices made in the first quarter of 2012 will be mentioned.

The thesis is structured into seven chapters. Before being able to understand the causes of economic imbalances, it is necessary to understand the development of the balances of payments. Hence, the current account development of the past twenty years will be examined. Additionally, the debt structure is explained since it has an influence on how vulnerable a country is towards economic changes. After having seen the current as well as historical current account development the causes of economic imbalances will be described in chapter three. Differences in economic growth and competitiveness, in the saving-/investment rate and in the financial markets will be explained. At the end of the chapter, the focus lies on showing the influence of national policies on the current account development. Based on the described causes, economic imbalances have been building up which can lead to benefits as well as costs. Those are presented in the following chapter whereas also the implications of the global financial crisis as well as the European crisis are analyzed. When realizing the impact on the global economy the question arises what kind of rebalancing possibilities do the countries have. Therefore, the traditional as well as alternative balancing channels are discussed. With the help of a comparison of US-Asia and Europe as well as the theory, the author is trying to answer the aforementioned research questions and will comment on the main points.

2. Key Indicators of Imbalances

In this section, the author is going to have a closer look at the key indicators of economic imbalances in order to be able to thoroughly analyze the causes as well as the consequences of economic imbalances. Therefore, the balances of payments of USA, China as well as of the chosen European countries are being presented.

Balance of payments shows all international monetary transactions of a country for a certain time period and is according to the broader definition comprised of the current account and capital account.

At first, the author is going to have a look at the countries’ current accounts which is followed by an analysis of the capital account and the resulting debt structure.[7]

2.1 Overview of Economic Imbalances

The current account is one part of the balance of payments account of a country and is defined as the sum of exports minus the sum of imports of goods and services.[8] Before the author presents the global imbalances of the chosen countries, the historical and current development of the overall world current account is shown.

In the past thirty years, the world economy has undergone a significant increase in globalization including trade as well as financial markets’ liberalizations. This led to a higher global trade openness[9] which rose by 16% up to 59% from 1980 to 2010. In 1980 the sum of current account balances as share of world GDP added up to 2%. Even though imbalances already increased significantly after the second oil price shock in the 1980s, they never hit a level of 6.3% of world GDP, like in 2008.[10]

After a short decrease in the beginning of the ‘90s, the aggregate current account positions started to rise again in the middle of the century and continuously grew up until the global financial crisis in 2008. The total value of global current account balances has doubled since the 1990s which gives a better overview to which extent those imbalances rose. After the financial crisis hit the world economy, imbalances decreased rapidly and were almost reduced to nearly half of the pre-crisis level. As one can see in the graph below, the current account positions slightly began to increase again in 2010 and continued to do so up until the beginning of 2011.

Figure 1 Global Current Account Balances as % of World GDP 1990-2011

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Source: Author’s calculations and illustration based on IMF 2012a; IMF 2012b[11]

In addition to the overall development of current account positions, one can see that the major current account deficits as well as surpluses are spread among a few countries. In 1990, 25% of the world deficits belonged to the United States which rose up to 75% in 2008 whereas the world surpluses were mainly divided among Japan, China, Germany, Saudi Arabia and Russia.[12]

Not only the imbalances between US and Asia (mainly China) contributed to the increasing global imbalances but also the eurozone accounted for a 20% growth of current account balances from 2000 until 2008 (see Appendix 1). Even though the eurozone itself is rather balanced, there are major economic imbalances within the eurozone which increased considerably in the years prior to the crisis. The counterpart of the main surplus countries Germany and Netherlands are Italy and Spain with current account deficits.[13] In the following, the current account positions of US-Asia as well as of the before chosen European countries are going to be examined more in detail.

2.2 Balance of Payments US-Asia

The US has been running a current account deficit since 1982 which even amounted up to the largest current account deficit of over 1.6% of world GDP in the years 2005 and 2006.[14] The US current account deficits built up because of an increasing gap between domestic demand and supply of goods and services. The rising imports mainly came from Asia, Middle East and Russia. China’s importance as an importing partner increased constantly since the 1990s. The volume of imports from China rose by 75% from 1995 until 2000.[15] The current account development will be shown with the help of three different time periods.

Global Imbalances: 1990 until 2000 Since the 1980s the US had only once a current account surplus which was in 1991. From 1990 until 1997, the US current account deficit in relation to the GDP was relatively small. It always stayed below 2% of GDP but started to increase rapidly after the Asian crisis in 1997/1998. The deficit even reached about 4.2% of GDP in 2000. Until the Asian crisis, Asia as a region[16] ran current account deficits whereas China also accumulated moderate current account surpluses. In 1993, China switched from surpluses into a deficit due to a significant increase of FDI. China’s current account surpluses rose constantly after 1995 and were only deflated by the Asian crisis as well as the dot-com bubble. The so-called twin surpluses[17] started to develop after the Asian crisis as a protection against future crises. In connection with the twin surpluses, a continuous increase in foreign exchange reserves started to take place.[18]

Global Imbalances: 2000 until 2008 During 2000 up until 2008, global imbalances started to widen as well as they proved to be persistent. The US current account deficit continued to rise up until the burst of the dot-com bubble in 2001. The US exports went down by one fifth of their world market share from 2002 until 2003.[19] After 2002 the US current account deficits rapidly increased up until 2006. As one can see in the graph below, the growing current account deficits of the US were reflected by increasing Chinese current account surpluses.

