As its crisis continues, more and more people are calling for Greece to follow the Argentine 2001 example and devalue its currency. This would imply leaving the euro and returning to the drachma, followed by a series of bank runs and capital controls to prevent capital flight. But, crucially, devaluation is supposed to cause a boom in Greek exports and sustain investment-led growth.
It is easy to understand why so many find this an attractive solution – a simple causal effect implies that cheaper currency will lead to lower prices of domestic goods, meaning that foreigners will want to buy more of them. Another immediate effect would be a decrease in the value of domestic wages in terms of foreign currency, making domestic workers more competitive on international markets.
However, there are many other indirect consequences that are likely to crowd out any positive effects of currency devaluation. The Greek people and businesses were, just like the Greek government, running high debts and used them to fuel their consumption before the crisis. A decrease in the exchange rate would imply higher interest payments in drachmas for all those with outstanding euro-denominated loans with the banks, leaving households and businesses with less disposable income. As a response to this effect the labour unions may negotiate higher domestic wages in terms of foreign currency (the euro) which will hinder the devaluation effect on wages, thereby undermining the increase in competitiveness. Besides, Greece needs to liberalise its labour market if it wants to make its workers more competitive on the international market. No currency devaluation will resolve the deep structural problems of the labour market, no matter how competitive it seems due to cheaper currency.
Nevertheless, many pundits claim that devaluation is the only possible path to a full recovery, citing the evidence from Argentina’s rapid growth in 2003 and 2004. However, they tend to overstate what really happened with the depreciation of the peso in Argentina and the real effects of the Argentine Corralito.
For those who don’t know, the Corralito was the name for a series of measures initiated in Argentinain 2001 to prevent capital flight and bank runs. It allowed for small sums of cash to be withdrawn on a weekly basis, but only in pesos (all dollar denominated currency could only be withdrawn if converted into pesos). When the depreciation was made, the peso-dollar exchange rate dropped from 1:1 to 4:1. But, while the new exchange rate was in place the people could only exchange their dollars for pesos at an old exchange rate, meaning that in one go Argentina effectively reduced the nation's savings by three quarters! Anyone with $100 in savings all of a sudden found themselves with $25. Needless to say this helped debtors but at the expense of savers, private companies and taxpayers. It had a huge negative impact on the nation's wealth.
What Argentina needed then and what Greece needs now is proper institutional reform, based on, above all, achieving political stability. This will be extremely hard to achieve, but in the case of Greece there are no short-term answers – only long term ones.
Besides, focusing on depreciation to reduce real wages and stimulate exports is a temporary measure that will only hide the need for institutional reform, just as it did in Argentina. And, the last time I checked,the Argentines are still suffering. Argentine depreciation is no case study for Greece - or anyone else for that matter.