Stiglitz on Internal Devaluation

Today’s Irish Times carries an interview with Joseph Stligitz.  A striking element is his advocacy of a uniform cut in wages and prices (the internal devaluation option), as the substitute for the nominal devaluation strategy that has been pursued by several countries with independent currencies.  He also highlights the importance of fairness in pursuing this option. While he does not describe in detail how this can be achieved, my own work has advocated a twin-track strategy:   wage reductions, coupled with more vigorous pro-competition policies to ensure that wage cuts are not simply absorbed into higher markups.

17 replies on “Stiglitz on Internal Devaluation”

It’s very good to see Stiglitz yet again being extremely forthright in his criticisms of the government’s cash for trash scheme. And even better to see him placing both this, and the issue of internal devaluation, into a common political framework centered on the critical issue of fairness.

Achieving an internal devaluation, which I agree would be very helpful, is clearly as much a political challenge as an economic one. It is less likely to occur smoothly in a context where workers feel that they are being screwed, as he puts it, while investors in banks are being bailed out. Nor will it be any easier for the government to convince people to accept budget cuts and tax increases, which I also accept are necessary, when it is wasting money in this manner.

The costs of overpaying for junky assets are thus likely to far exceed the headline costs that have been debated on this website and elsewhere, as a result of their effects on the political economy of the state.

The was a study recently about the effects of deflation (of prices and wages in a country) versus currency devaluation (externally imposed inflation) on government finances. Over the short term, devaluation was preferable, but over the medium term governments paid more for debt for longer even after the adjustment period was long gone.

Can’t find the study now, of course. Anyone?

Psychology vs economics. Devalue prices and my mortgage first and I’ll devalue my wages. If wages are devalued first, we will all just get screwed. This is rip-off Ireland, after all.

How much does this chap, Stiglitz, actually know about the Irish economy?

How much time does he spend studying Irish economic statistics?

I’d hazard a guess for both questions: very little.

According to the Irish Times Report:

In an interview with The Irish Times , he said one of the most successful countries in dealing with the current global crisis was Iceland, because it hadn’t invested taxpayers’ money in its banks in the way Ireland is doing, and could devalue its currency.

Devaluation and the banking collapse had given room to other sectors of the Icelandic economy, crowded out during the boom, to revive. Ireland cannot devalue as it is in the euro zone and the Government has, as an alternative, proposed that wage cuts could contribute to a restoration of international competitiveness.

So, Stiglitz is effectively saying that Iceland is pulling out of the recession faster than Ireland (and, indeed, faster than almost any other country) because its not in the Euro and can devalue, and because it has acted differently in regard to its banks.

But, is it?

I’m always suspicious when economists make claims that support their pre-conceived opinions, but don’t back it up with any statistics.

So, just for the record, here are the figures for the changes in GDP in Ireland and Iceland in the first two quarters of 2009 (i.e. the first two quarters since the financial crisis broke last autumn).

1st quarter of 2009:

Ireland GDP: -2.3%
Iceland GDP: -5.9%

2nd quarter of 2009:

Ireland GDP: -0.0%
Iceland GDP: -2.0%

Nice chatty article, but: para #17: ‘The Government (aka FF party) has identified three huge difficulties it needs to address … …

1. Fix banks so they can lend: This is not going to happen. The mathematics is firmly in the red zone on this one.

2. Fix the public finances: Cut, cut, cut and we’ll all be saved. Ideological, religious claptrap. Not a chance. Would drive economy into a tail-spin. Soup kitchens would make a comeback.

3. Restoring competitiveness: Can’t be done, unless you have the same social, environmental and business costs as your competitors, that is, (Chindia + East Asia) and their ruthless and complete disregard for all except themselves. Slap a huge impost on everything coming from these places and I mean everything. They won’t like it – well tough. Its us or them now.

I said this before: we are in a transition paradigm, from Smithian Permagrowth to Permashrink (thanks Pat!). The Good Old Days are over. Our contemporary financial model is a parallel of our fossil-fuel based economic development and expansion. The financial part used virtual credit and leverage to expand geometrically (it can continue to infinity if you can crowd enough zeros onto the banknotes).

However, the parallel physical part cannot expand in an exponential manner, so it inflects – as it is now doing, albeit in slow-motion. !!!mooB

Malthus was correct. Just a bit previous by 250 yrs or so.

Brian P

I fully agree with the twin-track strategy, but I fear that implementing more vigorous pro-competition policies will take time and may not be very effective. The Competition Authority, unlike DG COMP which has powers to investigate, prosecute and impose swingeing fines, has to go through the courts to prosecute miscreants who, if the prosecution is successful, end up paying puny fines. Even if the powers of the CA are enhanced it will take time and, even then, due process will have to be observed. There is a requirement to bring costs and prices down quickly.

As Another JohnM points out, this is a classic sequencing problem. Workers won’t accept pay cuts until they see solid evidence that prices and costs are falling and will fall. In a number of sectors such as health, education and where the semi-states dominate – and the costs of the services provided impact disproportionately on the budgets of low and middle income households – the state has direct or indirect control of pricing. The Government could direct significant cuts in the prices of these services immediately.

