David Coates

European Lessons for an America in Debt

With the Senate currently preoccupied with immigration and the House of Representatives with abortion, you might be forgiven for thinking that there is nothing seriously awry in the American economy right now – nothing so awry at least that it requires determined and detailed political action. But you would be mistaken. There are lots of things wrong in the contemporary American economy, not least the persistence of large scale unemployment and deepening poverty.[1]  Indeed one other major thing that is wrong in the American economy today is the lack of action on major economic problems by those who govern us.

But perhaps we are simply caught in a summer lull; and if that is so, the chances are high that the political weather will break in the fall in the form of yet another round of political in-fighting on debt levels and debt ceilings. If that in-fighting occurs, the chances are also high that the Republicans will periodically bring Europe into the conversation, pointing to the on-going Eurozone crisis as evidence of the need for both immediate and long-term reductions in federal spending and programs.

So we might as well use the summer lull, frustrating as it is, to do some homework on Europe and its crisis.

The Republican claims about Europe are normally three in number – two specific and one general. The two specific ones are these: that government over-spending is what caused the Eurozone crisis, so we shouldn’t overspend here; and that if we do overspend we will end up like Greece, entirely broke and in need of perennial bailout. The more general one is that the Eurozone crisis demonstrates beyond doubt that welfare capitalism as practiced in Western Europe is simply an inferior model to the liberal capitalism we have perfected here in the United States; and because it is, the big lesson we should take from the Eurozone crisis is that we need to be as dissimilar to Europe as possible.

Fortunately for those of us favoring a strengthening of our welfare net, the big problem with those Republican claims about Europe and its current crisis is that they are all entirely wrong.

·         Spending by European governments was a response to the crisis, not its cause. The root cause of the Eurozone crisis was a systemic banking failure – and that failure was in part imported from here. Greece aside, the governments of Ireland, Spain and Portugal were all financially solvent before the banking crisis broke. Irish government debt levels, for example, were lower than those in Germany in 2008;[2]and (as we argued in an earlier posting[3]) overall government debt in Europe was actually falling as a percentage of GDP prior to the 2008 financial crisis.  The European banking crisis was initially shipped in from America, with major European banks also caught up in the purchase of toxic assets – mortgage backed securities sold by Wall Street firms – that caused such panic here. The European crisis was then compounded by over-lending, particularly by northern European banks, to construction companies and property developers along the Mediterranean coast and in Ireland. It was the resulting scale of local bank indebtedness, and the threat that posed to the rest of their economies, which then led key European governments in 2009 to underwrite bank losses – with the Irish and British governments, for example, even taking some of them into public ownership, just as here the Bush Administration took Fannie Mae and Freddie Mac into conservatorship. Many of those European governments, particularly those in the smaller Eurozone economies, then found that the scale of the bank losses they had underwritten jeopardized their ability as governments to borrow in the money markets; and did so because “many Eurozone banks were large relative to the size of the economy where they were based.”[4] Banks weakened European governments after 2008, not the other way round: and many European banks remain weak still.[5]

·         The Eurozone is made up of at least four different economic models (Mediterranean ones like Italy, Continental ones like Germany, Nordic ones like Denmark and Anglo-Saxon ones like Ireland[6]). This variety is both the zone’s strength and its weakness. It is a source of strength – the northern welfare economies are able to sell products more easily into the south of Europe because of the Eurozone, and their exports benefit from an exchange rate for the euro that is depleted by southern European under-development. It is a weakness, because the Mediterranean economies are locked into patterns of combined but uneven development within Europe from which they cannot easily escape.[7] But do notice: contrary to Republican claims, it is the northern welfare states that are the strongest economies inside the European Union, with per capita income at/above U.S. levels.  They and the German economy perform the best: welfare capitalism does work in Europe. And do notice too – the United States is not like any Eurozone economy. Least of all is it like Greece.[8] Unlike Greece, we control our own currency, and indeed remain the world’s reserve currency. In consequence, we can print our way out of debt and deliberately alter the exchange rate of our currency in ways that Greece cannot; and we are currently so heavily in debt to surplus economies like Germany, Japan and China that we have become literally “too big to fail.” Greece can be forced into internal recession on a huge scale without that adversely impacting, except at the margin, the export performance of the German economy. A similar recession in the United States would plunge the world into another great depression, as so nearly occurred in 2008-9 – and no one is going to volunteer for a return to that.

