Economic developments in Germany and their impact on the EU economy - Essay Example

Economic Developments in Germany and Their Impact on the EU Economy Introduction: The European Union is a major example of regional economic integration and optimum currency area. It was established by twelve member states belonging to Europe (Germany, Italy, France, Belgium, Netherlands, Luxembourg, Ireland, Spain, Portugal, Denmark, Greece, and Ireland) through the sign of the Maastricht Treaty in 1992 and they decided to introduce the common European currency euro by surrendering their domestic currency, which came into effect in later days from 1st January 2002. (Kaiser, Leucht and Rasmussen 2008: 5-7) The European Union became a strong economic power over time. The main two economic pillars behind the unification were the theories of ‘Regional Trading Block’ and ‘Optimum Currency Area’. The former deals with a free trade area with a two-tier tariff system i.e. zero tariffs within the union members and some positive rate of tariff for the non union-members. (Robson 1999: 109-110) The latter deals with the introduction of a unique currency; it would enable the member states to enjoy the benefit of a fixed exchange rate system with the facility of full currency convertibility. (Krugman and Obstfeld, 1997: 631-33) The simultaneous functioning of a trading block and the optimum currency area was the main theoretical standpoint o the European Union and economic integration was the result of that. Economic integration is desired for the transfer of the benefit of economic development of one country to another. (Czinkota, Rivoli, Ronkainen 1989: 14-16) Let us consider the economic development of Germany and its influence on the European Union. Here our analysis would be concentrated on the economic development of Germany after the establishment of EU. German economy marks itself as a social market economy as the government undertakes a wide array of social services. As German economy is highly export oriented it advocated for European economic integration. After unification German commercial policies have been highly centred towards union. The social reform policies adopted by Germany for the welfare of the society and the structural industrial reform enhanced the performance of the economy and its global competitiveness. (US Dept of State 2008) The Impact on EU The basic logics behind the policy of regional cooperation or integration and monetary union or formation of optimum currency area are based on the political economic concerns. The regional integration implies the inclusion of all of the member states under the umbrella of a union characterized by free and costless trade. That would definitely bring about the benefits of the trading partners through an efficient allocation of the resources regionally and the regional division of labour according to efficiency. (Todaro 1989: 378) On the other hand the monetary integration by introduction of a single currency enhances the regional liquidity and hence it facilitates both trade and investment (both short term institutional and long term direct investments). (Krugman 2004: 398-399) Now we can judge the impact of the economic development of any country on the union. Here our main concern is the impact of the economic development of German on the entire union. To judge the impact of German economic development on the entire region we have to take the help of the economic theories. The economic theory of regional cooperation says that whenever there is an economic development on one of the members there will be some spill-over effects of that kind of economic development on its regional partners. For example if we consider the GDP growth of a country. It would be associated by a rise in demand for imports in the country and hence that would be followed by a growth of export of its trading partners. That would also lead towards a GDP growth of the corresponding country. The neoclassical theory can also be incorporated to the regional cooperation and regional integration. According to this theory the technological progress in one country would be transferred towards the other country, as the flow of commodity would imply the indirect flow of technology. (Sodersten and Reed, 1994) Besides the benefit of technological progress we can say that there will be a trend of convergence of the factor payments of different countries. First of all the economic integration would ensure free flow of the goods within the economies and hence there would be indirect flow of the factors and the mobility of the commodities would act as the mobility of the factors. This is expressed in the famous factor price equalization system. (Caves, Frankel and Jones 2001). In the European Union, Germany is a country, which identifies itself as a social market economy and hence along with the economic growth of the country’s interest is concerned with the standard of living of the German people. The government policy of Germany has always considered the economic growth as well as the minimum wage programme for the workers and the policies of subsidization and some unemployment benefits. By the regional integration this is also spread over then union. (Leonard 2006). The integration of the monetary systems has also influence in the spillover effects over the area. For example if any country in any union enjoys a huge trade surplus it would cause a huge inflow of foreign exchange. Under a pegged exchange rate regime this accumulation in the foreign exchange would cause a rise in the common currency of that union. This monetary expansion would cause the interest rate to decline by the action of the bond market. That would boost up the investment and hence aggregate demand and employment all over the region. (Kenen and Meade 2008:9-10) Apart from the theoretical part we can consider some real facts of the German economic performance and the impact on EU. The splendid performance of German automobile industry has a light of optimism in the recession time in EU. This caused an increase in the rate of employment. However, in later periods the workers bargaining and the German policy of unemployment benefits further caused cost ineffectiveness and setback to the industry creating a further problem in EU because of integration. This protection of work force hampers the investment pace in Germany that creates a setback to Germany as well as the union. Over time the German government eased the immigration policy and adopted rate of interest cut. (Williams, 2001:C1) Moreover, the decline of the industrial belt of Ruhr in the 1990s caused a huge setback to German as well as the European Union through the spill-over effects. (New York, N.Y.: (“Germanys Cautious