Amartya Sen and the exchange rate conundrum
It reads very much like an after-dinner speech: nothing too weighty in terms of facts and figures, some pleasing-on-the-ear intellectual history references for the bankers to peddle as their own at thier next dinner party (including a welcome reminder of Keynes’ grounded adversary, AC Pigou), and a gentle-enough pre-Cognac conclusion along the lines that someone, really ought to get a proper grip on the “policy challenges” facing Europe, though probably not tonight in a big hotel in Switzerland, as it would upset the ambience.
Nevertheless, there is a good deal of sense in the central part of the speech, in which Sen focuses on the seemingly intractable economic imbalance between North and South within Europe (my emphasis throughout):
There is nothing particularly surprising about the problems of balance of payments and other economic adversities that many of the European countries––Greece, Spain, Portugal—have faced, given the inflexibility of the euro zone restrictions on exchange rate adjustment and monetary policies. The consequent crises and rescues involving demands for draconian cuts in public services have also frayed people’s tempers on both sides of the divide…..
[M]ost of the attention has tended to be concentrated on the shortrun survival of the euro, through providing liquidity to the troubled countries, by one means or another. Many alternative rescue efforts are being considered right now, such as new bailout packages helped by the financially stronger countries, or the floating of guaranteed euro bonds, or the purchase of Greek, Spanish, and other high-interest bonds from troubled countries by Germany (thereby earning high interest, without much risk, so long as the euro survives in its present form).
Many of these “rescue” proposals are certainly worth considering and may prove useful, but none of the proposals address—or are meant to address—the long-run viability problem arising from the inflexibility of the exchange rate through the shared euro, even as countries with relatively lower productivity growth (such as Greece and Spain and Italy) fall behind other countries in the euro zone in terms of competitiveness in trade. A country such as Greece may find that it has increasingly less it can sell abroad at the fixed exchange rate of the euro, unless what is not done by exchange rate adjustment is brought about by the brutal process of cutting wage rates—even in terms of the national currency—to an extent that would not be otherwise necessary.
In the absence of exchange rate adjustments, competitiveness for the countries falling behind can indeed be recovered through sharp wage cuts and other ways of cutting earnings, thereby reducing living standards more drastically than would be otherwise necessary. This would yield much extra suffering and an understandable resistance. There would also be political resistance to the other “solution” through increased migration of the population—for example, from Greece to Germany. A unified currency in a politically united federal country (such as in the United States of America) survives through means (such as substantial population movements and significant transfers) that are not available to a politically disunited Europe. Sooner or later the difficult question of the longrun viability of the euro would have to be addressed, even if the rescue plans are completely successful in preventing a breakdown of the euro in the short run.
All of this, it seems to me, circles the key point nicely, but without addressing it.
If, as Sen tells us three times, the major problem is exchange rate inflexibility, then perhaps we should do something about it, rather than fannying about with measures to counteract its effects – measures which in any event Sen concedes politically and socially unacceptable.
Now, keeping the euro AND creating exchange rate flexibility doesn’t exactly work, as two or more euro rates simply mean we get two currencies which happend to be called the same thing.
But there is an alternative: the ‘artificial’ devaluation of economies within the euro through the introduction of mutually agreed export subsidies and import tariffs, which allows those countries with relatively poor trade balances to improve them through increased exports (including via limited inward investment based on these export advantages) and through import substitution processes.
Of course the immediate reaction will be that such an arrangement would breach the free trade tenets of the Single Market, and effectively negate the value the European Union/EEA as a trading bloc.
As I set out here, however, that’s not actually the case; Article 32 of the Lisbon Treaty allows wiggle room on the ”prohibition” of “duties on imports and exports and charges having equivalent effect” in cases where there is a need to:
avoid serious disturbances in the economies of Member States and to ensure rational development of production and an expansion of consumption within the Union.
If events we’re witnessing now in Europe aren’t serious disturbances in need of a whole lot of rational development, then I don’t what events are.
The unthinkable about the Single Market needs to become the thinkable. (After all, restriction of movement within the EU, the other key principle underlying the Single Market, has suddenly become thinkable again.)
Amartya Sen at least pointed out main obstacle to euro viability in his recent speech. Now we just need to move that obstacle.