Figure 2 US-China Current Account Balances as % of GDP 1990-2011

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Source: Author’s illustration based on IMFStat 2012

China’s current account surplus went from 2.6% in 2003 up to 5.9% in 2005 and even reached a so far unknown height of 10.1% in 2007. The rise in current account imbalances went on up until the financial crisis in 2008 whereas the US deficits already began to decrease in 2006 due to falling housing prices.

Global Imbalances after 2008 The magnitude of the global imbalances up until 2008, already gave hints to the risk of a disorderly unwinding of the imbalances. The decline of US current account deficits accelerated after the financial crisis in 2008 and reached its lowest point since 1998 by going down to 2.7% of GDP in 2009. In comparison to around 6% in 2006 it was a decline of more than 50%.

Alongside the sharply reduced deficits of USA, China’s current account surpluses started to decline significantly after 2008. It nearly was halved down to 5.2% of GDP in 2009. Since 2008, China’s current account surplus has been constantly falling as the domestic demand has been increasing. Its current account surplus declined up to 2.8% of GDP in 2011. According to the IMF, Chinese current account surpluses will most likely stay like that.[20]

2.3 Balance of Payments of Europe

Since 1990, the European Union as a whole has been close to balance. Even after the introduction of the Euro, the eurozone current account balance stayed on average below 1% of GDP. The eurozone can be divided into Northern and Southern countries. The Northern countries are comprised of Austria, Finland, Germany, Luxembourg and the Netherlands and mainly classified as having persistent current account surpluses since the Euro introduction. In contrast to that, the Southern countries including Cyprus, Greece, Ireland, Spain and Portugal are characterized by having constantly current account deficits.[21] Below, Germany as a representative of the Northern countries and Spain as a representative of the Southern countries will be examined with the help of the same time periods used in the previous analysis of the current account development. Additionally, as mentioned before, Italy will be included in the analysis.

Economic Imbalances: 1990 until 2000 In 1990, Germany had a moderate current account surplus which went into current account deficits and stayed below 2% of GDP in the following years. One reason for this development was the German reunification. Having a look at Italy and Spain, one can see that the current account development of those two countries was very different. Spain accumulated current account deficits during the whole period which fluctuated between a nearly balanced position of -0.1% of GDP in 1997 and 3.6% in 1991. Shortly before the Euro introduction in 1999, the current account deficits significantly increased. Contrary to Spain, Italy mainly had current account surpluses up until the Euro introduction. In 1993, the current account moved from a deficit to a surplus and had its peak with 3.2% of GDP in 1996. Overall, the period from 1990 up until 2000 was characterized by having moderate deficits as well as surpluses in the analyzed countries.[22]

Economic Imbalances: 2000 until 2008 After the Euro introduction, the past behavior of having current accounts close to balance was reversed and huge intra-euro imbalances emerged. With the creation of a single currency union, trade and capital flows were accelerated in the following years because of eliminating barriers and promoting European integration.[23]

In 2002, Germany had its first current account surplus since ten years. Starting in 2004, Germany’s current account surpluses increased heavily, amounting up to 7.5% of GDP in 2007 which was after China the world’s second largest surplus.[24] As shown in the graph below, this was mainly mirrored by the growing Spanish current account deficits. Those reached its peak in 2007 amounting up to nearly 10% of GDP. At the same time, Italy also went into the deficit area but compared to Spain those current account deficits remained quite small with a peak of 2.9% of GDP in 2008.

Figure 3 Euro Area Current Account Balances as % of GDP 1990-2011

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Source: Author’s illustration based on IMFStat 2012

Economic Imbalances after 2008

The global financial crisis also showed its impact on the current account development in European countries. Germany’s current account surplus went down by 1.5% of GDP from 2007 until 2009. After this drop, the current account surpluses stayed close to 6% of GDP. During the same time, Spain’s deficit declined by 5.2% of GDP and in the following years, it went even further down which was partly due to the burst of a housing bubble. Italy’s current account deficits have been growing after the financial crisis. Even though Spain’s current account deficits were falling after the financial crisis, German current account surpluses remained relatively high which are mirrored by deficits in Italy, Spain and also the European periphery.[25]

2.4 Comparison of Debt Structure

After having had a look at the current account as one part of the balance of payments, it is important to also look at how the current account is financed. The capital account[26] is the mirror of the current account and is also one of the key indicators for imbalances. The above mentioned current account imbalances can lead to an accumulation of external debt. Spain’s and Germany’s external debt was constantly rising in the previous ten years and even reaching 165.4% of GDP in Spain and 160.4% of GDP in Germany in 2011 (see Appendix 2).[27] In comparison to that, Italy’s and the US’ external debt level in percentage of GDP is significantly lower (around 45%-65% lower). Concerning the analyzed countries, China has the lowest external-debt-to GDP ratio which is around 9.3% (in 2010).[28]

Not only the overall external debt-to-GDP ratio is an indicator for rising imbalances which might develop in an unsustainable way, also the percentage of short-term debt reveals risks in growing economic imbalances. Italy and Spain’s short-term external debt as percentage of GDP was between 25% and 35% between 2000 and 2007 (see Appendix 3). USA had its peak with 40% of GDP in 2007. Since 2007 Spain’s external short-term debt rapidly rose up to the same level as Germany. Its external debt always included a high amount of short-term liabilities, even reaching 55% of GDP in 2010. The above mentioned facts show that Spain as well as Germany largely depend on external debt which mainly consist of short-term liabilities.[29]

Godleyan Sectoral Balances Identity states that the sum of public sector financial balance (=government budget), private sector financial balance and foreign sector financial balance (=capital account) equals 0.

