Fiscal devaluation without wage growth will trigger bad side effects both at home and abroad.

Fiscal devaluation without wage growth will trigger bad side effects both at home and abroad.

“Restoring competitiveness via structural reforms,” as the mantra goes, has in practice been a policy not so much geared toward creating productivity gains but rather designed to pursue wage and price reductions to boost exports. When these nominal or real reductions in wages were difficult to secure politically, they were replaced by fiscal devaluations, shifting taxes away from labor toward indirect taxes. It’s a policy that mimics an exchange-rate devaluation by modifying relative prices.

In effect, Europe has replaced the competitive exchange-rate devaluations of the 1970s and 1980s with wage compression and fiscal devaluations within the euro. The result is a policy race to the bottom that spreads deflation inside and outside the euro area. Even a country like Finland, which stands at the top of every competitiveness and ease-of-doing-business indicator, has now convinced itself that the best way to lift itself out of a three-year recession is to restore price competitiveness through a reduction in hourly wages.

The collective effect of this policy weighs heavily on aggregate demand and fuels deflationary forces. It also undermines the European Central Bank’s objective of achieving 2% inflation through low interest rates and purchases of sovereign bonds and other assets.

current-account surplus


The European Commission’s macroeconomic-imbalances procedure, which was established during the crisis to allow the better coordination of national economic policies, has so far been a failure. It has proved ineffective for spotting excessive deficits and impotent in confronting excessive surpluses.

The eurozone needs to address its internal and external imbalances more seriously. This can’t be achieved by fiscal consolidation, structural reforms and devaluations. It has to involve not only fiscal expansion in countries that can afford it most, but also a sustained rise in wages across the euro area to boost domestic demand.

The inability to do so is no longer simply a problem for the euro-zone itself. It’s a matter of global relevance. The eurozone’s current-account surplus is now 3.7% of GDP, the largest in the world in absolute terms, and it’s expected to remain at such elevated levels over the next few years. A possible new round of monetary accommodation by the ECB could increase it even further.

Indeed, a depreciation of the euro would only be expansionary for the whole world if the effects on domestic demand and financial conditions in the euro-zone were greater than the contractionary side-effect of appreciating other currencies in the rest of the world. Yet monetary policy alone, at least in the near term, won’t be able to countervail the demand-suppressing consequences of lower wages and debt deleveraging.


The debate on the degree to which Europe’s policy failure has become a global one hasn’t really started. The International Monetary Fund and the G-20 statements remain too kind and international pressures too limited.

Since the height of the crisis, the matter of global imbalances has receded and international coordination on the matter has declined. The IMF expects the U.S. current-account deficit to have shrunk by nearly half compared to 2007 levels. China’s slow rebalancing has brought the current-account surplus down to 3% of GDP from 10%.

Meanwhile, the U.S. and China seem to have found at least a transitory monetary peace, a pax chimericana: the U.S. government will agree to China’s newly created Asia Infrastructure Investment Bank and entry into the IMF’s special drawing rights basket of currencies, while China will try to maintain a relatively stable currency to prevent another round of rapid appreciation of the dollar.

This policy coordination between the world’s two leading economic powers seems far more developed and effective than what’s happening within the G-20 and surely within the euro-zone. And yet, the case against the eurozone’s macroeconomic policy is unlikely to be made effectively at the forthcoming G-20 summit in Turkey because it is politically charged and directly linked to the dysfunctional governance of the monetary union.

In Europe, there hasn’t been a meaningful discussion on macroeconomics since ECB President Mario Draghi’s Jackson Hole speech last year. The fiscal question remains largely taboo, and the policy consensus is that economic reforms and currency devaluation can somehow kick-start and sustain the recovery. Both the empirical and theoretical evidence suggest the opposite.

economic reforms

The euro-zone and its member states can’t continue to behave as if they were a small, open economy. It’s a mistake for the G-20 to let the eurozone continue to free ride and undermine the increasingly fragile global recovery.

Mr. Vallée, a former adviser to the French economy minister and the president of the European Council, is a senior economist at Soros Fund Management LLC.

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