Trade Surplus in Germany

Table of Contents

Abstract

1. Introduction

2. Theoretical Considerations

3. Germany’s Trade Surplus Model
3.1. The Methodology
3.2. The Data
3.3. Discussion of the Estimation Results and their Implications

4. Conclusion

5. Appendices

6. References

Abstract

This report analyses the impact of the real exchange rate two years beforehand and the GDP on Germany’s trade surplus between the second quarter 1993 and the first quarter 2007. It is found that both factors had significant impact on Germany’s trade surplus during the analysed period. Use of a piecewise linear regression technique, moreover, identifies changes in the development of Germany’s trade surplus over time. A temporary downward shift in the consistent growth trend of Germany’s trade surplus between the first quarter 1998 and the fourth quarter 2002 is seen to be due to changes in Germany’s fiscal and monetary policy during the introduction phase of the Euro.

1. Introduction

The real exchange rate is important for international business as it measures changes in a country’s competitiveness due to differing inflation rates among countries. Economic theory suggests that a drop in a country’s real exchange rate has a positive effect on its amount of exports, whereas an increase in real exchange rate causes exports to drop. Over the last four years Germany has been the world’s top exporting nation with exports (f.o.b.) mounting to € 896 billion in 2006 (IFS, 2007). However, while the country’s exports have continuously been growing since the reunification of West and East Germany in 1990, its CPI-based real exchange rate has seen considerable fluctuations during the same period (see Exhibit 1). Increasing from a base index of 100.0 in the second quarter 1991 to a peak of 117.9 in the second quarter 1995, it dropped to an index as low as 93.3 in the fourth quarter 2000 before moving back to a level slightly above 100 in early 2007 (IFS, 2007). Hence, no obvious relation can be determined between the development of Germany’s exports and its real exchange rate.

A further trade-related variable that has been suggested to develop dependant on a country’s real exchange rate is the trade surplus. Lecraw (1997) has identified an inverse relationship between the development of the U.S. real exchange rate from 1970 to 1993 and the US trade deficit lagged by two years. The author included a lag of two years in his analysis, because the time it takes importers and exporters to switch suppliers allows them to respond to changes in the real exchange rate only some time after the changes have occurred. This delay is due to the need for certain orders to be placed several months in advance as well as long- and medium-term contracts between buyers and suppliers. Having witnessed considerable improvements in information and communication technology over the last two decades a time lag of two years is increasingly regarded as too extensive to give a realistic representation of today’s business environment. However, this study will still include a time lag of two years. This is regarded appropriate as a great percentage of Germany’s trade is related to capital- and technology-intensive machinery that requires orders be made long before the actual delivery and payment of the product. Support for this reasoning comes from research conducted by Junz and Rhomberg (1973) who assert that the “delivery lag” (p.413) regarding high-technology equipment is most properly measured in years rather than quarters.

Yet, the trade of high-technology products implicates a further notion as well, that exchange rate changes do not have much impact due to the necessity nature of the traded goods. Still, one goal of this study is to determine whether a correlation between Germany’s real exchange rate and the development of its trade surplus lagged by two years exists.

With the real exchange rate being only one out of many possible variables to affect a country’s trade, this report will additionally include a second one in the analysis. This further explanatory variable will be Germany’s gross domestic product (GDP), as by definition a country’s GDP is related to the amount the country trades (GDP = C + I + G + NX; NX = TS = X – M).

The objective of this paper is, hence, to examine the impact of the real exchange rate two years beforehand and the GDP on Germany’s trade surplus between the second quarter 1993 and the first quarter 2007.

In order to address this objective, a model representing the effects of real exchange rate and GDP on Germany’s trade surplus will be derived. On basis of this model a linear regression analysis using data from the International Monetary Fund will lead to an estimation of the trade surplus’ dependence on the suggested variables. However, as a starting point, some theoretical considerations have to be made in order to derive a coherent model for further analysis.

2. Theoretical Considerations

In the course of his analysis of real exchange rate effects on the U.S. trade balance, Lecraw (1997) outlined the theoretical implications a change in a country’s real exchange should have on the amount it trades. An increase in Germany’s real exchange rate thereafter reduces the competitiveness of its domestic producers in export markets as well as it increases the competitive ability of producers abroad to export to the German market. The reverse effects for exports and imports hold true in the case of the real exchange rate decreasing. It follows therefore, that a rise in real exchange rate should result in a drop in the trade surplus, whereas a fall in its real exchange rate should cause the trade surplus to increase (TS = X – M).

Regarding GDP, the second variable included in the analysis of impacts on Germany’s trade surplus, some considerations are necessary, too. Per definition the gross domestic product is the sum of private consumption, investments in capital, government expenditures and net exports (i.e. trade surplus) in a country. There is, however, an ongoing debate among economist whether trade reacts to changes in productivity (i.e. GDP) or whether it is vice versa.

Export-led growth models contend that export growth promotes GDP growth because exports ensure the concentration of investments in the most efficient sectors of an economy, those where the country has a comparative advantage. Another argument is that stronger exposure to international competition provides incentives for the introduction of technological change which helps keep costs down and increases productivity. A third reason why exports might affect the GDP is because of the externalities they produce, i.e. they stimulate investment and productivity in related domestic industries as well (Kunst & Marin, 1989).

Technology-oriented theories, on the other hand, suggest that competitiveness in export markets can only be achieved through prior innovation; a company has to increase its productivity first before it can effectively compete internationally (Kunst & Marin, 1989). Moreover, Henriques and Sadorsky (1996) have come up with empirical results for Canada which suggest that changes in GDP growth precede changes in exports.

Thus, although strong arguments exists for the case of trade affecting productivity, due to the stated objective, this report will be based on the assumption that trade reacts to changes in GDP.

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