Since large private and public spending can lead to an unsustainable current account development, the debt structure has to be analyzed more in detail. For this reason, the Godleyan Sectoral Balances Identity will be looked at in order to find out which sector is mainly indebted.

This means if the private or public sector has a deficit, it has to be financed either by the other domestic sector or by the external sector or by a combination of both.[30]

Sectoral Financial Balances US-Asia

Since the US constantly ran current account deficits which increased rapidly up until 2006, the external sector development has been staying positive. In connection with the public deficits which started again in 2001, it led to twin deficits. The public deficit reached its peak with 11.6% in 2009 after private debt had to be taken over by the public sector due to the impact of the financial crisis. Such a high level of public sector deficit has been unprecedented in the previous twenty years. The public deficits led up to a government debt of 103% of GDP in 2011 (see Appendix 4).[31]

Figure 4 Sectoral Financial Balances as share of GDP, USA 1990-2011

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Source: Author’s calculations and illustration based on BEA 2012a; BEA 2012b

Having a look at the private sector financial balance, it becomes obvious that consumption was financed by accumulating debt.

In contrast to that, the Chinese private sector financial balance has been staying positive since 1993. It constantly increased in the following years, even reaching a surplus of 9.5% of GDP in 2008 (see Appendix 5). This was mirrored by a public as well as external sector deficit. Thus, China’s private claims on industrial countries, especially the US, constantly grew. Whereas the public sector remained relatively small (below 4% of GDP) leading up to a general government gross debt of 25.8% of GDP in 2011, the external sector was growing rapidly after 2004 leading to the twin surpluses.[32] In the balance of payments account the surpluses were evened with the help of an excessive accumulation of foreign exchange reserves.[33] All three sectors went down and moved closer to 0 after the financial crisis hit.

European Sectoral Financial Balances

During the economic boom years, the private debt of the eurozone countries increased by 35% of GDP per year (2005 until 2007). Thus, the main driving force behind the increasing overall debt ratios prior to the crisis has been private debt in the Southern countries whereas the crisis as well as after-crisis years were characterized by rapidly growing public debt.[34]

Except for 1995 the German public sector financial balance has been staying below 5% of GDP (see Appendix 6). After the Euro introduction, Germany accumulated high private sector surpluses which financed external as well as public sector deficits.[35] Concerning the external sector the mirror of Germany is Spain with significant capital account surpluses. Spain has accumulated huge deficits in the private sector financial balance leading up to 11.9% in 2007. As one can see in the graph below, the private sector deficits were mainly financed by high external sector surpluses as well as in between by moderate public sector deficits up until 2009.

Figure 5 Sectoral Financial Balances as share of GDP, Spain 1990-2011

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Source: Author’s calculations and illustration based on IMF 2012d

After the financial crisis hit, the relationship between public and private sector switched. Thus, the government deficits are mainly a result of the excessive private sector spending prior to the crisis years.

In contrast to that, Italy’s development after the Euro introduction showed constantly moderate private sector and external sector surpluses which were accompanied by public sector deficits (see Appendix 7).[36] Despite this moderate development in the recent years, Italy has accumulated high public debt prior to that which led to the eurozone’s second highest public debt-to-GDP ratio amounting up to 120% of GDP in 2011 compared to the Spanish 68.5% and the German 81.5% (see Appendix 4).[37]

In order to put emphasis on the differences and similarities between the two regions, a comparison of the main facts is going to be presented. According to the definition of global imbalances US-Asia and Europe are considered to be systemically important economic countries as well as regions. This is proven by the fact that Europe contributed 20% and US-Asia 46% to the growth of global imbalances.[38] When looking at the current account development, Europe as a whole is quite balanced whereas USA as well as China show huge current account imbalances. But when analyzing the different member countries of the eurozone, one can also notice huge intra-euro imbalances. Both regions, US-Asia and the eurozone, have high current account surplus countries like China and Germany which are mirrored by deficit countries like USA and Spain whereas Spain’s peak was significantly higher than the US’ deficit (in % of GDP). At the same time, the current account developments of both changed rapidly after 2002. Up to 2002, the surplus and deficit behavior was quite moderate in contrast to the widening from 2002 up until the financial crisis. Afterwards, the imbalances started to decrease.

