The Eurozone must not “move forward”

Suppose you are headed home and your GPS leads you down a blind alley.  A dead end.  A cul de sac.  What do you do next?  One solution would be to back out and take another route.  But the alley is narrow and hence backing out would be difficult.  So you decide to “move forward.”  Get the pick axe and shovel out of the trunk, and start demolishing the buildings that are blocking your path.

The policy elite of Europe thought it would be a great idea to have a single monetary unit for 17 different countries, which have very different policy needs.  This was to be done through the wise leadership of unelected technocrats, who would put aside all messy political calculations and focus single-mindedly on low inflation.  Unfortunately things didn’t work out, just as all previous attempts to put multiple economies into a fixed exchange rate straight-jacket eventually failed.

So do they propose abandoning the experiment?  No.  Many of the same people who brought us the euro now want to double-down on some sort of fiscal union, which might involve eurobonds.  Fiscal union would be like the euro on steriods.  All the current problems would be multiplied 10-fold.  German taxpayers would be asked pay for wasteful government programs in Greece and Sicily, even as German voters would have no say in how the money is spent. That’s a recipe for non-stop discord, for a revival of nationalism.  Recall that the taming of nationalism was the central political goal of the EU, which was created to prevent a repeat of the horrors that Europe experienced in the first half of the 20th century.

The beauty of the EU is that it’s currently a highly decentralized system, with EU spending being somewhere around 2% of GDP.  It’s sort of like the US federal government in the 1920s.  Now you might complain that the 1920s was followed by the Great Depression.  That’s right, and that’s why faster NGDP growth is a necessary condition for any sort of resolution of the debt crisis.  (I say necessary, not sufficient.)

Many people seem to be under the illusion that Germany is a rich country.  It isn’t.  It’s a thrifty country.  German per capita income (PPP) is more than 20% below US levels, below the level of Alabama and Arkansas.  If you consider those states to be “rich,” then by all means go on calling Germany a rich country.  The Germans know they aren’t rich, and they certainly aren’t going to be willing to throw away their hard earned money on another failed EU experiment.  That’s not to say the current debt crisis won’t end up costing the German taxpayers.  That’s now almost unavoidable, given the inevitable Greek default.  But they should not and will not commit to an open-ended fiscal union, i.e. to “taxation without representation.”

In addition to not being rich, Germany is fairly heavily taxed, like all other Western European countries.  If taxes were at US/Japanese/Australian levels, it might be possible to extract more revenue without killing the goose that lays the golden egg.  Even at current German tax levels it may be possible to extract a bit more revenue.  But there is certainly much less room for maneuver.

The EU must not move forward, it must move backwards.  That’s because the EU in the 1990s was a much sounder institution.  If it ain’t broke, don’t fix it.  The European Monetary System circa 1998 wasn’t broke, and should not have been fixed.

PS.  Karl Smith scolded me yesterday for my post on Keynes and stocks during 1937.  He argued that this is a very serious topic that affects the lives of millions.  I completely agree.  When I use humor it is to make a point.  I was trying to show that Keynes would have agreed with my claim that there was nothing in the so-called “fiscal contraction” of 1937 that would have led a reasonable Keynesian in early 1937 to expect a recession in late 1937.  Why is this important?  Because there were two great cognitive errors that caused our current recession.  One was made by those (mostly on the right) who didn’t see an AD problem.  The other was made by those (mostly on the left) who saw the AD problem but assumed fiscal stimulus was the best way to address the problem.  Obama was obviously in the second camp.  Fiscal stimulus is extremely weak for all sorts of reasons.  If Obama had focused on stocking the Federal Reserve Board with reliable stimulus proponents back in 2009, we might be far better off today.  Instead he completely ignored monetary policy and instead relied on ineffective policies such as deficit spending.  That’s a very serious mistake, and that mistake was the ultimate target of my post.  I left some additional comments over at Karl’s post.

I’m actually glad that Karl feels so passionately about this issue.  I wish more people felt that way.


Tags:

 
 
 

60 Responses to “The Eurozone must not “move forward””

  1. Gravatar of pct pct
    28. November 2011 at 08:26

    At the heart of the EU is what is politely known as the “democratic deficit.” EU initiatives are always advanced by the least democratic means possible, by policy elites. For instance, just last weekend there was leaked a Franco-German trial balloon for Brussels to have approval rights over national budgets. The assumption is always that the demos doesn’t want “ever-closer union” now, but once it is jammed down their throats, they will be OK with it. It will be interesting to see if the assumption is correct.

  2. Gravatar of Becky Hargrove Becky Hargrove
    28. November 2011 at 08:37

    I actually stuck a ‘blurb’ on the fridge some years back about the comparison between EU countries and Arkansas; it seemed so hard to believe. I lived in Arkansas for ten years, and pictures my cousin sent from Germany could made a small German town look poorer than a small town in Arkansas.

  3. Gravatar of John Carney John Carney
    28. November 2011 at 09:03

    Part of the problem is that the term “fiscal union” is so undefined. It means different things to different people. When Germans like Merkel talk about ceding budgetary authority, they mean allowing Germany to tell other countries what level of spending is appropriate. When non-Germans talk about it, they mean allowing other countries to spend German money.

    http://www.cnbc.com/id/45401667/A_Fiscal_Union_Won_t_Fix_Europe

  4. Gravatar of Mike Sax Mike Sax
    28. November 2011 at 09:15

    “The beauty of the EU is that it’s currently a highly decentralized system, with EU spending being somewhere around 2% of GDP. It’s sort of like the US federal government in the 1920s. Now you might complain that the 1920s was followed by the Great Depression. That’s right, and that’s why faster NGDP growth is a necessary condition for any sort of resolution of the debt crisis. (I say necessary, not sufficient.)”

