Research indicates that sustained productivity growth differences between the Eurozone and the rest of the world (ROW) serve as the core driving factor behind Europe's external surplus. Meanwhile, structural changes in trade patterns—such as declining home bias (the Eurozone's tendency to purchase locally produced goods) and falling import prices—have offset appreciation pressures caused by productivity growth gaps.
The Eurozone's investment weakness is largely dominated by global factors, highlighting the limitations of purely demand-centered explanatory logic and related policy recommendations. This perspective may help us better understand the European Central Bank's policy objectives.
**Can Persistent Trade Surpluses Not Represent Economic Health?**
Since the early 21st century, the Eurozone has consistently faced persistent growth challenges. The region's output and productivity growth have consistently lagged behind global competitors like the United States and China. During the same period, the Eurozone has maintained a persistent trade surplus, averaging 2.6% of its gross domestic product (GDP).
From 1999 to 2023, the Eurozone's real GDP grew at an average annual rate of only 1.26%, while other regions achieved 3.28%. The gap in labor productivity growth (measured by GDP per worker) was equally significant: the Eurozone's annual growth rate was 0.70%, compared to 1.95% in other regions. This difference is not a short-term phenomenon: the growth gap shows high persistence and is expected to continue.
(Eurozone GDP has underperformed other regions since 1999)
During this period, the region's trade openness continued to increase, but the real exchange rate (RER) showed no clear trend. Some viewpoints suggest that the Eurozone's positive trade balance actually reflects insufficient domestic demand, particularly weak investment.
Therefore, long-term trade surpluses cannot prove Europe's economic strength. Draghi (2024) proposed that insufficient integration of the single market and inadequate capital market depth have suppressed investment activity, leading growth to tilt toward external demand and maintaining the trade surplus pattern.
Existing long-term literature on Eurozone imbalances mostly focuses on internal adjustment issues within the Eurozone. Multiple studies indicate that resource misallocation and financial market defects played key roles in explaining the causes of weak demand in the Eurozone, especially after the financial and sovereign debt crises.
**New Framework for Studying Trade Surplus Phenomena Emerges**
A recent study abandons the common assumption that "external economic shocks are temporary" and quantifies the long-term drivers of external adjustment through this analytical framework.
Its core conclusion is that the Eurozone's productivity growth rate consistently lagging behind other regions is the core driving factor of trade surpluses. Trade structural shocks—particularly declining home bias in the Eurozone and falling import prices—also play crucial roles, offsetting appreciation pressures on the real exchange rate.
Research results indicate that Europe's persistent trade surplus and investment weakness stem not only from domestic demand conditions but are also closely related to long-standing productivity gaps and structural changes in global trade. The analysis supports recent calls for restarting reforms to enhance productivity and strengthen the region's resilience to global shocks.
A decline in the Eurozone's real exchange rate implies euro appreciation. The real exchange rate is measured using relative GDP deflators and presented as percentage deviations from 2010 levels.
Despite this growth divergence, the Eurozone's trade balance has consistently remained in surplus, and during the same period, the real exchange rate between the Eurozone and other regions has not shown a clear trend. During this period, the Eurozone's trade openness (measured as the sum of Eurozone exports and imports as a share of GDP) has doubled from 15% to 30% since 1999, while the relative trade openness of other regions has remained stable.
These phenomena raise two key questions: first, to what extent is the Eurozone trade surplus caused by weak productivity growth, and second, why has the real exchange rate remained stable despite persistent productivity differences.
To answer these questions, the research utilizes data from the Eurozone and other regions from 1999 to 2023. The core innovation of this analytical framework lies in explicitly modeling trend shocks.
This study uses an estimated model to conduct historical shock decomposition of key macroeconomic variables. In the estimated model, the persistent weakness of Eurozone real GDP is mainly caused by a series of negative shocks to Eurozone productivity growth, while strong growth in other regions further exacerbates this situation. The divergence in trend growth paths is an important reason for the persistent output and income gaps between the two regions.