Concerning the debt structure, one has to state that all the countries’ debt is mainly influenced by the private sector which contributes the most part to the overall debt.[39] Both major deficit countries USA and Spain ran private sector deficits in the 2000s up until the financial crisis. The difference lies in the public sector. Spain’s private sector deficit was significantly higher compared to the US and mainly financed by external sector surpluses leading to a close to balance public sector. In contrast to that, USA’s external sector surplus was equally caused by the public and private sector. Looking at the public and private sector development after the financial crisis, one can notice a directional change in the analyzed countries where the private sector moved into a surplus and the public sector deteriorated. The high current account deficit countries were hit worse than the moderate or the surplus countries.

After having had a look at the key indicators of economic imbalances and at the current situation in US-Asia as well as Europe, it is necessary to look at the causes of those imbalances.

3. Causes of Imbalances

Before being able to understand the implications of the above described economic imbalances as well as analyzing possible rebalancing channels, one has to take a look at the sources of the imbalances. General determinants of the current account are, for example:

- Demographical development
- Economic growth rates
- Exchange rates
- Terms of trade
- Fiscal policies[40]

Country differences in those determinants can lead to disequilibria. Referring to the Polanyian Dynamics theory those differences mainly occur due to distinct national policy decisions. They also have an influence on the competitiveness, the saving/ investment rate as well as the financial markets of countries. Hence, the author is going to have a look at these factors. At the end, the national policies, especially the monetary and fiscal policies, will be presented. The goal is to find out the main causes for the economic imbalances described in chapter two and to examine if there are similarities or differences between US-Asian and European sources of imbalances.

3.1 Economic Growth and Competitiveness

Differences in the economic growth rates between main trading partners as well as competitiveness play a key role in the building up of economic imbalances. A loss of competitiveness can result in current account deficits whereas a gain can cause current account surpluses. Competitiveness can be measured with different indicators such as unit labor costs, inflation rate and CPI-based real effective exchange rate[41]. An appreciation of a country’s currency can endanger its competitiveness and distort its trade flows. Thus, the author is going to examine the economic growth in connection with trade openness first and then analyze the differences in competitiveness mainly with the help of the CPI-based real effective exchange rate.

Economic Growth

In general, one can notice that the real GDP growth of the world amounted on average up to around 5% from 2004 until 2007 which did not look risky at that moment.[42] But when looking at the country level, the growth rates of the different countries diverged significantly. China’s real GDP growth increased rapidly after the Asian crisis and even went up to 14.2% in 2007. Such a high real GDP growth is a sign for an unsustainable development.[43]

In order to be able to examine the influence of economic growth on the current account development of different countries, one has to know the main trading partners. Included in Germany’s main trading partners are China, the US as well as Italy. In addition to that, one of Spain’s main trading partners is Germany. Thus, all the mentioned countries are interconnected concerning their trade flows.[44]

Figure 6 Real GDP Growth Rates in % 1990-2011

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Source: Author’s illustration based on IMF 2012h; IMF 2012i

When looking at the advanced countries, one can see above that Spain’s and USA’s GDP growth was higher than Germany’s, Italy’s as well as the Euro area’s GDP growth. Due to an increasing domestic demand in Spain as well as in the US in connection with a significantly higher industrial production of the main trading partner Germany, it supported the aforementioned current account deficits.[45]

In addition to that, the degree of trade openness[46] facilitates trade among different countries. Germany’s degree of openness has been very high in the recent years moving between 38% and 45% of GDP from 2005 until 2010 and even higher than the European average of 40.1% in 2010. In comparison to that Italy’s, Spain’s and the US’ trade openness moved around 22-30% in recent years.[47] Even China has a comparatively low degree of openness when looking at Germany (China: 26% of GDP in 2011).[48] But one has to take into consideration the size of absolute GDP which is a lot higher than the one in Germany. Since the trade openness has increased, a country’s GDP development is stronger connected to the external development which can be seen in the drop of GDP growth during the financial crisis.


A loss of competitiveness is usually shown in a huge appreciation of the real effective exchange rate and can lead to current account deficits. At the same time, it can be beneficial for a country to have a strong currency concerning the imports since they will be cheaper then. The US profited from an overvalued US dollar in the years prior to the crisis. The real effective exchange rate appreciated by over 20% from 1994 until 2001 which was partly due to the fact that the US followed a policy of having a strong dollar. As one can see below, after the peak of the CPI-based real effective exchange rate in 2001, it constantly depreciated.[49]

Figure 7 CPI-based Real Effective Exchange Rates 1994-2011 (2000=100)

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Source: Author’s illustration based on Bank of International Settlements 2012a

Even though the US dollar slowly depreciated as well as the Chinese Renminbi appreciated after 2004, the US dollar was still significantly valued higher than the Renminbi. Thus, the current account deficits continued to widen up until 2006. Until 2005, China fixed their currency with 8.28 Renminbi per dollar in order to support their export-led growth by staying highly competitive and thus, achieving rapid growth.[50] In 2005, China loosened its exchange rate strategy and used a currency basket to decide its currency evaluation. Since then the Renminbi has constantly appreciated in relation to the US by around 5-7% per year. At the same time, the current account deficits of the US decreased compared to 2006.[51]

The eurozone current account imbalances are mainly due to diverging competitiveness. Since the eurozone is a monetary union, the CPI-based real effective exchange rate is only influenced by differences in the prices. One can observe a real depreciation by increasing competitiveness in the Northern countries and a real appreciation in the Southern countries. This led to the increasing current account deficits in the Southern countries. As one can see below, the real effective exchange rates show that Germany is highly more competitive than Italy and Spain and has even the lowest real effective exchange rate compared to the euro area.