    Best I can say for that Scott is at least you admit that your lauding of the 20s is not wholly unproblematic-to understate things just a little…

    As to your claim that, “Fiscal union would be like the euro on steriods. All the current problems would be multiplied 10-fold”

    All the problems would be multiplied? It seems to me the biggest problem is that in the current EU member states lack their own currency and therefore the ability to set their own monetary policy. To the contrary the current set up has the worst of all worlds. Member states give up a large chucnk of national sovereingty and receive sacntimonious lectures on the need to impose even more structural reforms and yet no monetary control of their country-without a currency of their own how could they?

    “The European Monetary System circa 1998 wasn’t broke, and should not have been fixed.”

    Let me reveal my ignorance here and ask what was this fix? What was the EU Reform of 1998?

  5. Gravatar of TravisA TravisA
    28. November 2011 at 09:20

    @Becky: that’s remarkable. I was actually going to challenge the per capita ppp measure because I see that it ranks Japan below Germany and thus below Arkansas. I lived in Japan for about 5 years. The IMF has Japan at 33,385 per capita. Japan certainly doesn’t feel poor. Certainly housing and vehicles are expensive, so a lot of people make due with much smaller housing and fewer or no cars. But I think there’s a large substitution with other goods. Plus their public transportation system is fantastic. Cars are actually very impractical in Tokyo.

    Here’s a question for Scott: previously you have written that Germany gets as much government revenue per capita as the US, which somewhat implies a Laffer limit. But if that is the case, then why are German public services presumably so much superior the US’? Maybe they are in reality about the same, but my impression from what I’ve heard is that they are superior. Is my impression wrong?

  6. Gravatar of Neal Neal
    28. November 2011 at 09:31

    “Unfortunately things didn’t work out, just as all previous attempts to put multiple economies into a fixed exchange rate straight-jacket eventually failed.”

    Were there similar monetary problems when the British colonies united under one fixed exchange rate straight-jacket in 1791? Was the monetary system (gold standard) too different to make reasonable comparisons? Can we draw any analogies between the economy of the early US and the EU today? (Perhaps one lesson is that nationalism in the early US didn’t die with economic integration; it had to be forcibly put down and shot in the mid nineteenth century.)

  7. Gravatar of mbk mbk
    28. November 2011 at 09:36

    I’m sorry but I’m amongst those who find PPP per capita GDP wildly inaccurate as a measure of standards of living or such. Just from decades of personal experience. And I also still don’t understand why a common currency is supposed to be toxic for the diverse needs of the diverse European countries while it is perfectly OK for the diverse US states with their wildly differing economies and needs. The US states have to follow Washington’s dollar just the same, no matter how indebted or otherwise AD deficient they may be, and no one talks of the impending Dollar zone breakup just because Orange County goes bankrupt – or the whole of California for that matter. I see no logic to all this.

    This crisis was caused by the US financial / mortgage system. European Banks’ balance sheets collapsed because they held US debt that became worthless. European governments guaranteed their banks to stave off disaster and on top of that, took a large fiscal hit from the recession of 2008. This now causes the sovereign debt crisis a few years later. The collapse of the US debt ultimately has to be paid off jointly by the Europeans too, either by sustaining collapsing banks or by sustaining collapsing sovereign debt. None of this has fundamentally, at root, to do with the Euro. The discussions in Europe are about which of the various ways to pay off that debt can be sold to voters who are by and large innocent of incurring it.

  8. Gravatar of John Thacker John Thacker
    28. November 2011 at 09:36

    @TravisA:

    Did you live just in Tokyo, or did you travel outside the major cities? Even in, say, Yokohama where some of my friends live, having at least a family car is certainly not just practical but close to a necessity. If you go out to the 田舎 plenty of areas feel poor.

    By exchange rates, the numbers I found for Japan are “GDP per capita (in 2009): US$39,573 (average), high prefecture: Tokyo US$66,500 (2006 est.), lowest prefecture: Nara US$24,000 (2006 est.) Here’s another link.

    Of course, you have to adjust for cost of living, which is certainly higher in Tokyo, but there’s still a reason everyone in Japan moves to the Tokyo area. It’s wealthier.

    (Also it’s not just housing and vehicles that are expensive, food is very expensive as well in Japan.)

    So I feel like you’re probably comparing the wealthiest area of Japan, instead of looking at an average.

  9. Gravatar of Ambrose Evans-Pritchard comments on Market Monetarism « The Market Monetarist Ambrose Evans-Pritchard comments on Market Monetarism « The Market Monetarist
    28. November 2011 at 09:36

    [...] Scott Sumner also comments on Ambrose here – and in he has a related post to the euro crisis here. Share this:TwitterFacebookLike this:LikeBe the first to like this post. 1 Comment by Lars [...]

  10. Gravatar of John Thacker John Thacker
    28. November 2011 at 09:47

    @mbk:

    When the Michigan economy tanks and North Dakota booms, people gladly pick up from all over the US and move to North Dakota. It’s easy to do, there’s no enormous backlash, and it helps smooths things out. There has been and continues to be immense internal migration in the USA that far exceeds what’s occurred in the EU, for a number of good reasons. That’s just one reason why the USA is different. There’s a lot of research on optimal currency unions.

    Your assertion that it’s all due, even this many years later, to a rather small but significant amount of mortgage losses (note that index funds in GNMA securities or in REITs still have good 5 year performances compared to other things out there) is as silly as claiming that it’s all due to the Euro.

    The Euro made any crisis, when it occurred, worse. The mortgage activity also set the stage. The monetary authorities’ reaction has also made it worse.

