The Economic Consequences of Mr. Hugh

Edward Hugh and Paul Krugman and even Dani Rodrik are in agreement, as Ed meets the elite; although we don’t know how much Spain’s external account needs to swing towards surplus in order to get the economy growing, we know it needs to be going that way, and therefore it’s a choice between “internal devaluation” – i.e. wage cuts for everybody – of the order of 20% or else, departure from the eurozone.

I cannot support this contention.

Let’s have some axioms – things that have to be true, and which are generally accounting identities.

Number one: Exports to Mars remain a losing business. Therefore, the world economy cannot but have a balanced trade account. One man’s current account deficit is another’s surplus. This is true by definition. It is also true, but less so, of the eurozone – of course, the eurozone has a net imbalance with the world, but it is true that if a eurozone country has a current account surplus with the rest of the eurozone, a sufficient current account deficit must exist elsewhere in the eurozone to match it.

Number two: The money has to go somewhere. One man’s trade deficit is also his capital account surplus. If Spaniards want to buy more German goods than they sell Spanish goods to Germany, absent a massive extra-eurozone trade surplus, somebody must lend them the money. Similarly, if Germans want to sell more goods to the eurozone than they buy, they must do something with the surplus of euros that results.

Number three: The money still has to go somewhere. Stashing your export sector earnings in ultra-safe eurozone government bonds, like a stereotype German, is an economically identical activity to borrowing German money to spend on stereotypical Mediterranean corruption – for example having real-estate banks managed by the Church, although how DEPFA or IKB Deutsche Industriebank were any better is not obvious. Every Sparbuch is the flipside of a tax break for a mobbed-up developer setting fire to a Greek hillside. Obviously, it would be silly to hold individual German savers responsible – but the Great Banks of Frankfurt, the institutions through which the German trade surplus is recycled?

And it is no sillier than holding individual Greeks or Spaniards responsible, which is what Ed Hugh, Paul Krugman, the European Commission, the International Monetary Fund, the CEO of Banc Sabadell, etc, etc, actually propose to do.

As Ed rightly says, the real issue is “where will the growth come from?” With recovery, everything else will be surprisingly easy; his example of Finland is a case in point. Another would be the UK budget consolidation of the mid-90s, or for that matter, of the post-war era. Without it, there is arguably no point in worrying – in that case, in the fairly short term we are all dead, and default, euro failure, and an unquantifiable degree of misery are inevitable.

Unfortunately, although his analysis is correct, Ed’s prescription is very unlikely to lead to growth. What export market for Spanish goods is there that will outweigh a 20% hit to aggregate demand? Who will buy? What will they buy, that is currently overpriced by 20% divided by the percentage of marginal cost accounted for by labour? Labour is asked to fork out, but where are the guarantees that this patriotic sacrifice will achieve anything? One might well conclude that the actual content of this proposal is in the bit that is clear and well specified – the 20%.

To be more rigorous about this intellectually, think of it as follows; Spaniards suffer the 20% wage cut, and all else remains equal. We have no reason to think all else does not remain equal. No doubt this reduces the Spanish trade deficit by some number. This implies that the eurozone exporters – Exportland – see their trade diminish by the same value. The Spanish trade account is balanced, but we are all, on balance, poorer. And it is possible that the eurozone exporters will redouble their efforts to cut prices and hold onto market share – they have no reason not to, and in fact it is their core national economic strategy to export at all costs.

The only way this approach might not actually be deflationary at the eurozone level would be if it caused prices to fall sufficiently that they undercut Chinese prices; this is unlikely, and anyway would represent the export of European deflation to the poor.

So, to sum up so far, it’s just as possible to have a beggar-your-neighbour “internal devaluation” as it is to have a beggar-your-neighbour devaluation. The difference is that the “internal devaluation” option is also a beggar-yourself-and-indeed-everyone-else policy, and one that will create more actual beggars. And, in fact, beggar-your-neighbour internal devaluation accurately characterises the policy of Exportland’s economic leaders.

There is, of course, an alternative – it is the sunshine policy. Pay Germans more money – perhaps 20% more – and they can spend it, among other things, on one of Spain or Greece’s biggest exports, which happens to be sunshine. The dangerous imbalances would be reduced; demand would be created for the products of whatever new industries Ed’s new circle can think of. After all:

Put another way, thanks to the foreign funds which flowed in to finance the housing boom Spain became a major imports powerhouse, with the consequence that both the trade and the current account deficits deteriorated sharply, while a significant part of Spanish industry simply died. One of the major tasks of any recovery programme is to bring this industry back to life. In this sense what Spain’s economy needs is not rejuvenation but resurrection.

