Trade imbalances within the Euro Area: two regions, two demand regimes

Abstract

Greater trade integration, convergence in economic performance and a high level of employment among member states: this was why the Euro Area was created. In this respect, the paper analyses the sources of trade imbalances within the Euro Area, focusing on the direct trade relationship—intra-EA trade—between surplus and deficit countries. The econometric evidence based on a VAR/SVAR methodology suggests that asymmetric wage shocks determine asymmetric gains from intra-EA trade, resulting from opposing growth strategies. In addition, the empirical evidence shows that the Euro Area is divided into two economic regions representing different demand regimes: a northern region, which is profit-led and a southern region, which is wage-led. The paper suggests that wage coordination is an essential macroeconomic tool but is insufficient to achieve trade and economic integration given the current state of divergence. Thus, a trade-based transfer mechanism is proposed to restore convergence in the Euro Area.