  11. Gravatar of Vincent Vincent
    28. November 2011 at 09:48

    question: does per capita gdp account for taxes, and goods & services the government provides “for free”? stuff like roads, or health care in the case of germany.

  12. Gravatar of Luis H Arroyo Luis H Arroyo
    28. November 2011 at 09:57

    I agree completly:
    “The EU must not move forward, it must move backwards.”
    But see what M Rajoy, recently elected spain Prime Minister, has said today:
    “I will put Spain in the hard core of the euro”.
    Is no that an idiocy? Spain has got a unemployment rate of 22%. When the EMS, It had got a 24%… I don´t see exactly which he is meant with that, But that is the accurate expresion of what european politicians are selling to people. But people have no idea of monetary policy, except that it is always and forever inflationist.

  13. Gravatar of Neal Neal
    28. November 2011 at 10:05

    Vincent-

    Short answer: yes.

    Long answer: GDP includes government expenditures, but measured at cost. For example, free German health care may well be more valuable than (German GDP)*(proportion devoted to health care), but that’s not counted. Another example: US occupation of Iraq may well be less valuable than (US GDP)*(proportion devoted to occupying Iraq).

  14. Gravatar of TravisA TravisA
    28. November 2011 at 10:16

    @John: I lived in Tokyo, but did some hiking, which took me to the countryside and small towns. I went to Hokkaido and also Kagoshima. Some of the towns were ‘sleepy’, but I never thought they were poor. Of course, that’s through the eyes of a foreigner and I may have mistaken differences as coming out of custom rather than economic necessity.

    It’s difficult to find per capita gdp ppp figures for Tokyo, but I found one number of around $37,000.

    http://www.newgeography.com/content/00934-rating-world-metropolitan-areas-when-money-object

    Again, that seems too low.

  15. Gravatar of Mike Sandifer Mike Sandifer
    28. November 2011 at 10:18

    Of course, Obama’s failure to even nominate his own Fed board members has been a political disaster for him too.

    Of course, some of us weren’t high on Obama as a candidate, but who thought he’d be so politically incompetent?

  16. Gravatar of Richard A. Richard A.
    28. November 2011 at 10:39

    I too view the purchasing power parity(ppp) approach of calculating per capita income with some skepticism. There seems to almost be a conspiracy nowadays to avoid using the exchange rate approach to per capita income by country. Couldn’t those who prepare the statistics show both approaches?

  17. Gravatar of Nathanael Snow Nathanael Snow
    28. November 2011 at 10:55

    Does PPP control for the cost of healthcare?

  18. Gravatar of Kevin Donoghue Kevin Donoghue
    28. November 2011 at 11:52

    “If Obama had focused on stocking the Federal Reserve Board with reliable stimulus proponents back in 2009….”

    …the Republicans would have blocked them.

    Scott, there are some things you see very clearly and some things you don’t see at all. In the latter category is the fact that the making of monetary policy is an intensely political process. (So is the making of fiscal policy of course, but you do see that.)

  19. Gravatar of Sumner and Glasner on the euro crisis « The Market Monetarist Sumner and Glasner on the euro crisis « The Market Monetarist
    28. November 2011 at 12:05

    [...] Here is a bit of brilliant comments. Lets start with Scott Sumner: [...]

  20. Gravatar of Peter Peter
    28. November 2011 at 12:12

    I wonder if Sweden will be forced to adopt the Euro. We fulfill the criteria and are therefore legally obligated to adopt it. I doubt the EU will force the issue during these troubled times, but what will happen when things look better? I hope we can stay away from it somehow.

  21. Gravatar of Dustin Dustin
    28. November 2011 at 13:05

    Kevin Donoghue,

    It seems to me that for a brief moment, the Dems could have had their way. They could have forced things through and gotten seats filled on the BoG. (Didn’t they have a technical super majority for a brief time in the Senate?)

    It wasn’t until later that the woozy Repubs, almost TKO’d by the election, got back to their feet and started pushing back against Obama and blocking everything.

    That’s how I remember it. Am I wrong?

  22. Gravatar of John Thacker John Thacker
    28. November 2011 at 14:23

    @Kevin Donoghue:

    The same way the Republicans blocked the fiscal stimulus and PPACA/Obamacare from 2008-2010? When he had unified control with a massive majority, President Obama chose to focus his political power on tremendously unpopular things instead of doing the best thing to help the economy. He was rightly punished.

  23. Gravatar of ssumner ssumner
    28. November 2011 at 14:29

    pct, That’s right, and it’s why I oppose “ever closer union.”

    Becky, Yes, many are surprised by that comparison.

    John Carney, Good point.

    Mike Sax, you said;

    “Best I can say for that Scott is at least you admit that your lauding of the 20s is not wholly unproblematic-to understate things just a little…”

    It is unproblematic if you understand monetary economics. If the Fed had continued Governor Strong’s policies in 1929, the boom would have continued.

    I’m talking about the euro, which was introduced about 1999.

    travis, Tokyo is much richer than Japan. I would add that appearances also reflect culture. I’ve never been to Japan, but I’m told the culture prizes being clean and tidy. That tends to make a place look less poor.

    Germany does have much better public services, the money is spent in a much more effective way. Look at our Medicare, and Medicaid. Look at our military. Look at homeland defense. Look at Amtrak. I could go on and on. We spend more on education as well, and what does that get us? So I agree that PPP is somewhat biased.

    Neal, The gold standard is a good comparison–it failed more than once. Britain repeatedly devalued in the 20th century.

    mbk, The website I link to shows three different PPP estimates, all showing similar results. I don’t claim they are perfectly accurate, but they give you a ballpark estimate. Germans work much shorter hours than Americans, so it’s no big surprise that per capita income is lower.

