First Published 25 July 2011 in The Graduate Times
Greece, it is easy to gain a competitive advantage without devaluing your currency! Just cut all Greek wages by 20%!
A new Greek bailout has been agreed. The question is, will it work? History has told us that four ingredients are needed to solve a credit crisis. The four main ingredients are: devaluation; a short-term loan; fiscal restructuring, and privatisation. The Greek bailout includes three of these, but lacks one essential ingredient: an internal deflation or devaluation.
Devaluation of the Euro is possible. Relative wage levels in the Eurozone will not change, however. Greek wages are way above their relative productivity compared to other European nations. In many industries Greeks simply cannot justify their wages. An internal deflation is possible in a flexible market economy to deal with the competitiveness problem. Hong Kong proved this in their crisis, which lasted from 1998-2004.
Greece does not have a flexible market economy. Instead of allowing for a deflation of wages in those uncompetitive industries (as Hong Kong did), the state could decide to cut all wages in all industries by 20%. This is ofcourse sub-optimal. There may be an outcry, but the alternative – a 20% decrease in everybody’s income due to currency depreciation, is not inconceivable under an individual currency devaluation outside the Eurozone.