Devalue Now
Devaluation could give a significant boost to profitability output and employment in the open sectors of the Irish Economy.
In recent times there has been some considerable discusssion by both businessmen and economists on the merits or demerits of currency devaluation as a policy option in our present difficult economic climate. The general consennsus seems to be that a devaluation would have very little real beneficial effect on the economy and would lead, fairly quickly, to a higher rate of inflation. The farmers seem to be the only major group in favour of currency depreciation. This article puts forward some arguments and evidence that suggest the devaluation option should be considered serioussly - without, of course, maintaining that it is a painless panacea for all our economic ills.
From the middle of the last century until near the end of the 1970's the Irish currency was linked on a one to one basis with the pound sterling. In the postwar period up to 1971 this fixed exchange rate with the United Kingdom also implied reasonable stability against other currencies, as international exchange rates generally were fixed and only occasional discrete parity changes took place.
During the nineteen-seventies, however, international exchange rates were floating and sterling was weak on the international exchanges. The one for one link therefore implied that the Irish currency was generally soft - partiicularly against some of the European currencies. For exammple in 1970 the Irish pound/OM exchange rate was around 8.70. This compares with a current rate of around 3.50.
In March 1979 the European Monetary System (EMS) was formed and the Irish decision to join while the United Kingdom opted to stay out inevitably lead to the break in the long-standing link with Sterling at the end of March 1979. It was real Irish luck that having maintained the exxchange rate against sterling during all the years of extreme weakness we broke that link just at the point where the U.K. currency was about to stage a significant recovery in the international exchange markets.
The period of existence of the EMS has been one where that bloc of currencies has been weak against the other major currencies. Thus Irish exchange rate policy has continued to be a weak exchange rate policy. Since the forrmation of EMS the Irish currency has depreciated by 20 per cent against sterling, by over 25 per cent against the U.S. dollar and by over 15 per cent against the Japanese Yen. Within the EMS however we have pursued a rather aggresssive policy. Table 1 gives the figures.
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Table 1 : Irish Central Rates in EMS (units per IR£)
Start Now Percentage
of EMS Change
Deu tschemar k 3.7889 3.5209 -7.1
French Franc 8.7503 9.0210 +3.1
Dutch Guilder 4.1060 3.8919 -5.2
Italian Lira 1732.70 1900.31 +9.7
Belgian Franc 59.5471 65.0762 +9.3
Danish Kroner 10.6935 11.9159 +11.4
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We have appreciated against all but two of the currenncies in the system. Against the Italian, Belgian and Danish currencies the appreciation, at around 10%, has been subbstantial.
In examining the impact of these exchange rate changes most economists have relied on the Small Open Economy (SOE) model. Briefly, this contends that Ireland is a price taker on world markets and that the Irish rate of inflation will equal the world rate plus (or minus) any currency depreciation (appreciation). It also contends that the Irish labour market fully and quickly builds in any increase in the inflation rate into the wage bargaining process. Thus it is contended that a devaluation will quickly be reflected in Irish price and wage levels and will have no impact on the real economy.
While not contesting the validity of this argument in the long-run I wish to present some evidence which suggests that the adjustment is not nearly as quick or as smooth as is generally implied. Table 2 gives figures for inflation rates.
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Table 2: Rate of Inflation of Consumer Prices
(1981-1978)
Local Currency IR£'s
Germany 16.4 23.2
France 42.9 41.3
Holland 18.4 21.8
Italy 66.3 48.0
Belgium 20.3 21.4
Denmark 34.2 23.7
United Kingdom 49.7 87.2
U.S.A. 36.8 62.6
Ireland 61.2 61.2
Table 3 : Unit Wage Costs 1978-1981 (% Change)
Local Currency IR£'s
Germany 16.1 22.8
France 37.1 35.6
Holland 16.8 20.0
Italy 54.1 37.2
Belgium 18.6 19.8
Denmark 31.6 21.3
U.K. 54.3 ~3.3
U.S.A. 26.1 49.8
Ireland 53.7 53.7
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The figures given refer to the aggregate inflation rates in the three years 1979, 1980 and 1981. In domestic currency terms Ireland was second highest after Italy. The Irish inflaation rate was nearly twice as high as that in Denmark and nearly .three times as high as that in Belgium but yet against both countries the Irish pound has appreciated by around 10 per cent since we joined EMS. When account is taken of currency fluctuations and the inflation rates are exxpressed in a common currency (IR£'s) the Irish inflation rate is substantially in excess of all other EMS rates. The only country which has a significantly higher rate is the United Kingdom.
Few economists, including the present writer, would have predicted such a continued divergence of Irish and EMS price rises given the stability of the Irish currency in the system. The figures suggest that the size of the nonntraded sector in Ireland (i.e. the sectors not subject to foreign competition, at least in the short-run) is much larrger than had been appreciated. This is particularly so if one regards indirect tax increases as price rises for non-traded public services.
This higher .rate of inflation has seriously squeezed the exposed sectors of the Irish economy. The price increases which firms, trading in the international goods markets, have been able to obtain have been related to international inflation rates but their costs have risen in line with Irish inflation. We have seen too clearly the impact of these trends on profitability, plant closures and job losses. The figures for unit wage costs are in Table 3.
The picture is similar to that which emerged in the inflaation table. Apart from the U.K. Irish wage costs have risen substantially faster than in the other countries. Indeed developments in 1981 itself vis a vis the U.K. have reversed earlier trends. Since early 1981 the Irish pound has appreciated by nearly 10 per cent against Sterling and by the end of the year U.K. unit wage costs were rising at an annual rate of only around 2 per cent.
The conclusion therefore, is that because Irish labour and goods markets have failed to adjust to the strong currency performance within the EMS the open sectors of the Irish economy have been severely squeezed. The plight of the agricultural sector in this respect has been most commonly highlighted. However, in essence, the experience of the other trading sectors is no different. It has been argued that the situation is not as serious as it appears beecause the problems in the U.K. economy, our largest export market, were even greater (as is shown in the above tables). However, in reality this is of little comfort as we compete in the U.K. market not only against U.K. firms but also against other European, American and far-Eastern manuufacturers. In this respect the fact that we are last but one (rather than last) in the league is of little comfort.
The evidence suggests, therefore, that" a devaluation of the Irish pound would not be fully reflected inIrish prices and costs for some quite considerable time and for that period could give a significant boost to profitability, outtput and employment in the open sectors of the Irish econnomy. This is not, of course, to suggest that such a devaluaation is an easy painless way out of our present economic ills. These ills are a reflection of the fact that Irish expennditures are very much in excess of Irish incomes. Devaluaation will not reduce the need to bring incomes and expenn. ditures back into balance.
I would like to finish by mentioning the impact of deevaluation on the national debt. The view has been expressed that devaluation is not desirable because it would increase the real burden of the national external debt. This is a rather weird notion. These debts are denominated in DM's, Dollars etc. and have to be serviced and repaid in those currencies. Unless a devaluation reduces the nation's ability to earn these foreign currencies the real burden does not increase - regardless of the Irish pound value of it. Indeed the above arguments suggest that the country could inncrease its foreign exchange earnings (at least in the shorttrun) and thus reduce the real burden of the foreign debt through a devaluation. •