    You said;

    “This crisis was caused by the US financial / mortgage system. European Banks’ balance sheets collapsed because they held US debt that became worthless.”

    This makes the European banks seem like victims, not villains. The banks made the bad loans, or bought the toxic debt. That enable the bad debt to be made in the first place. They are just as guilty as US banks.

    You said;

    “European governments guaranteed their banks to stave off disaster and on top of that, took a large fiscal hit from the recession of 2008.”

    Two problems here. The decision of the Irish government to bail out their bank creditors was the cause of their debt crisis. You make them seem like victims. Second, the big problem is in Greece and Italy, and that was caused by irresponsible government fiscal policies, which caused the debt to GDP ratio to exceed 100% even before the crisis. Again, they are villains, not victims.

    I don’t see a good comparison between the US and Europe. We have one basic labor market, one language, one culture, they have many. Our local governments are small, their local governments are their national government, and are huge.

    Vincent, Yes, GDP includes free stuff like health care. But as I said earlier, I believe the German government is more efficient, so the published figures may slightly overstate the standard of living gap.

    Luis, I suppose he might succeed, but is it worth the cost?

    Mike, I agree.

    Richard, I agree that PPP has some problems. But the euro went from 85 cents to 1.60 during a period when the US and Europe had similar inflation and similar GDP growth. That’s got to throw estimates using market rates off by a lot. There’s probably no optimal PPP, but all three estimates in my link show similar results.

    Nathanael, See my reply to Vincent.

    Kevin, You said;

    “the Republicans would have blocked them”

    Then do recess appointments. If they squeal, then demand a Senate vote. He had the votes. The first two people he put up (after waiting 18 months for no good reason at all) sailed through.

    He never even tried. Even many Obama supporters concede it was a huge mistake (Yglesias, DeLong, etc.) Do they also fail to “see clearly?”

    Peter, I’d be shocked if they were forced in. Britain obviously won’t join, everyone agrees on that. Suppose it fails a Swedish referendum? You can’t force the Swedes to set sail on the Titanic.

    Dustin, You are completely right; that’s exactly what happened. But Obama never even tried. How can someone defend a “leader” who never even tries?

    BTW, Obama appointees now have a majority of the Board of Governors–who have the sole right to set IOR. They can even make it effectively negative, when FDIC fees are included.

  24. Gravatar of dwb dwb
    28. November 2011 at 17:14

    http://www.bloomberg.com/news/2011-11-29/for-fed-ngdp-could-spell-more-economic-stability-ramesh-ponnuru.html

    nice zingy quote: As Scott Sumner, an economics professor at Bentley University, points out, that fear would be reasonable if anyone knew what the current “policy framework” was.

  25. Gravatar of John John
    28. November 2011 at 17:40

    It would be a shame to see a large area with relatively free mobility of capital and labor dissolve. That dissolution would cause a serious drop in living standards around the world and especially in Europe as Europe and the rest of the world moved towards greater amounts of protectionism and less open borders. That’s why the EU needs to stay together in some form, even if they decide to go back to old currencies.

  26. Gravatar of Morgan Warstler Morgan Warstler
    28. November 2011 at 18:28

    John Thacker, mbk is right, US states is a fine comparison.

    The REALITY is that Southern states learned how to compete, by dropping regulations to win jobs, dropping labor protections to woo jobs, etc. etc.

    COMPANIES CAN MOVE.

    Your response isn’t honest, the honest answer is that for one reason or another you don’t think the Greeks can get their act together, or should be forced to get their act together.

    I think they can and should be forced to.

    Greeks are not animals. They are not idiots. They are rational, thinking people.

    Sure their way of life might end, but that’s a function of having a bad way of life.

    But struggling to stay int he Euro, they are giving up very very bad habits.

    Being Greek is not as good as being German. Being Italian is not as good as being Swedish, etc.

    They can be better, trust them to be.

  27. Gravatar of OGT OGT
    28. November 2011 at 18:31

    Arkansas is rich compared to every other place in the world except Massachusetts and other rich parts of theUS, certainly compared to Greece.  So, I very much doubt German reluctance to bail out Greece is due to a sub-conscious knowledge of PPP adjustment rates to individual US states.  This is especially dubious if you consider that they and the French went hat in hand to China and, even, India for God’s sake!

    That said, I am very suspicious of any of the further integration projects in Europe, especially those emanating from the top down.

    An interesting side note is that the Euro appears to be gaining popularity if anything.  A number of polls in Greece Italy, and Ireland, for example, have shown majority support for remaining in the Euro.  And no hint of support for monetary loosening or devaluation. Then again, polls probably would’ve opposed Gold devaluation in 1933.

  28. Gravatar of Neal Neal
    28. November 2011 at 19:15

    Comparisons to the economic integration of US states only makes sense during the late eighteenth and early nineteenth centuries. Certainly by the twentieth century, the US had been a single-currency, free-trade zone for so long, ramifications of integration had long since been lost.

    Put differently, there are two points of comparison and two times one can compare the EU and the US. The first point is: diverse cultures and languages in a single, integrated currency zone. The second point is: integrating many separate economies and currencies into a single currency zone.

    The two times are, broadly speaking, antebellum and postbellum. Comparing the EU’s integration issues with the US only makes sense, I think, for the early antebellum period, 1790-1830 or 1840. Comparing different cultures may be fruitful both antebellum and modern, although it’s probably worth mentioning that nationalism in the US has greatly decreased since 1865.

  29. Gravatar of dtoh dtoh
    28. November 2011 at 20:18

    Travis, John Thacker,
    So a couple of thoughts on Japan cost of living.

