Should The Ship Of State Abandon The Euro?

Irish economist, David McWilliams wrote and excellent article on Ireland’s options. Have a read below.

If the Irish Finance Minister is to be believed, we will be asked to take to the polls once again. The decision this time though will be to decide the economic fate of the Nation and choose to stay or leave the euro. To stay in means continued loss of sovereignty over our economic affairs, which will continue in the form of austerity budgets and continued attacks from the French and Germans over Ireland’s competitive corporate income tax rate. But what would the landscape look like if Ireland were to vote with her feet and elect to leave the euro? What does having ones own exchange rate mean for a debt beleaguered small nation such as ours, and what might having your own exchange rate allow you to do? How might this be a valuable alternative for Ireland.

For the moment, the core central mantra Irish economic policy is something called “internal devaluation”. It’s a concept and mantra backed by the “Troika” mechanics of it go something like this: Ireland needs to export its way out of the recession. But Ireland’s “running costs” and high wages mean that Ireland is uncompetitive. Since we’re tied to the euro, we don’t have an exchange rate that can fall. So the only other alternative is to slash at wages and drive them down over a period of years so that Irish industry can become competitive once again.

At the same time that we’re forcing down wages, we must also reduce government expenditure, because we can’t afford to pay for it. As the government deficit at the start of the IMF bailout programme was 14% of GNP and we need to get the deficit down to 3%, we will reduce spending by 11% of GNP over the next two or three years.

With government spending reduced so drastically, who then is left in the country to spend our way out of recession?

The answer to that question rests with us…the ordinary people. We are expected to spend and keep the local economy going. But we’re not. We’re worried (and rightfully so) about the future, so we are saving. Who is spending the missing 11% of our income which has just been taken out of the Irish economy? Now here is where our policy gets a bit overly optimistic, to say the least, because in order for our economy to stay just as it is, foreigners need to massively increase their buying up of Irish goods.

But why would they do this? Have Irish goods become so much cheaper or gained so much increased value in the last twelve months?

The theory of “internal devaluation” says that the Irish economy and workforce are so flexible that we will all take dramatic paycuts, this will drive down wages and we will become competitive this way. It can also be helped along with the mass exodus of emigration abroad in the search for work. Because we have no exchange rate and are members of the euro, we will devalue by cannibalising our own wages, or sons and daughters. But according to the governments present policy, even at these much lower wages we will be able to service the huge debts built up in the credit bubble. How is that even possible? Well frankly, it is not.

But before we explain why debt dynamics at lower wages makes servicing old debt impossible, let’s examine the first bit of the theory which says that Irish wages have fallen dramatically and will continue to do so. Let us examine the evidence that Irish workers — or any workers for that matter — accept reductions in their wages as the theory says.

Ireland and Latvia are in the euro (well, Latvia has a fixed exchange rate with the euro). We are both locked in austerity programmes, and we are supposed to be devaluing internally. Iceland on the other-hand has its own currency, the kroner.

Irish and Latvian wages have remained more or less the same since 2008 against our competitors. In contrast, Icelandic wages against its competitors have fallen dramatically. Iceland has become dramatically more competitive compared to Ireland and Latvia because it devalued its currency dramatically in 2008/09.

Iceland in one sharp devaluation swoop has achieved what Ireland and Latvia are supposed to achieve over years of eroding wages. If we are supposed to achieve Icelandic levels of wage competitiveness, we will have to shrink the economy over the next few years. By having their own currency the Icelandics did in a few weeks what we have been trying, unsuccessfully, to do over the past four years.

Having its own exchange rate allows a country to adjust quickly. Yes, living standards when measured in euro fall, but that has to happen in both the Irish and the Icelandic case. The question is how do you achieve this and are you giving your people a chance?

There is a reason why no economy in the world has ever emerged from a recession like ours without changing its exchange rate. The reason is that it simply can’t be done. There is no evidence anywhere, ever, that shows that a country can operate a successful “internal devaluation”, particularly an economy carrying as much debt as we have.

So if it can’t be done, what are we trying to do? And more to the point, what is the cost of this lunacy? Much is made of the “flexibility” of the Irish labour force. But the flexibility is not in wages but in levels of unemployment. The Irish labour market adjusts alright, but the adjustment comes not in falling wages but in rising unemployment and emigration. This is what we don’t want to happen, yet this is what the policy is leading to.

So those getting paid too much in Ireland still get paid too much, yet the people who feel the real cost of the “internal devaluation” are those who lose their jobs because rather than cut wages, employers cut staff.

When people are laid off, it is very difficult to get a new job because no one is spending in the economy. The government is not spending and the people are not spending. But what about the the much heralded export-led growth which postulates that foreigners will buy loads of Irish goods, more than compensating for the fall in domestic spending?

Well it doesn’t happen, partly because Irish wages haven’t fallen, so Irish goods are no more competitive than they were a few years ago. Yes, exports have risen, but nowhere near enough to offset the local contraction. This is why unemployment has trebled in three years and why emigration is running at over 1,000 people a week. It is not that the policy of internal devaluation is not working, it can’t work. It has never worked anywhere, ever.

Yet the really strange thing is that it is billed as being mainstream economic thinking. It is not mainstream economics, it is highly radical. What is mainstream and proven is the power of devaluations. Yet those recommending the course of action that mainstream economics tells us to do are labelled radicals.

Language will be very important in a referendum year and you will notice that the Irish and European economic establishment will deploy language to paint those who support the country returning to its own currency as extreme. The truth is that what is extreme is following a policy which has never worked anywhere and the cost of which is mass unemployment and mass emigration. Now that is truly radical.

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