There has long been argument over whether the European Union constitutes what economists call an “optimal currency area”. The worsening economic conditions in the state are bringing the arguments against into sharp focus. Ireland has for long suffered wage inflation higher than the rest of the current monetary union. This increased the purchasing power of Irish consumers, and intially brought prosperity. Meanwhile, the country’s competitiveness was suffering as it became a more expensive place to do business. This is the major source of Ireland’s current employment crisis.
Under normal circumstances, governments would initiate a devaluation of the currency. Indeed, the problems which can result from ill-advised harmonisation of monetary policy were seen in 1992 when George Soros attacked the value of Sterling, eventually forcing devaluation. The economy, which had been suffering recession and high unemployment, then rallied as it became a better place to do business due to lower costs.
Unfortunately, the Irish Government today has no such means at their disposal. The European Central Bank has no intention of allowing sufficient devaluation. In any regard, Ireland would still have substantially higher wage rates than the rest of Europe and economies which have currencies tied to the Euro. Since wage costs cannot be decreased through currency exchange rate changes, they must fall of their own accord. This can only be brought about by a painful period of high unemployment. The beginnings of this inevitable process can already be seen. Although there are means by which the government can ease the resultant interim harms, they are not taking advantage of them.
This is most evident in the recent budget released. It should first be noted that the imposition of higher taxes only serves to perpetuate higher wages, by decreasing the incentive for individuals to return to work and making welfare less unattractive than it might have been.
Meanwhile, the government has completley spurned ‘active labour market policies’, programs which help the unemployed to find work. The Back to Work Allowance Scheme will be soon closed to new applicants, as announced in the Supplementary Budget. This program creates incentives for those on welfare to take up employment, as they hold onto part of their payments for a while. Although it would appear that getting a job should be its own reward, the scheme importantly encourages people to get back into the labour market even if they have to accept a lower wage than they would have otherwise taken. As well as preventing the slide into long-term unemployment patterns, this has a depressing effect on average wage levels.
In the UK, the government grants subsidies to employers that hire people who have been unemployed for a long time. Although difficult to prevent abuse, this policy has similar effects. In most cases, these initiatives are efficient from the perspective of the tax-payer. In Germany, the government there has for long topped up the wages of workers who find their hours cut. This is less burdensome on the rest of society than these people going straight to welfare, motivated by the inability to support themselves on their current wage.
In the UK, private work-to-welfare companies are paid fees by the government if they successfully bring claimants back into the labour market. Similar intiatives could be applied to the Irish context. This minimises search costs for the unemployed, and makes the labour market more efficient. If not feasible, the government could take on this role through invigorating job search assistance schemes which are under-funded and over-worked in the current climate.
Not all of the policies will be as worker-friendly. Given the increase in incapacity claimants during the boom years, it may be prudent for the government to initiate a revision of the checks and balances which prevent welfare fraud, or even reclassify those who are currently committing it – an increasingly attractive racket in these recessionary times.
Similarly, it may be necessary to reduce the time that can be spent by workers on social welfare. This would force people back to work, rather than allow them to subsist on hand-outs from the government. It is consistent to believe that unemployment benefits should be less generous, in absolute terms and in temporal terms, during harsh ecnonomic times. It’s likely that such measures would be politically unpopular and would be exploited by the opposition. Nevertheless, it would have a depressing effect on wages and force workers to come to terms with the limited economic opportunity that they will have to endure for some time. It remains to see if the current government has the leadership and political capital to institute such measures.
In the long-term, the most generous active labour market policies will have to be abandoned. Ireland has for long benefited from flexible labour markets. They will precipitate the restructuring that will be necessary to return to economic growth and compete in the global economy. Meanwhile though, the assymetric costs imposed on Irish society can be alleviated, and the burden on the taxpayer can be minimised in unexpected ways.
First published as “Wage cuts not only inevitable, but desirable” in Trinity News (21st of April, 2009).
© The Free Marketeer 2009