Friday, November 20, 2015

Read Carefully Before Signing: The Eurozone Crisis Narrative

A group of economists is circulating a document called Rebooting the Eurozone: Step 1 – Agreeing a Crisis Narrative.  (Their on is off.)  It was written by a high profile team including such luminaries as Richard Baldwin, Olivier Blanchard, Paul de Grauwe and Daniel Gros and asks readers to send in their own endorsements if they are economists.  A bunch of heavy-hitters have their names appended at the bottom.

For the most part it is a reasonable account.  The two main factors they identify are the imbalances that accumulated within the EZ before 2008 and took the form of excessive private debt and the absence of institutional features that would otherwise permit adjustment within a currency zone.  (Fiscal federalism and flexibility are not on their list, probably to obtain consensus across a political spectrum from center-right to center-left.)  They call attention to the partitioning of banking along national lines, which fed the “doom loop” of bailouts, macro deterioration, nonperforming loans, deterioration of sovereign debt in bank portfolios and greater vulnerability of the financial system to runs, leading to further bailouts etc.

I thought about signing on.  Then I stopped, reread the letter and saw a bullet point smuggled in at the end of their list of crisis-inducing features:

Interesting....  All the other bullet points have short explanations to convince the reader that the observation is correct and important, but not this one.  Perhaps the authors thought that a reference to the evils of “rigid factor and product markets” would be uncontroversial and obvious.  Or perhaps they can’t actually supply a justification based on agreed-upon research.  Or both.

There are two reasons why this little sentence bears attention.  The first is that it is probably wrong.  There has been a large volume of research on the relationship between price (especially wage) flexibility and macroeconomic performance, and the best you can say is that it is inconclusive.  In Europe at least, countries with the most “managed” labor and product markets tend to outperform the paragons of liberalism.  Of course, it depends on the time period.  During the 90s, when it was struggling to absorb the former GDR, Germany looked like a macroeconomic weakling, and economists were quick to jump on it for its elaborate “Rhineland Model” of worker participation, industry associations and public banks.  Now Germany is on top, and economists—well, they will talk about almost anything but the effects of the social market model.  Now it’s southern Europe that has sclerotic regulation that prevents it from being competitive.

But the second reason gets to heart of what’s wrong with this letter: it misses not only a key piece of the economics, but just about all of the politics.  It seems to assume that the reason the political elite of the eurozone imposed self-defeating austerity and failed to take low-cost, utterly feasible actions to defuse the crisis, like quickly extending lender of last resort protection to governments and their financial systems, was lack of economic information or understanding.  A great cloud of confusion has supposedly settled on the European capitals, and it is up to the good people of the Consensus Narrative to let the sun shine in.

I’d argue, however, that EZ policy has been consistent and even rational, if you adopt a different view of what the policy actually is.  Suppose the overriding goal of the elites is to use the leverage of Europe, and especially its common currency, to undo the post-WWII social compromises that are unbudgeable at the country level.  Reduce union power, cut back the welfare state, privatize public enterprises, get rid of the levers that permit public intervention in how companies are managed and run.  In that case, it would be dereliction of duty to permit countries to escape crisis without taking these desired measures, now packaged as “reforms”.  The “rigidity” bullet point summarizes this perspective, vitiating the whole point of the exercise.  The response to the narrative will be something like, “Yes, you have reasonable arguments, but as you acknowledge yourself, failure to reform is at the heart of the problem.  This is why we can’t simply support uncompetitive countries  without insisting on a corresponding package of reforms.”

No, I don’t think I’ll sign.

1 comment:

Sandwichman said...

Nice catch, Peter. I would add that the "rigidity of factor markets" typically alludes to protective labor market institutions. Did I say typically? How about exclusively? We never hear about the rigidities imposed by the private ownership of the means of production. Nope, labor -- and labor alone -- is the designated flex factor.