Over the past couple of months, there have been unprecedented levels of interest in Greek economic affairs and the likely impact they might have on the entire euro project. Among those smirking from the sidelines have been those in the UK who have always looked on the euro project with scepticism and who point to the current fiscal difficulties within the eurozone as proof, if it were needed, that the UK did the right thing in not joining the euro.
Having your own currency decisions and your own interest rates decisions, this conventional wisdom suggests, is just what macroeconomic policymakers need when a once-in-a-lifetime economic crisis comes knocking.
There is another way to view this, though. Countries like Ireland and Greece would, in previous decades, have taken a look at their debts and deficits and decided there was nothing for it but to devalue their currency and start all over on the growth cycle. And there’s no denying that competitive devaluations played a large part in Ireland’s economic successes after 1987. However, there is downside to pulling that trigger: it severely reduces the need to address the underlying problem, namely the government’s errant spending path.
In other words, the eurozone gives countries like Ireland and Greece something new and highly desirable – the (almost) irrevocable clarity of purpose to keep proper control of public finances. Other countries with similar boomtime growth stories but with their own currencies still don’t have this purpose of mind. For example, with Ireland and Greece pulling out the stops to get their deficits back to 3% by 2013/14, the UK has much more limited aims: a deficit perhaps twice that size by the same time.
This is not just pointless picking on the UK either. Sometimes it’s easy to forget in all this talk of PIGS but the UK government finances are in a very shaky position and, with no annoyed Germans on the other side of the table, do not look like improving any time soon. Four points:
- The UK’s fiscal deficit is projected to be larger than any PIGS country both this year and next. (For those curious, Ireland [not Greece] takes second place.)
- Linked to this, the UK will move into the developed world’s heavily indebted club pretty quickly, while interest payments on national debt will be larger than Spain, Portugal or Ireland by next year. (Its gross debt will be between Ireland and Portugal next year, the OECD estimates.)
- Government spending as a proportion of the economy is rising faster than any other developed country apart from perhaps Finland.
- Lastly, assuming they stay safe within their currency union, Ireland, Spain and Portugal are expected to undergo competitive devaluations (through consumer price channels). Like Sweden, through higher inflation, the UK will pay the price for having its own currency.
Various different indices exist giving an insight into pressures on particular countries and currencies. I’ve taken four key state finance metrics, deficit, debt, interest payments and total government spending (all as % of GDP), and using OECD projections ranked 24 developed countries in terms of both where they will be in 2011 and how much they’ll have changed between 2007 and 2011, eight metrics in total. To these, I’ve also added three macroeconomic variables from the European Commission’s detailed economic forecasts: GDP growth, unemployment and inflation.
Taking the simple rank in each of the 11 metrics as that country’s score, the sum gives each country a number between 0 (top rank on all metrics) and 253 (worst rank on all), which is then normalised into a number between 0 and 100, a higher number representing a worse state of government finances, taking into account the health of the economy. The result is below, with the “two-Ied PIGS countries” in red and their eurozone neighbours are in blue.
Some pre-emptive methodological comments:
- Australia, New Zealand, Canada and Korea are omitted due to their exclusion from European Commission projections.
- Current accounts are not included because they reflect many things and this is essentially a measure of Government finances, not private finances.
- Composite indices like this are a function of what goes in – in particular here, ranks hide gaps between, say, 19th and 20th placed countries.
- The inclusion of the level of Government spending in 2011 as a variable is of course potentially ideologically charged. Then again, more than likely so are bond markets.
The UK saw its currency depreciate strongly in late 2008 (see graph to the right). As an adjustment, though, that marked the start rather than the end, because it threw purchasing-power parity between the two currency areas out of whack.
With the UK as a major reserve currency worldwide, further devaluation and inflation (i.e. making foreigners and children pay) does not seem an ideal solution to its economic woes. Instead, it should look to take the bull by the horns and bringing back into balance tax receipts and public spending.
Having its own currency may have spared the UK the full wrath of the bond markets so far, but in allowing deficits and debt to grow, it may turn out to be a curse-in-disguise.