Better yet, there is a simple policy lever available to make this happen. German wages are essentially set by the annual bargaining round between IG-Metall and the Industriellenvereinigung, which acts as a price leader for the rest of the economy.

Surely, though, we need to cut, cut, and cut again to stay competitive with China? Well, this statement would be interesting if it wasn’t wildly counterfactual. At the current relative wage rates, it’s blindingly obvious that eurozone exporters are not succeeding in beating Chinese producers on price. They are doing so on their products. And, soon enough, the question will be absurd because the Chinese will themselves be looking over their shoulders – apparently, GDP per capita in Shanghai is comparable to that in Lisbon. The only future strategy is to have good products; after the bubble world of the 90s and 2000s, we’re back to the late 80s view that the future belonged to whoever had the best products and supply chains.

Some other ideas: perhaps the ECB should make it a policy objective to run over the shorts? There are surely some hints here.

Fitch, meanwhile, thinks that Spain’s creditworthiness is adversely affected by its plans for internal devaluation, but I am on record as saying that anyone whose investment decisions were guided by credit rating agencies would have lost their shirts three times over in the 2000s – once with Enron, once with the alt-telco bonds, and again with mortgage-backed securities. (I’m also the proud owner of the domain name, if anyone has ideas about what to do with it.) However, our hypothetical investor would have avoided these catastrophes, because they would have had no money to lose in them, having already lost it all in Russian GKOs in 1998, Thai or South Korean corporates the year before, or Mexican government bonds in 1994.

I commend the proposal of just sitting back and being rich, as Harold MacMillan once said, to my readers, and indeed to the CEO of Banc Sabadell, who no doubt has greater expertise in this matter than myself.

53 thoughts on “The Economic Consequences of Mr. Hugh

  1. “where are the guarantees that this patriotic sacrifice will achieve anything?”

    – no guarantees at all. In Latvia the marges released by 40% wage fall were immediately occupied by monopoly profits.

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  3. ““internal devaluation” – i.e. wage cuts for everybody – of the order of 20% ”


    The price paid by employers for labour needs to fall: that is not the same thing as saying that wages paid to labour need to fall.

    wage labour costs are not especially high in Spain, we shall concentrate on non-wage
    labour costs”

    That paper (and the quote) do not prove my contention of course: but they do indicate what the contention is. From an outside view the Spanish labour market looks near entirely dysfunctional with a huge gap between those lucky enough to have “permanent contracts” and those on short term or temp ones. Reduce the costs (ie, make firing easier, with lower compensation rights, just as one example) of those permanent contracts and you’ve lowered the costs of labour without lowering wages (although you have of course lowered total compensation by the same amount you’ve reduced costs….unless there’s a free lunch in there, in that workers value the security less than it actually costs to provide….that could go either way really).

    In short, there is a “third way”. Supply side reforms.

  4. So you’re basically suggesting that everyone is too thick to notice that their accumulated pension entitlement got nicked? Genuinely worstall.

    Don’t trouble to reply, my finger’s itching.

  5. Neat title.
    It’s probably true that hiring & firing needs to be made easier in Spain. Another thing that could be tried, if the stats are right, is making starting a business easier: Spain is in line with the global average by having it take 47 days to start one, but that’s well higher than most countries, as they’re 53rd out of 172 countries listed, meaning everyone below them on that list gives entrepreneurs an easier time about it. This list is probably a pretty decent proxy for regulatory pressure in general on a business in a country, actually, so from that POV Spain needs to lighten up.
    But that doesn’t get you around the main problem: without a currency union, a devaluation would allow all those new businesses you’re now allowing to start up if you do lighten up a leg up both at home and abroad. Inside a currency union, you can’t give them that leg up. You’re asking them to go head-to-head with the best from the entire Continent right from the start. This is completely unrealistic.

  6. Mr. Harrowell,

    If the Germans are saving too much money now, how will paying them more money fix the problem?

    In other words, what would you do to fix the structural problems that cause the Germans to want to save so much of what they make and invest it in other countries?

    And what makes you think that if the German’s spent more money, it would be spent on Spanish goods instead of Chinese goods?

