The Eurozone crisis as a balance of payments crisis – one possible solution
Martin Wolf’s column in today’s FT is, as usual, a must-read.
He clearly and convincingly explains how the current crisis in the Eurozone is, at root, a balance of payments crisis. Looking at public debts or deficits between 1999 and 2007 would have failed to identify the countries currently afflicted whilst looking at current account deficits would have revealed the ‘at-risk’ nations to be Estonia, Portugal, Greece, Spain, Ireland and Italy.
As Wolf concludes:
This is, at its bottom, a balance of payments crisis. Resolving payments crises inside a large, closed economy requires huge adjustments, on both sides. That is truth. All else is commentary.
Austerity won’t resolve the fundamental issues – in the medium term it is simply killing growth, causing unnecessary suffering for the people of the ‘periphery’ and failing to deal with the fiscal deficits.
Meanwhile default risks inflicting catastrophic losses of the European banking sector and further damaging the Eurozone’s economic prospects.
If we are truly dealing with a balance of payments crisis then the resolution has to involve the deficit currencies moving towards balance by boosting exports and reducing imports, something which could be achieved through leaving the Euro and devaluing. However the consequences of a country leaving the Euro are also potentially catastrophic. Hence the current focus of ‘internal devaluation’ – using austerity to push down wages and costs in order to regain competitiveness.
I think this is, in most cases, highly unlikely to work and, even it does succeed, will result in much higher unemployment and lower living standards for the afflicted countries. I remain unconvinced that any democracy could go through this process in the medium term.
So, if the Eurozone periphery faces a balance of payments crisis but can’t externally devalue (by leaving the Euro) and if internal devaluation is unworkable is there a third option?
There might be – artificial devaluation. By imposing a duty on imports and equal subsidy to exports a country can, in effect, devalue its currency without leaving the Eurozone. A, say, 15% surcharge on imports and a 15% subsidy to exports in Greece would be effectively a 15% devaluation in the currency.
As these countries run deficits it would, at first, be fiscally beneficial as the surcharge on imports outweighed the costs of subsidised exports.
This isn’t painless – it would, for a start, raise domestic inflation as the price of imports increased – but none of the current options are pain free. Equally this isn’t a panacea. Support would still be required from the ECB for bond markets and banks would still need recapitalising (possibly something best done at a European level) but I think it is at least worth consideration as a an option on the table.
The idea of (even temporary) duties and tariffs runs counter to the Single Market and would face strong objections from many European policy makers but given the alternatives I don’t think it should be ruled out.