Felix Breuer's Blog

The Euro crisis - links and thoughts

As a German currently living in the US, I am amazed how completely different the discussions about the Euro crisis are inside and outside Germany. I am disappointed in the German media for completely ignoring the arguments that commentators outside Germany make. I am shocked that German economists keep conflating moral and economic issues and turn a deaf ear to sound economic advice without even engaging in a dialog. And the petty, angry and even hateful user-comments that dominate German news websites make me sad.

I would like to recommend a few articles on the current economic crisis and the Euro crisis in particular that give a much sounder picture of what is going on than can be found in the German news media at large.

Here is the gist of what I take away from all this:

I can understand the reflex to say “if you have lived beyond your means, you have to tighten your belt and save”. On the level of a single household or a single company that is sound advice. But it does not make sense at the level of an entire economy. As Paul Krugman puts it: “Your spending is my income and my spending is your income.” This means that I can only save (i.e, earn more than I spend) if there is somebody else who lives beyond his means (i.e., spends more than he earns). Therefore, it is simply impossible for everybody to save at the same time. But this is exactly what people, companies and governments all over the world are trying to do right now. People and companies try to save because of bleak economic prospects, governments try to save because they think they need to be austere. This creates a vicious cycle in which everybody tries to spend less then everybody else. The result is a depression in which nobody manages to save.

We are in a depression that is caused by a lack of demand. Therefore, propping up the supply side will not help in getting us out of this depression. So while structural reforms in the European periphery are certainly important, structural reforms alone will not get us out of this crisis, as long as demand remains depressed. And the austerity politics that Germany in particular is hell-bent on pursuing only depress demand even more.

This lack of demand creates massive unemployment (which further depresses demand). This is no accident. On the contrary, mass unemployment is the official goal of austerity politics. Austerity politics in Europe seek to achieve “internal devaluation” in the European periphery: Mass unemployment is supposed to reduce wages which in turn will restore the competitiveness of the periphery. Unfortunately, this does not work because of a phenomenon called “downward nominal wage rigidity”, which basically means that wages decrease less in a depression than they would increase in a boom. Moreover, the idea of internal devaluation disregards the catastrophic effect that mass unemployment has for the people, especially when they are young. The unemployed have to cope with huge psychological and economic pain (which even results in higher suicide rates). Also, the skills of the unemployed deteriorate which has a negative long-term effect on the economy as a whole.

An alternative means of balancing the differences in productivity between the core and the periphery is to create modest inflation in the core while keeping the inflation rate in the periphery close to zero. This would devalue the euro, making European exports more competitive on the world market. It would also create less unemployment and put less pressure on the demand in the periphery, allowing structural reforms to actually translate into economic activity.

Note that so far this has little to do with the rescue packages that seem to be the only thing that European crisis management revolves around. In fact, I think it is pointless for Germany to finance the debt of peripheral countries as long as there remains the slightest chance that peripheral governments might default. We have to make government default in Europe impossible, in exactly the same way that all other countries that are in control of their own currency do it as well: The ECB has to guarantee European sovereign debt, acting as a lender of last resort. Yes, this may amount to printing money. Yes, this will create inflation, but controlled inflation helps reducing the debt burden. Yes, this devalues the Euro, but that stimulates exports. Yes, this would amount to an implicit transfer payment from Germany to the periphery, but I am not against transfers. I am all for transfers as long as they make sense. And yes, of course this introduces a moral hazard that requires further political and financial integration to be kept in check.

German public opinion about the ever-recurring bail-out packages ranges from weary to hostile, because people rightly observe that these bail-out packages do not work but cost billions. Curiously, however, the reasons why these packages fail - from the refusal to change the ECBs role to the self-defeating mechanics of austerity - are rarely discussed in German media. Thus, most people do not realize that Merkel’s austerity is the cause of the problem. Instead, they are of the opinion that the compromises that Europeans extract from Merkel are to blame. As long as this self-serving ignorance of the German media continues, Germans will keep supporting Merkel’s policy and Merkel will keep being the hardliner that Germans expect her to be, even if Germany drops into recession.

Germans feel that they are being taken advantage of. The reasons for this lie in recent German domestic policy. The hard social security and labor market reforms that Schröder introduced with his Agenda 2010 hurt. Badly. And it took years for them to bring about economic benefits. And just now, when the sharp austerity measures that Germans themselves endured are starting to bear fruit and lead Germany into this economic boom, other countries ask Germany to step up and pay the bill for them. They didn’t do their homework and now they don’t want to endure what Germany has endured. Of course this is not entirely true, but I would claim that this is what is going on in the “German subconsciousness”. It also explains the Germans’ insistence on structural reform and their focus long-term economic outlook: these are the measures that worked for them, so these are the only measures that will work for anyone else. “There is no easy way out, so do not ask us to pay for short-term relief.”

Unfortunately, what worked for Germany in the previous decade cannot work for Europe today. There are many reasons for this. The most important one is that Germany could flourish because of its export-oriented economy. It could behave like a household that tries to earn more and spend less, because there were other countries who spent more than they earned. Now, we are in a global depression, where everybody spends too little. So the only way out is to lead Europe like an economy, not like a household. And this means stimulating demand.

Of course this will have to be at the expense of Germany. Whether this is fair or not is beside the point. It is necessary, if we do not want the world to slide into a Second Great Depression. Of course, all the unfairness entailed in and all the moral hazard created in this process will have to be addressed: No, it is not fair that the 99% pay for a crisis that the 1% caused and from which they even profited. No, it does not make sense that Germans have to work until they are 67 years old or even longer, just so that the French can enjoy an early retirement at the age of 60. And no, one country should not borrow without limit at the expense of another. But these issues can only be resolved through tighter European integration and cooperation. Trying to force tighter integration now, in the middle of this self-inflicted depression, will succeed only in fostering anti-European sentiment on all sides, without accomplishing anything.

Europe is worth paying for. And even those who do not agree should realize that this crisis will cost Germany huge amounts of money, one way or another. But when we invest these resources we have to make it count. Any workable solution needs to have widespread support in Europe. To that end we have to finally start listening to each other. We need to create a true European public and start a true dialog across national boundaries.