(I will spell things out a bit more in this post than I might have if we didn’t have an infusion of NYT readers, but probably I should anyway. Some of our readers don’t know a lot about economics.)
We’ve been debating the wisdom of savage wage cuts in Spain and other countries, which Ed thinks is necessary. The idea is that wages have risen far more than is reasonable because of bubbles, which means they’ve become uncompetitive. Normally, that could be solved by currency devaluation, but Spain is in the euro. So Ed wants “internal devaluation”: wages cuts, which will also lead to cuts in prices.
The thing is, what weâ€™re calling internal devaluation isnâ€™t actually analogous to actual devaluation. Itâ€™s not even close. It’s not a question of your perspective; itâ€™s not â€œonlyâ€ a psychological difference. So how would you get an â€œinternal devaluationâ€ that lived up to its name? Richard Nixon might have an idea…
Currency devaluation can be relatively painless, but wage cuts will be a very painful process. People will be poorer, which will also lead to a collapse in demand, which will lead to a general economic collapse. Price cuts – deflation, sound nice, but are very destructive. It leads to people expecting lower prices, and delaying purchases, which lead to lower production, which leads to lower wages and lower demand, which in turn leads to even lower prices, which leads to people delaying purchases even more. A downward spiral of misery.
Also unlike an actual devaluation, lpeople will have less money to pay back loans, which isn’t a small thing. You already have a lot of people underwater or close in Spain.
History shows that wage cuts and deflation will normally be a very slow and painful process. A government can induce a faster “internal devaluation” by slashing wages for public sector workers. That would still not be very similar to actual devaluation. It would give the economy a body blow, a veritable death blow. Deflation would still be gradual and destructive. It would also hit some people far harder than others, without necessarily targeting less productive sectors of the economy. The more well-off segments of private sector workers probably wouldnâ€™t see any wage cuts at all.
This wonâ€™t do. So if – if – savage wage cuts are the least bad option, why not just have a government directive to cut wages for every resident and all prices in one fell swoop, and then retain controls for a couple of months? This way you won’t get a deflationary spiral, you won’t get the same utter collapse in demand. There would be a collapse in corporate profitability, which would happen anyway. It would also be less manifestly unfair.
This still leaves you with loans that havenâ€™t gone down. One immediate thing you could do would be to institute (temporarily) very lenient bankruptcy laws. Currently, they don’t allow any kind of personal bankruptcy, you just (fail to) pay off your debts until you die, and live like a pauper. Probably something more radical is needed.
Most of the arguments against a conventional use of wage and price controls donâ€™t apply here. In any case, Spain doesnâ€™t actually have any good options. What we need to figure out is the least bad option.
Does anyone know if there are any EU rules against something like this?