    1. Vehicles are not expensive in Japan, just expensive to operate (high gas and parking).

    2. Other than cost, there is no big city in the world that is more practical for driving than Tokyo. You can get practically anywhere in a very short time, few traffic jams, and ample parking. (I drive almost every day in central Tokyo).

    3. I think it is very hard to measure the PPP adjusted cost of living. It’s somewhat akin to Scott’s argument on inflation.

    4. If I were to offer some guesses based on observation. I would say the Japanese spend more on clothing and dining out. They spend less on cars and second homes. (In the country side, a car is a necessity, but people buy really cheap 1.2 liter engine cars, e.g. Daihatsu, etc.) They spend a comparable amount on vacations but get a lot less bang for their yen. Housing is probably comparable; prices and rents are higher, but this is offset by a lot more young adults living with their parents. There are a lot of people living off wealth accumulated in the past. Living standards in central Tokyo are very high. Living standards in the country side are rapidly declining to third world standards (albeit without a lot fewer social problems.) The Japanese spend a lot less on defense and health care compared to the U.S.

    5. One of the reasons that housing prices are expensive is because you have low property taxes but high transaction taxes on property sales. This results in lower property turnover and depressed property development (i.e. increase in floor space relative to the underlying land area.)

  30. Gravatar of mbk mbk
    28. November 2011 at 20:52

    John Thacker: yes of course the initial housing losses were relatively small, but they triggered the collapse of the whole financial house of cards. Scott says in 2008 money was suddenly tight. Well let’s assume that’s correct – why was it suddenly tight? This question is never asked or answered. Small percentage issues, highly levered, on the margin, can transform into large solvency issues. I remember politicians saying, only a year ago, that Greece couldn’t possibly be a problem because it’s only 2 or 3% of Eurozone GDP. It’s a complete failure to think on the margin if you think that 2 or 3% don’t matter. Paying 6% on bond issues instead of 4% is also just a 2% interest rate change.

    To US economic integration: labour is more flexible in the US than in Europe, but capital and companies move pretty fast, and this is the whole point of the EU. Witness Ireland pre 2007. All built on European integration.

    Scott: of course European banks were victims in part. They were victims of the US bust and of course also victims of their own gullibility and of badly thought out regulatory schemes – many banks, but also pension funds etc., bought these now toxic assets because real estate and government bonds were considered safest. The banks now in trouble for holding bad EU government debt in Europe, trouble soon to come back once more to the US because US banks hold those bonds too, mind you, these banks sometimes were statutorily encouraged to hold “safe” government bonds. So guilt and victimhood are very mingled here.

    In any case governments had little choice but to absorb all of this because the entire finance system hung in the balance and with it, public pension funds. I don’t see how there was any alternative to massive government debt, with or without eventual monetization of that debt. The entire debate over easy money is about whether or not this debt should be
    - monetized and paid off as inflation by the general public, – not monetized and paid as direct taxes by the general public to governments assuming other governments’ debts, or
    - paid privately in a very lumpy way by whoever held bonds in collapsing institutions (banks, governments, no matter) in case governments do not bail out banks. Since a lot of these investors are also public (pension funds), it’s also once more the public paying.

    The entire Eurozone is a victim of the 2008 crash – isn’t that obvious? The critical adjustment phase of the Euro introduction was not over yet and this has made the crisis worse. The debt issues were actually on the mend right up until 2008. It is the 2008 crisis that has created the European government debt issue. Yes if the past had been perfect it would not have occurred but without that 2008 crisis all of it was manageable. Download the data yourself from

    http://epp.eurostat.ec.europa.eu/portal/page/portal/government_finance_statistics/data/main_tables

    Those are EU government debt per GDP ratios 1996-2010. I can’t link to a meaningful graph there but you can download the table into Excel. Then graph debt/GDP ratios: even the worst (Greece…) had stable debt levels until 2007, while almost all countries had dramatically improving (yes!!) debt figures. Belgium was at 130% debt/GDP in 1996!! And went to a low of 84% in 2007 in a straight line. Now they’re back at 96%. Italy was at 120% in 1996 way before the evil Euro! Low point at 103 in 2007. Yes, Italy was improving straight down from 1996, though rather slowly after 2003. All the debt curves are U curves with low points in debt in 2007, what a coincidence. If you look at this you see that the Euro was actually on the way to working. Even the maligned growth and stability pact was working more or less.

    The Euro area didn’t miraculously hit a wall it was fated to hit. It was hit by an external shock. Now, the reaction to that shock, we may debate this. But the shock itself is clear.

  31. Gravatar of Lorenzo from Oz Lorenzo from Oz
    28. November 2011 at 21:36

    Kevin Donoghue: If Obama can get people appointed to the Supreme Court, he can get them appointed to the Fed.

  32. Gravatar of Lorenzo from Oz Lorenzo from Oz
    28. November 2011 at 21:49

    mbk: But that the euro would handle external shocks badly was the basis of most criticism of it–e.g. by Milton Friedman. (As far as I know, Bruce Goodhart was one of the few who picked the lack of a lender of last resort as a debilitating problem.)

    Australia is experiencing some of the strains of currency union, since not all States benefit equally from the commodity boom and those that do less are suffering more from the high exchange rate. But Australians identify as a common country, people move and the welfare system compensates. Also, labour mobility is disproportionately important because labour votes and consumes welfare (or not).

    Of course, that our public finances are sound, we have had no banking crises, our housing prices seem to be sagging slowly rather than collapsing means we are managing the problems of uneven prosperity rather than uneven loss of it.

    As for 2008, a financial crisis is a bad moment to surreptitiously disinflate. (Actually, there is no good time to surreptitiously disinflate: but some moments are much worse than others.)

