http://www.ft.com/cms/s/1/6fd49b12-e152-11dd-afa0-0000779fd2ac.html
The Irish must be feeling green, and so too the Spanish, Greeks and Portuguese. Over the past week, all four countries have been warned that their debt ratings could be downgraded. Dublin, Madrid, Athens and Lisbon may bat this away with reassuring noises about how they will put their financial houses in order -- even if they, meanwhile, suffer higher borrowing costs. What they cannot dismiss so easily, however, is the solution to their troubles: deflation.
The potential downgrades are only a manifestation of a deeper problem: a loss of competitiveness. That is largely why the Irish, Greek, Spanish and Portuguese trade deficits are so large and their economies slowing so fast. It has been a long decline. Euro membership lowered borrowing costs, but unleashed a credit boom and a rise in prices -- most obviously in housing but also in wages.
Ireland shows the problem writ large. Since 2000, its relative wage costs have risen by 20 percentage points versus Germany. (Greek wage costs have risen by about 5 points.) Export performance has been further hurt by the weakening currencies of two of its major trading partners, the US and the UK. That is why Brian Lenihan, the Irish finance minister, lashed out at the UK, saying the pound's fall had caused Ireland "immense problems". The quick solution would be for Ireland to devalue too. As a euro member, it cannot. Instead it has to deflate.
Germany managed this at the start of the millennium. But as its trading partners were inflating at the time, German prices only had to rise at a slower rate for relative wages to fall. Today, with inflation falling, that path is not open to uncompetitive eurozone countries. Instead, wages have to fall in absolute terms. That is immensely painful. It is also politically unpalatable; democracies generally don't "do" wage deflation. Even East Asian countries, with their more flexible labour markets, did not manage it during the 1997 crisis -- or at least not without political change. The Irish referendum this autumn on the European Constitution may well be an explosive vote.