According to the Stability and Growth Act of 1967, Germany is striving for an external balance. Should the balance of trade, i.e. the difference between exports and imports, be zero? Then the Federal Republic would have been in a permanent imbalance for decades.
When the balance of the German goods trade balance due to expensive energy imports in May 2022 in a turned red zero, many joined in the swan song of Germany as a leading trading nation.
However, this conclusion is incorrect because trade in goods is only part of the much more meaningful current account. The latter also includes the increasingly important cross-border trade in services, which account for 70 percent of value creation in Germany.
In addition, so-called primary income is recorded in the current account – mainly profits from companies and capital income generated abroad. In 2021, these contributed 127 billion euros, 48 percent of the current account surplus.
But it would also be wrong to base a country’s economic success on its current account balance. In recent years, Germans have consistently produced more than they consumed.
As a result, current account surpluses emerged. There are indications that there is a shift towards permanently lower export surpluses.
This is not a cause for concern, because imports are not disadvantageous per se: They serve to satisfy domestic consumer needs and are therefore relevant to a country’s prosperity.
Imports increase the number of available products at lower prices. Exports, on the other hand, are merely a means to an end because they finance current or future imports.
>> Read here: The strong dollar reveals the major problem of the German business model
The mercantilist notion that is often found in Germany, according to which exports are good and imports are bad, is economic nonsense.
However, the current increase in imports is mainly due to higher prices. Larger amounts of imported goods are not consumed, instead spending increases due to a weak euro exchange rate and higher import prices – the so-called “terms of trade” deteriorate. This means a welfare loss that can be redistributed by government action but cannot be reversed.
A few years ago, high German current account surpluses triggered political debates. However, state intervention to reduce these fails both because of a lack of theoretical justification and because of the practical possibilities: As part of the EU and the euro zone, Germany does not pursue an independent customs and currency policy and is also bound by fiscal rules.
Greenhouse gas emissions from international trade must be priced
The situation is completely different when there are external effects: if society incurs costs from international trade that are not taken into account by the actors involved, there will be market failure. Cross-border trade would be excessive.
This is the case with the two dominant policy areas of our time, climate and geopolitics: if greenhouse gas emissions from international transport are not priced, too much trade will take place.
In addition, there is the problem of carbon leakage: the production of climate-politically ambitious countries is replaced by imports, so that emissions are merely shifted abroad.
In the worst case, global emissions even increase if other countries produce with inferior technologies and transport emissions also occur.
In principle, however, free trade conserves resources because those providers who operate with the lowest use of resources per unit of output prevail on the market.
Relocation of production due to differences in productivity is at the heart of welfare gains from trade. To fundamentally hinder them would make neither economic nor ecological sense.
The EU Commission is planning a CO2 border adjustment mechanism that will subject the CO2 content of imports to the same price as that of domestic production.
However, this initially requires a standardized recording of emissions along the value chain.
At the same time, emissions that are included in advance payments and have already been priced must be excluded from further pricing in order to avoid double taxation. Otherwise it would punish production in value chains.
Technical progress is the biggest driver of falling emissions
The creation of these conditions should be a priority goal of the climate club initiative of the federal government, because a globally uniform emissions price does not seem feasible at the moment.
Empirical evidence shows that technical progress has been the biggest driver of emission reductions over the last few decades. Political action should promote this.
It is also shown that the trade gains exceed the environmental damage even if the assumed CO2 damage is high. Carbon leakage, on the other hand, is (currently) of less practical relevance.
The EU Commission should therefore shelve its proposal for CO2 border adjustment if the proposed model is not compatible with world trade law.
A collapse of the already endangered WTO system would do the climate a disservice because it would slow down technical progress and reduce global production efficiency.
Import quotas for individual countries should apply to critical goods such as gas
Another externality arises in the procurement of critical goods from geopolitical rivals, who could stop deliveries in the event of conflict. Until 2022, it seemed rational for gas buyers in Germany to purchase large quantities of cheap Russian natural gas.
In a market economy, such decisions are uncoordinated and decentralized. As we are currently experiencing, however, this means that Germany’s foreign and security policy sovereignty is restricted because the corresponding quantities of gas can only be dispensed with at very high economic costs.
Geopolitical considerations usually play no part in the calculations of a gas buyer. However, they represent a procurement externality that fundamentally justifies political intervention.
The diversification of the sources of supply can be administered via import quotas. The allocation of quotas should be based on security of supply in the event of a crisis.
Within country quotas, auctions should be held where companies pay to be allowed to import. This minimizes the economic costs of limiting quantities.
Trade policy is faced with the task of addressing external effects resulting from cross-border trade. If these costs were fully priced, the degree of openness of an economy would probably decrease.
However, this does not mean less prosperity, but on the contrary promotes prosperity, because climate and security policy considerations are also relevant to welfare. A contemporary consideration of the foreign trade balance should consist in the fact that true costs have been established in international trade.
The authors:
Martin Braml is an economist and co-founder of the consultancy Munich Economics.
Gabriel Felbermayr is Director of the Austrian Institute for World Economic Research.
The article is based on the focus paper “External trade balance as a state goal in the 21st century”, which was created for the Bertelsmann Foundation’s Sustainable Economy project.
More: “The climate club is in a coma” – How China and the USA are jeopardizing the future of the earth