The Eurozone is a Polarised Economic Model

24/04/2012 16:01 | Updated 24 June 2012

The Eurozone is not a uniformly successful economic model. For one group of member states to succeed another group will fail. This is as a result of the Euro providing a single currency value across the whole of the Eurozone, which in turn alters each member states relationship with foreign exchange and trade. This relationship has helped the stronger states like Germany and the Scandinavian member states, but it has come at the expense of the weaker Eurozone states namely the PIIGS.

Countries in the Eurozone that receive high demand for their goods from outside the Eurozone will benefit from being in the single currency. The high demand for goods produced in countries like Germany would normally push up the price of the currency and make the country less competitive. When a foreign buyer wishes to purchase goods in another country they will have to obtain the currency of the seller to do so. The higher the demand for those goods the higher the demand for the currency in which they can be purchased in. Thus successful manufacturing and exporting countries become less competitive over time as they become more in demand.

This is where the Euro is of great benefit to these successful manufacturing and exporting countries. The Euro value is not based on the demand of one country it is based on the demand, for the whole of the Eurozone. The weaker countries in the union push the value of the currency down in comparison to what the individual successful countries currency value would have been if still independent. The demand for the products of the successful countries does not impact on the price of the Euro because it has been absorbed by the reduction in value of the weaker countries in the union. This enables the stronger Eurozone member states to maintain high exports without the inevitable loss of demand through domestic currency value appreciation.

In short the Eurozone has enabled the successful member states to receive a level of economic output they would not be able to achieve if they were not in the union. It has also had the opposite effect on the weaker countries in the union. The higher price of the Euro in comparison to the currency the member state had before entering into the currency union has dampened international demand for their goods. Now the price of goods purchased in the weaker states of the currency union has increased it has made them less competitive with the rest of the world impacting on their economic output.

Is it possible to blame the Euro for the economic difficulties the PIIGS states have encountered as a result of this relationship?

As the economic model is based on a single currency across the whole of the region the currency has developed a midpoint aggregate value. For higher exporting countries there is a long term benefit to being in this union because the currency effect is to boost their own economy. Conversely the low exporting countries will lose economic output due to the reduced interest in their products created by the higher midpoint currency value the Euro has created. The European single currency has created a polarised economic model that will create an economic benefit or consequence depending on where each member state lies on the midpoint value of the Euro. It is possible to say that the successful member states only benefit at the expense of the member states that had a currency value below the midpoint value of the Euro, when they were an independent state. The higher level of exports the midpoint value has created for successful states has reduced exports for the sub-midpoint member states.

There is a lot of evidence suggesting the European currency union has led to a decrease in exports from the weaker member states. In 2009 the level of exports from Greece fell to $18.64 billion from $29.14 billion in the previous year (economywatch 1). . In 2010 all of the PIIGS member states with the exception of Ireland had a net deficit in their trade balance indicating a reduction in exports in relation to imports (eurostat 2). Although Ireland had a net surplus in their balance it is likely this was a result of a reduction in imports rather than an increase in exports. This argument is strengthened by the import figures over the last few years showing there was a decline from the peak of $87.6 billion in 2007 to $70.36 billion in 2010 (indexmundi 3).

On a macroeconomic level it could even be argued that the increase in public sector borrowing among the weaker states may have been a result of the lack of international demand from this sub-midpoint currency value mechanism. The borrowing and government spending may have been implemented to compensate for the lost demand seen as foreign interest in the sub-midpoint member states decreased as a result of joining the Eurozone. It could be argued, if the sub-midpoint member states did not join the Eurozone they would not have required public sector funded fiscal stimulus to compensate for the lost foreign demand the Euro midpoint currency value created.

The worst part is what is happening now. The worse the economic situation becomes in the PIIGS area the more polarised the relationship becomes. The more the weaker states deteriorate the further they fall from the Euro midpoint value and the greater impact on foreign demand. Conversely the opposite is true the stronger states such as Germany have and will benefit greatly as a result of the worsening situation of the PIIGS member states. The economic region will become more polarised as the crisis worsens and create a divide in economic power across the whole of the Eurozone.