Finland's Problem Is The Same As Greece's; Neither Should Be In The Euro As Krugman Says
Finland’s central bank governor, Erkki Liikanen, tells us that Finland is going to have to work hard to get through this current difficult economic situation. The country’s GDP is still significantly below pre-crisis levels and it’s likely to be a number of years before there’s a full recovery. But the real point behind this story is that it just doesn’t have to be this way. As Paul Krugman has been pointing out recently and as many others of us have been shouting for years. Finland simply should never have joined the euro, as Greece should not have. As, in fact, pretty much most of the current members should not have joined the single currency. Further, none of this is a surprise. It’s inherent in the very design of said currency, indeed it was pointed to by Robert Mundell, the man who worked out the economics of single currencies.
That it would all go wrong is exactly what the warning about the euro was. It is going wrong, has gone wrong, and for exactly the reason predicted:
Finland is in trouble, and in the words of the central bank this week, the situation is “grave”. While France has often been branded Europe’s “sick man” and Greece’s problems are well known, Finland’s economy is still 5pc smaller than before the financial crisis. The country will barely crawl out of a three-year recession this year, while unemployment is forecast by the OECD to grow in 2015.
Faced with a bloated state, below-par growth, and prices and costs that have risen at a much faster pace than the rest of the eurozone, the medicine is a familiar one.
What Finland has to do is have an internal devaluation. That is, it’s got to force down labour prices. That’s something that is difficult and something that can only be done with considerable economic pain. It’s also what Spain, Portugal and the extreme case of Greece have all also had to do. And the reason is that they’re in the euro. As Paul Krugman points out:
What’s going on? Well, in the case of Finland we’re seeing the classic problems of asymmetric shocks in a currency area that isn’t optimal. Finland’s two main export sectors, forest products and Nokia , have tanked; this creates the need for a sharp fall in relative wages to make up for the lost markets, but because Finland doesn’t have its own currency anymore this adjustment must take the form of a slow, grinding internal devaluation (which is, by the way, why the garbled discussion of wages turns the story into nonsense).
Krugman again:
Why can’t Finland recover this time? Debt is not a problem; borrowing costs are very low. But it’s all about the euro straitjacket. In 1990 the country could and did devalue, achieving a rapid gain in competitiveness. This time not, so that there is no quick way to adjust to adverse shocks………This shouldn’t come as a surprise; it’s the core of the classic Milton Friedman argument for flexible exchange rates, and in turn for the tradeoff at the core of optimum currency area theory. The trouble in Finland is what everyone expected to go wrong with the euro.
Krugman’s making exactly the correct point here. This isn’t something that’s taken us all by surprise. We knew this would happen. If a single currency area is too large then when an asymmetric shock hits then the areas badly affected by it must undergo that internal devaluation given that they can no longer devalue their currency. Both methods end up in the same place. Where labour is now repriced and is competitive again. Devaluing the currency takes a week and no one minds all that much. Internal devaluation takes years and requires substantial unemployment to grind wages down. This is not a right wing point by the way, this is pointed out by Keynes in his noting that we really, really, don’t like declines in nominal wages. It’s the major insight at the heart of New Keynesian theory, those sticky prices, that wages are sticky downwards. But if both methods get us to the same place, one is easy and one is hard, then why on earth have we all ended up with this single currency that forces places like Finland to do it the hard way?
Quite. The eurozone is simply too large, too many countries joined the euro, countries that really should not have. And as above, this isn’t a surprise. The euro is failing and it’s failing for exactly the reason that we all said it would. It’s too large a currency area to be optimal.
forbes
