Greece Should Ponder the Benefits of Devaluation

February 27, 2015 3:30 PM

Standard economic theory suggests that currency devaluation is a significant boon for export competitiveness and economic growth after a crisis. Although a direct devaluation is not available to Greece as a member of the euro area, the government in Athens should be considering other paths to that goal.

Examples of such actions can be found not far from Greece's borders. On February 21, the Central Bank of Azerbaijan set the local currency (the manat) at 1.05 to the dollar, thus reducing its value by 25 percent in one stroke. The impetus was falling oil prices and the need to strengthen export competitiveness. Kazakhstan, the main regional rival to Azerbaijan in terms of oil exports, made a similar move last year, devaluing its currency, the tenge, by 19 percent. Armenia and Georgia, Azerbaijan's neighbors, maintain flexible exchange rates and have seen their currencies fall by about 20 percent against the dollar this year.

Further away, it has often been argued that this tool was used by East Asian governments during their growth miracle years. Similar claims have more recently been leveled at China. The logic is that the price of local resources falls, making exports cheaper.

The devaluation tool was also used successfully by Poland during the euro area crisis. Its currency, the zloty, devalued more than a third in 2009, helping the economy grow throughout the crisis years. In fact, the Polish economy was the only European economy to record positive growth during 2009–13.

Too bad that Southern European economies like Greece cannot use devaluation to their competitive advantage. Being part of the euro area, they do not have their own monetary policy and rely on the European Central Bank instead. Most macroeconomists would agree that Greece would have had an easier time going through the euro area crisis if it could devalue. To some, this reasoning led to the logic of Greece voluntarily exiting the euro area, although that option would have brought more problems than it would have solved.

There are two other mechanisms through which devaluation could occur, but both are more painful and less efficient than the currency (so called external) devaluation. One way is to simply reduce wages, thus achieving lower prices of domestically-produced goods and making them cheaper abroad. This is easier said than done. Wages are notoriously sticky, and even the wage cuts that Greece accepted have already brought protesters to the streets. Greece reduced wages of public-sector workers in 2010 and again in 2012 and endured months-long strikes. The new Syriza government has just started to undo these measures, with pledges to increase wages to precrisis levels.

The other mechanism to achieve internal devaluation is through tax policy—by reducing taxes on labor and increasing consumption taxes. Reducing taxes serves to reduce the overall cost of labor and hence production. It also encourages firms to look for other markets, as higher consumption prices at home reduce demand. Several European countries tried this, including Italy under Prime Minister Mario Monti in 2012—with some success.

These options are set before the new Greek government. So far it has chosen to put all its energy into renegotiating its rescue package with its main creditors, without making significant headway. Perhaps it could better use its time by studying what other countries have done in similar circumstances to encourage growth. Standard economic tools apply to Greece as well.

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Simeon Djankov Senior Research Staff

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