Thursday, 29 March 2012

Blanchard and Delong on the Greek endgame - and implications for Spain and the future of the Euro

After the crisis is before the crisis... Olivier Blanchard (via Brad Delong) has some simple home truths for those who think that Greece has now been "rescued" by cutting its privately-held debt by ~80%, a uniquely savage restructuring for any country except Ecuador and Argentina -- what great company for the Eurozone. It's really a gentle reminder that Merkel, Schäuble, and the rest of the German "Austerity Will Solve Everything" Muppet Show just failed Econ 101. The real underlying issue, as Blanchard points out, is the continued current account deficit - still 10% of GDP. Olivier points out that leaving the Eurozone would give Greece a chance to finally increase competitiveness, but with his IMF hat, seemingly rules this out as impractical. Brad Delong, probably remembering the experience of leaving the gold standard in the 1930s, strikes a different balance -- with quitting the Eurozone looking much better. And everything that we say about Greece also applies to Spain. Here is why "internal devaluation" (ie savage wage cuts), the only alternative route to make countries competitive, will never work in the Club Med:

  • strong unions combined with an inclination to strike and raise hell. That will damage growth directly
  • high private debt burdens. The average Spanish family carries so much debt thanks to consumer + mortgage lending that even a 10% wage cut translates into a 30% fall in disposable household income
  • small export sector -- after years of post-industrial growth, there isn't enough of a manufacturing sector left that could benefit from a major increase in competitiveness
So, overall, I think Brad is right - for many countries in the South of Europe, the costs of staying in the Eurozone far outweigh the benefits. Responsible governments should prepare for the day after.

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