April 30, 2010


Leaving the euro behind? (Sebastian Mallaby, April 30, 2010, Washington Post)

The euro project can work only if its members are improbably virtuous. This is often thought to mean simply that governments must avoid borrowing too much: Countries that use the euro are supposed to keep budget deficits below 3 percent of gross domestic product -- not that they have done that. But the crisis has spotlighted a second temptation: Countries in the eurozone must prevent private companies from raising workers' pay too fast. Otherwise they can't compete against the cost-containing Germans.

Of these two temptations -- too much borrowing and too much pay -- the first is getting all the attention, but the second is most threatening to the euro. After all, a government that borrows too much can simply default. It can do that whether it is inside a currency union or outside it.

But a eurozone member that allows wages to rise unsustainably has no such easy exit. It cannot regain its competitiveness by the usual trick of devaluing its currency because it no longer has its own currency. It therefore must compete by pushing wages down, an extraordinarily unpopular recourse that is unlikely to succeed in a democracy. Offered a choice between this root-canal austerity and quitting the euro, there is little doubt about which option most voters would go for.

Moreover, even if workers could be persuaded to accept wage cuts, the medicine could well fail anyway. Uncompetitive countries run trade deficits: They buy more from other nations than they sell and pay for the difference by borrowing from foreigners. Now, what happens when an indebted country tries to become competitive by forcing wages down? Falling wages means deflation, and deflation increases the burden of those debts -- if you owe a bundle on your credit card and your wages take a sudden hit, you will struggle to make your next payment. Because of this debt-deflation pincer, uncompetitive and indebted countries must choose between default and leaving the euro.

Posted by Orrin Judd at April 30, 2010 6:02 AM
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