Can Krugmanomics Be Saved?

By Steven Hill, Social Europe Journal, February 24, 2011

Paul Krugman recently penned a 6000 word essay for New York Times Magazine provocatively titled “Can Europe Be Saved?” (January 16, 2011) Coming from anyone else than a Nobel Prize winning economist, such a title questioning the survivability of the largest economy in the world, with more Fortune 500 companies than the United States and China combined, would be laughably dismissible. Imagine an essay titled “Can America Be Saved?” Or “Can China…” or India or Brazil or planet Earth be saved, and you can grasp the hubris of the framing.

So I presume that Professor Krugman did not write the title, probably it was written by some bleary-eyed copy editor at 3 AM who did not even notice that the article is not even about “Europe” but about the “euro.” A title of “Can the Euro Be Saved?” is a better fit for the article itself and is worth discussing. Asking “can Europe be saved?” is cataclysmic thinking on the silliest order.

In his New York Times column and bestselling books, Professor Krugman has done yeoman’s work in educating millions and being a commonsensical center-left voice in a fairly narrow American political landscape. He is one of a rare American breed, a public intellectual that reaches a mass audience. The last time I heard, he also is still teaching a course load at Princeton University, in addition to writing a blog, appearing frequently on TV and giving public lectures. He is clearly putting his heart and soul into his work, and for that we owe him our gratitude, even when we don’t agree with him.

Unfortunately, Professor Krugman also has his blind spots, and they are laced throughout his essay. Krugman lays out familiar arguments regarding the challenges of the euro zone and its 17 member states; there really is nothing new here that Krugman and others haven’t covered extensively before. But the more revealing aspect of Krugman’s essay is what he left out. As such, it reveals much about the fallacies of his thinking regarding international economics, and to some degree about the economics profession in general. The European and U.S. economies have diverged in fundamental ways and had been leaving different tracks in the sand well before the economic crisis. But the boilerplate of Krugmanomics, applied in a one-size-fits-all fashion, prevents Krugman from being as astute a commentator on either Europe or international economics as he is on U.S. domestic politics.

In a nutshell, Professor Krugman argues the following in his essay: The euro was always a dubious idea because it did not combine a monetary union with a fiscal union. But European leaders “engaged in magical thinking” and pretended the downsides didn’t exist. Chief among those downsides is that individual eurozone nations have lost their monetary flexibility, so when a country like Ireland has a crisis it can’t devalue its currency in an attempt to boost its competitiveness, exports and employment, because it now shares that currency with 16 other nations. Instead, it must cut government spending and workers salaries to increase competitiveness, relinquishing the chance for Keynesian type stimulus spending to jumpstart the economy, further deepening its economic crisis and enduring painful deflation.

Of course, deeply troubled U.S. states can’t devalue their currency either, since all share the use of the dollar, but Krugman says they benefit from a key difference: a “transfer union,” led by a central federal government that can bail them out when the going gets tough. Also, the U.S. has a more mobile workforce that can move when jobs are scarce to where jobs are more plentiful. European nations, Krugman says, have neither—language and cultural barriers discourage migration, and strong countries, especially Germany, have been refusing to help weaker ones sufficiently. But Germany’s selfishness must change, Krugman argues, if the eurozone is going to survive. “Odds are the current tough-it-out strategy won’t work. … Europe’s stronger nations will have to make a choice.” Yet Krugman hints at his own doubts that Europe will make the correct choice. His piece has all the drama of an oracle predicting an economic disaster in the making.

But the first crack in Krugman’s thinking is revealed at the end of his very first paragraph, when he writes: “Europe’s gross domestic product might have fallen as much as [in the U.S.], but the Europeans weren’t suffering anything like the same amount of misery [as Americans]. And the truth is that they still aren’t.”

Instead of spending a few paragraphs exploring why it is that Europeans are suffering less than Americans – for example, exploring how Europeans have introduced elements of worker democracy into their social capitalist economy via practices like works councils, partially worker-elected boards of directors of major corporations (codetermination), a more robust cooperative system, short work and a culture of consultation which helps spread the pain around; or how Europe manages to provide quality, universal healthcare to all its people for about half the amount of money that Americans pay per capita for healthcare, even in the midst of an economic crisis; or how Europeans provide more support for families and workers than Americans can even imagine – is it due to better institutions, practices and policies? Is it better leadership? Is it dumb luck? Or is it just a matter of time before they are doing as poorly as Americans? — instead Krugman gives us 6000 words of macroeconomic boilerplate about how, as he says in his very next line, “Europe is in deep crisis.”

