Italian version posted on October 27
When the great ones speak, the not-as-great had better think seriously before entering the arena. Myself, I believe i have been silent long enough after reading Joseph Stiglitz The Euro and its threat to the future of Europe. Allen Lane, Penguin Random House, 2016. I began discussing some of the book’s ideas in my Not the Euro Threatens Europe, but the National Governments, posted on October 21 (English version; Italian version posted on September 22). In that piece I was clearly putting some distance between Stiglitz’s positions and mine: the difference between the two titles speaks volumes.
Today I want to argue in favor of my positions further by moving on to consider Stiglitz’s claim according to which a member state of the Economic and Monetary Union, also denominated (derogatorily, I think) ‘the Euro Area’, can rid itself and its citizenry of the deadly constraints imposed by the Euro simply ‘exiting the Euro’, whether going alone or joining up with other likely-minded states. Here is my thesis: it would be the end of that country. Where by ‘end’ I do not mean ‘simply’ the end of that country’s economy: rather, I refer to the end of the country itself. Others have studied the effects of such a move through quantitative estimations. That job having been done, and considering it totally irrelevant in our instance, I will simply ‘talk’ about the scenarios that such move would open up. Indeed, I believe that the effects of exiting would be so catastrophic that no quantitative issue can actually arise, because assuming that quantitative effects are measurable amounts to assuming continuity between the ‘before the exit’ and the ‘after the exit’ scenarios. A continuity that I flatly deny exists. And since Stiglitz often refer to Greece in his excellent book, I also will refer to the ‘Greek case’, albeit less than Greece deserves. But I will get to that later.
The question to address initially is rather obvious: what, exactly, is the reason why a member country may wish to ‘exit the Euro’? The anti-Euro (and anti-EU) ‘literature’ is unanimously supporting the view that the EMU is not an Optinal Currency Area. Which seems to imply that a country that is a member of a NON OCA finds itself abiding to the discipline imposed by the common currency in a way similar to that binding the economy of a country operating in a regime of irrevocably fixed exchange rates. It follows from such line of reasoning that the country at hand will never be able to use competitive devalutation policies to compensate for the loss of international price competitiveness due to the negative productivity differential plaguing it relative to other member countries. Given the unavailability of such option, the only alternative would be wage deflations: that is, deteriorating working conditions and real wage contraction down to level unimaginable just ten years ago. The logici s not difficult to follow: let us cut labor costs to the point where we can match the loss of productivity and reaffirm a, hear hear, global competitiveness that productivity denies us. Finally, we may conclude that the logic of the would-be exiters is to exit the Euro exactly to circumvent wage deflation and act, thereby, on competitive devaluations. It may seem difficult, buti t is not. Two costly solutions, wage deflation and exiting the Euro. Apparently comparable. But they are not.
Let us concentrate on the exit strategy as an alternative to wage deflation, that is, increasingly more humiliating conditions on the labor market and falling labor reward. Mind you, it is a noble act to look for alternatives to wage deflation. The probem is: what is the cost of exiting? Is it comparable to that of wage deflations? Those who know me know that I find wage deflation hateful and unjust, and those who do not know me should have understood it already by my choice of adjectives. I also have no problem saying that the only proper way our of wage deflation is increasing producitvity, which is the true reason for the loss of international competitiveness. Now, if somobody does not see, or does not want to see, the role of productivity in all this, and ignore it altogether, honesty still demands that we ask the relevant quesiton: is the cost of exiting bearable? That is, is it comparable to wage deflation both in quantitative and qualitative terms? More: is it a strategy potentially able to lead the exiting country to the promised land that, freed of the Euro, will deliver freedom and opportunity?
There are two ways to attacking the exiting hypothesis: one, which is purely theretical, though supported by abundant empirical testing results, claims that foreign demand of domestic goods is NOT nearly as elastic as it used to be in the good, old times. It follows that a post-exit competitive devaluation (of what, by the way?) would not supply the exiting economy with that positive shock that exiters dream of. In other words: do you want exit to enjoy the freedom to devalue, and yet you do not know that such a move would mostly generate domestic inflations while leaving the level of exports largely unaffected? The second line of attack to the exiters is reacher in argument and approach: it includes the first, just described, but it also rests on the working of mechanisms more complex and more powerful that the simple ‘price elasticity of demand for exports’. I christen this second explantions ‘the end of the world theory’.
