Babies With Candy 3/16

A Continent Adrift

...the situation in Europe worries me even more than the situation in America.

Just to be clear, I’m not about to rehash the standard American complaint that Europe’s taxes are too high and its benefits too generous... they’re actually a mitigating factor.

The clear and present danger to Europe right now comes from a different direction — the continent’s failure to respond effectively to the financial crisis...

On the fiscal side, the comparison with the United States is striking... America’s actions dwarf anything the Europeans are doing.

The difference in monetary policy is equally striking. The European Central Bank has been far less proactive than the Federal Reserve; it has been slow to cut interest rates (it actually raised rates last July), and it has shied away from any strong measures to unfreeze credit markets.

The only thing working in Europe’s favor is the very thing for which it takes the most criticism — the size and generosity of its welfare states, which are cushioning the impact of the economic slump... these programs will also help sustain spending in the slump.

But such “automatic stabilizers” are no substitute for positive action.

In previous columns, Krugman has questioned positive action being able to lift us out of the crisis (noting, for example, that it took a world war to get us out of the great depression). He also has expressed concern for long-term costs. Expectations of efficacy and cost aside, he never wavers from cheer-leading such policy.

Why is Europe falling short? Poor leadership is part of the story. European banking officials, who completely missed the depth of the crisis, still seem weirdly complacent. And to hear anything in America comparable to the know-nothing diatribes of Germany’s finance minister you have to listen to, well, Republicans.

This is an odd mirror to the run-up to the iraqi war. Then, in the eyes of Democrats, Europeans were wise friends whose council and co-operation we ought never reject unilaterally. To Republicans, they were weak and mushy and incapable of responsibility. Now, the views are reversed. The commonality may be a lack of decisiveness.

But there’s a deeper problem: ...unlike America, Europe doesn’t have the kind of continentwide institutions needed to deal with a continentwide crisis.

This is a major reason for the lack of fiscal action: there’s no government in a position to take responsibility for the European economy as a whole. What Europe has, instead, are national governments, each of which is reluctant to run up large debts to finance a stimulus that will convey many if not most of its benefits to voters in other countries.

...there is a European Central Bank. But the E.C.B. isn’t like the Fed, which can afford to be adventurous because it’s backed by a unitary national government — a government that has already moved to share the risks of the Fed’s boldness, and will surely cover the Fed’s losses if its efforts to unfreeze financial markets go bad. The E.C.B., which must answer to 16 often-quarreling governments, can’t count on the same level of support.

Europe, in other words, is turning out to be structurally weak in a time of crisis.

It turns out, somewhat ironically, that we have the state dominated economy we thought Europeans had, and they have the divided government we thought we had.

To Krugman this is a factor in our favor.

The biggest question is what will happen to those European economies that boomed in the easy-money environment of a few years ago, Spain in particular.

For much of the past decade Spain was Europe’s Florida, its economy buoyed by a huge speculative housing boom. As in Florida, boom has now turned to bust...

In the past, Spain would have sought improved competitiveness by devaluing its currency. But now it’s on the euro — and the only way forward seems to be a grinding process of wage cuts. This process would have been difficult in the best of times; it will be almost inconceivably painful if, as seems all too likely, the European economy as a whole is depressed and tending toward deflation for years to come.

This argument assumes that there is a pain free path out of a Spain, or Florida, style bust. There may well be not, and all the positive expensive attempts to avoid any pain may, in the end, only serve to radically increase it.

An economist like Krugman should welcome different governments pursuing different policies in response to the crisis as that will produce more and better data for economists to study. The partisan political commentator in Krugman may fear the tale that data will tell.