Thursday, 13 January 2011

Krugman's prescription for saving Europe

Tom McDonnell: Following on from Citigroup analysis of the Euro debt crisis earlier this week, here is an excellent analysis by Paul Krugman.

Krugman runs through the four possible scenarios for Ireland. He predicts that Ireland will ultimately have to restructure its debts. The four scenarios are:

1) Toughing it out – the current plan. Very harsh fiscal austerity to achieve internal devaluation and restore competitiveness, with accompanying depression level hits to output and employment.
2) Debt restructuring. Krugman sees debt restructuring, in conjunction with toughing it out, as being the likely scenario for Ireland.
3) Full Argentina – the nearest European equivalent being Iceland. The default and devalue combination.
4) Revived Europeanism – going down the transfer union path. The E-bond proposal would be the first step in this direction.

Krugman sees the internal devaluation strategy as a recipe for years of depression. According to Krugman the European currency union project is doomed to failure unless it also becomes a full transfer union.


Slí Eile said...

@Tom This is an important contribution by Krugman to the situation in Europe. There needs to be a much wider discussion on the options including European level convergence in regard to how to deal with these issues. In the way Krugman has framed the questions it appears like a one option solution from an available four. In practice it may be a combination of all four including much closer fiscal scrutiny and oversight from the European centre along with debt-restructuring. The possibilty of a Euro breakup (at least into two currencies) is not ruled out either. Some measure of cooperation and coordinated fiscal stimulus at European level is needed I think including the option of a Euro-bonds and national sovereignty bonds to tap into the huge level of domestic savings as consumption has taken fright. It seems to me that the present strategy of bleeding the Irish taxpayer dry to pay off foreign banks will not work - and if the national authorities that dominate the European political agenda have sense they will revise the programme to allow for more time and more leeway. after all having a collection of long-term slums on the periphery just doesn't do anything for investor confidence and intra-EU export markets. In the meantime, the days of fiscal dumping are numbered.

Brian McLoughlin said...

Krugman’s article is about the euro crisis and the possible consequences for Europe. Our situation in Ireland is a key aspect of his analysis.

Yes, we are following the ‘toughing it out’ option. We have a ‘recovery’ plan agreed with the EU/IMF, to bring about an ‘internal devaluation’ using savage and unjust measures, reduce the deficit to 3% of GDP and enable Ireland to return to the markets for funding. However, people increasingly realise that the plan will not work and that most likely we will at least default on debts incurred by the banking system. In the improbable event that the plan ‘succeeds’ we can expect to endure long term stagnation, persistently high unemployment and levels of indebtedness that will blight the lives of generations. Krugman thinks Ireland will probably have to default, Willem Buiter, TASC and others think so, and, based on current yields on Irish debt, the market gods think so. Topping all of this, it appears the plan’s backers, the EU and IMF, think so too. They are now projecting Irish growth rates that are significantly below those contained in the plan, making it non-viable.

Based on these conjectures the plan amounts to no more than an attempt by Ireland, the EU and IMF to ‘kick the can down the road’, as economists are fond of saying these days, apparently to buy time to plan further measures to deal with the crisis and to give major European banks an opportunity to strengthen their balance sheets. Shamefully, the EU will turn a profit at our expense while fully aware of the needless hardship innocent people will suffer. Our own government’s role is shameful too, for its incompetence as well as its moral bankruptcy.

The plan to ‘tough it out’ will lead us over a cliff and we need a radical change of direction. Such change should be one of the options open to the electorate during the upcoming election. However, the two government parties and the two leading opposition parties are committed to reducing the deficit as planned, though with differing proposals as to how the pain is to be shared. Remarkably there are no proposals to deal with a probable default. In this context the prospects for serious debate on the radical options necessary to rescue our economy and build a more equitable society appear to be limited.

Slí Eile said...

@Brian Very well put.
Hear, also, interview with Kevin O'Rourke on VoxEu

Paul Hunt said...

I have made the point previously that the EU/IMF deal is economically damaging, but politically unavoidable. (Those who advocate default or withdrawal from the Euro have simply not thought through the full implications of these decisions.) Rather than railing about the economic burdens it imposes - and making wild claims about what we would, and could, do if these burdens were alleviated - my case is that it would be far better to make the most of what we have within these constraints. While the prospect of doing a deal or pulling a stroke exists it allows those who capture rents and impose deadweight costs to defend their ill-gotten gains and to avoid the reform and restructuring that is required to lift the performance of the domestic economy and to tackle the serious unemployment problem. This is where our focus should be.

And we must also recognise that, in the eyes of our peers, Ireland has lost the ability to govern itself responsibly. Through-going political reform is a sine qua non if we are to regain the exercise of national sovereignty that is consistent with responsible membership of the EU.

Brian McLoughlin said...


In my case it is not that I am an advocate of default, it is that that I think that at least a default on bank debt is probable if we persist with this damaging deal.

Bad as our position is I know of no reason to think it is irrecoverable. Therefore it must be possible to produce a plan to recover the economy, create jobs and restore our finances. Furthermore, there must be a variety of feasible plans, with different risks, timescales and ideological underpinnings. Some may avoid a default, others may provide for default, with the implications fully addressed.

Given that a feasible plan is produced it is difficult to understand how a damaging deal that will not work is politically unavoidable. Unless, perhaps, the EU is irresponsible?

Paul Hunt said...

@Brian McLoughlin,

I don't think the EU is being irresponsible. I suggest you track the debate on The progressive-left is rapidly becoming irrelevant. It has a good case to make, but it is compromised by its defence of the insiders who block the reforms that are required to lift economic performance and to tackle the real crisis - unemployment.

This conversation with Eric Hobsbawm is emlightening:

Those at the top level of the capitalist system have perfected the technique of subborning the stste and exercising politcial power to make money and nothing else. The goods and services their firms produce are irrelevant; it's the amount of money they make that matters.

Those who exercise authority and influence on the progressive-left have supped at the capitalists' trough and have gained some limited benefits for the 'lower orders'. But they have taken a liking to the swill and are loath to forgo their share - even if there is less to go around and the trough needs to be re-designed.