Pointless Pain In Spain, by Paul Krugman, in NY Times: It’s no fun being Prime Minister of a debtor nation without its own currency. Unlike the US or the UK, Spain has no easy options.
That said, the new austerity measures just announced make no sense at all.
According to news reports, Rajoy has announced 65 billion euros of tax increases and spending cuts; this will clearly deepen Spain’s depression. So what purpose will this serve?
Think of Spain as facing a three-level problem. The topmost level is the problem of the banks; set that aside for now. Below that is the problem of sovereign debt. What makes the debt problem so serious, however, is the underlying problem of competitiveness: Spain needs to increase exports to make up for the jobs lost when its housing bubble burst. And it faces years of a highly depressed economy until costs have fallen enough relative to the rest of Europe to achieve the needed gain in competitiveness.
So, what do the new austerity measures contribute to the solution of these problems?
Well, Spain’s deficit will be smaller. Not 63 billion euros smaller, since the further depression of Spain’s economy will reduce revenues; say it’s 40 or 45 billion euros less debt, which is around 4 percent of Spanish GDP. Does anyone think this will make a big difference to the long-run fiscal outlook, or restore investor confidence?
What about competitiveness? Let’s be frank and brutal: the European strategy is basically for debtor nations to achieve relative deflation via high unemployment. Think of it in terms of a Phillips curve:
I’ve drawn this curve very flat at high rates of unemployment – which is what all the evidence suggests. If nothing else, this crisis has given us overwhelming evidence that downward nominal wage rigidity is real and a major factor.
Now think about what Spain is doing: basically, it’s moving from A to B – driving its unemployment rate even higher. This will possibly lead to a slight acceleration of the improvement in Spain’s competitiveness. Maybe. But it won’t be significant.
So, Rajoy is imposing harsh further austerity that will raise unemployment while making no significant dent in either the fiscal problem or the competitiveness problem. And this makes sense why?