Certainly some countries in Europe, including the notorious PIGS (Portugal, Ireland, Greece and Spain), as well as the smaller Baltic republics and Great Britain, are having difficult times. But others – Germany for one, but also the Scandinavian countries, France, the Netherlands, Denmark, Switzerland, Poland and others in central Europe – are doing remarkably well. In fact, 14 of the 23 European countries that are members of the Organization for Economic Cooperation and Development have lower unemployment rates than the U.S., including Germany, Britain, Sweden, Italy and Belgium; France, which American ideologues typically like to skewer, has an unemployment rate the same as in the U.S. An article exploring why some countries in Europe are doing well and others not so well, and why most of them are doing better than the U.S., truly would have been a valuable contribution to the discussion. Instead, Krugman goes on to rattle off the well-traveled narrative about the lack of a fiscal union to go along with a monetary union that has been much discussed for months in numerous publications and websites.

The reason it’s important to point this out is because Krugman’s article unfortunately shares much in common with a long trail of gloomy and distorted American media reportage about Europe. Well before the economic crisis of 2008–9, the European economy (and especially the economies of Germany, France, and Italy) were regarded as in a state of perpetual crisis, written off by most American eurosceptics as a clumsy, sclerotic basket case, a “sick old man” condemned to long-term decline. Starting in 2003 and lasting until late in 2006, gloom and doom headlines predating Krugman’s prevailed in the U.S. media, such as “The End of Europe”; “The Decline and Fall Of Europe”; “Is Europe Dying?”; “Why America Outpaces Europe” and dozens more until —surprise, surprise—it was discovered that the European economy actually was surging and had equaled and then surpassed the U.S. economy during those years. In fact, an article published in the international version of Newsweek on November 20, 2006, blared the headline “The Great Job Machine: Despite Its Laggard Reputation, Europe Continues to Grow Faster, and Create More Jobs, than America”—yet that story never appeared in the domesticversion of Newsweek. To this day, the patriotic U.S. media continue to shield Americans from injections of reality that are badly needed to understand our country’s relative standing in the world.

Krugman has contributed his share over the years to his readers’ confusion about international economics. For example, no one has been more influential in defining a misleading narrative about Japan being an economic basket case than Paul Krugman. Recall that in the early 1990s, in the wake of a recession, economists predicted that Japan’s surging, export-driven economy would eat America’s lunch and the U.S. would be looking at huge government deficits for years to come (indeed, deficit obsession gave Ross Perot his political rise in the 1992 presidential election). Then, by the end of the decade, the U.S. budget showed a sizable surplus and the schizophrenic economics profession did an about-face and concluded instead that the land of the Rising Sun had been mired in a “lost decade,” economically speaking. Krugman wrote a series of gloom-and-doom articles, with titles like “Japan’s Trap” and “Setting Sun,” bluntly stating: “The state of Japan is a scandal, an outrage, a reproach. It is operating far below its productive capacity, simply because its consumers and investors do not spend enough.” (italics mine)

But let’s look at some of the Japanese metrics during that time. Throughout the alleged lost decade the Japanese unemployment rate was a mere 3%, about half the U.S. unemployment rate. The Japanese also had universal healthcare, one of the lowest rates of inequality, higher life expectancy than Americans, and lower rates of infant mortality, crime, and incarceration. In other words, Americans would have been so lucky as to experience a Japanese-style lost decade.  Even today, Japan’s unemployment rate is about 5% –a bit over half the U.S. rate –and it still has healthcare for all its people, low income inequality, crime, incarceration, homicides and is one of the world’s leading exporters to boot. It also has been doing far more than Obama-led America to reduce its carbon emissions which contribute to global warming. While Japan certainly has its challenges – what economy doesn’t – doesn’t it sound like a country from which Americans might learn a thing or two about how to get out of the mud hole in which we are stuck?

Not according to Paul Krugman. In Krugman’s theoretical world, “consumption” and “aggregate demand” are crucial components and any country like Japan that falls short in those categories is portrayed as suffering from a disease. Indeed, the Japanese situation has been called “Japan syndrome,” sounding like a sickness to warn policymakers, as in “you don’t want to end up like Japan.” Experts like Krugman consistently have chosen to emphasize their own preferred measuring sticks, seeing the glass as half-empty rather than half-full (to be fair, recently Krugman has slightly retracted some of his earlier views on Japan in the face of his glaring oversights).

So Professor Krugman, unfortunately, has been part of this disquieting American tradition in which the media and leading thinkers have been so wrong about international economics and have misled Americans about our country’s relative standing in the world. It is important to keep that in mind as one reads Krugman’s NYTM article. Like his Japan narrative, Krugmanomics applied to Europe uses the wrong measuring sticks and results in a flawed understanding of Europe’s situation.

The transatlantic ideological divide

Professor Krugman’s article contains several inaccuracies in its rendition of the challenges and dilemmas faced by Europe. First, the author has manufactured his own version of recent European history. He writes:

“The tragedy of the Euromess is that the creation of the euro was supposed to be the finest moment in a grand and noble undertaking:  the generations-long effort to bring peace, democracy and shared prosperity to a once and frequently war-torn continent. But the architects of the euro, caught up in their project’s sweep and romance, chose to ignore the mundane difficulties a shared currency would predictably encounter…Instead, they engaged in magical thinking, acting as if the nobility of their mission transcended such concerns.”