The financial fall-out – and the bruised egos of sector regulators – could be managed over time. And the general fall in costs and prices – and accompanying reductions in payroll costs – would help the management of the financial fall-out.

@ john

For once I agree with you. The Irish commertariat has a great tendency to latch on to the words of any high profile econo-celebrity who lands here, collects a cheque or an honory doc and then departs. Now if he was from Scandinavia, he would be carried through the streets on an open car, pulled by 46 academic economists with rose petals strewn in his path.

“So, Stiglitz is effectively saying that Iceland is pulling out of the recession faster than Ireland (and, indeed, faster than almost any other country) because its not in the Euro and can devalue, and because it has acted differently in regard to its banks.”

The Foreign Minister of Iceland wrote in the letter page of the FT yesterday that the IMF had failed/refused to complete its review due last Feb. in order to release agreed funding to Iceland. Apparently only the Faroe Islands has provided cash.
If the Foreign Minister of a Sovereign State is reduced to pleading his case in a letter to the FT, then I doubt that they are progressing as attributrd.

@podubhlain “The Foreign Minister of Iceland wrote in the letter page of the FT yesterday ….. “.

I didn’t get around to reading the FT yesterday. I am shocked that any Minister of a Sovereign State should need to resort to that. What the hell are the IMF up to?

@ Joseph

basically IMF said that nothing can proceed until the negotiations between Iceland and UK/Netherlands are finished. YES, extreme example of systematic banking collapse (not scaremongering!), but it does show that some nations view banking collapses as quasi-soveriegn obligations. Should at least be taken into consideration before we repudiate some of our banking sector debts.

This thread is running the risk of being NAMAised. I’m sure Prof. Stiglitz, insofar as he may be aware of it, is scratching his head as to why the Irish state rushed in with a €400 bn bank guarantee to secure liquidity when the ECB would have shovelled in liquidity to protect the Euro if it had been asked.

I’m more interested in the key issue in the original post: how may the concept of ‘fairness’ – seen by Prof. Stiglitz as of central importance – be given substance in the context of an internal devaluation accompanied by a major fiscal adjustment.

My suggestion is state-directed costs and prices first, then public sector pay and SW rates accompanied by other BSN recommendations and followed by strengthening the CA’s powers and resources. The effects should be mutually reinforcing in terms of the internal devalution and fiscal adjustment.

When people say that the ideology of capitalism has been damaged it prompts me to consider that the lines became blurred between production and business services on the one hand and the legal framework and infrastructure which supports capitalism on the other hand. It is not that capitalism was wrong but rather that we lost control of the increasing complexity which technology and exponential growth allowed for. In the end we threw up our hands at the problems, reduced regulation and let the invisible hand do work it wasn’t suited for. The dynamic strengths of capitalism should remain if we can rescue it from the tsunami of adverse sentiment and the mangroves of financial engineering (so that’s a tsunami hitting us after we have got tangled up in the mangroves – try not to get confused by the malignant metaphors).

One ill effect of this cantamination of capitalist legal infrastructure by creative banking products is that we are left with unclear legal and economic relationships. The law of sentiment has stepped into the vacuum at the level of highly sophisticated commercial markets where the law of the land and its certainties would be more appropriate.

“YES, extreme example of systematic banking collapse”
Eoin, we could nationalise BOI and have a banking sytem, then make a deal with the AIB bondholders from a position of strength and have our whole banking system. We could give the senior bondholders a little trim
and the subordinates just a little bit less than the 30 cents you are happy to give them.

For Anglo and Nationwide though the situation is different. They were property companies which took deposits. All the bondholders knew this. They knew that a rampant property boom lasting more than a decade was raging in Ireland. Nothing for the subordinates let the seniors have Anglo & Nationwide.

“but it does show that some nations view banking collapses as quasi-soveriegn obligations.”

As was pointed out on a previous thread the Icelandic bondholders are getting shares. They are not being treated like our national debt. It is the deposits that Brown and the Dutch are – disgracefully – blackmailing Iceland over.

“Should at least be taken into consideration before we repudiate some of our banking sector debts.”

Once we revoke the guarantee, which was given before the public was told about the scale of our banks loan losses, the bondholders will revert to what they were before and should become again, liabilities for our banks.
“we” are not “repudiating” anything. These are bank bonds not national debt. For Anglo & Nationwide give the seniors the companies. For AIB & BOI give the subordinates as little as possible and the seniors equity.
Managed properly it will be a smooth process. Instead of the Nama millstone and two feeble banks we will have two strong shiny banks.
And no one around the planet will bat an eyelid or lose a night’s sleep. They will all welcome the elimination of the risk to our national finances, the rest will say that’s capitalism. And the Icelandic case shows that bondholders will settle for equity.

If some of the world’s huge number of investors are offended by our treatment of our bank bondholders so be it. We can fund our national debt from many, many others. In any event the average ones have already grasped the difference between our national debt and that of private banks.

You should look a little closer to your historical ideology – the tendency of capitalism is to move to financial oligopoly, control of the means of production through ‘capital’. Well, capital decided it could mate with other capital and multiply itself without the intermediation of production…

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