Blanket austerity across the crisis-hit countries of the eurozone was self-defeating. Germany’s analysis of what needed to be done was wrong. The European Central Bank (ECB) was slow to come up with a stimulus package designed to offset the demand-sapping impact of wage cuts.
Those were the main messages of an important International Monetary Fund (IMF) intervention into the debate about how the eurozone should have responded to the problems that affected five of its members – Greece, Ireland, Portugal, Spain and Italy. This quintet accounts for 30% of eurozone output.
The traditional IMF cure for a country in trouble is a solid dose of structural adjustment – tax cuts, privatisation, reforms of the labour market – designed to make the domestic economy more efficient, coupled with a devaluation that makes exports cheaper and imports dearer.
This recipe was obviously not available to countries inside the eurozone because they all share the same currency. Instead, the recovery plan involved internal devaluation, making an economy more competitive through a reduction in costs. Given that pay is the biggest element of these costs, it requires wage cuts – and thumping ones at that.
The IMF paper asks whether this policy actually works. Its conclusion is that if a single country cuts wages, the effect is positive both for that economy and for the eurozone as a whole.
But if five countries adopt the same strategy at once, there has to be action from the central bank to offset the demand-sapping wage cuts. Put simply, if millions of workers across Europe have less money in their pockets, they will consume less. That will affect their own economies and the economies of other non-crisis eurozone countries that export to them.