Since late 1990s macroeconomic imbalances in the Eurozone increased constantly and became a critical factor in causing the current debt crisis. In these years southern European countries experienced huge losses in competitiveness and persistent accumulation of large current account deficits against northern Europe. In addition, during the global crisis the financing of the stimulus measures caused huge budget deficits, leading public debt to unsustainable levels, especially in Greece after the truth about the real conditions of public finances was found out by the new elected government of Papandreou in 2009. Before the global financial crisis, little attention was paid to the increase of current account imbalances as they were considered the result of financial integr ation and liberalisation (Blanchard and Giavazzi, 2002). In addition, they were considered an optimal outcome of private saving and investment decisions (Gourinchas, 2002) justifying the policy of no government intervention (Clarida, 2007; Blanchard, 2006). A remarkable exception is given by Dullien and Fritsche (2009) who already in 2006 warned about the excessive ULC growth in Portugal, and to a lesser extent in Spain and Greece, coupled with the strong fall in Germany. Following the global financial crisis, with the explosion of current account deficits and public debts in some southern European states, a growing body of research is dealing with the causes of imbalances. While most contributions point to the role of real (Croci-Angelini and Farina, 2012) and financial integration as well as interest rate reductions in southern member states (Schmitz and von Hagen, 2011; Croci-Angelini and Farina, 2012; European Commission, 2012; Chen et al., 2013; Schnabl and Freitag, 2012), some authors suggest that the excessive lending of northern states contributed to such unequal development (Collignon, 2013; Makin and Narayan, 2011) especially when investment is not aimed at increasing the productive capacity (Giavazzi and Spaventa, 2010). Another strand of literature points to the role of wages and unit labour costs developments in European countries (Brancaccio, 2012; Onharan and Stockhammer, 2013; Collignon, 2013), in connection with the performance in external

trade (Guerrieri and Esposito, 2012, 2013; Chen et al., 2013). Most of these works conclude for the necessity of symmetric and coordinated policies at European level (Guerrieri and Esposito, 2012), mainly via coordinated wage setting processes (Brancaccio, 2012; Onharan and Stockhammer, 2013; Schnabl and Freitag, 2012). This chapter investigates the role of the external performance in explaining the increase in imbalances by comparing the two main export-led growth economies in the Eurozone: Germany and Italy. More specifically, we will attempt to assess, on the one hand, the role of global trade integration, not only in terms of outsourcing, but also in terms of penetration of fast-growing markets. Following previous works (Guerrieri and Esposito, 2012, 2013; Chen et al., 2013) we devote particular attention to the role of fragmentation of production with Central and Eastern European countries. In addition, we will focus on the integration with the Asia-Pacific region as it is the most dynamic area of the world in terms of growth and external performance. In a second analysis we will assess whether the introduction of the single currency has had a direct impact on the two countries’ net trade and on the widening of imbalances. The structure of the chapter is as follows: in the second section we will summarise the performance of the two countries and compare it with the evolution of cost competitiveness; in the third and fourth sections we will focus on external performance and stress the role of internationalisation and recomposition of trade flows as result of the increasing importance of emerging economies; in the fifth section we will provide an econometric test of the importance of outsourcing and trade integration in explaining the two countries’ net exports; the verification of the impact of the euro introduction is in the sixth section while the seventh section concludes.