    I agree that Mr. Hugh’s plan does not make much sense. But yours does not either and for the same reasons that Mr. Hugh’s does not. Both of you are arguing for a change in the relative exchange rate within the Euro zone. Only instead of having the Spaniards increase their competitiveness you want the Germans to lower their competitiveness. I fail to see the effective difference based on the very same axioms that you laid out.

    The fundamental problem with your approach is that Germans who spend more are just as likely (I would argue, more likely) to spend their extra money on goods made in China as they are in on goods made in Spain. And that is if you could induce them to spend it instead of saving even more.

    Spain’s fundamental problem is not that Germans won’t buy their goods. Spain’s fundamental problem is that they built too much of their economy around a housing sector which will not produce a real return. They need to restructure their economy and that is going to be painful no matter what.

    Germany’s problem is more complex. But again, you are not going to solve it by giving the Germans more money to spend when they already save to much. More to point, if you did away with Germany’s surplus, who would lend the Spaniards the money they need to restructure?

  7. pantom,

    it is unrealistic. As are completely blatant demagogy the German responses to divergency critics: the South must make themselves more competitive.

    But what the South must do, if on the internal European market there is place only for one, in order to keep economies of scale competitive globally? And this one is usually some German Mittelstand, popped up with German protectionism – wage dumping, massive gifts of intellectual property to businesses, far beyound de minimis, low interest rates due to shear size of German economy.

  8. And that also response to Ape Man:

    Germany is the only European economy where no minimal wage exist. That has lead to buildup of the largest low-wage sector in Europe of at least 4 Mio persons, based on Hartz reforms.

    The EC must have the prerogative to impose minimal wages in the EU related to productivity.

    Imposing minimal wages in Germany will be an extremely efficient instrument against European divergence.

  9. Mr. Govs from Latvia,

    Don’t mistake me for a apologist for Germany. I don’t hold the lenders in this mess to be any more virtuous than the borrowers. But at the same time, I don’t thing you can come up with a simplistic fix for the problem by focusing on the lenders any more than more than you can come up with a simplistic fix by focusing on the borrowers.

    In other words, divergence is not all the Germans fault.

    Lets step away from Europe for a second and take a look at the Untied States.

    We have federally imposed minimum wage. We have a federal government with more powers than the EU can currently dream of. And yet we still have several States with GDPs as big as most European countries that are tottering on the edge of bankruptcy.

    If those states are bailed out by the feds, the states that are not tottering on the edge of bankruptcy are going to be furious. On the other hand, if those states are not bailed out, the result is going to be catastrophic for everyone.

    In other words, we have divergence in spite of of having a national minimum wage and stronger Federal government.

    So I don’t think you will be able to fix the EU’s problems by paying the average German worker more. Especially if the average German worker keeps on saving at typical German rates.

  10. That’s true, to fix the divergence the capital gains tax in Germany should be also at least doubled.

    I am absolutely not criticising Germany. My interest is – are there any other exits from the present situation other than Germany paying the bill for the divergence?

    Is the Germany really so much interested to protect the present divergence if they will unavoidably pay the final bill?

    The paradox is – in the 90-ies the CEE’s had difficult situation, really difficult, but they never where really teetering on the brink.

    Now, after they have joined the EU which aimed in the Lisbon strategy to become the most competitive region of the World, they have become so uncompetitive that they really are teetering on the brink.

  11. “So you’re basically suggesting that everyone is too thick to notice that their accumulated pension entitlement got nicked?”

    Umm, given that I didn’t mention pensions at all I’m struggling a little to understand what on earth you’re talking about.

    Perhaps you could put that itchy finger to work and explain it to me?

    My point is very simple: that the cost of labour is made up of both the actual wages paid to labour and the restrictions placed upon the employment of that labour. If we want (for whatever reason) to reduce the costs of employing labour we might therefore want to look at the way in which we can reduce the non-wages part of the cost of employing labour.

    You are actually a Lib Dem and this is the point that’s been made by Lib Dems of the Orange Book persuasion (and I don’t know whether you are of such) quite well.

    We can quite happily go off and have that discussion of how much redistribution there ought to be later….first, let’s apply the classically liberal tropes about maximising what there is to be redistributed. Which has the added benefit or reducing debt as a percentage of the economy.

  12. 3 years ago the price of a small coke was

    – 1,90 € in Italy
    – 1,90 € in Germany


    -2,30 € in Italy
    -2,10 € in Germany

    Prices applied by the same company on selling point on the highways.