Figure 8 CPI-based Real Effective Exchange Rates 1994-2011 (1999=100)

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Source: Author’s illustration based on Bank of International Settlements 2012a

The diverging competitiveness can also be clearly seen in the unit labor costs. The unit labor costs in the deficit countries increased rapidly after the Euro introduction (see Appendix 8). Due to a cumulative increase of unit labor costs of just 8% for Germany compared to 24% for the euro area between 1999 and 2009 as well as an inflation rate even below the Euro average, Germany remained highly competitive and could accumulate such high current account surpluses (inflation rate see Appendix 9).[52] In contrast to that, all competitive indicators of Spain as well as Italy point to a decrease of competitiveness after the Euro introduction.

3.2 Saving-/Investment Rate

illustration not visible in this excerpt

Current account can be defined with the following simplified equations:

Decreasing savings in connection with increasing investments lead to current account deficits which have to be financed from abroad whereas surpluses show the excess of national savings over investments. Thus, the saving- and investment rates of the different countries influence the capital flows.[53] The theory states that capital should go from rich to poor countries leading to current account surpluses in rich countries and to deficits in poor countries. This is explained by the fact that poorer countries tend to have better growth prospects and thus, they should be able to attract foreign investors as well as the saving rate is lower due to a low capital-to-labor ratios.[54]

In the years prior to the financial crisis in 2008, the world average gross saving rate has grown from 20.9% in 2003 up until 24.4% of GDP in 2007.[55] Even though the saving decreased in a lot of countries the rising saving behavior of major emerging as well as developing countries outweighed this fall in savings. As one can see in the graph below, advanced economies such as USA and Spain can be accounted for as largest net debtors whereas the largest net creditors include emerging and developing countries such as China and Saudi Arabia.

Figure 9 Net Foreign Debtors and Net Foreign Creditors in $billion 2010Abbildung in dieser Leseprobe nicht enthaltenAbbildung in dieser Leseprobe nicht enthalten

Source: Author’s illustration based on Roxburgh et al. 2011, p.8

On the one hand, this shows that capital is not necessarily flowing from rich to poor countries, which is called downhill, but that it also flows uphill. On the other hand, the intra-euro saving- and investment behavior seems to be according to the above mentioned theory. High-income countries (such as Germany) have become lenders to low-income countries (such as Spain). Germany has been acting as a financial intermediary. It borrowed money from the rest of the world (through current account surpluses) and lent it to other European countries. Since the introduction of the Euro Germany`s current account surpluses mainly accumulated due to a declining investment and high savings. As one can see in Appendix 10, Germany’s investment rate has been staying constantly below the EU average as well as below Spain and Italy since 2001 and it reached its lowest level with 16.5% of GDP in 2009. However, its saving rate went up steadily and stayed above the Euro average since 2004, growing up to 26.7% of GDP in 2007. Even after the crisis, the saving rate stayed at a relatively high level compared to the years before 2004. At the same time, Spain’s investment rate was continuously rising since 1997 reaching its peak with 30.9% of GDP in 2007. In contrast to that, Italy’s saving as well as investment rate behavior moved in a moderate range which explains the comparatively low current account deficits.[56]

Figure 10 Gross National Saving Rates as % of GDP 1990-2011

illustration not visible in this excerpt

Source: Author’s illustration based on IMF 2012m

Compared to the European development, USA’s saving rate has been constantly staying below the Euro average as well as Chinese saving rates. Until the 1990s, the US has been largely a net creditor for foreign countries. This behavior changed after the 1990s leading up to becoming the largest foreign net debtor in the world. The increasing US current account deficits are correlated with a decrease in its saving rates and increase in its investment rates. In contrast to that, China’s saving rates have been constantly exceeding its investment rates after the Asian crisis even amounting up to 53.5% of GDP in 2009. In the years after the Asian crisis, the high saving rates were mainly caused by the household sector due to a lacking social welfare system as well as the consequences of the Asian crisis which was then followed by saving rates mainly influenced by the corporate sector. The uphill flow of capital can be explained by a rise in precautionary savings as well as financial market imperfections. The different degree of financial globalization has been causing a surge for supposedly safe assets in foreign countries.[57] Therefore, the following chapter will deal with the financial markets’ situation and what kind of influence it has on the current account development.

