The Guardian Unlimited, March 25, 2010
As the EU summit meeting convenes, Greece is dominating the agenda much more than Germany’s Chancellor Angela Merkel had wanted. This week she has thrown cold water on the idea that Germany and other EU countries would take responsibility for helping Greece to roll over some of its debt, handing that job off to the IMF.
Greece had already proposed a set of draconian budget cuts and fiscal tightening, but it wasn’t good enough for the Germans. For Greece, turning to the IMF is not necessarily all that different – in fact, the European Commission could push for even harsher policies than the IMF, as it has done in Latvia – where the IMF/EC have presided over Latvia’s record downturn. Latvia has lost more than 25 percent of GDP since their recession began, making it the second largest cyclical downturn on record – and if IMF projections prove correct, it will soon pass the 1929-33 decline of the U.S. Great Depression.
The so-called PIIGS countries – Portugal, Ireland, Italy, Greece and Spain – have a problem very similar to that of Latvia, and unfortunately the authorities – local and European – are proposing the same solution. It is not clear that this solution – which consists mostly of budget cuts, tax increases and further shrinking of their economies – will work for these countries.
The problem is that they have a fixed – and for their level of productivity – overvalued currency. For the PIIGS countries, that is the euro. As many observers have noted, if these countries had their own national currencies, they could allow their currencies to depreciate. This would give their economies a boost by making their exports more competitive and reducing imports.
But this is only one part of the problem caused by their subordination to the euro. It is not just the impact of the euro on their trade that is crushing their economies. The more important part is that they are unable to use the expansionary fiscal and monetary policies that would help pull their economies out of recession – or worse, they are being forced to adopt “pro-cyclical” policies, as in the case of the budget cuts and tax increases being adopted in these countries.
All of the PIIGS countries have low or negative inflation. Therefore, if not for the euro and the rules governing the European Central Bank, they could adopt the kind of “quantitative easing” that the U.S. and UK have used – in other words, create money and use it to buy up your own government debt. This could help their economies recover and lower their long-term debt burden.
Instead, they are following a program of “internal devaluation” – shrinking their economies and increasing unemployment so as to lower wages and prices relative to their trading partners. If they can accomplish this, then the hope is that they can export their way out of the recession (with a boost from imports falling as well).
All of these economies shrank last year – Ireland led with a more than 7 percent decline. All of have them double-digit unemployment rates – Spain’s is now at 20 percent. The Greek economy fell by less than one percent last year but can be expected to do worse if it adopts the pro-cyclical policies now on the table.
The problem is that there is no way to see when there will be light at the end of the tunnel. Even if some of these economies return to growth next year, there could very easily be a long period of high unemployment and stagnation, especially if they follow a long-term program of cutting their budget deficits to the prescribed target of 3 percent of GDP by 2014.
And it is not clear that the path of austerity and pain will lead the PIIGS countries to a point where the structural problems – i.e. their inability to compete internationally with the euro as their currency – are resolved. This is especially true if they are forced to cut education and public investment that are necessary to raise their productivity to competitive levels. So they could end up in this situation again, perhaps after another spurt of growth driven by some combination of real estate bubbles, over-borrowing and an influx of foreign capital. (In some ways, this has been the problem of the United States, which has also had bubble-driven growth for the last two decades – first the stock market and then the housing bubble. One underlying cause of this phenomenon is that the U.S. has also had an overvalued currency that makes it uncompetitive in international markets).
Of course withdrawing from the euro has its own costs and risks. But if the alternative is an indefinite period of recession, high-unemployment and stagnation, it is something that is worth serious consideration.