Interview. Austerity Is Useless. Interviewed by Mauro Lacentini. Epoca (Milan), 27 October 1976), pp. 28 30. English translation by Maria Torchio. Epoca: I have the feeling that Italy is no longer happy with the agreements which have followed Bretton Woods, particularly those concerning flexible exchange rates and the sale of gold by the IMF. The impression is that floating rates are the cause of the present inflation and of the drop in the value of the lira. As far as the sale of gold is concerned, it decreases the value of one of the few goods Italy has, which is its gold reserve. What is your opinion on the matter? Friedman: Both these objections are unfounded. The idea that the devaluation of a currency is the cause of inflation is false: it is like putting the cart before horse. What causes depreciation are internal inflationary pressures which manifest themselves in depreciation. That is, depreciation is the effect, not the cause of inflation. If instead of floating there were fixed rates, instead of depreciation there would be an accumulation of pressures leading to a sudden crises and to a concomitant explosive devaluation. Floating rates dramatize internal problems before they erupt forcing the country to try, at least, to solve them. Epoca: why has floating not solved any problem in Italy? Friedman: The point is that there has never been a floating system in Italy because of the continuous Government intervention. There has been a dirty float. The Italian Government, by intervention, has maintained for a long time an artificial exchange rate and the result has been that you find yourselves in the same position as if there had been fixed exchange rates. You have not been courageous enough to let floating work and now you bear the consequences. 1
Epoca: Even considering this as a response to a dirty float, our lira has devalued by 1/3. The belief was that such devaluation would have increased our exports, by reducing our prices abroad, and hence stimulate the economy. However it is clear that our exports are not increasing at all because the other countries are also in crisis. Even countries like USA or Japan are undergoing a period of stagnation and don t import. How would you explain this. Friedman: The idea of a recovery based on exports resulting from devaluation is nonsense. You have to look at the reason why a currency depreciates or is depreciated. If devaluation takes place without any particular reason, suddenly, while the economy is in perfect equilibrium and without problems, then certainly exports jump due to a lowering of the price abroad. A country devaluates because its currency and its prices are not in line with those of other countries. The characteristic pattern of what happens is the following: a country Italy for example allows an internal inflation greater then the one prevailing in the rest of the world. At the same time it keeps the exchange rate artificiously high. The consequence will be that while the internal prices rise, import and export prices remain constant because they are tied to the world market by the artificial exchange rate. So, even before devaluation, there is a distortion in the price structure that discourages exports and encourages imports: in turn this causes a balance of payments deficit that the government must cope with. What does it do? It allows depreciation. It does it not because it wants to, but because it must. Because it can no longer keep the exchange rate fixed. The consequence of depreciation is to make foreign prices increase with respect to the internal prices and to eliminate the previous distortion in the price structure. Imports go back to the normal level and exports are no longer artificiously reduced. But devaluation does not cause any jump in exports, it just eliminates the preceding distortion. In itself it is not a way to re-launch the economy. Q: The Italian government has adopted a series of austerity measures. Do you think they are in the right direction? 2
A: Unfortunately, I would say they are completely in the wrong direction. I saw the list of these measures and I understand why the communists have had no objections. Their only effect, in fact, will be to render Government unpopular while not solving any of the grave problems of Italy. Q: What do you find wrong? A: The first and most urgent problem of Italy is inflation. There is only one way to fight inflation which is through a cut in public expenditures and print less money. What is the so called austerity plan doing in this direction? Nothing The only thing it does is to increase taxes and restrictions, but this is exactly the way to increase inflation, not reduce it. The only effect of such measures is to discourage production and dissuade people from working. Why, for example, does not the Government plan tackle the problem of the huge waste of your useless bureaucracy? Why does it not tackle the problem of inefficiency in industries run by the Government? These are the causes of your huge increase in public expenditure and inflation. But your program does not tackle any of these problems from the roots of their causes. It is a silly program, a collection of half-measures that can t but have a negative effect. Q: So what would you do in the place of the Italian Government? A: Cut expenditures and the source of expenditures, and definitely stop manipulating the exchange rate. There is then another aspect of the Italian situation which distinguishes it and is very important: that is, for reasons that go beyond economics, people send capital abroad. Of course, I would do the same if I were Italian. The obvious reason is the fear of a communist Government. In this situation, an artificial exchange rate becomes even more dangerous than usual, because in fact it represent a subsidy to capital export. If the exchange rate were really free, the huge export of capital would lower it automatically and the incent to export money abroad would decrease proportionally. The Government must try to reduce the 3
capital drain and, at least until it can t, eliminate the danger of the Communist Party, which would be the best solution. It has the duty to not subsidize capital drain. Q: But are there measures against capital drain? A: The measures against capital drain are useless and have always been useless in every country. And this is especially true in the case of Italy where people have had a millennial experience in cheating Governments. There is in fact no need for these measures. I would eliminate them completely. The country would certainly gain from this, if your leaders had the courage of allowing the Italian currency to find its true international value, and in this way, to stop the capital drain. Q: The Italian Government has frequently been criticized because it does not have the strength to undertake a wage policy in the sense, at least, of a bake on the escalator which perpetuates the price-wage spiral. What is your opinion? A: This time I perfectly agree with the Italian Government. First of all, I believe that wage policies of private industry should not be the concern of Governments. Secondly, to stop escalation, at least when it is the result of free agreements between trade unions and industry is as unjustified as is price manipulation. It is as useless to try to dampen inflation in wages as it is to try to stop price inflation: what must be done, to repeat, is to eliminate the causes at the roots of inflation, not its manifestation. The problem in Italy, as far as the management of industry and inflation are concerned, is another one: industry should not be in the hands of the Government, which is not in a position of managing it in an efficient way, and consequently has to print money to cover wastes. Q: But is there a solution to this situation? A: Certainly it exists. It just requires some courage. There wouldn t, for example, be any harm in privatizing the Italian economy, in giving it back to the people. Let s say that half of the Italian industry, which is managed by the Government, belongs to the people. Well, if it 4
is badly managed, there must be a way to give it back to them. You can create a consortium absorbing the capital of the various enterprises that are owned by the state. Then distribute to all Italian citizens the shares of this consortium. The new owners can buy and sell the shares to each other so as to create a market. The value of the shares will increase as enterprises go back to an efficient and productive position. It would be even better to create not one, but three or four consortia so that they would have an incentive to compete and to try to make industries they control work as much as possible. It is of course a very rough idea, but it is a way of showing that there is a way. Q: In other words, you would take all public industries and re-sell them to the people. Has this ever been done? A: No, I wouldn t resell anything: first of all because nobody would buy these industries in such a bad shape. Secondly because the money would go into the pockets of the Government, and this is not desirable at all. They should be given freely back to the public. An almost similar thing was done in Germany with the restitution to the public of shares of Volkswagen previously controlled by the Government. The case of other German industries is different, because it concerned private, not government industry, as the shareholders were the workers. I would like Italians to think about my idea: it would at the same time be the most efficient way to complete with communists, because it would make of every Italian a capitalist and the most efficient way of eliminating inefficiency in these industries by giving them the normal incentives of competition in private industry. Note that I would gradually eliminate, say in five years, every state subsidy to these industries, so that once restored to the private regime, they would proceed on their own. Q: What are your forecasts on the world economic recovery? A: I don t like to talk in world terms. I think we should look at each country by itself, even though there are reciprocal influences. This is even more true in a floating system. If we 5
look at each country, I would say that USA, Germany, and Japan are recovering quite well, and that the slow-down of these last weeks is temporary and was foreseen. 6