In actual fact, European leaders were quite aware of the potential landmines of having a monetary union without a fiscal union. There was no “magical thinking,” just a pragmatic recognition of the compromises one has to accept sometimes to move an ambitious project forward. Europeans on both the left and the right, such as Jacques Delors, who as President of the European Commission (the closest thing Europe has to a U.S. president) laid the groundwork for the introduction of the euro, warned about the difficulties resulting from having a monetary without a fiscal union. Indeed, Delors considered fiscal federalism an eventual by-product of monetary union, once these defects manifested themselves. But the fact is, the disparate nations of Europe were not prepared to agree to the whole package at one time. Remember, this is a continent that not that long ago had fought brutal wars against each other, going back centuries.

So it was necessary to construct their union in stages (much as Obama is doing with his ambitious healthcare overhaul). A monetary union, a single European market, a European Parliament and some other common institutions and laws was the most they could get agreement on initially, knowing full well that at some point the defect of lacking a fiscal union would rear its gnarly head. Nevertheless, any steps taken toward creating a more unified Europe were broadly seen as having important political as well as economic advantages that helped to unite the European continent. So this was a compromise of necessity, not unlike the one that the American founders had to make in the Big State vs. Little State compromise over political representation (which resulted in every state, regardless of population, receiving two senators, a compromise that haunts the most populous states like California to this day since they are saddled with a transfer union that increasingly drains their state economies, as we shall see).

Indeed, Krugman doesn’t even bother to reflect on our own nation’s history, and how we came to become more of a union. Under the first government of President George Washington in 1789, the U.S. not only did not have a common fiscal policy from state to state, it didn’t even have a monetary union. Different currencies and scripts were used in the 13 different states. The situation was abysmal, causing the first Secretary of the Treasury, Alexander Hamilton, to embark on an ambitious project to create just such a fiscal and monetary union. His efforts were opposed mightily by none other than Thomas Jefferson and James Madison, who feared too much central government power, attesting to the complexity and controversy of these issues that is evident in Europe today. Would Krugman say about those early American efforts, as he has about Europe’s, that the elimination of the thirteen different colonial currencies for one unified dollar without a strong fiscal union was “magical thinking”?

Krugman seems never to contemplate that Europe today is a work in progress, just as a new American nation once was. From the inauguration of the first American government it took the U.S. about 80 years – and a bloody civil war – to cease being a collection of regions and to bind into a nation. And during that time the U.S. suffered at least eight banking crises and financial panics.  Seen in that light, it’s helpful to remember that the current configuration of the European Union – 27 nations and 500 million people – only dates to 2007 (when Romania and Bulgaria joined). Nearly half the EU member states have joined since 2004. The use of the euro dates only to 2002. ‘Old Europe’ actually is quite young. Societies change on the order of decades, and it’s necessary to see past the daily headlines and discern the trajectory of the future. The realization of “union” does not occur with the passage of a single treaty or with signatures on a page. That’s just the beginning of the journey, after that comes decades of institutional evolution and of cultural and historical adaptations before the tree of union takes firmer root.

But Krugman has little patience for this European work in progress, and so instead he turns up the rhetorical heat. He writes:

“These [European]achievements are now in the process of being tarnished, as the European dream turns into a nightmare for all too many people.”

Nightmare? Let’s keep this in perspective, shall we? Sudan is a nightmare; China’s gulag of political prisoners or Abu Ghraib were nightmares; Mubarak’s Egypt was a nightmare “for all too many people”; a ravaged Europe during its two world wars was a nightmare. But Europe today, all things considered, is a remarkably civil place, with little in the way of nightmares haunting it, even during this economic crisis. That’s not to say the Europeans don’t have their challenges, especially still in the Balkans, but even Krugman has said that Europeans are suffering less than Americans. Currently, some of the European countries are having a difficult time, but certainly not all of them, or even most of them. When I visited Greece in October 2010 and interviewed Prime Minister George Papandreou, the tensions and protests were palpable but so were the beautiful weather, gorgeous landscape, great cuisine and pleasant people. I don’t find the street protests in Greece or Ireland alarming – indeed, I wonder why more Americans aren’t in the streets. Nightmare? Hardly.

Krugman also confuses cause and effect. He praises the UK for staying out of the currency union, yet the Brits, just like Greece and Ireland who are in the euro zone, face huge budget cuts and unemployment increases, with upset people marching in the streets. Krugman fails to realize that being in or out of the eurozone is no guarantee of anything. Germany, which is in the eurozone, is by far the most robust economy in Europe and other euro zone countries are doing fine as well; Greece and Ireland are inside but are having difficulties. The UK and Iceland are outside the euro zone and having real problems; Sweden, Poland, Switzerland and Denmark are outside and doing fine.

