Global Imbalances - Where Are the Greatest Adjustment Burdens?

In contrast, current accounts in the EU and the euro area have largely moved sideways with a recent downward tendency. The respective governments must address the structural economic causes jointly in order to reduce global imbalances:

• EU and euro area: The EU and the euro area have been moving in the right direction in recent years and the current account surplus is on a downward trend. They have stepped up their previously insufficient investment activity, for example, with the Recovery and Resilience Facility, which promotes jointly financed investments in digital and green transformation projects. Private investment is being incentivized through the EU's ongoing bureaucracy reforms and a more serious initiative by key member states for a Savings and Investment Union. The Draghi report also identifies a wide range of measures to increase private and public investment, which the EU and its member states should implement more consistently. The key is the consistent implementation of these plans.
• Germany: Germany still has a relatively high current account surplus. However, its marked decline since 2020 and the significant increase in public investment point clearly in the right direction. Nonetheless, attention must be paid to effective implementation. In addition, the federal government should further strengthen the reforms already initiated to improve competitiveness and create more incentives for private investment.
• United States: In the United States, the need for action remains persistently high. In particular, the fiscal deficit, which is at the root of the high current account deficit, must be reduced. This should be done by strengthening government revenues instead of using import tariffs. Owing to the much higher net external debt, initial concerns are emerging about a potential financial crisis, as the financing structure of US foreign debt has become more fragile and the erratic policy of the US administration is creating uncertainty.
• China: In China, the need for action is greatest and has become even more pressing. The current account surplus has recently risen significantly. The Chinese leadership has so far addressed the need for substantial reforms only tentatively. The scale of the necessary rebalancing in China is immense, multifaceted and systemic.

The currency management of the People's Bank of China also plays a pivotal and underestimated role in China's widening current account surplus. China's currency is significantly undervalued, which promotes exports while dampening imports and consumption. The extent of the undervaluation is estimated at between 20 and 30 percent, implying a need for appreciation of 25 to 43 percent. Despite the widening deficit in the euro area’s trade with China, the nominal exchange rate of the yuan against the euro reacted only slightly. In addition, industrial producer prices diverged dramatically between China and its Western trading partners since 2020. In 2021 and 2022, industrial producer prices in Europe and the United States rose sharply as a result of supply-chain bottlenecks during the Covid crisis, which affected China to a much lesser extent. In the EU, they also rose because of the energy crisis following the Russian war against Ukraine. This largely exogenous cost shock made industrial products from the euro area (on a common currency basis) more than 40 percent more expensive than Chinese industrial goods between January 2020 and January 2026.

In response to the immense price divergences and the rising Chinese current account surplus, the yuan should have appreciated significantly - if the Chinese exchange rate were free, flexible and market-based. However, the Chinese central bank manages the exchange rate by closely aligning the yuan with the US dollar. China has thus largely disabled the normal adjustment function of the exchange rate in response to the large cost and balance-of-payments imbalances that have emerged and has secured lasting cost advantages. This enables Chinese exports around the world to enjoy unfair price advantages over European products. Price disadvantages of around 40 percent can be reduced only marginally through business efficiency measures and domestic economic-policy reforms. The competitive pressure from China is therefore likely to make a major contribution to deindustrialisation in Europe and Germany.

Against this background, the effect of a substantial appreciation of the yuan against its trading partners was simulated using the macroeconometric Global Economic Model of Oxford Economics. As with any model estimate, the results should be interpreted with caution, but they provide a rough orientation. A significant appreciation of the yuan against the US dollar of 43 percent induces a rebalancing process in the Chinese economy. The trade surplus declines, while private consumption increases, mainly because import prices and interest rates fall according to the simulation. After a brief decline in real economic output in the first year, a rebound follows, so that the decline in the real GDP level in 2028 compared with the baseline scenario is estimated at only around 0.2 percent. This slight loss could be further reduced through fiscal measures by China, such as consumption vouchers or income and consumption tax cuts. In contrast, the real GDP level in the euro area, Germany, France and the United States rises by between 0.2 and 0.3 percent in 2028 compared with the baseline scenario. Cumulatively over the years 2026 to 2028, this implies an estimated higher real economic output for Germany of around 40 billion euros in 2025 prices.

The EU and Germany should therefore try to exert influence on China so that it undertakes the reforms necessary for rebalancing. In addition to a significant currency appreciation, this includes reducing industrial-policy subsidies and reallocating them toward stronger support for private consumption. For example, tax cuts or an expansion of the social security system could help to reduce households' incentives for precautionary saving. If China does not respond accordingly, the EU should impose broad equalising/countervailing duties, if distortions of competition resulting from Chinese subsidies and China’s undervalued currency can be sufficiently proven and if imports from China threaten production in Europe. The European economy must cope with China's fair competitive advantages. Domestic policy should support competitiveness through appropriate reforms. Properly calibrated equalising duties are not protectionism, but are intended merely to restore fair competitive conditions, that is, a level playing field. As an instrument of global regulatory and competition policy, they are a substitute for the non-existent strong global competition authority.