It almost seems quaint already to talk about the European “debt crisis” as sharp commenters are moving onto a deeper realisation, that the problem in Europe is not about debt, but rather trade, or more specifically trade imbalances.
In a post at the NYT Economix blog, Simon Johnson hits the nail on the head here, explaining that when Mexico got bailed out in the mid-90s, its economy was able to rebound via a devaluation of the peso. This led to more competitive exports, which led to a trade surplus.
Important parts of the euro zone, like Portugal, Greece and perhaps Italy, badly need a reduction in their real costs of production. If their currencies were independent, this could be achieved by a depreciation of their market value. But this is not an option within the euro zone, and it is within the zone that they need to become more competitive.
These countries could cut nominal wages — a course of action being pursued, for example, in Latvia. But Latvia is a special case for many reasons, including its desire to become much closer with the euro zone, which it aspires to join. It is unlikely that any Western European government making such a proposal would last long.
Unable to move the exchange rate and unwilling to cut wages, the Portuguese government is embarked on an innovative course of “fiscal devaluation,” meaning it will cut payroll taxes, to reduce the cost of labour, while increasing the value added tax, or VAT (a tax on consumption), as a way to maintain fiscal revenues.
And this inability to devalue isn’t just an impediment to a PIIGS recovery. It’s fundamental to what caused the crisis in the first place.
Kash Mansouri (via Krugman) recently posted this very useful table showing the big current account deficits racked up by the PIIGS nations from 2000 to 2007. The worst five countries from a current acount perspective were exactly the PIIGS: Portugal, Greece, Spain, Ireland, and Italy.
Photo: Street Light Blog
Given that a negative current account balance is a negative for growth, it’s obvious that these countries had to fill the gap with deficit spending, because in the absence of natural trade adjustments, there was no other way to keep growth up.
All of this is a good reminder about the absurdify of German or Finnish anger at the bailouts: For years they’ve enjoyed big trade surpluses with their neighbours, allowing them to grow without racking up huge debts. Now of course they’re furious at the idea of money going in the other direction.
Ultimately, any “deal” that just addresses the acute financial crisis without getting at this issue is going to fail pretty soon.
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