    May be that before talking of anything else a bit of internal devaluation is required

  13. So, if Finland is not an option, we are left with Argentine, aren’t we?

    And therefore the really important question is: how fast are eurozone banks dumping Greco-Iberian debt on the ECB lap?

    Do the math and you will find our how much time is left before the corralito…

  14. ANSWER FOR TIM (other readers may skip): you seem to be suggesting cutting employer social contributions.

    As anyone with the slightest interest in labour economics knows (i.e. not you, ‘cos I got mine Jack), these are effectively nonwage compensation. If you cut everyone’s unemployment benefit/healthcare/pension entitlement/etc, and they have to pay it themselves, *this is an equivalent withdrawal from aggregate demand for everything else*.

    If I have to spend the berserk percentages of my income my American friends do on health insurance, I CAN’T USE THAT MONEY FOR ANYTHING ELSE. Not consumption, not saving, not investment. I get less stuff for the same number of hours. No matter what the repellent, low, deceitful, pathetic lying may be.

    NOTE FOR SERIOUS, NON-WORSTALL READERS: This is actually a very important point at the macrolevel – whether you call it “tax” or not, whether labour or capital pays, the costs do not go away. In a PAYG state pension system, the government has to raise taxes, either now or in the future. In a funded system, the funds have to collect interest, claim dividends, or sell assets in order to pay pensions – either way, current national income is transferred to pensioners.

    Demography is a problem precisely because you cannot get around it. There is no pony. Privatisation changes nothing. The pensions must be paid somehow; as Terry Smith so wisely said, cash is king, follow the cash.

  15. The Great Success Crisis made by Social Democratic Governments obsessed by growth and employment hence very low rates continues. Growth is not eternal Demographic and technology make it possible. Technology makes possible to live better without growth. Today an economy with crap cars that last 5 years have more growth than a one with good cars that last 10 years. Bah! The Social Democracy tax/slavery obsession would love the first and will hate the last . But it can’t last.
    So who will buy a decacore CPU in 2015 to process some text?

  16. “you seem to be suggesting cutting employer social contributions. ”

    No, I’m not. I’m suggesting attacking the structural rigidities which make labour more expensive to employ. Like, say, the very high protections against sacking that permanent employees have… I make reference to.

    Not the tax wedge, or the national insurance (or equivalent) wedge, but the non-monetary costs which are added onto the price of labour.

    You know, supply side stuff.

  17. It’s a relief to hear a different set of arguments than the usual ‘deflationary contraction’ or ‘spend like there’s no tomorrow’ that have come to dominate the economic discussion. I tend to agree with the view that giving Germans more income will benefit the sunshine states disproportionately. At the same time there are reforms and austerity measures in Greece & Italy (I’m less familiar with Spain) that are way overdue. An effective rise in the retirement age would benefit their economic wealth, broaden the tax base and reduce the dependance ratio.

    I would like to add new point to this discussion: EU-subsidies. These are stimulating the southern european economies to borrow money for projects for which the economic benefits are at best doubtful. You cannot turn the Mezzogiorno into an economic powerhouse by throwing borrowed money at it. And we’re about to make the exact same mistake with the eastern european countries.

  18. MarcVdB,

    while agreeing that the Cohesion policy of the EU has failed completely, the issue of Structural funds is not so simple.

    Structural funds are way how Germany & Co pays to CEEs for the opening their markets. Because weaker economies can never profit from a common market, unless they get direct transfers (structural funds) or to some extent are allowed to print money as a part of monetary Union.

    An interesting question – will the total opening of labour markets in the EU occur as planned on May 1st, 2011?

    Without direct transfers there will be no reason for the CEE’s to stay in the common market.

  19. My solution. A few million Germans move to Greece for the weather. This will prop up real estate. Ditto for the English and Spain.

  20. No, I’m not. I’m suggesting attacking the structural rigidities which make labour more expensive to employ. Like, say, the very high protections against sacking that permanent employees have… I make reference to.

    Do you actually believe Spain’s problem is that unemployment isn’t high enough?

    You know, and I know, and most of our readers know that the supply-side argument is that wages haven’t fallen far enough due to “labour market rigidities”. Get rid of the rigidities, and wages will fall, all will balance, ponies!

    So yes, you’re arguing for a wage cut (for everyone else). Which would be, as I have very carefully explained, a further round of deflation eurozone-wide.