·         The only really delinquent state at the start of the Eurozone crisis was Greece – and its delinquency took the form of an excess of honesty. The internal trigger to the Eurozone crisis was the admission, by its incoming center-left government, of how earlier Greek governments had cooked the books: with Wall street’s Goldman Sachs helping to obscure Greece’s 100% debt-to-GDP ratio when it joined the Eurozone in 2001. It was the admission of the true scale of Greek debt which then sent a ripple of fear through a European banking system that had over-invested in property development all along the Mediterranean coast, triggering a series of sovereign debt crises in one Mediterranean government after another as banks rushed to pull back debts they feared they would otherwise never recover. The European banking system had used the first decade of the euro to over-leverage itself in exactly the manner of U.S. financial institutions during the American housing boom; and like that property boom, when the European one popped the stability of the whole financial system was immediately put in jeopardy.

·         There are deep structural problems inside the Eurozone. They are simply just not problems that have American parallels. The Eurozone is a monetary union. Individual state governments operate under a single currency and a single central bank. But they retain their own fiscal powers. The Eurozone is not a fiscal union. There is no central European Treasury Department to match the American one. Each state has its own Treasury department. Moreover, the Eurozone brings together economies of very different levels of efficiency and development, and societies and cultures that speak different languages and have different (and often very antagonistic) histories. Indeed the EU was originally created precisely to prevent further wars between its members. So within the Eurozone governments are free to spend, and to borrow if they can, under steady electoral pressure from their own people. Those governments share a common currency, so borrowing from banks outside their national territory is easier; and when those banks have to be organized to bail them out, as in 2009-10, the subsidizing of the spending of one country by the lending of another is clear for all to see.  That is not so here. Our regional differences, though acute, are not of the same order; and when blue states subsidize red ones (and they do, via the distribution of federal programs and Pentagon spending) that subsidization goes almost entirely unnoticed. As Wendy Carlin put it, as against the U.S. system “the situation in the Eurozone is very different. In fact it is more or less the polar opposite: there is no federal stabilization; the members have national fiscal autonomy; bank failures are dealt with at the national level; and member governments are being bailed out.”[9]

·         The European economy most like ours is the UK’s, and it is struggling mightily with the risk of a triple-dip recession. Like the United States, the United Kingdom retains its own currency, and its own major international financial center – the City of London. Foreign Direct Investment flows in there as it does here, and the Bank of England can (and does) pursue quantitative easing to offset fiscal constraints. The problem that the U.K. presents to Republicans, however, is that since 2010 the Conservative-led government there has pursued exactly the kind of austerity program that conservatives would have the federal government pursue here, on the familiar argument that the best way to stimulate private sector growth and job creation is to cut government taxes, regulations and programs.[10] But no such private sector growth has yet appeared. Instead, the U.K. economy has been through two recessions since 2010, and is currently close to dropping into a third. The UK’s “annual pay packet has shrunk by £52 billion since the start of the financial crisis,”[11] with real wages down 6% since 2008 – “the largest five-year drop on record.”[12] With its European markets flat and public spending cut at home, U.K. private firms lack the market confidence to invest and hire on any scale, and U.K. banks are reluctant to lend to them for similar reasons. The austerity route to prosperity so canvassed by the American Right has been tried in London and found wanting.

·         The two big European problems are austerity and inflexibility. We would do well to avoid both. The Eurozone governments led by Germany, and the Eurozone banking system overseen by the European Central Bank (the ECB), have struggled to find a route out of their recession because the German government has insisted on tough lending and repayment terms by southern economies to their northern banking creditors – the northern banking system fearing that too generous a bailout of the south would leave them financially insolvent. Yet that very German toughness has led to savage cuts in public sector programs and employment in the southern Eurozone economies, plunging more and more Europeans into poverty. That poverty has then turned round and bitten the northern economies back, by robbing them of the southern markets on which their long-term profits so often depend.  The scale of that dilemma would have been less severe had the ECB been free, from the outset of the crisis, to underwrite those northern banks with bonds issued by the ECB itself, and if quantitative easing was as easy for the European Central Bank to perform as it is for the Federal Reserve and the Bank of England. Slowly, the ECB has come round to playing this expansionist banking role, and slowly the Eurozone crisis has eased. But we have no need to repeat European austerity and inflexibility. It hurt their economies, and it would hurt ours also.