Krugman’s overblown hyperbole misses other important subtleties as well. Greece and Ireland have been reeling, to be sure, and Spain’s 20% unemployment rate is alarming. But everyone in the PIGS countries still has health care and access to the many safety net supports that European countries provide. Compare their plight to California: a recent report found that 25% of Californians do not have any health insurance, and California’s unemployment rate is the same as Greece’s, at 12.5%. Many communities in the Golden State have been hard hit with waves of foreclosures; in some counties in California half of the outstanding mortgages are “underwater,” meaning their house is worth less than the mortgage and so they are essentially bankrupt. State and local governments have slashed tens of thousands of jobs and programs have been cut that affect the most vulnerable. California’s jewel of a university system is in the process of severe atrophy and becoming unaffordable for the middle class. Many Californians have been left to fend for themselves, and this story is being repeated in many other U.S. states. Greece, Ireland and Spain combined make up a smaller portion of Europe’s overall economy (about 12%) than California does of the US economy (about 14%). California is “too big to fail,” to use the parlance of the day, and is dragging down the American economy, yet no federal bailout on the order of what Europe has done for Greece and Ireland is remotely in sight.  So the “tarnish” in the troubled European countries is nothing like what is being experienced by many American states because those states entered this recession already lagging Europe’s safety net.

Should California exit the dollar zone?

The situation of California and other hard luck American states speaks volumes to Krugman’s discussion of various currency regimes. Krugman declares that “liberal American economists, myself included, tend to favor freely floating national currencies that leave more scope for activist economic policies — in particular, cutting interest rates and increasing the money supply to fight recessions.” One can’t help but wonder whether Professor Krugman’s fondness for freely floating currencies could be extended to any of the individual 50 American states. Following Professor Krugman’s logic, one can’t help but conclude that California, for example, should exit the “dollar zone.” That’s because this fiscal union has been a bum deal for Californians for a long time. California taxpayers have subsidized most other states for years, since for every dollar in federal taxes it sends to Washington DC, Californians only receive back about 70 cents, with the other 30 cents going to mostly conservative ‘red’ states. California could use that money right now since its economy has taken a nosedive.

Indeed, California’s dilapidated condition caused then-Governor Arnold Schwarzenegger to go hat in hand to the federal government in 2009 and ask for a bailout. Despite the Golden State’s decades-long generosity to other states, the Obama administration spurned California’s ‘Brother, can you spare a dime’ appeal, forcing California to issue IOUs to keep from defaulting, in the process becoming a national laughingstock on late night comedy shows. Also in return for its long-standing benevolence toward its fellow states, California and its 38 million people are only allowed two U.S. Senators, the same as Wyoming and it’s half a million people, to fight for its residents’ priorities. Clearly when it comes to receiving help from this “fiscal union”, California’s congressional delegation has been impotent to help the largest state in the union. Today California punches far below its weight nationally; consider for a moment that its economy is as proportionate to the US economy as Germany’s is to the European economy, yet Germany exercises far more influence in Europe than California does in the U.S.

So should California exit the dollar zone, and possibly even these United States? According to Krugman’s logic, California could solve its financial problems by devaluating its currency, if it had one. A number of other heavily indebted states (Illinois, New Jersey, New York, Arizona, Kansas, Nevada and many more) could do something similar. Just recently the New York Times reported that policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts. Aren’t these states being burdened by sharing a single currency, and a single interest rate, with an inability to devalue their currencies and enjoy the alleged benefits of devaluation? Indeed, following Krugman’s logic, if all 50 states had their own currencies, each could devalue it and there could be a splendid race to the bottom as each state tried to outdo each other.

Beyond currency exits and devaluations, Krugman attempts to illustrate the advantages of having a fiscal union by telling a “tale of two places” in which he compares Ireland and Nevada to show the differences in what happens when you have a federal transfer union. Krugman writes:

“The fiscal side of the crisis is less serious in Nevada. It’s true that budgets in both Ireland and Nevada have been hit extremely hard by the slump. But much of the spending Nevada residents depend on comes from federal, not state, programs. In particular, retirees who moved to Nevada for the sunshine don’t have to worry that the state’s reduced tax take will endanger their Social Security checks or their Medicare coverage. In Ireland, by contrast, both pensions and health spending are on the cutting block.”

But Krugman completely misses several crucial points. First, Ireland already had more “automatic stabilizers” as well as more robust pension, unemployment and health care systems than Nevada, so now during a deep recession it has more room to maneuver. Even after making some cutbacks, the Irish have far more supports for families and individuals than Nevada. Second, Nevada is able to depend on federal programs because, as mentioned above, Nevada is being subsidized by states like California and Illinois. For California and Illinois, which are having difficulties at least as bad as Nevada, it’s an increasingly dubious deal. California and Illinois are NOT getting bailed out by federal programs — instead they are forking over billions of dollars to the federal government to give back to Nevada. Indeed, the way the fiscal transfer union works in the U.S. is that the more liberal blue states for the most part have been subsidizing the conservative red states, even as the red states complain about “big government” and give the middle finger to states like California and Illinois. Krugman’s selective use of examples is blurring the lines of fiscal accountability by distorting the aggregate reality of fiscal unions. In fiscal unions, some receive and some take. The European nations, especially those like Germany and others that will be the ones doing the subsidizing, are wise to step into this cautiously.