**New Analytical Framework Reveals the Secret of Eurozone's Long-term Surplus**
Our historical decomposition results show that productivity improvements in surrounding countries relative to the Eurozone contribute between 1/4 and 1/2 of the Eurozone trade surplus.
Productivity improvements in other regions outside the Eurozone boost the future income and wealth levels of their businesses and people, prompting households and businesses to increase consumption and investment in Europe and other countries.
This temporarily drives demand from other regions for Eurozone exports while reducing savings levels in other regions. The negative impact of Eurozone growth shocks on trade balance means that weak Eurozone productivity suppresses expected returns and investment scale, triggering capital outflows and inhibiting imports.
Therefore, the secret to the Eurozone's long-term trade surplus lies in foreign productivity improvements increasing foreign purchases of Eurozone goods, while slow economic growth in the Eurozone and slow income growth suppress residents' and businesses' willingness to consume abroad because consumption is a function of income C=F(Y), ultimately resulting in the Eurozone maintaining a long-term trade surplus with the outside world.
**Long-term Surplus Promotes Euro Appreciation, But Why Has the Real Exchange Rate Changed Little?**
Currency appreciation affects trade terms, making imported products relatively cheaper but exports more expensive. Therefore, real exchange rate changes have significant impacts on a country's foreign trade.
Standard theory predicts that accelerated trend productivity growth in other regions should lead to trend appreciation of the Eurozone's real exchange rate (real exchange rate (ε) = nominal exchange rate (E) × (foreign price level/domestic price level)).
However, data shows that the real exchange rate has been quite "stable" (in the medium term). This seemingly contradictory phenomenon can be explained by structural trade changes: the trend decline in Eurozone import prices reflects accelerated productivity growth in the tradable sectors of other regions (especially China and other emerging market countries).
This change has reduced the relative prices of foreign goods faced by European households and businesses, increased the Eurozone's import share, and alleviated appreciation pressure on the real exchange rate.
Meanwhile, the Eurozone's home bias has experienced long-term decline, with consumers showing stronger preferences for foreign goods, and Eurozone producers losing market share in their domestic market. These trends may be interconnected: as other regions' tradable sectors improve productivity, their product quality and variety also improve, further intensifying import penetration.
Finally, the model also reveals external determinants of Eurozone underinvestment. Positive productivity shocks in other regions not only drive increased foreign absorption (Y=A(absorption)+(X-M), meaning increased consumption by foreign economies in their own countries) but also push up global interest rates and foreign relative returns.
In the context of financial openness, these changes weaken investment incentives within the Eurozone and crowd out domestic absorption. Therefore, the persistent weakness of Eurozone investment reflects not only insufficient domestic demand but also the influence of external structural factors operating through global capital markets, namely improved foreign productivity.
**Policy Implications**
The Eurozone's long-term economic underperformance, despite stable and mature product quality and manufacturing capabilities, reveals that the secret to long-term surplus lies in its persistently lower GDP growth compared to neighboring countries, leading to insignificant domestic income growth, reduced vitality in investment and consumption, and decreased imports, while economically active other countries' income growth has promoted their imports from the EU.
This is not a long-term solution, as product quality and competitiveness do not remain unchanged. The persistent productivity growth gap between the Eurozone and other regions requires addressing this productivity shortfall by boosting Eurozone demand and attracting capital inflows, while also helping to narrow the currency appreciation issues brought by trade surpluses.
Improving financing environments for startups, reducing regulatory burdens, and increasing skills investment should be primary tasks for achieving this goal.
Second, while short-term fiscal and monetary policies remain important tools for addressing cyclical fluctuations, supporting reforms should focus on enhancing potential output. Analysis shows that external imbalances reflect both cyclical and structural factors. Purely demand-centered interpretive logic may overlook this key fact.
Third, considering current policy discussions around competitiveness, low investment levels and weak productivity are major factors hindering growth, calling for new strategies to strengthen the economy's supply-side capabilities.
External factors—such as accelerated foreign productivity growth and global trade structural changes—have significant impacts on European economic outcomes. This highlights Europe's need to develop a coherent strategy that addresses both internal structural challenges and adapts to external developments.