Hans-Werner Sinn has an op-ed in Saturday’s New York Times calling (again) for a Greek exit from the Euro, a recommendation on which he agrees, as he notes, with Paul Krugman and Joseph Stiglitz. Part of his argument is that is that an official lending “bailout” program within the Euro won’t work because it will impede the necessary decline in local prices to make Greece competitive again within the single currency. His evidence that not getting a bailout improves competitiveness is … Ireland:
Take the case of Ireland. Like Greece, Ireland became too expensive, as interest rates fell sharply during the introduction of the euro. When the bubble burst, in late 2006, no fiscal rescue was available. The Irish tightened their belts and underwent a drastic internal devaluation by cutting wages, which in turn led to lower prices for Irish goods both in absolute and relative terms. This made the Irish economy competitive again.
But, you might object, I have a clear memory of Ireland getting a Troika bailout? Indeed –
Granted, Ireland also received fiscal aid. But that came much later, toward the end of 2010, and when it came, the internal devaluation stopped almost immediately. Twelve of the 13 percentage points of the Irish decline in relative product prices came before that date.
This interpretation of Ireland plays an important role in Sinn’s recommendation for Greece: it showed that it’s possible to manage a real devaluation without a bailout, but Greece began too late and had too far to go for this route to be feasible, hence it should leave the Euro.
But is this valid?
It is indeed true that the Celtic Tiger had peaked in 2006, but even towards the end of 2008, the government was frantically trying to lock in pay increases with the unions. Of course by then the economic tide had clearly shifted and the government spent the next 2 years chasing it to the shore. Furthermore, while it is true that some price adjustment had been accomplished by late 2010, there was still a lot of unit labor cost adjustment to come during the bailout period: productivity increased as the economy stabilized; see pages 13-14 of this excellent IMF paper for the details. As the Fund paper points out, Greece was actually doing a huge amount of price adjustment from 2009 onwards, but it couldn’t deliver any cost benefits because output was falling even faster.
There is indeed a case for Grexit, but the claim that Ireland illuminates the path of the pro-active non-bailout real devaluation is not part of it.