From the TUC

The Eurozone crisis as a balance of payments crisis – one possible solution

07 Dec 2011, by Guest in Economics

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.

13 Responses to The Eurozone crisis as a balance of payments crisis – one possible solution

  1. Tony Morgan
    Dec 7th 2011, 2:57 pm

    “15% surcharge on imports and a 15% subsidy to imports”, I think you mean, “subsidy to exports” ;)

  2. Duncan Weldon

    Duncan Weldon
    Dec 7th 2011, 3:55 pm

    Amended! Thanks.

  3. Shane
    Dec 7th 2011, 7:47 pm

    Very interesting. Such a plan could just as usefully be applied here in Ireland.

    Are internal tariffs illegal under the single market?

    Would ramping up inflation in the core perform the same task?

  4. George Irvin
    Dec 8th 2011, 5:36 pm

    I agree that it’s a BoP crisis. I also agree that austerity won’t solve it—although in principle it *is* possible to reduce absorption by an amount large anough to balance the CA. Lots of people may starve in the process though.

  5. Falco
    Dec 11th 2011, 10:49 am

    So as I understand it your solution to saving the EU, Euro and the common market is to completely destroy said common market making the EU and therefore the Euro entirely pointless. You weren’t in charge of certain actions in Vietnam by any chance?

    Oh and the above is before getting onto the utter insanity of thinking that trade barriers will increase prosperity.

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  9. Frances Coppola
    Dec 22nd 2011, 2:02 pm

    Trade tariffs are illegal under EU law, I think. Even if they weren’t you can bet the Germans and Dutch would think of some reason why they should be, because they would stand to lose. Which is the point, really – all measures to sort out the trade and fiscal imbalances in the Eurozone must involve surplus countries giving up their surpluses. Understandably, they don’t want to. So far Germany has blocked every suggestion that might have meant reduction in their surpluses. I can’t work out if they are really so economically illiterate that they don’t realise that they can only keep their surpluses if the deficit countries remain in deficit, or whether they are cannily trying to hang on long enough to build up their external exports so they don’t take quite so hard a hit when their exports to the Eurozone deficit countries collapse.

  10. Chris
    Dec 22nd 2011, 2:53 pm

    This is a joke right? Putting aside the utter insanity of erecting trade barriers – are you not familiar, a little, with the economic history of Britain?

    Devaluation does not work. It has never worked and the British have spent a century proving it again and again and again. The Greeks do not need to devalue. Nor does anyone else.

  11. Duncan Weldon

    Duncan Weldon
    Dec 22nd 2011, 3:33 pm

    They are illegal as part of the internal market.

    The question would be is Europe preapred to suspend the single market (for a time) in order to save the Euro (and possibly the EU).

    Agree on the woder adjustment point.

  12. Duncan Weldon

    Duncan Weldon
    Dec 22nd 2011, 3:37 pm

    Not a joke at all Chris.

    Tariffs, in some circumstances, make sense. I think most economists would recognise this. Dani Rodrik is worth a read on this point:

    In my book The Globalization Paradox, I contemplate the following thought experiment. Let a journalist call an economics professor for his view on whether free trade with country X or Y is a good idea. We can be fairly certain that the economist, like the vast majority of the profession, will be enthusiastic in his support of free trade.

    Now let the reporter go undercover as a student in the professor’s advanced graduate seminar on international trade theory. Let him pose the same question: Is free trade good? I doubt that the answer will come as quickly and be as succinct this time around. In fact, the professor is likely to be stymied by the question. “What do you mean by ‘good?’” he will ask. “And good for whom?”

    The professor would then launch into a long and tortured exegesis that will ultimately culminate in a heavily hedged statement: “So if the long list of conditions I have just described are satisfied, and assuming we can tax the beneficiaries to compensate the losers, freer trade has the potential to increase everyone’s well-being.” If he were in an expansive mood, the professor might add that the effect of free trade on an economy’s growth rate is not clear, either, and depends on an altogether different set of requirements.

    A direct, unqualified assertion about the benefits of free trade has now been transformed into a statement adorned by all kinds of ifs and buts. Oddly, the knowledge that the professor willingly imparts with great pride to his advanced students is deemed to be inappropriate (or dangerous) for the general public.

    Devaluation surely does work, again, in certain cases. Greece has to regain competiveness – I don;t think it is politically possible for this to be done through a policy of deflation. Do you?

  13. Chris
    Dec 22nd 2011, 5:05 pm

    It is a policy of deflation. By devaluing you cut the value of everything everyone owns, everything they get paid and everything they pay and you hope they won’t notice. The cost of imports goes up, everyone realises they’ve been had and you get inflation.

    Devaluation really doesn’t work and it’s been tried enough time to prove that. Remember Harold Wilson’s ‘pound in your pocket’? – it was a disaster.

    From a British point of view one of the great arguments for the euro is that it stops the idiots in charge debasing the currency.