  21. Sure, the direct transfers are compensation for the current account deficits, agreed there’s nothing wrong with that. But in order to get these funds the countries must borrow themselves too AND the projects must get EU approval. It’s incentivised malinvestment and it doesn’t solve the current account imbalances at all. It would make much more sense if Germany would be required to invest directly in the southern european countries or face tariffs when they fail to do so.

  22. I agree with this article. Some economists are fixated on text book formulas: if you decrease w(ages) than e(xport) will increase. In reality it’s about the products you sell and the world wants to buy. I think you better put a business person in charge of Spain than an economist.
    And there is another more obvious solution for the trade deficit problem countries like Spain face, already mentioned in the article: they should simply loan less. It’s interesting to see that economists like Mr. Krugman are eager to claim that Spain needs to have a internal devaluation, while he does not prescribe this for his own country the US, who has the exact same problem as Spain with a trade deficit and too much debt. No, in the case of his own country, it’s China that in his opinion needs to solve the US problems by revaluing their currency. Why no internal deflation here, Mr Krugman? Too painful?
    There are however some industries where prices (not wages) might need to decrease like tourism. Purely based upon my own experiences I suspect that the introduction of the euro has been used as a chance to increase prices much more than inflation in some areas.

  23. I think people are missing the point of why smart people like Hugh and Krugman are advocating for an internal devaluation.

    Let us take a step back and think about what would happen if Spain was not part of the Euro.

    In the first place, it should be noted that the Spanish currency would be falling like a rock. This is how countries all over the world adjust to problems similar to what the Spain faces now. This is what happened to the Asian Tigers. This is what happened to the US in the 70s. And one can go on and on with various other examples.

    Hugh and Krugman are simply trying to figure out a way to make the normal adjustment happen and yet still keep the Euro area together. The problem with their idea is that it forces all the pain onto the workers. In the 1970s when the US let the dollar go into a free fall, the lenders suffered right along with the workers.

    This is how it should be in Spain as well. You can’t expect Spanish workers to take a pay cut and still expect them to pay their debts (when they had pretty much max out their ability to pay debts in the first place). But Krugman and Hugh seem to be trying to avoid any kind of massive defaults because they are scared of what that might bring about. But all they are accomplishing by not addressing how the defaults should be carried out is divorcing their prognostications for reality.

    At the same time, I am amazed that so many people here seem to think that more German domestic demand is going to help Spain. I could see an argument based around the fact that more domestic demand in Germany would help the Baltic States and Eastern Europe. But I don’t understand why people think that this would appreciably help Spain.

    The idea seems to be that there is an unending supply of people wanting to go to Spain if only they had the money. But there is a very real limit to how many tourists that a nation can absorb before the old saw about “nobody going there because it is too crowded” kicks in. Best case scenario for Spain is that it goes back to the boom years level of tourism spending. But that would not be enough to rescue Spain from its collapsing housing bubble and over-investment in hotels and like.

    The level of construction in Spain only made sense if the growth of tourism and immigration continued exponentially. That just is not going to happen.

    The bottom line is that Spain needs a complete restructuring of it economy in order to provide jobs for the people who use to be employed in the housing sector. But in order for the restructuring to occur, there will need to be investment. And I don’t think that investment will occur unless labor costs in Spain fall significantly.

    Increasing German wages costs are not going to do the trick because Spain is not competing solely against the Germans. They are also competing against the Eastern Europe and the Baltics. As it stands right now, if I was a businessman and I thought that German domestic demand was going to go up sharply, I would be investing in Poland, not Spain.

    Put it another way, the rewards of increased domestic demand in Germany would would go to those countries best prepared to take advantage of it. And right now that is not Spain.

  24. While fully agreeing that the demand is not distributed from a watering-can, there still is a question – is the internal demand in EU large enough?

    Will it bring positive effects, if more of German national income will be distributed to workers, and retracted from German banks, which used to invest it into sub-primes.

  25. as I believe the problems of Spain are mainly a one off event, caused by a combination of a housing bubble and easy money after the introduction of the euro, it needs a one off solution. My solution would be:
    Send the millions of immigrants that came to Spain during the housing boom home. There will never be enough work for them.
    Clean up the banks and default on (mortgage) debt that will never be repaid anyway. Too bad for the banks or pension funds in Europe, but that will teach them a lesson.
    Introduce strict rules for loans and planning for new houses, like in other sensible European countries, so no more Anglosaxon style boom-bust housing bubbles.
    In short, simply correct the mistakes of the past 10 years and start over again. But don’t listen to the deflation/devaluation anti-euro scare stories from Anglosaxon economists who think they know the solution for the ”pigs”, they did run their own economies into the ground, we have nothing to learn from them.