If Krugman’s policy choice of devaluing one’s currency is so attractive, then why is it that a breakup of the dollar zone has no political legs and makes no economic sense? It’s because there is a fallacy in Krugman’s theory. His operating model seems to assume that it is OK for countries to take on too much debt, as long as they make sure to retain the ability to devalue their currency and default on that debt. That way they can make others pay for their irresponsible behavior, as well as for the benefits that country has enjoyed (like Greece, for instance, which Krugman says benefited initially by being in the eurozone because it was able to receive much lower borrowing costs). Keep in mind, these are not former colonized countries whose dictators ran up huge debts and stashed the money in their own foreign bank accounts. These debts were assumed by democratically elected governments and for the most part the residents of the country benefited.

So according to Krugmanomics, taking on too much debt is not the problem – it’s not being able to pay the debt that is the problem. And Krugman’s solution, apparently, is to be able to depreciate your currency and/or default on your debts, leaving the creditors holding the bag. This line of argument seems fundamentally immoral, the equivalent of stealing other people’s money. Indeed, Krugman ignores the problem of moral hazard altogether, of the Greece’s of the world that try to hide their debt and then, when all hell breaks loose, ask for a bailout. Unquestionably Germany in particular is insisting that the profligate countries aren’t just bailed out, that they feel some of the pain resulting from their past poor decisions. Why is it any better to let countries off the hook for their debts than the big banks, as long as that debt was not accumulated by dictators? Should a country like Greece borrow to the hilt and provide an unsustainable level of benefits for its people, only to ultimately yank it away from the next generation? Or is it better for each generation to try and live roughly within its means? These are hard and important questions that the Europeans are trying to figure out but which find no place in Professor Krugman’s discussion.

Indeed, Krugman proposes his interventions like devaluation with an intellectual ease that borders on recklessness. He goes on to say, “If you still have your own currency, you wouldn’t have to go through the protracted pain of cutting wages: you could just devalue your currency — reduce its value in terms of other currencies — and you would effect a de facto wage cut.”

“Just” devalue your currency? It all sounds so easy and antiseptic, but in fact devaluation of a nation’s currency is a brutal affair. It leads to near-immediate increases in unemployment, inflation, a likely run on the banks as people move their liquid assets to safer countries, and other destabilizing jolts. Attesting to its difficulties, even Spain, which is headed by a Socialist government with no strong ideological adherence to free market ideology, so far has declined to go down this road, despite what Krugman and other economists recommend. No matter how you approach it, Greece and Ireland, and possibly Portugal and Spain, are in a tough spot and there is no easy way out. From the average person’s perspective, it matters little if their countries have their own currency and devalue it, or default on its debt, or instead manage to roll over that debt at a high interest rate and pay off creditors. Either way, these countries are going to have to tighten their belts, lay off people, and that will be a hardship for everyone. They have been living beyond their means (especially Greece and Portugal, the Irish governments overspending didn’t begin until they began bailing out its failed banks), rolling up deficit after deficit, allowing their economies to become less competitive, and the bill has come due.

To be clear, I am not advancing a conservative argument against deficits, public credit or government debt writ large, but instead a conversation about degree and kind. Public debt can be immensely advantageous, such as when it is invested in infrastructure and education that makes your economy more competitive and paves the way for the future. But what Krugman isn’t grasping is that, despite the hardships of trying to remain in the euro zone Greece and Ireland feel that their place belongs smack in the heart of Europe, including the euro currency. Greece, Spain and Portugal are countries that were run by military dictatorships until the mid-1970s. That’s really not that long ago, and there is a broad consensus across the country that full membership in all that is Europe – even with the downsides – is preferable to the alternatives. So they are willing to sacrifice and pay the economic price to do so. Remaining in the euro zone may not make economic sense in the short run, but theirs is a rationale based, at least in part, on culture and history. It is a vision based on aspirations for the future. Perhaps those are qualities that many economists cannot understand.

Krugman also underestimates the extent to which Europe already has a “transfer union,” i.e. a federal system in which the better off member states help the worse off. The poorer member states of the European Union receive significant amounts of funding from the EU for various development and infrastructure projects, the common agricultural policy and regional assistance programs. A quick look at the EU budget shows that vast amounts of money flow from richer to poorer countries (see http://en.wikipedia.org/wiki/Budget_of_the_European_Union). The four member nations in deepest trouble now (Greece, Ireland, Spain and Portugal) had the poorest economies when they joined the European Community more than forty years ago, and mechanisms have been in place to transfer wealth to these nations ever since.

Moreover, to meet the recent challenge brought on by the Greek debt crisis, Europe was able to pull together a trillion dollar bailout fund, a kind of European Monetary Fund, as well as other reforms. At the end of the day Europe was able to accomplish what America could or would not do – extend a hand to a member state (such as California). Despite the fact that there is no history, tradition or even legal structure for mounting a bailout of another nation, Germany, France and others – which have fought wars against each other for centuries – pulled together and did just that. Europe’s unprecedented action – clumsy at first but ultimately bold – was extraordinary, indeed it was historic. Yet the usual corps of eurosceptics typically whined that it took Europe too long – a whole four months – to throw a lifeline to Greece.  California should have been so lucky as to receive such help from the federal government and its fellow member states. California and other struggling states are still waiting.

