(Currency) snakes and (development) ladders

(from "Il tramonto dell'euro", p. 220. Versione italiana.)



A more profound motivation, perhaps unconscious, but firmly inscribed in the logic of macroeconomics, could lie behind the obsession for the balanced budget. I will try to explain it as well as I can.

We have seen that the economy is not only supply, as believed by platitudinarians. You also need demand to make the economy work. The cleverest café owner is not the one that produces one hundred coffees per hour, but the one who manages to sell them, and in order to sell one hundred coffees it’s not enough to just line them up on the bar. Demand, in any country, can derive from households, firms, government, or from the rest of the world: economists speak of (households) consumption, (firms) fixed investment, (government) public expenditure, and exports (towards the rest of the world).

Now, as it happens, these sources of demand are not all equal. “That’s for sure!” the platitudinarian steps in, petulantly. “Public expenditure is unproductive!” Sit, my friend, sit - you can have a nice long bark later on, now let me finish my argument. The difference I am trying to bring to your attention is another one. Consumption and fixed investment depend in some ways on national income: households and firms can spend only to the extent that they have earned some income, or expect to earn some income in the future. True, private investment depends on many things, among which the rate of interest, but, according to the most classical explanation, the role of demand, i.e. of income, is at any rate crucial  [1]. Public expenditure and exports, on the other hand, do not depend on national income: they are “autonomous” items of aggregate demand, (autonomous from national income, of course). Exports depend on the income of our trade partners (not on our own) and public expenditure does not depend on national income, to the extent that we allow for deficit spending.

Why I am telling you these things? Because during a crisis income falls, and the economic system experiences an excess of supply (many people that would like to work, i.e. to supply labour services, are unemployed). In order to re-balance the economy, more demand is needed, but this demand must be autonomous, for the very reason when income falls, one cannot count on household consumption or on fixed investment (both depending on income) to set the economy back on track: it would be like a dog chasing its own tail. Therefore, recovery can come from either public intervention (i.e., from deficit spending), or from exports. It then follows that whenever a set of countries adopt pro-cyclical fiscal rules, that is, rules that force them to cut public expenditure when things go wrong, the only source of autonomous demand they can resort to is external demand, namely exports.

The imposition of rigid fiscal rules therefore, forces the member countries of any economic union to sustain domestic growth through foreign demand. But the logic of the European Economic and Monetary Union implies that, during a  recession, in order to play this game, you must resort to “internal” devaluation, the devaluation of nominal wages, since “external” devaluation, the devaluation of currency, is obviously impossible. A reader of my blog gave a wonderful description of this logic: “It looks like giving up eating at home so that you can have more food to sell at the market”. It looks absurd, doesn’t it? And it is also plainly obvious, as we said before, that this mechanism cannot work because, if everybody is a net exporter, who will import?

As it happens, by imposing the “sterilization” of government balance, Germany has forced all the other Euro member countries to play the mercantilist game, being aware of the fact that the weaker members of the Union would lose, for two precise reasons: firstly, because the strategy of “giving up eating at home” (i.e., the strategy of moderating wages) implies smaller sacrifices for a country that is ahead of the game, like Germany [2]; secondly, because the same country that imposed these rules, Germany, took advantage of its political power to change them to suit itself, owing to its double moral standards, such as the double moral standards of the adulterer over the adulteress.


[1] Let me remind scholars of Samuelson’s accelerator model. To the layman,  who may legitimately find these words somewhat mysterious, it will be enough to observe that as a rule nobody builds a factory if he does not expect that someone will buy the goods that will be produced therein. Therefore, income, being an indicator both of future demand and current purchasing power, positively affects any investment decision.

[2] In 1999 per capita income in Portugal and Greece, at purchasing power parity, was equal to about 70% of the German one; Spain was at 85% of German per capita income. We can easily assume that wage moderation is politically easier to propose to a relatively wealthier population, rather than to a relatively poorer one, especially when the latter is told that entry into the monetary union would have delivered it from a recent past of poverty – at the beginning of the Eighties Greece and Portugal were still developing countries according to the World Bank.

(the original title was: "Il gioco dell'OCA", the OCA game. OCA stands for Optimal Currency Area, something the Eurozone is not, as ascertained by a huge number of studies. But in Italian "un'oca" is a goose, and "il gioco dell'oca" is something like "snakes and ladders": a game where you very often risk to go back to the beginning. If you adopt a single currency in a region that cannot sustain it, you risk to go back to the beginning. This is exactly what happened to us, as well as to many other European countries. The "currency snake" was the first attempt to adopt a semi-fixed exchange regime in Europe after the fall of Bretton Woods, and the "development ladder" is the one you kick away, once you have climbed on the tree of prosperity, which is the standard behaviour of imperialist countries. Guess who is trying to do it now?)

(I warmly acknowledge the kind assistance of Grace Anderson, Patrick Lynch and Elena Marini. Owing to my bad temper, and boundless narcissism, it may well be that I decided to retain some of my most beloved errors. They are not to blame for this, and should instead be praised for their patience!)