  26. Hey, Alex!

    Good post. Full agreement. Three things, though.

    First, you may be harshing on Ed a little. (Not that I’m not sympathetic; dude never answers my questions. I feel dissed.) He’s asking what should Spaniards do if the Germans don’t see reason. You, you’re asking what reasonable Germans should do. Me, I wouldn’t bet on the Germans seeing reason anytime soon, so Ed’s question isn’t unreasonable. No?

    Second, there is another moving part, which is Spanish productivity. I wrote a little about it over here. There seems to be a lot of room for growth there, assuming that, you know, businesses don’t want to go under.

    This is where the flexibility arguments come in. I don’t think more unemployment is necessary, but I also don’t think the arguments for it are crazy. Sort of: (1) a quick way to grow more efficient is to lay off unproductive workers; (2) the efficient businesses will increase net exports; and (3) the higher returns from the efficient businesses will get growth going again sustainably. Second best to goosing inflation or making Germans spend more, I agree. Maybe even third best to other alternatives. But not entirely insane.

    Third, I am actually sympathetic to the “cutting social benefits” argument … simply because I don’t believe in efficient markets. There are ways to cut labor costs that will prompt employees to immediately cut back a lot on spending, and there are ways to cut labor costs that won’t. (Of course, as you know, I make a living trying to explain to MBA students that pension privatization doesn’t change the arithmetic any.)

    In other words, 100% agreement, but German politics really seems to be handing Spain a lemon, here. Reducing labor costs in a way that allows workers to keep spending and trying to goose productivity growth (which I suspect is going to pick up anyway) might be the best of a bad lot of options, absent sanity in that very peculiar land sittin between the Rhine and the Oder.

  27. Apeman: I quite agree that industrial reorganisation and reinvestment is vital. However, trying to recreate Spanish manufacturing in the context of a massive squeeze on both internal and external demand and financing constraints is an incredibly hard proposition which is, I think, doomed to fail.

    Improving productivity is a question of squeezing out incremental improvements here and there, project by project, over time, with significant risks of failure in any given project, often requiring capital investment up front. It’s a levels-of-analysis issue – strategy beats tactics.

    My mental model of this is the UK in the 1980s; there were plenty of warm words, and some action, about regenerating the industrial base and the urban fabric, but in the macroenvironment of Thatcherism, it just wasn’t going to happen because the sterling/mark and cable rates were too high, typical interest rates were too high, and the FIRE sector was absorbing so much capital.

    Arguably, what most of the projects achieved was a kind of shadow welfare state – redistribution by project failure, and the creation of a semipermanent taxpayer-funded third sector claiming to deal with the problems of the north, but often doing so by keeping its own staff employed. The problem simply wasn’t fixed – we instead chose a property/finance/current account deficit reprocessing boom and symptomatic relief.

    Michael Heseltine, for one, saw it in terms of having a massive shakeout, and then pouring huge investment into reindustrialisation in a context of European integration and a low sterling/mark rate. The shakeout bit got delivered, the rest not so much. Strange how that happens!

  28. This is of course the old “all economists are determined by their first economic crisis” thing – Keynes – WW1 and the Depression, Friedman – 70s inflation, etc. The UK in the 80s and early 90s is my mental model of pretty much everything.

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  30. Mr. Harrowell,

    It very well may be doomed to fail. But that does not change the fact that your prescription is very unlikely to help.

    At this stage in the game, I think Spain is more dependent on the price of capital (so that it can get the investment it needs to retool) than German domestic demand. Per the axioms that you stated, if German consumption goes up and its savings go down, who is going to be stupid enough to invest in Spain?

    I am not arguing that no one would benefit from a German re-balancing. In fact, I think that Germany itself would be the biggest beneficiary, followed by eastern Europe. But I don’t see how Spain would benefit and I can see lots of ways in which it would get hurt.

    Lets look away from Spain for a bit and consider the biggest PIG of them all. Namely, America.

    China and America are locked into a defacto currency union. Right now, a lot of people in America would really like to see China pay its own workers more and increase its domestic demand just as you say Germany should. But would this really help the US?