Certainly this type of federalism is nowhere near as developed in the European Union as it is in the United States, but the early American nation did not have much of a transfer union either. Indeed, the first federal government under President George Washington barely had any revenue at all, not even enough for its own standing army and had to rely on state militias. The euro crisis now has revived the case for an even more powerful federal state. We have not seen the last of the reforms for creating a tighter fiscal union coming from this European work-in-progress.

Next, Krugman overemphasizes another point when he writes that “while Europeans have the legal right to move freely in search of jobs, in practice imperfect cultural integration — above all, the lack of a common language — makes workers less geographically mobile than their American counterparts.” Krugman’s demographic observations seem grounded in Europe’s quickly receding past, as the transatlantic differences in this regard are becoming increasingly fewer (one of the online respondents to the NYTM article commented, “Professor Krugman’s thesis that Europeans aren’t mobile across national boundaries must be something he got from his junior year abroad.”). Europe is not the melting pot that America is, but it’s on its way there. Travel to any of the cities today and you can see that the minority and immigrant populations of Europe are some of the fastest growing in the western world. In a place like France, where there has been Islamaphobic fears over Muslim immigrants, the largest immigrant group actually is from Portugal, not North Africa. Another online commentator reacted to the Krugman article saying, “My apartment here in Norway is being refurbished by a Polish company and my office was cleaned today by a Lithuanian who is soon to have a child. My children live and work elsewhere in Europe. On the subway I hear Spanish, Italian and a smattering of other languages. Europe’s workforces are indeed mobile, and unlike the U.S., they’re multilingual and well-educated.”

The younger generation in particular has grown up with the 5 E’s that are changing Europe –email, English, Erasmus (the popular student exchange program), the euro and Easy Jet (the airline that pioneered low cost flights all over Europe). The “Erasmus generation,” as it is called, is used to hip hopping around the continent and has embodied a more pan-European consciousness. As they become adults, the invisible borders of language and mobility will become less prominent. True, it’s hard to imagine that Europe will ever have a single language, but on the other hand, with the Hispanicization of the US occurring rapidly, America is becoming more of a place of two languages; Chinese and Asian populations in urban areas have added multiple more languages to the cityscape. Go to any Walmart today and it’s practically a mini United Nations of polyglot commerce. Besides, if the U.S. has such a strong “labor flexibility advantage” over Europe, how come unemployed Californians are not heading in droves to the Dakotas, where unemployment is so much less?

The Fifth Option–a European alternative

In the final section of his article, Professor Krugman provides a helpful outline of four potential scenarios for how this crisis may play out in Europe. But he also reveals his most glaring omission. The four scenarios are: toughing it out, in which the troubled economies will endure the pain and contraction of government budget cuts, cuts in services and higher unemployment, but will avoid either default or devaluation; debt restructuring, which would reduce the troubled economies’ debt by a significant amount at the price of losing all ability to borrow any more money on the international markets from those investors who were forced to take the haircut; “full Argentina,” by which Krugman means troubled countries would break their link with the euro, create their own currency and then devalue it to increase competitiveness and exports; orrevived Europeanism, whereby the better off countries would play a bigger role in bailing out the troubled countries, moving Europe closer towards a fiscal union. All four of these have been discussed by many experts for months, and he quickly outlines the pros and cons of each. He concludes that, for now, the plan Europe is choosing is “tough it out” which he predicts will produce disastrous results.

However, there is a fifth scenario that Krugman never explores, and that is the one that Europe actually seems to be pursuing. It’s called “pushing reset” –- embarking on a very un-American course to figure out how advanced economies can provide for their people without having roaring growth rates driven by asset bubbles, hyperactive consumption and carbon-belching activities. Europe’s economic evolution, spurred on by this crisis, marks a departure from the U.S. development model that has dominated the global economy since the Reagan era.

This growing transatlantic difference over development models was glaringly evident during the Group of 20 summit in Seoul, South Korea in November 2010. Prior to the summit, Paul Krugman, U.S. Treasury Secretary Timothy Geithner and others had proposed a controversial intervention for the global economy, founded on an economic theory just as divisive. Krugman and Geithner declared that the recent economic collapse was caused not only by America’s Wall Street casino capitalism but also by certain global trade imbalances. In these economists’ theoretical world, if the trading surpluses of some nations don’t balance the trading deficits of other nations, then disaster surely awaits.