·         Before we gloat about European economic problems, we need to remember the appallingly social and human costs now being paid by European workers who are entirely innocent of any causal role in this mess – and then avoid recreating those costs over here. The human cost of the Eurozone crisis is truly horrendous. Unemployment levels among young workers – 18-25 – in Spain, Italy, Portugal and Greece, are now running at around 50%. In Greece, that proportion is currently 59% – almost two young Greeks in every three.[13] Cuts in welfare programs are eating into the already modest living standards of the European poor. So bad indeed has become the social crisis inside the Eurozone economies that the earlier leadership enthusiasm for an austerity response has now been largely abandoned, and even the International Monetary Fund has gone on record as believing that the level of cuts in public spending on which it initially insisted were too severe.[14]

The big lesson that Europe has to teach us is not that austerity works and that government spending on welfare, education and infrastructure crowds out private sector economic growth. The lesson is rather that that these days whole economic regions are so closely interlocked that the health/prosperity of one is absolutely vital to the health/prosperity of another. Global economics are no longer a matter of zero-sum competitiveness, with U.S. companies somehow taking advantage of European troubles. European consumers are a vital part of our prosperity too.[15] We help them best by generating growth here – markets into which their companies can sell – and by encouraging them to grow. And the key to growth – there and here – is not austerity and inflexibility, but targeted government spending, generous international loans and further rounds of quantitative easing.[16]

[1] Brad Plumer, “The U.S. job market is still worse than at any point during the last downturn,”  The Washington Post, June 12, 2013: available at http://www.washingtonpost.com/blogs/wonkblog/wp/2013/06/12/the-u-s-job-market-is-still-worse-than-at-any-point-in-the-last-downturn/

[2] See Henning Meyer, “Analyzing the Eurozone Predicament – Not One Crisis but Three,” Liebniz Center for Economics, Intereconomics, 2012: available at http://www.ceps.eu/system/files/article/2012/10/Forum.pdf

[4] Wendy Carlin, 10 Questions About The Eurozone Crisis And Whether It Can Be Solved. UCL European Institute, September 2011: available at http://www.ucl.ac.uk/european-institute/highlights/10questions

[5] Stephen Fidler, “Austerity Isn’t Only Thing Weighing on Europe,” The Wall Street Journal, June 6, 2013: available at http://online.wsj.com/article/SB10001424127887323844804578529311559082832.html

[6] On these distinctions, see André Sapir, Globalization and the Reform of European Social Models. Brussels, 2006: available at http://www.bruegel.org/publications/publication-detail/publication/31-globalisation-and-the-reform-of-european-social-models/

[7] On this, see Stephanie Blankenburg, Lawrence King, Sue Konzelmann and Frank Wilkinson, ‘Prospects for the eurozone,” Cambridge Journal of Economics, 37(3), May 2013, pp. 463-78: available at http://cje.oxfordjournals.org/content/37/3/463.extract

[8] See Matthew O’Brien, “No, the United States Will Never, Ever Turn Into Greece,” The Atlantic, April 17, 2013: available at http://www.theatlantic.com/business/archive/2013/03/no-the-united-states-will-never-ever-turn-into-greece/273748/

[10] Larry Elliott, “Britain is a lab rat for George Osborne’s austerity programme experiment,” The Guardian, May 26, 2013: available at http://www.guardian.co.uk/business/2013/may/26/britain-osborne-austerity-programme-experiment

[11] See Katie Allen, ‘Wage cuts for British workers deepest since records began, IFS shows,” The Guardian, June 12, 2013: available at http://www.guardian.co.uk/money/2013/jun/12/workers-deepest-cuts-real-wages-ifs

[12] Brian Groom, “Rise in UK employment raises hopes for economic recovery,” The Financial Times, June 12, 2013: available at http://www.ft.com/intl/cms/s/0/2b5e8c3a-d33e-11e2-95d4-00144feab7de.html#axzz2W6JG5Wlw

[13] See Rupert Neate, “François Hollande: the Eurozone crisis is over,” The Guardian, June 9, 2013: available at http://www.infowars.com/francois-hollande-the-eurozone-crisis-is-over/

[14] Matina Stevis and Ian Talley, “IMF Concedes It Made Mistakes on Greece,” The Wall Street Journal, June 6, 2013: available at http://online.wsj.com/article/SB10001424127887324299104578527202781667088.html

[15] Sudeep Reddy, ‘Economic Woes Abroad Bode Ill for the U.S.,” The Wall Street Journal, April 22, 2013: available at http://online.wsj.com/article/SB10001424127887323551004578436863860612032.html

[16] On this, see Kenneth Rogoff, ‘Inflation is Still the Lesser Evil,” Project Syndicate, June 6, 2013: available at http://www.project-syndicate.org/commentary/the-benefits-of-higher-inflation-by-kenneth-rogoff

David Coates holds the Worrell Chair in Anglo-American Studies at Wake Forest University. He is the author of Answering Back: Liberal Responses to Conservative Arguments, New York: Continuum Books, 2010.

He writes here in a personal capacity.

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