Columbia International Affairs Online: Working Papers

CIAO DATE: 11/2014

Versailles Redux? Eurozone Competitiveness in a Dynamic Balassa-Samuelson-Penn Framework

Kevin Stahler, Arvind Subramanian

November 2014

Peterson Institute for International Economics

Abstract

Stahler and Subramanian apply the Balassa-Samuelson-Penn (BSP) framework to compute measures of changes in the real competitiveness of European and other advanced economies after the recent global crisis. They find that competitiveness deteriorated in the euro area periphery countries between 2007 and 2013. Within the euro area, Germany has improved its competitiveness on their measure by 9 percent while Greece's competitiveness has deteriorated by 9 percent. Real competitiveness changes are strongly correlated with nominal exchange rate changes, which suggests the importance of having a flexible (and preferably independent) currency for bringing about external adjustments. Internal devaluation—defined as real competitiveness improvements in excess of nominal exchange rate changes—is theoretically possible but seems limited in scope and magnitude in practice, even under the stringent restrictions of the euro area at present.