In practical terms, that means that countries with robust manufacturing sectors and big trade surpluses, like Japan, China and Germany, must be good sports and step up to the plate to further stimulate their domestic consumption, helping to lift the world out of its current slump in aggregate demand. They would do this by increasing their public spending, i.e. running up bigger deficits, and importing things from countries like the United States with big trade deficits (as soon as it can be figured out what the U.S. manufactures that these nations want to buy). And this boost in global consumption would not only provide more electronic trinkets, big screen TVs and stylish clothes for those frumpy Germans and buttoned-down Japanese, it also would help the world rebalance its trade imbalances.

Indeed, just as Paul Krugman has criticized Japan for not spending and consuming enough, he has written stridently in other articles about Europe’s insufficient fiscal stimulus needed to jumpstart the global economy. He has written that the Germans—one of the few economic bright spots in a struggling global economy—“seem to be getting their talking points from the collected speeches of Herbert Hoover,” and along with China – another bright spot in the struggling global economy – he has called them both the “axis of depression” for their alleged failures to consume more and act as a driver of global economic recovery. To a stimulus hawk like Professor Krugman, now is the time for massive Keynesian spending in the form of government stimulus to jumpstart sluggish economies. While he doesn’t explicitly say this in his New York Times Magazine piece, elsewhere he has stated that he sees the current euro difficulties as a threat to Europe’s ability to mount sufficient fiscal stimulus spending.

That’s the theory, anyway, and Geithner and President Obama actually came to the Group of 20 meeting with a demand that no nation should run up a trade surplus of more than 4 percent of gross domestic product. But as Indian statesman Jawaharlal Nehru once said: ‘A theory must be tempered with reality.’ Surely Secretary Geithner and Professor Krugman have visited Germany and Japan and noticed the obvious: that these wealthy nations are hardly lacking in material goods or modern trinkets. So what exactly are the Germans and Japanese supposed to buy more of, especially in quantities large enough to make a difference? Americans are the only ones who seem to think they need three refrigerators, four televisions and a car for everyone in the household.

China is a different story. There, about a billion poor people could use some of the things money can buy to raise their living standards. But unfortunately the Chinese authorities think it’s better to finance the U.S. budget deficit and American consumers’ profligacy as a way to boost Chinese exports and create jobs, rather than spending their surpluses directly on the welfare of their own people. Without a functioning democracy in the People’s Republic of China, the people have little recourse to make their demand.

So the Krugman-Geithner global trade rebalancing proposal was completely unworkable. The impracticality of their proposal reflects the unreality that certain experts like Paul Krugman sometimes inhabit. His theoretical frame seems to assume that not only economies, but also the national cultures in which economies are situated, can be precisely manipulated by policymakers pulling the right levers. Economists’ efforts in that regard appear like Charlie Chaplin’s character in Modern Times, struggling to get his unruly industrial machinery to obey like a giant steam engine, pulling on one lever here and closing a valve there, twisting a few dials, pressing on the accelerator and – presto! – off you go.  But if we’ve learned anything from the economic collapse, it is that economies are wildebeests that tend to defy easy corralling. That’s not to say that institutions and policy are unimportant, but it’s an act of hubris to think that an economy is infinitely malleable. Policymakers face constraints and ignoring that reality results in poor policy.

Part of the challenge in understanding these matters is rooted in the fact that the European and U.S. economies have become quite different animals in fundamental ways. So this discussion rightly belongs to a broader conversation regarding Europe’s social capitalism versus America’s Wall Street capitalism. The U.S. economy is still substantially a trickle down one, where more of the prosperity produced goes into the pockets of the wealthy – it has far more inequality and poverty, and 50 million people without health care.  Absent the redistributive advantages of the European countries, the U.S. economy undoubtedly needs more stimulus to ignite it so that enough of the wealth trickles down to those at the bottom. But for Europe’s steady state economies, which have the institutions and values to foster a more broadly shared prosperity and to more fairly distribute the pain during a down economy, a different intervention is needed. And that intervention, to some degree, is restoring budget sanity to their economies after a dizzying collapse. They are endeavoring to return to sustainable levels of debt and spending so that the costs of borrowing aren’t so high, and so that they are not continually jerked around by corrupt rating agencies like Moody’s and Standard & Poor’s (Europe is in the process of reforming its governance over these rating agencies). And then from that new normal, mapping out the best way to maintain this broadly shared prosperity by rejecting a wildcat economy that is built fragilely on asset bubbles and overconsumption. Balance and sustainability are the catchwords of this approach.

This latter course certainly seems to be what German Chancellor Angela Merkel and other European leaders have in mind. At the G-20 meeting, Merkel completely rejected the entreaties of President Obama and Tim Geithner for a global rebalancing of trade, or for further fiscal stimulus by her government. Instead, she gave an earful to the cowed Americans. Said Merkel, The United States is the one that must take the necessary steps to increase its competitiveness. The U.S. should not try to put limits on countries that have figured out how to get the world to buy their goods. Merkel continued: “The benchmark has to be the countries that have been the most competitive, instead of reducing to the lowest common denominator.” Ouch, that hurts – America being called ‘the lowest common denominator.’