  33. Gravatar of Lorenzo from Oz Lorenzo from Oz
    28. November 2011 at 21:55

    On Oz public finances: we means-test welfare (including pensions)–it makes a difference.

  34. Gravatar of mbk mbk
    28. November 2011 at 23:40

    Lorenzo – means testing is implemented in some European countries as a matter of course. Most old stereotypes are just not so true anymore. But yes it depends on the country. The great strength of the EU up to this point was the diversity of policy approaches and in the ideal this should allow a kind of natural selection process – a discovery of what works best. In the short run it all looks chaotic and catastrophic but in the long run I do have good hopes of substantial progress in the Eurozone. My big hope is that it won’t centralize and homogenize more than it already des, and so preserve that diversity.

  35. Gravatar of Lorenzo from Oz Lorenzo from Oz
    29. November 2011 at 00:41

    mbk – I take your point on means-testing, though they must either not do it as much or what they don’t means test is much more “generous”.

    The EUrocracy’s mad empire-building “harmonising” gets seriously in the way of the development-through-diversity model. Unfortunate, since competitive jurisdictions were crucial to the long-run success of Europe.

  36. Gravatar of Nevorp Nevorp
    29. November 2011 at 01:46

    “Suppose you are headed home and your GPS leads you down a blind alley. A dead end. A cul de sac. What do you do next? One solution would be to back out and take another route. But the alley is narrow and hence backing out would be difficult. So you decide to “move forward.” Get the pick axe and shovel out of the trunk, and start demolishing the buildings that are blocking your path.”

    Are we talking about Europe or neoclassical economics?

  37. Gravatar of Brett Brett
    29. November 2011 at 02:13

    @Scott Sumner

    This was to be done through the wise leadership of unelected technocrats, who would put aside all messy political calculations and focus single-mindedly on low inflation.

    To be fair, they did eventually create an elected body of representatives. They just didn’t give it any real power, and now it might be too late.

  38. Gravatar of Rien Huizer Rien Huizer
    29. November 2011 at 03:35

    Scott,

    I completely understand where you come from and maybe the EU will turn out to be a failure (basically a customs union with some institutional standardization).

    However that was never the idea of the EU. IT was supposed to create an equivalent to the US. That is costly and maybe the underlying democracies will not be prepared to make sacrifices with the same enthousiasm they embraced the UE credit card. It that is the case, Europe is back at square one, because a customs union is pointless among states with deeply ingrained corporatist and mercantilist cultures. Possible, but not satisfactory for Europeans who think that the current fragmentation should end. It is pretty hard for Americans to understand this. Apparently. Not for Brits, but they have a very different agenda.

  39. Gravatar of mbk mbk
    29. November 2011 at 05:35

    Rien,

    agree. And I personally love the Euro, the free movement across borders, and the lessening power of the nation state. And even German business leaders think that way, according to reports. It’s the general public in Germany that has its hesitations.

  40. Gravatar of Jason Odegaard Jason Odegaard
    29. November 2011 at 06:08

    Hi Scott, just thought I’d point you to Krugman’s latest blog entry about the ECB. He cites that the U.S. recovery of 1933-37 was all about monetary policy expectations. Thought you would like seeing that.

    http://krugman.blogs.nytimes.com/2011/11/29/the-ecbs-reverse-fdr/

  41. Gravatar of Claron Claron
    29. November 2011 at 06:23

    As many commentators have said PPP adjustments are not very precise. Subjective judgements based on places seen while hiking are, of course, less precise but maybe they are more accurate (living standards are subjective, so maybe subjective observation is better). I currently live in Germany and have traveled quite a bit around the world. The poorest places I have seen are in rural Idaho followed by some places in China.

    The biggest problem with PPP comparisons of different countries (or states) is that PPP is taking into account the price at the point of purchase. So countries with high consumption taxes (Europe) will always come out poorer than countries whose taxes are not reflected in the price at the point of purchase (US, Canada). I have brought this up several times in comments here before:

    http://www.themoneyillusion.com/?p=9417

    This is not to say the comparison is invalid but all three major PPP adjustments do this so one needs to be aware of these caveats.

  42. Gravatar of ssumner ssumner
    29. November 2011 at 07:10

    dwb, That’s a good article.

    John, I totally agree.

    Morgan, You said;

    “Being Greek is not as good as being German. Being Italian is not as good as being Swedish, etc.”

    I don’t agree, they all have wonderful countries.

    OGT, Here’s another way of making my point. If you list European countries by per capita GDP, top to bottom, Germany is above average, but doesn’t stand out as particularly rich. Germany is big. Attention is focused on Germany for the same reason we focus trade attention on China (which actually has a small trade surplus in per capita terms.)

    dtoh, Interesting observation on Tokyo traffic. Can I assume it’s not easy to park downtown? Or it’s expensive?

    Isn’t the biggest difference with the US that Americans have much bigger houses and also garages full of “stuff” (boats, snowmobiles, RVs, etc) and most Japanese don’t.

    Mbk, You said;

    “Well let’s assume that’s correct – why was it suddenly tight? This question is never asked or answered.”

    Please! You’ve been reading my blog for quite a while–you know that’s not true.

    Regarding the crisis, European banks were just as guilty as American banks, it wasn’t an “external shock” there was rampant real estate overbuilding in both countries, fueled by reckless bank lending from banks in both countries.

    I completely disagree on the debt figures. The Greeks were lying about the size of their debts, they were much bigger than reported, and rising fast even before the recession.

    Italy’s debt was way too high, the euro limit is 60% of GDP and they were at 100%, even before the crisis. There’s no way Italy should have been in the euro. Australia’s public debt was roughly 0% of GDP before the recession, that would have been an appropriate number for Italy.

