Calmfors Driffill revisited

Everyone agrees that the Irish economy needs to restore competitiveness. Absent the possibility of devaluation, this either requires freezing nominal wages, and letting inflation erode their real value; or reducing nominal wages. The former course of action seems insufficient, since it will take too long, and we may even be heading for deflation.

So, the old Calmford Driffill literature from the 1980s may be relevant. (I couldn’t find their 1988 Economic Policy article online, but a survey article is here.)

Remember the basic point: if labour markets are very competitive, then wages will fall by themselves. If there are strong sectoral unions, on the other hand, then they may all play a game of ‘after you, my dear Alphonse’, and wages may not be cut. In that case, moving to central bargaining can help in coordinating wage cuts, in that no-one feels that they are falling behind in relative terms. Some would say that the introduction of social partnership in the late 1980s is a good illustration of that mechanism in practice. (OK, it involved wage restraint, not wage cuts, but that was useful in itself at the time, especially in the context of devaluation.)

The question for you all is: how flexible are private sector labour markets in Ireland today? We have all read about particular firms cutting wages, but how common is that? Are there studies on this? Will private sector wages fall sufficiently on their own, or is there a role for government coordination here?

Tax increases are inevitable: discuss

Garrett had an article in the Irish Times on Saturday which I thought made an important point: the scale of the deficit is so large, that to claim it can be fixed by expenditure cuts alone is inherently implausible. (Although a pay cut for people like us would certainly help.) Presumably (?) the government understands this, and doesn’t really mean it when it claims there will be no more tax rises.

So: what tax increases will do the least damage to the economy? Like expenditure cuts, all tax hikes will obviously drive the economy further into recession, but given that we have no choice here, the question as to what is the least-worst strategy seems worth posing.

Free riding

Nice article in the Irish Times today by Jim O’Leary. I particularly liked the following unusually honest section:

The case for borrowing more to fund an attempted stimulus package would be more difficult to rebut if there was a high probability of it being successful, but fiscal stimulus is notoriously difficult to effect in a very open economy like Ireland. The reason is that a high proportion of any increase in demand leaks out through imports.

From our point of view, the best sort of stimulus package are those put in place by our trading partners since these boost demand for our exports without costing us anything. And here, the good news is that most of our main trading partners have announced reflationary fiscal measures of one sort or another in recent weeks/months. What we need to do is ensure that we are well-positioned to avail of the opportunities that will flow from these and what that means, first and foremost, is reducing our production costs to competitive levels.

It is hard to disagree with the logic. If the amazingly profligate government we have had over the past decade had listened to people like JOL on issues like benchmarking, then we might have tried to pull our weight as part of a Europe-wide reflationary package, but as things stand, we are going to have try to free ride. Not very glorious (and rebalancing the books will obviously make a bad recession worse) but there you are.

But let’s hope that too many others don’t also take a similar view! The thing about free riding is that what is individually rational can be collectively disastrous. Dani Rodrik is gloomy here.