Candidates” 2002: A8). On the year 2006 the German economy faced a 0.9% growth and that caused a growth of the entire European Union. The growth boosted up the consumers over the Germany and hence the union also (Dougherty, 2006: C3) The construction of the roads for the ease of transportation between former East Germany to the western part increased the economic activities and had facilitated the connection with the neighbouring country to enhance the economic activities. (Steinborn, 2008: R4). The government of Germany has adopted the different efficient tax reform policies in the country to enhance the trade facilitation and the increase in economic transaction some other member nations. This tax reform policy facilitated overall business. (Crawford, 2009: A8.) The matter of fact is that there are both positive and negative effects of economic integration. In the paragraphs given above the positive effects of the regional integration and the establishment of an optimum currency area have already been explained. Similarly there are some negative effects of such integration. The major problem regarding integration is that the economies are more exposed to external shocks and the business cycle facts of one economy affects the other. For example we consider the protection of the workforce in Germany and its impact on the European Union. If the workforce of Germany is protected by better unemployment benefits and some minimum wage law the workers would charge higher wage to work. If they are not paid that amount simply they would like to remain unemployed as the unemployment benefit is high enough. That causes a decline in the competitiveness in the labour market which is not healthy for the entrepreneurs as the cost of production becomes high and high cost makes the product less competitive. Consequently, the flow of investment is hampered. This has effect of the trading partners of the country. The foreign countries which were selling some inputs for this industry would face a loss in their export earnings due to fall in the investment in Germany. That would cause a fall in the level of aggregate demand of the trading partner and the consequence would be a decline in employment. If that country has no labour protection policy this decline in employment would cause an excess supply situation in the labour market pulling down the wage rate. The consequence is a decline in the standard of living of the workers of the trading partner. So a beneficial policy for labourers in Germany is followed by a negative effect of the labourers of its trading partners. This is the one part of spill-over effects which is connected to the backward linkage. There is another effect related to the forward linkage. The high labour cost in Germany due to the protection policy would cause cost push inflation in Germany. The other countries which purchase German products as intermediary or input good would face a rise in the cost of production. That would cause a cost push type of inflation in their country. Moreover, while there is cost push inflation in that country that would be followed by a rise in price of their exportable products in the global market and the consequence would be a loss of competitiveness in the global market especially outside the market of the union. Hence the country would face a loss of export and hence trade balance would decline as a consequence. As the trade balance is a component of aggregate demand the decline in trade balance would cause a decline in aggregate demand. That would take place through a multiplier effect ( This is known as foreign trade multiplier According to simple Keynesian model  Autonomous Consumption  Marginal Propensity to consume   Investment is autonomous in nature.  => Public investment is autonomous in nature Equilibrium implies   +  +  +  Differentiating both sides totally we get:    Or   Or  As we know 0 < b < 1 that implies  > 1) The above derivation proves that a decline in balance of trade causes greater decline in the aggregate demand of an economy. (Rivera –Batiz, and Rivera –Batiz, 1993: 164-165) Concluding remarks The overall discussion makes it clear that an economic integration has both positive and negative effects. The major cause of such behaviour is mainly attributable to the increase in the sensitivity of the economic variables of the partners. In the regime of a restricted trade the restriction in the flow of goods and services always implies the restriction in the degree of exposure to the foreign economy. Similarly opening itself implies the freedom of the economic environments of different countries to affect each other. Thats why while we think of integration we have to be prepared to take collective and comprehensive actions for the common benefit of all the partners. References: 1. Caves, R. E., Frankel,J.A. and R. Jones (2001), World Trade and Payments, NJ: Pearson Education 2. Crawford, D. (2009) “World News: Germany Urges Penalties For Offshore Tax Havens”. Wall Street Journal. (Eastern edition). N.Y.: Mar 17, A.8 3. Czinkota, M.R., Rivoli, P. and I.A. Ronkainen (1989) International business California: University of California 4. Dougherty, C. (2006) “Economy Grows Nearly 1% in Europe”. New York Times. Late Edition East Coast. N.Y.: Aug 15, C.3 5. “Germanys Cautious Candidates” (2002); [Editorial]; New York Times. (Late Edition, East Coast. N.Y.: Sep 12, A.26 6. Kaiser, W. Leucht, B. and M. Rasmussen, 2008, The History of the European Union, London: Taylor & Francis 7. Krugman, P. R. (2004) The great unravelling: losing our way in the new century. NY: W.W. Norton 8. Krugman, P. R. Obstfeld, M. (1997), International economics: theory and policy. NJ: Addison-Wesley 9. Leonard, T.M. (2006), Encyclopaedia of the developing world, London: Taylor & Francis 10. Peter B. Kenen, Ellen E. Meade 2008 Regional Monetary Integration: Cambridge: Cambridge University Press 11. Peter Robson: 1998: The economics of international integration. London: Routledge 12. Rivera –Batiz, F. L. and L.A. Rivera –Batiz, (1993) International Finance and Open Economy Macroeconomics, NJ: Prentice Hall 13. Sodersten, B. and G. Reed (1994) International Economics:, London: Macmillan Press Ltd 14. Steinborn, D. (2008) “The Road to Growth”, Wall Street Journal. (Eastern edition). New York, N.Y.: Jul 28, R.4 15. Todaro, M.P. 1989, Economic development in the Third World, NJ: Longman 16. US Department of State: (2008) ‘Background Note: Germany’, Available at: http://www.state.gov/r/pa/ei/bgn/3997.htm (Accessed on May 24, 2009) 17. Williams, C.J. (2001) “Sputtering German Economy Stalls Interlaced Neighbors; Europe: Nations resistance to reform is stunting growth”. Los Angeles Times. Los Angeles, Calif., Jul 21, C.1 Read More