    Yes, the stupid ECB policy of letting eurozone NGDP plummet has made those debt ratios even worse, Obviously I agree on that point. But the debt was way too high even before the recession. The euro was dysfunctional from day one.

    The Irish government made a huge mistake in bailing out bank creditors. This create moral hazard and makes the next crisis almost inevitable and also contributed to this crisis. They should have let the banks fail.

    It’s the ECB’s job to control macro policy, not the job of individual governments–there is little they can do.

    Brett, Good point.

    Rien, You said;

    “I completely understand where you come from and maybe the EU will turn out to be a failure (basically a customs union with some institutional standardization).”

    I don’t think you do know where I’m coming from–I predict the EU will be a success.

    I don’t agree that the EU was set up to become like the US. I don’t think even the French want that. Maybe a few dreamers, but that wasn’t the mainstream view.

    Thanks Jason.

    Claron. You said;

    “I currently live in Germany and have traveled quite a bit around the world. The poorest places I have seen are in rural Idaho followed by some places in China.”

    Either you are kidding, or you’ve never traveled to any developing country outside of China. BTW, even urban China is many times poorer than rural Idaho (I’ve visited both.)

    The poorest places in America are native American communities. In Europe it is the Roma (gypsy) communities. It’s interesting that the European welfare state hasn’t been able to help out the Roma. That makes me think that much of inequality is cultural/discrimination/etc, not the existence of lack of existence of a welfare state.

    The VAT adjustment is an issue, but would not make much difference to the gap.

  43. Gravatar of Morgan Warstler Morgan Warstler
    29. November 2011 at 07:10

    In India I have had massive teams of begging children swarm me like a candy laden rube.

    In Idaho, Arkansas, or West Virgina, not so much… not in any county int he country with a PCI Index score of 60% or lower, not on an Indian reservation, not anywhere.

    Claron, exactly where in Idaho did you get swarmed by beggars? Where are the slums?

  44. Gravatar of Morgan Warstler Morgan Warstler
    29. November 2011 at 07:13

    Scott,

    You’ll also have to admit, if the PIIGS bend, and make the cuts, and then the ECB re-targets higher NGDP, that it was worth it.

    How you feeling about your ginormous bet on Obama?

  45. Gravatar of Morgan Warstler Morgan Warstler
    29. November 2011 at 07:23

    Matty is already eating it.

    http://www.slate.com/blogs/moneybox/2011/11/28/new_eu_plan_won_t_solve_the_problem.html

    Do you know how sweet it is to watch Matty complain about the coming bending of the PIIGS?

    Why do you think he doesn’t even consider companies moving to Portugal when they sell super cheap labor with low corporate taxes and pensions for public employees never worth more than 50% of past wages?

    Why do you think he doesn’t even consider Greece refusing to teach anything but STEM to the next generation of students, like India?

    Why doesn’t he want to see vast cultural shifts away from people behaving like Matty?

    I don’t get it. He has to know that less people being like him is a good thing.

    Mind boggles.

  46. Gravatar of Claron Claron
    29. November 2011 at 07:41

    My point is not that Idaho is that poor (its not) but it is where I saw poverty the closest so it seemed poor. My point is that, as a subjective matter, what travelers see is almost meaningless in making an analytical judgement about relative average living standards (did you count the beggars and divide by the observed wealth?). Seeing for ones self what different places look like and experiencing in a limited way what its like to live some place can provide valuable context for social statistics but in the end we are discussing aggregates and averages. I agree that as a matter of fact such averages are much higher in the USA than China, India, or Ecuador. I do not believe, however, that Germany is much poorer then the US. I think PPP is misleading in comparing countries with such wide disparities in consumption taxes. Scott disagrees, which is fair enough.

  47. Gravatar of StatsGuy StatsGuy
    29. November 2011 at 09:28

    @ Morgan

    “John Thacker, mbk is right, US states is a fine comparison.”

    No, it’s not… From 1980 through the present, there was a MASSIVE fiscal transfer from northern states to southern states. If the progressive income tax system stays that way, it will eventually reverse – then we’ll see rich Texas complain bitterly about sending money to poor Michigan.

  48. Gravatar of John Thacker John Thacker
    29. November 2011 at 10:24

    “If the progressive income tax system stays that way, it will eventually reverse – then we’ll see rich Texas complain bitterly about sending money to poor Michigan.”

    Eventually. But Texas, along with some of the other states, has at least one big advantage with the income tax system; the lower cost of living (mostly due to land-use regulations). The federal taxes and transfers are based on exchange rates (1:1, natch) rather than state-level PPP. Of course, the state-level PPP is mostly a result of policy choices (land-use regulations) and general favorability of climate/terrain, so it doesn’t upset me too much.

    US States have greater internal migration and greater transfers than the EU. It’s true that at times US monetary policy has not been right for all 50 states– just look at the huge complaints in the late 19th century and early 20th over monetary policy, complaints that were state (and urban v. rural) based.

    There are advantages and disadvantages to a common currency. The US has larger advantages– common language, culture, willingness to migrate– than the EU does yet. Eventually the EU may get there to a common identity that will increase the advantages. The euro was an attempt to hasten that process prematurely (the tariff removal and free movement of people came first). It might have worked, absent a crisis. But it made a crisis more likely and made the ill effects of a crisis worse.

  49. Gravatar of o. nate o. nate
    29. November 2011 at 10:39

    Surprised no one has mentioned the issue of inequality in the PPP comparison between Germany and Alabama. Perhaps Germany seems richer because the income is more evenly distributed.

  50. Gravatar of Morgan Warstler Morgan Warstler
    29. November 2011 at 11:03

    StatsGuy, wrong! And it shows your distorted historical reality.