Her finance minister, Wolfgang Schäuble, was even more blunt. He described American policy as ‘clueless’ and said the American growth model is stuck in a deep crisis. “The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base.” Ouch again. Germany – previously sneered at by U.S. pundits as Europe’s “old man” – lecturing America about how to grow its economy. Certainly Germany has deployed its share of stimulus spending, but it also asserts that stimulating your economy alone does not increase real competitiveness since competitiveness comes from factors like productivity gains, business environment, physical infrastructure, supply of qualified workers and innovation. The Germans, Japanese and Chinese weren’t buying any of the Krugman/Geithner/Obama ‘global trade rebalancing’ proposal, nor were many of the other 16 of the G-20. Right in front of the world’s major leaders, Merkel finished the process of knocking the American paragon off its post-World War II perch. The U.S. is losing the global argument over the best development model for the 21st century. The Washington consensus, if not dead, is on life support.

Economic and Ecological Sustainability

But Merkel said something else at the G-20 that is even more of a game changer, and directly addresses a point that Krugman has missed many times in his writings. “It is essential to return to a sustainable growth path,” she said. Advancing her own theory for the economic meltdown beyond global trade imbalances, she said that a primary cause was that “we did not have sustainable growth. In many countries growth was built on debt and [speculative] bubbles.”

What Merkel was saying – and it’s revolutionary in its ramifications – is that the era of U.S.-style, trickle-down, consumption-driven economics is over. The world needs to figure out how advanced economies can provide for their people without having roaring growth rates, asset bubbles and hyper consumption, and also how to develop in a way that is ecologically sustainable (unlike the Obama administration, European leaders have not shelved their global warming interventions in the midst of this economic crisis). Krugmanomics, which is based on massive government stimulus spending to boost aggregate demand, consumption and job creation, is neither economically nor ecologically sustainable. More stimulus and growth, if not accompanied by greater conservation and energy productivity, will pump excessive carbon into the atmosphere.

European leaders seem to believe they are pushing reset on this Wall Street capitalist development model and offering a necessary corrective for a renewed 21st century capitalism. Already they are much further along than the Obama administration in redesigning their financial regulatory system, including the creation of four new agencies mandated to intervene if necessary to prevent another collapse (here is a list of Europe’s comprehensive financial industry reforms).  Europe has been criticized by Krugman and others for not doing enough to re-stimulate its economies, but Europeans believe it is wiser to wait until a healthier financial architecture is in place, otherwise they would likely replicate the conditions that contributed greatly to the economic meltdown, i.e. launch a new round of bubble-driven, debt-ridden economic growth. Led by Germany, Europe’s biggest contribution may be the redesign of capitalism itself, still inching toward a “new normal” in the wake of the recent meltdown.

This amounts to a direct rebutting of Krugmanomics. If consumer-driven growth was the order of the day in the post-World War II era for the developed nations, in the new era it will be steady-state economic growth – growing not too fast, but not too slowly – and manufacturing value-added products that the rest of the world wants to buy. The real game is no longer strictly about economic growth, it is also about sustainability, both economically and ecologically. More than the developing economies like “Chindia,” the developed world must lead the way towards a different path of development, a way to learn to “do more with less.” That is not an easy challenge.

This then is the Fifth Option, the one that Paul Krugman never imagined. It involves a degree of toughing it out, yes, but also undoubtedly will include more proposals for forging a greater degree of European fiscal union founded on a more stable bedrock of a redesigned capitalist system. In a series of EU summits planned for February, March and June many insiders expect a major strengthening of European governance that includes the eurozone. The measures being debated and so far finding tentative favor include:  greater eurozone oversight of the economic strategies of individual eurozone governments; a further increase in the financial aid available to help eurozone countries in difficulty; enabling the euro rescue fund to buy distressed governments’ debt, resulting in lower bond interest rates and retaining access to markets; reductions in the interest charged for financial aid to Greece, Ireland and potentially other eurozone states (Germany is showing signs of leniency after its initial tough line against moral hazard delivered the right message); tougher sanctions against those who deliberately undermine eurozone discipline; and renegotiation of the terms of bailout agreements to make possible bigger sacrifices by bank shareholders and bond holders rather than tax payers. When these agreements are launched, says John Palmer of the European Policy Centre, “Those EU countries which share the euro will have taken major steps towards an economic as well as a monetary union and with it the foundations of a European ‘economic government.’” Palmer and others are predicting “not EU disintegration but deeper European integration among its core members in the euro-area.”

Europe is trying to learn from the economic meltdown, and use it as an opportunity to reform and ready itself for the 21st century. In practical terms, that means trying to enact a new future that is economically and environmentally sustainable. Americans of all stripes should hope that the Europeans succeed. Even better, Europe is hoping that its trans-Atlantic ally will join in this epochal-defining endeavor. That’s what Professor Krugman and other economists need to grapple with if they want to stay relevant.

Steven Hill (www.Steven-Hill.com) is a political writer whose latest book is “Europe’s Promise: Why the European Way is the Best Hope in an Insecure Age” (www.EuropesPromise.org).

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