Paul Krugman’s article in today’s NYT describes his perspective on the European situation. His main focus is on thedifficulty in European-level policy coordination, in view of the current institutional configuration. However, he also flags the adjustment difficulties facing Spain (largely similar to those facing Ireland):
“In the past, Spain would have sought improved competitiveness by devaluing its currency. But now it’s on the euro — and the only way forward seems to be a grinding process of wage cuts. This process would have been difficult in the best of times; it will be almost inconceivably painful if, as seems all too likely, the European economy as a whole is depressed and tending toward deflation for years to come.”
It is interesting to note that Krugman accepts the thesis that wage cuts are required as part of regional adjustment within the euro area (indeed, he has signalled this on his blog in the past). For Ireland, the level of pain may be lower than in Spain, in view of the relative flexibility in the labour market and the potential for the social partners to contribute a pain-reducing level of coordination to the wage adjustment process as part of an overall reform package. However, a slow rate of adjustment will lead to a prolonged period of high unemployment. In addition, the slower the rate of economic recovery, the worse will be the fiscal situation.