Saturday, 31 January 2015
Weeping and wailing over Greek austerity.
I’m getting tired of people who weep and wail about austerity in Greece – unless the weepers and wailers have some nice simple solution to the problem, in which case I’m all ears.
The popular chant “austerity doesn’t work” is fatuous. That chant doesn’t begin to solve the basic problem.
For the benefit of the uninitiated, the basic problem is as follows, and it’s quite simple. If you just stop weeping and wailing for a minute, it’s easy enough to grasp.
If a country in a common currency area becomes uncompetitive, it’s external balance of trade deteriorates and it runs into debt. For a country with its own currency, that problem is solved by devaluing its currency. E.g. the UK’s currency fell 25% in value in 2008, and no one I know personally even noticed.
In contrast, for a country WITHOUT its own currency the only real option is to cut wages and profits in money terms. That’s called “internal devaluation” and it comes to the same thing as the above “regular” devaluation. And just like regular devaluation, there isn't a big effect on living standards in the relevant country in that the above mentioned wages and profits are themselves a big constituent in the cost of goods and services consumed in the relevant country.
Unfortunately the only really effective way of cutting those wages and profits is to cut aggregate demand in the relevant country: i.e. have a period of deficient demand, and that means excess unemployment – possibly lasting for many years.
And that is a HUGE DEFECT in common currencies. That’s the basic problem.
Moreover, there is no absolute guarantee that regular devaluation or internal devaluation will work. If the elasticity of supply and demand for a country’s exports and imports are sufficiently low, neither form of devaluation will work. Indeed Wynne Godley claimed that that was the case for the UK about twenty years ago. And if neither form of devaluation works, the only remaining solution is mass emigration from the relevant country, and that to a significant extent has been the solution for Greece for many decades. And if emigration goes on for long enough, obviously the country just becomes an area that specialises in “extensive agriculture”: that is (like agriculturally unproductive areas of Australia) where large amounts of land are used in combination with few other in puts like labour or machinery or fertiliser.
A popular alleged solution for Greece is debt forgiveness or a debt jubilee. Unfortunately that simply kicks the can down the road. It completely fails to deal with the above competitiveness problem.
In contrast to the above fatuous non-solutions, one possibly realistic solution recently suggested by Simon Wren-Lewis (Oxford professor of economics) is to organise a MODERATE increase in unemployment in uncompetitive countries, rather than the sort of catastrophic levels of unemployment we currently see in Greece. As Wren-Lewis points out, it is possible that the fall in wages, profits and prices in the problem country would be almost as fast as where the unemployment level is in the “catastrophic” range.
But the disadvantage there is that an increase in demand is involved which means the country draws in more imports which means it goes further into debt .
My proposed solution.
Another solution which I suggested long ago is as follows.
As pointed out above, regular devaluation can take place overnight, whereas internal devaluation involves years of pain. However, IN THEORY it would be possible to organise a more or less overnight internal devaluation. One would have to get almost everyone in the relevant country (wage earners, entrepreneurs, pensioners, etc) to agree the same percentage cut in pay.
In a country with a high degree of social cohesion, a country where everyone trusted everyone else, a country where everyone behaved responsibly, that would work. But unfortunately that’s not Greece. Greece is more in the nature of a country where everyone tries to cheat everyone else. E.g. the scale of tax avoidance by the elite as well as by doctors, lawyers and taxi drives exceeds by a big margin the tax avoidance that takes place in other countries.