Thursday, 9 July 2015

Does Mark Blyth understand austerity?

Blyth is the author of a book on austerity (cover pictured above). He currently teaches at Brown University, Providence, Rhode Island. But seems his grasp of austerity leaves something to be desired to judge by this article of his.

His first mistake is the claim that improving the competitiveness of less successful countries in the Eurozone is zero sum game. That’s in the following passage (quoted in full, in italics).

“European reforms take the more subtle cover of simply asking everyone to become “more competitive” — and who could be against that? Until one remembers that being competitive against each other’s main trading partners in the same currency union generates a “moving average” problem of continental proportions.

It is statistically absurd to all become more competitive. It’s like everyone trying to be above average. It sounds like a good idea until we think about the intelligence of the children in a classroom. By definition, someone has to be the “not bright” one, even in a class of geniuses.”

Actually improving the competitiveness of less successful countries serves a very useful purpose (which is not to suggest the Euro is on balance necessarily a good idea). The useful purpose is thus.

Incidentally some readers may find the following explanation boring and elementary. All I can say is sorry – but apparently it is necessary to spell out some very basic economics.

Anyway… if an EZ country loses a significant amount of competitiveness, it ends up with an external deficit and runs into debt, assuming constant aggregate demand within the relevant country. Clearly that’s not sustainable.

A solution is to cut demand. But that raises unemployment or if you like brings “austerity”, which is not ideal either. However, that austerity does have a merit: it tends to result in prices and wages in relevant countries falling, which ultimately should mean they become more competitive, hence demand can be raised again, and full employment restored. That’s sometimes called “internal devaluation”.

Now that’s not, as Blyth claims, a “zero sum” outcome is it? That is, internal devaluation, for all its faults, solves the external deficit and debt problem.

Incidentally, that’s not to say that devaluation, regular devaluation or internal devaluation necessarily works too well in Greece. To judge by the third and last chart in this Bruegel article, Greece seems to be an oddball. But with other countries, it should work.

As to EZ core countries like Germany, i.e. the countries that never lost competitiveness, they can maintain full employment throughout the above internal devaluation process.

Austerity per se is wrong.

As to any idea that my above rebuttal of Blyth’s argument is flawed because austerity per se is wrong, that doesn’t stand inspection: peridic bouts of austerity for various countries is an INHERENT characteristic of common currency areas. And if you think that that proves common currency areas should be disposed of, you might be jumping out of the frying pan into the fire: that is, there is plenty of argument about whether Grexit really would benefit Greece, and more generally about whether the Euro is a good or bad idea.

German reunification.

Next, Blyth claims that the unification of East and West Germany gave West German firms a plentiful supply of cheap labour which enabled those firms to keep costs down, whereas other EZ countries did not enjoy that advantage, thus austerity won’t solve the problem of excessive Germany competitiveness. Well the flaw in that argument is that other Western countries over the last twenty years or so, both in and outside Europe have taken advantage of globalisation to much the same extent as former West Germany: that is they have out-sourced production to less developed countries.

And that similarity between former West Germany and other developed countries shows up in the inflation rate of Germany and other countries. That is while Germany’s averge rate of inflation over the last ten or fifteen years has been on the low side (a bit below the 2% target) it has not been not MILES below inflation in several other developed countries.

Moreover, that cheap labour available from former East Germany and indeed the rest of Eastern Europe in no way stopped the Germans implementing a bit more stimulus over the last ten or fifteen years so as to cut their unemployment a bit and raise inflation to the 2% target. I.e. Germans should have gone SOME WAY towards being Greeks, but obviously not a long way in that direction.

Thus Blyth’s points about cheap East European labour does not stand inspection.


  1. We are struggling a little with the meaning with the word "Austerity"?

    Are we describing an economy that produces more than it consumes at current prices? Such an economy would be the victim of "Austerity".

    1. I was assuming austerity is where GDP is lower than the level at which inflation becomes unacceptable: NAIRU if you like. As the possibility of an economy producing more than it consumes, that happens where a country has a balance payments or "external" surplus. But a country's external position is bound to gyrate between deficit and surplus: i.e. it's impossible to keep it in exact balance all the time.

    2. Your assumption surprised me. That said, I didn't have an expected answer, but non-the-less, a surprise answer.

      I will ponder the implications, particularly in view of the Greek-euro situation.



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