Friday, 7 September 2012

EUROPE: ECONOMICALLY CHALLENGED

Introduction

This post is in reaction to the fact that I read a lot of economic stuff (technical term, that) - blogs, on-line magazine, e-letters etc. - and, since most of them are written by Americans, they tend to focus, naturally enough, on America's problems.

But, from the outside, the economic issues facing the USA are fairly simple. They've spent thirty years destroying every support pillar on which the middle class was built and giving more and more money and power to a really tiny elite. It was supposed to unleash limitless growth as energy and entrepreneurship were freed. It hasn't worked, to say the least.


Yes, there is a problem with the future path of Medicare which will bankrupt the US government if it is not fixed but, on the other hand, they have the least cost-efficient health care system in the whole wide world so, since just switching to any system of any of the other developed (and even emerging!) nations would sort most of it, it just cannot be a huge deal, conceptually.
But it is - Politically.



Politically, liberal Americans can't seem to make the case (or make it stick in the nation's psyche) that the economic policies of the last thirty years killed the American middle class and that the middle class spending its own income is the corner-stone of any and all developed economies - anything else is unsustainable. Politically, Americans can't seem to agree on how to fix their health care system. I am not an expert on Obamacare but it seems to me that it's mainly about insuring millions more. Which is surely the nice and humane thing to do but without a simultaneous increase in health care supply (a subject on which Obamacare seems pretty deficient, as far as I can tell), I don't think it'll end up well. At least, that's what Supply and Demand 101 would seem to imply.
Basically, America's problems are political. Namely, they are all about how the 0.1% manage to convince, in each and every election cycle, between 45 and 51% of the electorate to vote for their lackeys or ideologues. In most modern western democratic systems but especially in the US system, 45% of the popular vote is enough, with a bit of luck and gerrymandering, to paralyze effective government. And, although another 'conservative' counter-revolution [more tax cuts for the wealthy] would probably be awesome as far as the Koch brothers are concerned, the reality is that the status quo is good enough for people already at the apex of the social pyramid.

So, for me, the problems of the USA are mostly about how to bring about the needed solutions, not about what ail them.

The problems besetting the European Union are, in my modest opinion, significantly more complex and thus potential solutions are far less clear cut, regardless of the politicians' capacity (or lack thereof) for implementation.



1- IT'S THE TRADE DEFICITS, STUPID!

For example, many economists/bloggers have taken to summarise the EU debt crisis by saying that it's a problem of trade deficits between the core and the periphery brought about by the rising gap of competitiveness between said core and periphery.

Now, that's certainly true. And it's indeed the proximate cause of our present problems with Greece. Or Italy.





But you can immediately add that none of that would have been possible, regardless of competitiveness, without the core lending recklessly to the periphery. To quote the World Bank Blog:

"While the process of financial integration in the Euro- zone had been ongoing since 1957 and had gained impetus with the adoption of the Financial Services Action plan (FSAP) in 1999, it was the adoption of the Euro that led to a fully integrated financial market. Financial integration and the reduced risk of lending in non-core countries resulted in a sharp increase in cross-border capital flows with claims by core countries on non-core countries’ banking systems dominating the increase (Figure 1). Lending by German and French banks to non-core countries’ banks was by far the most important factor in this increase".




So, already, it's a bit more complex than just a competitiveness gap and, ditto, more complex than just reckless lending, the way sub-prime lending was.


2- IT'S A SOVEREIGN DEFICIT CRISIS, STUPID!

Another popular way of summarising the Euro on-going crisis has been to emphasize the role of government debt.




There is a lot of truth in that explanation as well, especially as governments had to bail out banks and taking on that extra debt pushed some formerly 'good-student' (like Spain or Ireland) into the 'basket case' category.

So much debt taken on to save banks and to keep 'unsustainable' welfare systems (so they say) is leading to quite a few countries being shut off the bond markets and/or having to pay high interest rates on their debt - with dramatic consequences for their economies as governments may be forced to raise taxes in the face of an economic slowdown.

But the truth is that the consequences of high debt are not all that clear - As the private sector is de-leveraging and the economy remains weak, it is hard for government debt to do anything but go up. Furthermore, the case of Japan proves that high level of government debt can be tolerated, at least for a while - even a good long while.

So any solution(s) to the Euro crisis would have to address the sovereign debt crisis but the exact nature of the solution(s) remain unclear because it is hard to see said sovereign debt crisis as anything but a consequence of the crisis rather than the cause.


3- IT'S THE EURO/EUROPE, STUPID!

If you look at the 2 first graphs above, you can easily say the Euro is responsible for all that mess.

After all, it all started going haywire in 1999. Which is as true as saying it's a matter of competitiveness/balance of payment crisis but, contrary to that line of argumentation, which is clearly a cause, it is tautologous/misleading. The Euro is in trouble so the Euro is the source of the trouble. The USA are also in trouble and no one is blaming the US$ or suggesting states (re)adopt individual currencies.

A more nationalistic/retrograde variation of the same explanation is that the whole European project is doomed and the problems now facing Europe are the proof of it.


4- A MONETARY UNION WITHOUT FISCAL UNION IS DOOMED, STUPID!

A more refined version of the previous argument and, again, one which contains much truth is that a monetary union without fiscal, budgetary and economic union is doomed.

I am certainly in agreement with that statement but I would note, as have others, that the USA, for example, did not emerge fully integrated on the eve of September the 3rd, 1783. It took time and the Union grew and deepened in response to a series of crises similar or comparable to the one presently facing the European Union.

Thus, I would maintain that the EU can still decide how to react to the problems that are engulfing it.


Conclusion: Squaring the Circle

To summarise the arguments above, I would say that the best way to try and describe the Euro crisis correctly is as follow:

Following the oil crisis and wage-price inflation struggle of the 70s, western Europe, like the US, proceeded to crush the income growth of its middle class. However, as opposed the US, it maintained a highly developed social safety net. Also it used public deficits to boost aggregated demand - Again, this is different from the USA where the boost was provided by private consumers over-leveraging themselves.

Following the introduction of the Euro, real interest rates were kept at an historically low level and growth was anaemic in core countries so core financial institutions started pouring money into the periphery. Simultaneously, some core countries, especially Germany, adopted an export-led model with reforms aiming at boosting further still their competitiveness.

These 3 fundamental elements - the crushing of the middle class, the ever rising indebtedness of many core countries and the adoption of the Euro which led said core countries adopting an export-led growth model and consumption-led growth in non-core countries, with the attendant payment and competitiveness imbalances - make up the crisis we are facing.

And, I would argue, untangling that Gordian knot is going to take even more political skill than bypassing Republican obstructionism and more political vision than fixing health care or reducing the income gap in the USA.