3.3 Financial Markets

The features of financial markets can also cause economic imbalances and are related to a country’s saving-/investment rate. The differences in financial market development as well as institutional quality and the supply of adequate financial assets influence the magnitude and direction of the capital flows and thus, the building up of capital account deficits as well as surpluses. This highly depends on the investors’ trust and the functioning of the market. Therefore, it is necessary to look at the structure of the financial markets.[58]

First of all, one can notice an increasing financial integration during the last twenty years. This becomes obvious when looking at the financial openness[59] of industrial and emerging countries (see Appendix 11). Industrial countries noted an increase of 100% from 1970 up until 2005 (from 20% of GDP to 120%) and even in the emerging economies the financial openness doubled, reaching over 40% in 2005.[60] Europe’s financial openness in particular has increased rapidly since the Euro introduction and led to highly integrated financial markets and to increasing capital flows. In general, the growing financial integration has resulted in rising international capital mobility, in countries financing each other’s debt and subsequently in a higher interdependency of countries. This has been also a major source of economic imbalances and is reflected in the banking sectors of the analyzed European countries.[61]

Figure 11 Banks’ Exposures to Public Sectors as % of Capital 2010

illustration not visible in this excerpt

Source: Banca d'Italia 2011, p.18

As one can see above, Germany’s banking sector has the highest foreign exposure of in this paper analyzed countries. In general, the largest European banks are highly international which is represented by 57% of their activity being foreign related compared to 22% of US banks.[62]

Besides the higher financial integration, the banking sectors’ concentration is also increasing. The US as well as the Chinese banking system is highly concentrated which can be seen in the fact that 48% of all the Chinese banking assets are held by four banks and in the US even 56% are held by the four largest banks.[63] This fact can also be found in Europe with a concentration ratio of the top ten European banks amounting up to 26.1% of the overall European banking assets.[64] According to the Bank for International Settlements, the accumulated assets of the top three banks amounted up to 189% of GDP in Spain, 121% of GDP in Italy and also 118% of GDP in Germany in 2009. Due to the concentration of the banking sector it is important to look at the health of the major banks. The stress test results of 2011 showed that Germany, Italy and Spain are all ranked in the top four concerning the highest capital needs. The major banks like the Italian UniCredit or the Spanish Bankia are in capital needs in order to reach the EU requirement of 9% core capital (see Appendix 12). In the US, four banks failed the stress test including Citigroup which is the third-largest US bank.[65]

Investors usually take into consideration the above named factors when developing their judgment of the financial market and deciding on where to invest. In order to find out the investor’s trust, the long-term interest rates of the mentioned countries’ government bonds will be analyzed. About half of the US as well as the European government debt is hold by foreign investors (45% up to 50% in 2010[66] ). A high interest rate as well as a constantly changing interest rate shows a distrust of investors since an investor usually requests a higher premium if the perceived risk goes up which can be caused by a weak banking sector, high foreign exposure as well as high short-term external debt.

Before the Euro introduction, the interest rates of all mentioned European countries have been relatively high. After the Euro adoption, the European long-term interest rates have been nearly the same and moved between 3.3% and 4.5%.[67] Since the financial crisis, the interest rates moved accordingly to the risk of the country itself and not Europe as a whole. As one can see below, Germany can be considered as a safe haven because of further declining interest rates as a result of investors moving their money from Italian and Spain’s government bonds to German bonds.

Figure 12 Long-term Interest Rates (10-year Government Bonds) 1993-2011

illustration not visible in this excerpt

Source: Author’s illustration based on ECB 2012a; Federal Reserve 2011[68]

At the end of 2011, the Italian interest rate even reached a peak of 6.8%. According to a number of strategists, an interest rate above 7% can be considered as unsustainable. Thus, the Italian banking system and its possibility to still raise debt in international markets seems to be endangered and volatile. This diverging behavior of interest rates can be argued as being a reversal of the European financial integration since the countries’ characteristics are being more important now than the eurozone as whole.[69]

US government bonds’ interest rates have been moderately decreasing since 1993, reaching a lower level than Spain and Italy after the financial crisis. In 2008, one would have expected a significant increase due to a loss of investors’ trust. But by preferring to buy foreign bonds instead of domestic bonds, the US interest rates were kept low whereas the Chinese domestic interest rates went up. The Chinese government bond yields reached its peak with 4.6% in 2008 (see Appendix 13).[70]

As seen in the analysis, the investors’ trust as well as the features of the banking sector play a key role in a country’s possibilities to raise capital in the international market. The banking sector needs to be considered as stable in order to be able to receive international funds.

3.4 National Policies

- Foreign exchange market interventions
- Macroeconomic and structural policies
- International regulatory concerning financial markets and trade.

The fourth main underlying cause of global imbalances is the national policy development of the different countries which influences the above described causes. According to Obstfeld and Rogoff, it is evident that the economic imbalances are not only caused by the fact of having free open markets but also by the policy interventions which lead to distortions. Such policies include:

This assumption also fits to the Polanyian dynamics theory which says that national policies also influence the other countries’ development.

First of all, foreign exchange interventions reflect an economic distortion. A fixed exchange rate does not necessarily lead to a contortion if it would depict the underlying economic development. If that is not the case, it results in a distortion which can pose risks to the economy.[71] When looking at the US-Asia case again, one can notice that policy decisions led to a great part to the building up of the current account imbalances. In the years prior to the financial crisis, China kept a fixed exchange rate over a number of years and used sterilization[72] in order to avoid inflation and currency appreciation. It purchased US dollar in the form of government bonds which provides the external financing for USA and leads up to the accumulation of a high amount of foreign exchange reserves. This led to the undervaluation of the Renminbi and the competitive position of China. Chinese export-led promotion policy was built up on an undervaluation of the local currency, foreign exchange intervention and the accumulation of dollar-denominated reserves. This policy decision was a major reason why the US could finance its growing economic imbalances with cheap foreign money due to decreasing long-term interest rates.[73]