    First, I think you’ll find that the Southern states are fine with keeping whats theirs…

    But really, REMEMBER, we are just United States, not America. We’re built to let a bunch of little poor states veto ANYTHING and EVERYTHING.

    Paying off poorer states is the only way to get them to put up with your big Federal gvt. shit.

    You break, you buy it. Stop the payments, lose DC. Wanna trade? I’m a huge advocate the blue states do exactly that.

    But, I’m 100% sure that when the Euro block gets this fiscal hurdle out of the way, there will come a point where the poor states get bought off… but that comes later, right now they still have put them into balance budget straight jackets.

  51. Gravatar of mnop mnop
    29. November 2011 at 15:41

    “Given that the US has by far the most unequal distribution of income among the rich countries, we can safely guess that the US per capita income overstates the actual living standards of more of its citizens than in other countries.”

    “Because they have much less job security and weaker welfare supports, US workers, especially the non-unionized ones in the service industries, work for lower wages and under inferior conditions than do their European counterparts. This is why things like taxi rides and meals at restaurants are so much cheaper in the US than in other rich countries.”

    Ha-Joon Chang, 23 Things They Don’t Tell You About Capitalism

  52. Gravatar of ssumner ssumner
    29. November 2011 at 19:23

    Morgan, I haven’t placed my Obama bet, but I will.

    Thanks for the Yglesias link. I wondered where he’d moved.

    Claron, Maybe I shouldn’t have said “much poorer,” I think 20% poorer is about right. And of course they have more leisure time, but that’s not relevant to this post, which is about income, not leisure or living standards.

    Statsguy and John Thacker, I agree with both of you.

    o. nate. That’s probably part of it.

    mnop, True, but I wouldn’t push that too far. We are still a huge magnet for immigrants, both rich and poor. Many prefer the US to Europe. Some refugees move to Europe, don’t like it, and come here. That’s revealed preference data for fairly high living standards.

  53. Gravatar of OGT OGT
    29. November 2011 at 20:21

    Sumner- I think you’re right that size, more than wealth, drives the calls for a “German” bailout. No one expects to much from Luxembourg! But the other size driven factor is Germany’s outsized political power in the Eurozone. By all appearances they are the ones running the ECB, after all.

    It looks to me like the German trilemma is that they can two of the following options, but not three 1. Low inflation/NGDP growth 2. The Eurozone intact 3. No bailouts of the periphery. Merkel seems to be, perhaps, moving very slowly to choosing the worst of those options, 1 and 2, with bailouts. But, I suspect the market will move them into 1 and 3, with the Eurozone shrunk considerably before Germany actually acts.

  54. Gravatar of OGT OGT
    29. November 2011 at 20:22

    By the way, I think the discussion on PPP is off a bit. There is generally no controversy of on the NGDP part, it’s the degree of adjustment for cost differentials. My tourist experience is that prices for a tourist basket of goods in Europe is not a far off as the PPP adjustments indicate, but that’s mainly food, drinks, transient lodging, and transportation, which makes me wonder how much of a driver real estate is in those indexes.

  55. Gravatar of Floccina Floccina
    30. November 2011 at 08:28

    German, Alabama and Arkansas are “rich”, just not compared to most other USA states and some other countries.

    As far as the comparison of Alabama and Arkansas and Germany, people often mistake sloppiness and poor upkeep for poverty.

  56. Gravatar of Josiah Josiah
    30. November 2011 at 11:40

    FYI, Scott, I quoted you in my latest Daily Caller column:

    http://dailycaller.com/2011/11/30/fiscal-union-cant-save-europe/

  57. Gravatar of Morgan Warstler Morgan Warstler
    30. November 2011 at 17:13

    Josiah,

    “Europe’s technocratic elite is right to think that having a single continental monetary policy without a unified fiscal policy will lead to disaster (though this is something they should have realized before they gave us the euro). But they fail to recognize that fiscal policy cannot be separated from national sovereignty. Rule by technocrats may delay economic disaster, but it cannot paper over conflicts of vital national interests indefinitely. If the European Union wants to survive, it needs to plan for an orderly break-up of its currency union. And to remain viable over the long run, it must give more latitude to the prerogatives and liberties of its individual member states, rather than trying to lash them all together so that the sinking of one will cause the rest to drown.”

    Europe is just one step ahead of the US right now, when we have a Balanced Budget Amendment, we’ll get the same kind of true state competition Europe is going to get… without Federal largess to paper over inequalities between states, real change will come and wash all the scum off the streets.

  58. Gravatar of ssumner ssumner
    30. November 2011 at 19:22

    OGT, Good points, but are they actually running the ECB? Everyone says this, so I sort of assume it’s true. But why? An Italian is in charge, and 17 countries are represented at the ECB, aren’t they? Where does Germany’s control come from?

    Floccina, I agree about sloppiness. But German per capita GDP (PPP) is fairly typical for developed countries–albeit a bit above average. That was my point.

    Thanks Josiah, good post.

  59. Gravatar of Why Sovereign Debt Ratings May Not Matter That Much – v i b r a n t f i n Why Sovereign Debt Ratings May Not Matter That Much – v i b r a n t f i n
    6. December 2011 at 11:08

    [...] is far short of the level of wealth needed to even agree to something like funding a “first loss” facility for periphery [...]

  60. Gravatar of Why Sovereign Debt Ratings May Not Matter That Much | Boy Scout Website Why Sovereign Debt Ratings May Not Matter That Much | Boy Scout Website
    22. December 2011 at 04:06

    [...] really is far lacking the amount of wealth required to even accept something similar to funding a "first loss" facility for periphery [...]

Leave a Reply