Internal devaluation

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Internal devaluation is an economic and social policy option whose aim is to restore the international competitiveness of some country mainly by reducing its labour costs – either wages or the indirect costs of employers. Sometimes internal devaluation is considered as alternative to 'standard' external devaluation when nominal exchange rates are fixed, although social implications and speed of economic recovery can significantly differ between the two options. While proponents usually blame fiscal profligacy or loss of competitiveness as the reason for a need to devalue internally, critics oftentimes view macroeconomic imbalances and the absence of a fiscal transfer mechanism within a currency union as culprits.^[1]

Internal devaluation was first considered during the Sweden financial crisis 1990-1994 and after Finland's accession to the European Union in 1995.^[2] Internal devaluation gained popularity during the economic recession of 2008–2010 when several countries pursued such policies with aim to restore competitiveness and to balance national budgets.

Latvia is often named as successful case of internal devaluation by popular media,^[3] although its poor performance in the international development indices (e.g. Global competitiveness indices, European Union Innovation Scoreboard,^[4] the rating levels had not changed in the following year as well ^[5]) as well as severe emigration have been claimed to prove the negative impact of internal devaluation on the development of the human resources and potential GDP (whose performance can be measured by the notable inflation rate).