Thesis 1. Competitive devaluations stimulate domestic inflation much more than they stimulate foreign demand for ‘domestic’ good
Those who do research on the issues we are discussing know well, and if they do not they’d be better off studying more and better, that the contemporary structure of production processes and their localization possess a feature that we call international fragmentation of production. It is such feature which has changed, and keeps changing every day, the nature and the impact that an exchange rate change can actually exert on international price competitiveness of the devaluing country. To help exiters understand: when a good, or a service, is produced entirely in one country without recourse to imported intermediate inputs, then a devalutation of the currency of country where that good, or service, is produced may generate, under certain conditions and certainly not always, an effect of the foreign currency price of that good. But let us now assume that we are living in the XXI Century, or even in the fourth part of the XX, when hitherto domestically integrated production processes underwent a process of dismembering which consisted in fragmenting the production process itself and then allocating those fragments to productive units located in other countries. Why was that? Certainly, as most Italians like to think, to take advantage of lower labor costs, which is a stupid thing to say if one does nor weigh those lower labor costs wil the local producitivty; or, as many think elsewhere, fragmentation was taking hold because of the opportunity to recruite better competences and skills than available at home, local conditions leading to higher productivity and/or better quality. All that, of course, as a way to also penertrate foreign markets under the benevolent eye of the foreign government and local subcontractors. It is then easy to see that when the global production process takes on such form, a devaluation of the domestic currency may generate some price competitiveness on the export side, but it will certainly weigh negatively, that is, in an anti-competiveness manner, on the costs of foreign-produced, and imported, goods and service, included those intermediate products and components that have became the preponderant part of international trade. And that negative effect does not exclude the cost of foreign labor, of course, unless it is paid in the currency of the devaluing country. Ergo, stop dreaming, if you are dreamers; and stop spreading lies, if you know what I have been saying but lie to protect your private interest.
Thesis 2. The end of the world
Let us now suppose that the government of the country wishing to exit were able to keep mum about its intentions all the way to the chosen moment for the public announcement (please do not forget that the probability of that is extremely low, that being a government who could not even recognize the true sorce of wage deflation, that is, falling producitivity!); suppose further that the same government had identified the new unit of account and means of estinguishing debts, public and private (I do not understand why, when talking about this issue, exiters always use expressions such us ‘return to the lira’ o ‘return to the dracma’, depending of where they are airing their absurdities from. I suspect thay do it simply because of the psycologically reassuring power of whatever is past); imagine that the government were able to resurrect its own central bank as a policy authority, that is, as a ruler on monetary policy and not just as a printing press; that it were able to organize the banking system and the domestic system of payments, etc. Well, what happens at the precise instant of the announcement?
Let me clear the table of a false problem: whether the exit will be ‘friendly’ or not, whether it will be just one country to exit or a coalition of them, makes no difference whatsoever with respect to the only thing that matters: the new scenario that will unfold, and that for a rather obvious reason: tl will be financial markets to decide what scenario will prevail, not governments, neither the exiters nor the remainers. In the instants following the announcement mutual fund managers, treasurers, pension fund managers, banks and financial intermediaries throught the world would immediately stop buying debt issued by the exiter government and, for good measure, would start shorting it. To be sure, they would also start the process of recalling their credits towards that country: which are, of course, denominated either in Us Dollar or Euro –those Euro the exiter government no longer has access to.
Financing of public debt and government deficit will then necessarily be a residents’ problem. Who, not being particularIy stupid, will have catched the drift of years of discussions about better- in vs. better-out, and will have kept a sensible amount of their wealth in an extremely liquid form –call it Euro denominated cash.. Meanwhile, debts contracted by residents with foreign counterparts will have to be repaid in Euro, simply because nobody will accept waste paper, whether new or old denomination: not governments, not banks, not firms. Energy producers, oil producers among them, will want to be paid in Dollars or in Euro. Which, as always, the exiting country will have to amass through the only two ways available: either borrowing them, or through excesses of exports over imports. And now ask: who, exactly, form the rest of the world would lend to firms, central and local governments, residents of a country whose government has declared that it wants to devalue?? Nobody. For good measure, those in control of the distribution channels and, especially, food, will be careful not to price their goods in the ‘old’ currency, or a new one for that matter, since waste paper they are: it so happens that residents will start making use of their saved Euro, and a beautiful, wholly new black-market experience will be born………
But I am realizing just now that about this mechanism I wrote already, and perhaps better than I am doing now, in a piece posted on 25 February 2015, La Grecia deve uscire dall’Euro, svalutare e poi rientrare. E perché? E per chi? when the Greeks began their fierce resistance against ‘being exited’. They, the Greek people and their Government (or at least the less vocal majority of it), had seen the full scenario unfolding, and out they did not want. Paid, and still paying blood for it. Of course. But that someboly counld imagine to harm themselves without the Troika forcing them to, really!
Conclusion? I can only state my thesis again: it is not by ‘returning’ to each nation-state authority on their currency and their monetary policy that we will see the European Union progress and prosper, or wage deflation end. Rather, we need to transfer fiscal authority from national governments to the EMU/UE, thereby giving the Union what national governments have originally given financial market. For the exiter(s),’ exiting the Euro’ is tantamont to ‘the end of the world’.