Second of all, macroeconomic as well as structural policies can lead to distortions. Monetary policy and fiscal policy influence the demand as well as the growth of a country and thus, they can cause economic imbalances. Monetary policy [74] has an influence on the short-term interest rates. The US followed an easy monetary policy starting after 2001 and despite economic growth kept the interest rate for three years below 2%, even reaching down to 1%. This loose monetary policy created a credit expansion which in connection with the low long-term interest rates led to a growing housing market appreciation. After real GDP growth picked up again in 2004, the US monetary policy became more restrictive.[75]

Because of having a monetary union, the monetary policy of the member states is one and the member states cannot adjust it to their national political needs. Hence, it cannot balance individual bust and booms anymore. According to Trichet, there was excess liquidity caused by a low level of interest rates in 2004. The ECB’s key interest rate reached its so far lowest point of 2% in 2003 and then slowly started to grow again in 2006.[76] Here as well it resulted in an increasing demand and strong credit growth in some European countries such as Spain. This was only possible because of the Euro introduction, the resulting financial market integration and the low interest rates.

In contrast to that, national fiscal policies[77] differ. As seen in chapter 2.4, the US accumulated high budget deficits due to their expansive fiscal policy. They increased their budget spending in order to push their own economy. The same aspect can be found in European countries. Spain as well as Germany accumulated government debt but stayed close to the European level whereas Italy has been running very high fiscal deficits in the 90’s. USA’s and Spain’s fiscal policy as well as easy lending policy had an influence on the current account development of their countries but also on the current account development of China and Germany.[78] Additionally, policies affecting goods and labor markets influence the development of current account imbalances. This can be found in the diverging unit labor cost development in Europe which increased in the Southern countries by 35% whereas Germany’s unit labor cost just rose by 8% since the Euro introduction.[79]

Thirdly, the national financial markets development can cause distortions which also bear risks. This fact could be seen in the US when capital from China mainly went into the US. At the same time, the overall deregulation of the market and the excess availability of liquidity due to the above mentioned policies led to a search for a higher yield. In that respect, new financial, very complex innovations were developed and allowed to borrow money to risky lenders. When looking at Europe, the aforementioned higher financial integration of the markets led to a higher access to foreign capital without taking into consideration the different development of the countries. After the financial crisis hit Europe, the financial integration process is currently partly reversed due to realizing the differences in the countries and their policy space, e.g. diverging debt levels and the resulting sovereign risk.

Because of the mentioned differences in policy decisions, economic imbalances built up and have a huge influence on the global economy. Spain’s easy lending policy in connection with the eurozone’s loosened monetary policy in 2002-2006 and the low long-term interest rates led to an increase of credit and to a Spanish housing boom. The same development could be seen in the US due to an easy monetary policy. But not only monetary and fiscal policies have an influence on the overall money supply, financial markets regulations can also cause economic imbalances. The saving- and investment rates are affected by the financial markets development which is governed by policy decisions as well as by the countries’ conditions (e.g. lacking welfare system in China). Additionally, the current account development is influenced by the competitiveness. The diverging competitiveness in Europe was amongst other things influenced by the differences in the labor market structure whereas China has been using its exchange rate in order to stay competitive. To sum up, it becomes obvious that a nation’s policy decisions are the underlying cause for the diverging current account development.

After having seen the causes of economic imbalances, the author is going to have a look at the consequences and how the financial crisis as well as the European crisis affected the different countries.

4. Consequences of Imbalances on the Economy

Referring to the given definition of global imbalances, they are caused by distortions or/and may pose risks to the global economy. Risks include macroeconomic as well as financial implications for the world economy. This is connected to the pessimistic view mentioned in the introduction which sees a high risk of further crises when keeping global imbalances. In contrast to that, with reference to the optimistic view it may be desirable to hold economic imbalances in a globalized world in order to more efficiently allocate resources. Therefore, the author is going to analyze possible benefits as well as costs of economic imbalances and examine the implications of the global financial crisis as well as of the current European crises.

4.1 Benefits of Economic Imbalances

The optimistic view of economic imbalances refers to the increasing optimal allocation of resources in a globalized world with the help of a growing financial as well as trade integration. According to theory, it is said to be beneficial for the growth of a nation as well as its welfare, if the country runs current account surpluses over an extended period of time.[80]

Concerning the trade integration, it is favorable for some countries to export more than to import in order to push their own economy if the domestic demand is not sufficient. Because of the increasing demand in the foreign countries while having a moderate domestic demand, the surplus countries’ exports can grow steadily. By following the strategy of an export-led growth a country’s own economy can grow and lead to an improved living standard. This can be seen in Germany as well as China. China followed an export-led growth strategy which resulted in the economic imbalances and was mirrored by USA’s current account deficits due to the increasing domestic demand in the US. Thus, China could benefit from the US demand and overcome its own missing domestic demand. Germany as well did profit from the Euro introduction and its resulting growing exports whereas Spain accumulated high current account deficits. A trade imbalance can also be beneficial for deficit countries. Due to a decreasing output or lower productivity, countries could overcome this weakness by importing more than exporting. However, the growing imports need to be financed. The mentioned deficit countries could only finance them by being able to borrow cheap. This fits to the optimistic view of current account deficits which states that by being able to borrow from foreign countries, countries can grow beyond what they are domestically capable of.[81]


[1] Kerry 2012, p.1

[2] Dullien et al. 2010

[3] Bracke et al. 2008, p.5

[4] Bracke et al. 2008

[5] Karl Polanyi was born in 1886 and died in 1964. He studied in Hungary as well as in Austria and later on moved to Canada and adhered to socialist conviction. He is known for his book “The Great Transformation”. (Levitt 1996)

[6] Eichengreen 2008

[7] Krugmann & Obstfeld 2009

[8] Ibid.