    In the long run, maybe. But in the short run American would be in a world of pain if China stopped running a surplus. This is because American is the disproportionate beneficiary of China’s cheap loans (do you think Mr. Bush would have been able to cut taxes and wage two wars if China had not developed a huge appetite for US bonds during the 8 years he was in power?). Yet America would be very unlikely to befit from a run up in China’s demand in the same disproportionate way. Simply put, American is not in a positioned to sell what China is likely to want to buy (well, I am sure China would be happy to buy F-22s…).

    To a certain extent, we can see this playing out right now. China’s attempts to stimulate demand are benefiting a lot of people (primarily commodity producers, but also a lot of its neighbors). But all the US is seeing is higher commodity prices.

    The biggest problem I have with your argument and other like it is that it assumes that that biggest beneficiary of doing away with trade surplus will be the nations that were running trade deficits. This does not follow.

    Indeed, history argues against it. But that is an argument for another post.

  31. Good post all round!

    Bad times are when one has to point out the obvious, and hey thats is exactly what you had to do here: it is impossible for every country to have a trade surplus. Then there is the other issue: much of the spanish trade deficit is in non tradeables, i.e. real estate. Germans have plenty of houses in Spain, as do British people. Those appear in the accounts as investments and therefore in the negative column for Spain, while if a spaniard buys a bmw it appears in the german accounts as a sale. You just have to look at what happened last year: the minute every foreigner stopped buying property in Spain our trade account surged 5%!! How ironic is that?

  32. If wages aren’t reduced, people will be fired and businesses will go under. Simple ? 20% unemployment , 40% plus youth unemployment , little manufacturing or exports – there is simply nothing better to be done than help return Spain to the cheap destination it once was, it is uncompetitive in most other realms, and will remain so for quite a while. Of course it can be done the hard way – further layoffs, labour reform and general strikes, sovereign default and international avoidance. The result ? Wages will drop 20%. Study the average increase in wages here over the last ten years and 20% will not seem excessively unfair either. Being permanently unemployed and without benefits would – especially if you are one of the near 90% of those recently laid off that just happen to be temporary workers under the age of 35.

  33. “If wages aren’t reduced, people will be fired and businesses will go under”.
    False. Businessmen didn´t hire workers based on the higher o lower level of wages… for the same reason that I don´t hire four workers if I only need two workers, and I don´t mind how much I have to pay them.
    “Study the average increase in wages here over the last ten years”
    I propose another thing…study the average economic growth in the last ten years…and it is was not only the real state sector…

  34. The number of PYMES in difficulty is severe. If they cannot lower wages or fire workers more cheaply (preferably the first), the chances they will fail increases – there also comes a point where a business cannot be run with less staff. If businesses become more competitive , through wage decreases for example, the chance of attracting foreign investment and spending increases. Comes a point maybe when the entire population are mileuristas ? I doubt it but to have an economy/business where the disparity in earnings and job protection is so great, as in Spain, cannot be constructive. I understand the inflation issue, public sector pay has been loosing spending power for the last thirty years, income per capita has increased however nearly threefold in ten yrs. , though not nescessarily equally across society. That had not avoided a high poverty rate , which has jumped an extra million since 2007 to over 9 million people. The economic expansion was mainly construction, services and hence retail. Why not study Spanish private debt while we are at it – combined with public debt it puts Spain amongst the highest endebted countries in Europe. There is no easy way to deflate a credit driven economy, there is no easy way to rewrite the economic script – even less so without currency control at hand. Any better ideas ? Even to inflate our way out of the current situation across Europe brings other difficulties. The ECB and governments will attempt to maintain the financial structure of the Eurozone, and of public debt – that will not necessarily bring economic recovery to the region, let alone to those in greatest difficulty. What is the use of higher capital ratios and liquidity when all it does is sit with the ECB at a quarter % ? It will be a long time before confidence and investment returns, and in the meantime everyone will be too busy protecting their own backs to consider extending further investment where it matters.

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  38. Well, Br, I don´t agree with you.
    Firts, because I think that the main dificulties of PYMES are not due to wages, but it is due to the general economic downturn, and the credit crunch. And, of course, it is in part their lack of competitiviness, but you can´t support them by the payment of misery wages.
    So, the solution is that with the economic recovery they will have a chance, but the kind of measures that you are defending are not appropiate for the target. Yes, that´s the truth.

