Internal devaluation

Abstract: The dominant view, both on the mainstream right and on the left, holds that the Eurozone crisis is a crisis of labour-cost competitiveness—with trade imbalances (and hence foreign indebtedness) being driven by divergences in relative unit labour costs (RULCs) between surplus and deficit countries. To re-balance Eurozone growth, the mainstream solution is a deflationary policy of ‘internal devaluation’ (i.e. cutting the wage share by as much as 30%) in the deficit countries. The ‘progressive’ view holds that the surplus countries should adjust by raising their wage shares. We argue that both sides of this debate are wrong and unhelpful. Europe’s trade imbalances are determined by domestic and world demand—whilst RULC divergences play only a negligible role. Eurozone growth can only be revived when Eurozone demand growth is restored, not by lowering wages here and/or raising them there. The current deflationary adjustment forced on the wage-led economies of Greece, Italy, Portugal and Spain is self-destructive: it is a ‘confidence killer’, not only deepening the free fall of southern European incomes but also damaging their productive base and productivity growth. The outlook is depressing—further increases in already high unemployment rates, inequality measures and poverty rates inconceivable in prosperous Europe just a few years ago—and arguably dystopian.

Abstract: Latvia’s boom, bust, and recovery provide a rare case study for macroeconomists: an economy that responded to a balance-of-payments crisis by maintaining its currency peg and adjusting through internal devaluation and front-loaded consolidation. This paper lays down the facts about Latvia’s boom and bust and analyzes the policy response and the mechanics of the adjustment through internal devaluation. While Latvia’s adjustment was very costly, with a large drop in output, a big increase in unemployment, and substantial emigration, it was eventually successful. The internal devaluation worked faster, though quite differently, than what had been expected. Productivity increases, rather than nominal wage cuts, drove much of the unit labor cost reduction. These then led to an increase in profit margins, rather than a decrease in prices, and to a surprisingly fast supply response. The strong front-loaded adjustment did not prevent the recovery. The lessons of the Latvian experience for other countries may however be limited, since many of the elements of the eventual success appear to have been due to factors largely specific to Latvia, factors that are not present in southern euro countries, in particular.

Abstract: As often pointed out in the literature on the European debt crisis, the policy programme of austerity and internal devaluation imposed on countries in the Eurozone's periphery exhibits a lack of democratic legitimacy. This article analyses the consequences these developments have for democratic support at both the European and national levels. We show that through the policies of economic adjustment, a majority of citizens in crisis countries has become ‘detached’ from their democratic political system. By cutting loose the Eurozone's periphery from the rest of Europe in terms of democratic legitimacy, the Euro has divided the union, instead of uniting it as foreseen by its architects. Our results are based on aggregated Eurobarometer surveys conducted in 28 European Union (EU) member states between 2002 and 2014. We employ quantitative time-series cross-sectional regression analyses. Moreover, we estimate the causal effect of economic adjustment in a comparative case study of four cases using the synthetic control method.

Abstract: During the early 2010s, creditor states and EU institutions demanded that the Southern states of the eurozone liberalise their labour markets to facilitate internal devaluation and export-led recov...