[9] Global trade openness shows the exports plus imports in relation to GDP

[10] Cecchetti 2011

[11] Partially estimates after 2010. Oil Exporters: Algeria, Angola, Azerbaijan, Bahrain, Brunei, the Republic of Congo, Ecuador, Equatorial Guinea, Gabon, Iran, Iraq, Kazakhstan, Kuwait, Libya, Nigeria, Oman, Qatar, Russia, Saudi Arabia, Sudan, Syria, Trinidad and Tobago, Turkmenistan, the United Arab Emirates, Venezuela and Yemen. (IMF 2012a)

[12] Bracke et al. 2008

[13] Mello & Padoan 2011

[14] Author’s calculations based on IMF 2012a; IMF 2012b

[15] Glyn 2005

[16] Including developing Asia, ASEAN-5 and newly industrialized Asian economies. (IMF 2012c)

[17] Twin surpluses are surpluses on both the current account and capital account. (Yongding 2006)

[18] Obstfeld & Rogoff 2009

[19] Glyn 2005

[20] IMF 2012d

[21] Holsinki et al. 2010

[22] IMFStat 2012

[23] Zemanek et al. 2010

[24] Hnat 2010

[25] Priewe 2011

[26] Capital account is the broader definition whereas the narrower meaning defined by the IMF divides capital account into financial account and capital account (where financial account includes the main transactions). (Ajami et al. 2006)

[27] IMFStat 2012

[28] Author’s calculations based on The World Bank 2012

[29] IMFStat 2012; China: The World Bank, 2012

[30] Papadimitriou & Wray 2011

[31] IMF 2012f

[32] Ibid.

[33] Adams & Park 2009

[34] Kouretas & Vlamis 2010

[35] IMF 2012e

[36] Ibid.

[37] IMF 2012f

[38] Roxburgh et al. 2009

[39] Roxburgh et al. 2012

[40] Nickel & Vansteenkiste 2008

[41] “It measures the competitiveness and takes account of exchange rate movements and consumer price developments. Ratio of domestic consumer prices to a weighted index of consumer prices in trading partners.” (Ricci et al. 2008), p.5

[42] IMF 2012i

[43] IMF 2012h

[44] CIA 2012a

[45] According to Grauwe, higher GDP growth rates in comparison to the main trading partners can lead to relatively higher growing imports than exports. Since China is a developing country and also trades a lot with other Asian countries, the economic growth is not being analyzed further here.

[46] Degree of openness = Exports+Imports/ 2xGDP

[47] Economic and Financial Affairs 2010

[48] Author’s calculation based on CIA 2012b

[49] Bank of International Settlements 2012a

[50] Liu 2004

[51] Rabinovitch & Anderlini 2012

[52] ECB 2011a

[53] Krugmann & Obstfeld 2009

[54] Bussière et al. 2004

[55] Obstfeld & Rogoff 2009

[56] IMF 2012m

[57] Rajan 2008

[58] Obstfeld & Rogoff 2009

[59] According to the IMF, financial openness can be measured as overall holdings of financial assets and liabilities in relation to GDP.

[60] Bracke et al. 2008

[61] IMF 2012n

[62] Veron 2011

[63] Martin 2012

[64] Schoenmaker 2011

[65] BBC News Business 2012

[66] USA: OECD.StatExtracts 2012; Europe: Eminescu 2011

[67] ECB 2012a

[68] European countries’ data was just available after 1993. After searching the major statistical sites, the author was not able to find data for Chinese long-term interest rates for the years 1993-2004. Therefore, the Chinese interest rate is shown separately in Appendix 13.

[69] Tett 2012

[70] TradingEconomics 2012

[71] Bracke et al. 2008

[72] Central bank intervenes in order to counteract the effects on the money supply caused by current account surpluses or deficits. (Ajami et al. 2006)

[73] Obstfeld & Rogoff 2009

[74] Monetary policy uses tools such as increasing the money supply by adjusting interest rates, foreign exchange reserves as well as buying/selling government bonds. Increasing the money supply is called expansionary policy whereas decreasing leads to a restrictive monetary policy. Krugmann & Obstfeld 2009

[75] Mees 2011

[76] ECB 2012b

[77] Fiscal policy focuses on changes of taxes, of government spending as well as borrowing.

[78] Zemanek et al. 2010

[79] Krugman 2012

[80] Krugmann & Obstfeld 2009

[81] Bracke et al. 2008


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Titel: Causes and Consequences of Economic Imbalances: Comparison of US-Asia and Europe