Dani in the middle

Posted: 9 June 2012 in Uncategorized
Tags: , , , ,

Dani Rodrik locates himself in his customary position, smack dab in the middle, straddling the two sides of the mainstream debate in macroeconomics.

On one side are the right-wing neoclassicals, such as Christine Lagarde, who extol the virtues of austerity policies in Latvia.

“Latvia decided to bite the bullet and instead of spreading the pain over a number of years, you decided to go hard and to go quickly,” Lagarde said. . .

“The achievement was incredibly impressive: in the first year of the programme Latvia implemented fiscal adjustment – in one year alone – of 8% of GDP,” she noted of Riga’s biting austerity drive. This was part of a 2008-2009 €7.5 billion IMF-EU bailout.

On the other side are the liberal Keynesians, such as Paul Krugman, who have been criticizing the “internal devaluation” imposed in Latvia.

it’s remarkable what passes for success in these discussions:

IMF World Economic Outlook database

Wow, we’ve trimmed a more than 20 percent decline in GDP to around 15 percent.

Then, there’s Dani in the middle:

Even though Latvia’s external imbalance was eliminated, it is not clear that there has been a sizable improvement in competitiveness.  The much vaunted internal devaluation has been small. Wage cuts have been mostly in the public sector, where they don’t really help with export competitiveness.  Private sector wages have been surprisingly resilient.  As the next chart shows, the unit labor costs-based measure of the real exchange rate has come down (depreciated) only moderately, following a huge rise over 2004-2008. Consequently, it is not at all clear whether Latvia has regained sufficient competitiveness to sustain growth without running sizable external deficits yet again.

To an outsider what is the most striking aspect of the Latvian experience is the relative absence of political conflict and social strife during what must have been a catastrophic economic crisis. . .

The main lesson I take from all this is the need to avoid easy generalizations that do not respect country peculiarities. Fiscal austerity missionaries are surely off base when they say Latvia’s experience decisively proves Keynesians and advocates of currency depreciation wrong.  It is too early to judge the Latvian experience a success.  But it is also too early to say Latvia has been a failure.  Growth may continue, in which case the country will look better and better.

On one hand, on the other hand. Too early to call it a success and too early to declare failure. Dani’s role is to cement the two sides of the mainstream debate. Mainstream macroeconomists disagree on the policies, in Latvia and elsewhere, but they all agree on the goals: economic growth, price stability, and balance of payments equilibrium.

They also agree on avoiding the alternative. As middle-of-the-debate Dani explains,

The real secret of their success is that they did not have a revolution on their hands.

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