  39. What recovery ?
    Tourism – flat or declining.
    Construction – flat for many years or declining still.
    Retail – flat or declining (see other sectors).
    Consumer Credit – mostly flat (no/less wages, people are still over endebted).
    Credit on equity – overleveraged still, the markets are still to devalue most equity where it is supported by outside forces.
    Business Credit – the real economy is still shrinking and there is no new direction to date.
    Manufacturing – the likes of China or Germany have it covered and are ahead in the game.
    Services – see all of the above.

    I don’t need to defend these measures, they are a feasible suggestion. What Edward Hugh is suggesting is short of being able to devalue the currency to make the local economy more attractive, another solution is to devalue the economy itself . The market will take care of equity where prices are not propped up. Businesses can close then open to rehire at lower prices and restructure, it is less efficient maybe . I don’t agree with misery wages either – if there is no demand due to competition elsewhere , including through wages, or simply due to any sector reaching its peak for now, what else ? There is only so much money in circulation, increase its velocity ? How ? Become more productive. Studies place Spain below Indonesia and Khazakstan in terms of difficulty starting and running a business . Foreign investment will mostly go where it is more productive or cheaper. Equally Spain could leave the Eurozone and devalue. Equally it will be partly supported within the Eurozone while it deflates. Equally the economy and society as is may fall through and be repieced. Uncertainty rules.

  40. Hello, Br. Very interesant, but I have little time. Anyway I will answer you.

    “What Edward Hugh is suggesting is…”
    Well, if I didn´t misunderstand Hugh, what he is proposing is to put into force a deflationary process. Yes, that is “very good” for the economic recovery…

    “Businesses can close then open to rehire at lower prices and restructure, it is less efficient maybe”.
    It is something that happens continuously. It has nothing to do with effciciency.

    “…including through wages, or simply due to any sector reaching its peak for now, what else ?”
    Simply, in my opinion, what you are presenting as a solution or necesity is practically irrelevant.

    “Studies place Spain below Indonesia and Khazakstan in terms of difficulty starting and running a business”
    And is it the cause of our present dificulties???

    “Foreign investment will mostly go where it is more productive or cheaper”.
    Ok. Spain is more productive than China, and cheaper than Germany, etc.

    Anyway, you can think what you want, but Hugh´s proposals are against reason. Sorry.
    I generally like Edward´s posts because he exposes a lot of data, but I do not agree with his interpretations.

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  42. There is no need to apologise, we are all entitled to our viewpoint.

    “Well, if I didn´t misunderstand Hugh, what he is proposing is to put into force a deflationary process” – Well he makes an easier scapegoat than Germany or Brussels, or than broad financial miscalculation and greed, maybe by taking responsibility he would let society off the hook ? We are in a deflationary process, only the US still believes in printing, borrowing and spending its way out. In Europe we are facing austerity, efficiencies, competitiveness issues to deal with circumstance. ECB liquidity increases have done little, they tend to earn a fraction of a % in central deposit, which is however more than Spain’s GDP increase, especially after government borrowing and spending , which no one wishes to pay for any more. Inflation I would save for unemployment stats, business closures, defaults, writedowns, cost of government borrowing etc.

    “It is something that happens continuously. It has nothing to do with effciciency” – it is more efficient to reduce wages than to hire and fire, or close and then open businesses, especially on the current scale..though maybe that is what is needed.

    “Simply, in my opinion, what you are presenting as a solution or necesity is practically irrelevant.” – That depends on whether it is implemented or not, the latter being most likely.

    “And is it the cause of our present dificulties???” In many ways yes – though of course there are also many ways to run an economy – who am I to judge – que soy Guirri. Imagino que estas leendo y contribuendo aqui en Ingles porque estas encontrando ideas nuevos , entonces no tengo que defender unos impositiones de mi parte.

    Anyway, it was good to discuss with someone of different economic schooling , how else are we to broaden our knowledge, contribute and learn ?

    Regards Br.

  43. P.S El Economista took the effort of reproducing this

    article almost entirely, which says about the same thing backed up with examples, but in a manner you might find more acceptable. Coincidentally an accompanying article from The Nation in El Economista advocates a return to the high government spending and inflation outlined in the first article – to do that Spain would have to leave the Euro…

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  45. In order to get these funds the countries must borrow themselves too and the projects must get EU approval. It’s incentivised malinvestment and it doesn’t solve the current account imbalances at all. It would make much more sense if Germany would be required to invest directly in the southern european countries or face tariffs when they fail to do so.
    It was nice . Thanks.

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