ExIT: reflections of a mainstreamer

A few days ago I had a long talk with James Politi, the Rome correspondent of FT. He gave a fair account of our conversation here, a praiseworthy achievement considering the pressure under which he was working. Many aspects of our conversation were obviously omitted, but the main message remains. In my experience this is extremely unusual, especially with the Italian media. I shall not mention all the aspects omitted, but wish to add some nuances that were lost in translation (mostly my fault).

The most important one concerns my statement about “having been saying this stuff for seven years and eventually becoming a mainstreamer”. This is exactly what I said, but it is perhaps worth adding a caveat: as readers of my blog know, the economic mainstream has always been very skeptical about the euro. As early as 2011, I reported the mainstream view here, in my baroque Italian, building on this paper, which the international reader will find more accessible. While my statement still makes sense in the framework of the very provincial debate conducted in Italy, in the light of scientific research it is just the opposite: advocates of the euro have never been mainstream in the scientific literature, and almost nothing I have been saying for seven years is original. It is all the more regrettable that so much courage was needed to say such obvious things, but that is another subject.

As for my statement that “those who are in denial are not doing a service to the country”, let me add a few words that escaped Mr. Politi’s attention: “because it is not completely up to us to decide whether the euro will stay or collapse”. In other words, in claiming that the euro is irreversible, the ruling elite, represented in the article by Mr. Padoan (my former teacher and colleague at University of Rome I), Taddei and Codogno, are simply confessing their inability to manage its end, which could come as a consequence of a major political or financial shock. This is not a judgment of their intellectual quality, it is a consequence of the “political philosophy of total optimism” on which the whole European integration process rests, in the words of Giandomenico Majone. This philosophy is now backfiring because it is preventing the ruling elite from studying events they claimed to be impossible. If they studied those scenarios, there would be leaks, and voters could suspect that another world is possible, breaking the TINA (there is no alternative) philosophy of European integration. Our only certitude about exit from the euro is that it will be managed by people who in a sense were forced to be incompetent by their flawed political discourse.

And, yes, this will inevitably lead to pain in the short-run, followed by a recovery in the medium-run (after one or two years). Nobody denies it, and again it is not my idea: it is scientific literature. The finding that adjustment after a disorderly currency collapse is normally V-shaped is not the product of a strange, marginal, provincial teacher’s mind. It is confirmed by recent scientific literature: the most comprehensive study is “Output recovery after currency crises”, published by Sheida Teimouri and Taggert Brooks in Comparative Economic Studies.

On the other hand, I have been unable to find any factual evidence that major devaluations lead to a fall in real wages. The data shows that major devaluations are generally not followed by major inflation episodes, and hence there is no fall in real wages, as I showed here (the text is in Italian, but the graphs are in the universal language of data). Again, the scientific literature has provided a number of explanations of why this must be so (the most convincing by Ariel Burstein, Martin Eichenbaum and Sergio Rebelo in the NBER working papers focuses on import substitution). We also have a blatant counterexample: the establishment guys seem to overlook the fact that Italy underwent a major devaluation (about 30%) between 2014 and 2015, when the euro fell with respect to the USD. As a consequence, inflation fell (instead of rising), which in principle should have boosted real wages. However, nominal wages were cut because of “internal devaluation” policies, as shown by Eurostat. Real wages, i.e. the ratio of nominal wages to prices, fell not because of an increase in the denominator, but because of a fall in the numerator. In other words, while we have no evidence that real wages would fall if the euro collapses, we have evidence that they did fall in an effort to defend the euro by internal devaluation policies.

Mr. Taddei’s commendable attention to the wages of the poorest is therefore completely unsupported by any evidence or by mainstream economic research, suggesting that Mr. Taddei is irrational (which as a mainstream economist, I must rule out by assumption), or that he is defending someone else’s interests. The close ties between his party and the Italian banking system could provide a clue.

A final remark: the idea that “devaluation would be minimal” is not my personal opinion but a finding common to all the available scientific research. The most recent studies estimate average misalignment of the Italian currency in a range between 2.35% (Makram El-Shagi, Axel Lindner, Gregor von Schweinitz in the Review of International Economics) and -1% (Cedric Durand and Sébastien Villemot in a Sciences Po working paper). Surprise! While the establishment guys talk about a disastrous 30% devaluation (without explaining why the previous one went completely unnoticed in 2015), there are also people who estimate that a new Italian currency would appreciate (albeit by very little).

A clever opponent (I have not found one so far, so I must play the devil’s advocate myself) could then ask: “Well OK, Italy is currently running a current account surplus. Its exit may not turn out after all to be a disaster for its currency, but why exit now, when things are going better?” The answer, my friend, is blowing in Brussels: things are certainly going better than in 2009, but they are not going well enough. With youth unemployment at around 40% and a secular flattening of labor productivity, the Italian government is prevented by the European rules from making investments that would be crucial for enhancing productivity and employment. Should we decide to implement such policies, which everybody agrees are needed, within the euro, Italy would soon hit a balance of payments constraint and the ECB would eventually blackmail us as it did with Greece in order to enforce rules that led nowhere but to foreseen disaster. The need to loosen this monetary noose is first and foremost political. The sooner this simple fact is acknowledged, the less the damage for all participants in this negative sum game.