Krugman: Nominal Wage Cuts Necessary but Difficult

Paul Krugman discusses the problem facing those EMU member countries that are currently suffering from a lack of competitiveness (note, by the way, his use of the word competitive!) and accepts that nominal wage reductions are a necessary part of the adjustment: you can read his discussion here.

He also links to a posting by Edward Hugh that probes the difficulties involved in engineering nominal wage reductions: you can read it here.

INSIDER LENDING, INSIDER BORROWING

How much the collapse of Anglo-Irish Bank was due to insider borrowing remains unclear.  There seems to be much more to it than that, and perhaps in the end Seanie Fitz—and other insiders, yet unnamed—will repay with interest the millions they owe the rest of us.

 

However, in the (happily few) sensational failures like Anglo’s in Irish banking history, secretive insider borrowing has been a big part of the story. 

 

The potential conflict of interest for bankers short of capital has long been obvious.  For this reason, eighteenth-century Irish banking legislation banned merchants engaged in foreign trade from being bankers.  The restriction, alas, led to undercapitalized banks.

 

Joint-stock banking met that problem, and produced the relatively stable banking system that lasted from 1825 to 2008.  However, there were some failures along the way, and it may be worth recalling that the two most famous stemmed from the abuse of insider borrowing privileges.

 

In early 1856 the Tipperary Bank collapsed when it was discovered that its leading light, John Sadleir M.P., had committed suicide on Hampstead Heath.  It soon emerged that he owed his own bank nearly £300,000 (something like €30 million in today’s money).

 

In 1885 it was the turn of the Munster Bank, laid low by the cronyism of a coterie of Cork merchants.  For an account of that episode see http://irserver.ucd.ie/dspace/bitstream/10197/441/3/ogradac_bookchap_pub_068.pdf. 

 

In the cases of the Tipperary and the Munster, unsuspecting but relatively well-heeled shareholders bore the brunt of the directors’ swindling.  Like Anglo shareholders last week, they protested loudly, but they certainly did not expect the government to bail them out.  In addition, the banks’ depositors were also badly burnt.

 

History says that insider lending may be work in highly unusual circumstances.  On this the classic work is Naomi Lamoureaux’s Insider Lending: Banks, Personal Connections, and Economic Development in Industrial New England (Cambridge, 1996).  But Lamoureaux’s yankee banks may be the exceptions that prove the rule.  In general insider lending is dangerous, and a bad deal for both customers and shareholders. 

 

 

Ireland and EMU

The Daily Telegraph gives prominence today to the recommendation by David McWilliams (made on RTE radio over the weekend) that Ireland should consider leaving the euro area: you can read the article here. The notion that Ireland or some other member country might leave the euro area is now a factor in the government bond market.

However, the adverse economic consequences of leaving the euro area are so large that this option should not be taken seriously. Barry Eichengreen has written a comprehensive paper on this topic, which you can download here.

The benign scenario described in the comments attributed to McWilliams in the Telegraph article envisages Ireland being able to use monetary independence to achieve real exchange rate depreciation in a stabilising fashion. However, a new Irish currency would be emphatically not trusted by the markets (a government that is willing to take the steps to exit the euro area is not a government that can be counted upon to keep its promises), such that either the new central bank would have to offer high interest rates or the government would have to impose capital controls. Neither is a recipe for a growth recovery.

Holding our nerve

At the time of writing, the Irish bank shares have fallen by about 50 per cent since last Friday’s closing price. The last time there was a one-day fall of comparable percentage size was at end-September, 2008 and it was immediately followed by the announcement of a blanket guarantee.

Let’s not have any knee-jerk reaction this time. The bank shares were already worth almost nothing, so there is scarcely any real impact of this price movement on the economy and on incentives.

Instead we need to have a process of confidence-building in the coherence and feasibility of the overall economic policy strategy for recovery. This must include a broad acceptance of the parameters of tax and spending policy, including on public sector pay. (Banking issues are only part of the equation and they will not be improved by sudden or half-baked initiatives.)

Previous posts have talked about public sector pay and restructuring the tax system. Getting a broad social consensus around an acceptable policy approach must surely be the priority. Here too, precipitate action will not be helpful. We need to know not only the government’s intentions; but that they will be seen as sufficiently effective and fair to elicit broad support rather than a general rejection and protest.