Is EMU really bad for the periphery?

Much has been written about the inability of the PIGS countries to adjust wihin EMU as they cannot devalue their currency vs. their most important trading partners (i.e. the other EMU members). This has frequently been given as a reason why these countries should or might leave the Eurozone. Should they leave, they can then significantly devalue their new currencies and growth will re-appear. I have previously argued that devaluation without default does not help as these countries suffer from the combination of a lack in competitiveness as well as an over-indebtedness problem. Just leaving the euro would make the over-indebtedness issue much worse (as the debts would remain re-denominated in the euro). But leaving the euro and defaulting would cause serious havoc on the financial sector as well as the sovereign.

Furthermore, a weaker currency alone does not guarantee an improved export performance. The chart below compares the evolution of the trade balance for PIGS as well as Iceland and the UK. The Icelandic Koruna has collapsed dramatically and indeed the Icelandic trade balance improved very sharply. However, also GBP weakened significantly in trade-weighted terms since the start of the financial crisis (in fact GBP weakened by approx. 20% vs. the Euro compared to 2007). But UK net exports have not moved significantly. Rather the trade deficit widened slightly. This is in sharp contrast to the development in the trade balance of Portugal, Spain, Greece and especially Ireland. As can be seen from the chart, the Irish trade balance improved by more than 10% of GDP and thereby helped to stabilise the Irish economy. Furthermore, also the Spanish, Greek and Portuguese trade developments provide support to GDP! So, yes as Iceland shows, a much weaker currency can help but as the UK shows, it does not need to be the case. More importantly as the PIGS show, even with a stable currency (the trade-weighted euro is at the same level as in 2007), trade developments can provide a significant positive impetus.

Development of the trade balance/net exports as a % of GDPSource: Eurostat

Another important topic is the development of unemployment. Yes, especially Spanish and Irish unemployment rates are extremely high. However, my opinion is that this is mainly a functiion of the previous construction bubble.
The chart below shows the relative size of the construction sector (i.e. construction employment relative to total employment) at the peak of the bubble vs. the latest unemployment rate. Clearly it is not a perfect fit, but with an R2 larger than 60% it is quite good. In general, the larger the previous construction bubble, the higher current unemployment. This should not come as such a surprise as construction is usually very much a domestic sector (i.e. within construction exports and imports are not that important). In turn, once a construction bubble bursts, a lot of people will get unemployed in the domestic economy (because there are not many construction imports), even with a sharply weaker currency (because there are not many construction exports). As these people get unemployed, domestic demand is weakened and employment drops as well in other sectors.

The larger the previous construction bubble, the higher current unemployment rates

Source: Research Ahead, Statistics Iceland, Eurostat

Overall, the development in net exports for the PIGS countries is encouraging so far. To expect that unemployment - especially in Spain and Ireland - would drop fast if they had their own much weaker currency seems illusionary given the size of the previous construction bubble. Once such a bubble bursts, the costs must be borne and can not be exported away. EMU does not seem to be the main problem for PIGS.
While the developments in Iceland seem encouraging as net exports have grown significantly amid the sharply weaker currency which has also helped to keep unemployment down, the situation in the UK raises a warning flag. Net exports are not rising despite a weaker currency and the only effect seems to be to raise inflation, thereby eroding living standards.
I remain of the opinion that the Eurozone will rebalance over a 3-5 year timeframe with a relatively high real growth rate and high inflation in the north-eastern economies while the PIGS will suffer from relatively low real growth and limited inflation.