Tuesday 29 May 2012

Economists Can't Solve Europe's Crisis

Often the most difficult thing to do in life is to see something for what it really is. The imbroglio in Europe today offers a crystal clear case

27 May, 2012

To call the continent’s current predicament a “debt crisis,” as virtually everyone does, is to obscure its true nature.

It is only a debt crisis in the sense that high government debt levels catalyzed the reconsideration—and repricing—of risk across the region. (Recall the October 2009 post-election confession from Greece’s then-incoming PASOK party that the nation was running an annual deficit much higher than what the previous administration had reported.)

But the situation could just as easily, and perhaps more accurately, be called a “growth crisis.” In fact, the correlation between weak growth and high borrowing costs may even be higher than that of high debt levels and high borrowing costs.
Spain, for example, at the end of 2011 had a relatively manageable 68.5% level of government debt to gross domestic product (Germany’s amounted to 81.5%; America’s was 103%).

Its total public and private debt levels were far higher, of course, as were Ireland’s, thanks in part to real-estate bubbles and over-large banking sectors.

That, however, is a different kind of problem than the strictly government debt crisis which most who use the term have in mind—and one that might seem to argue for a different kind of “solution,” by the way, than strict fiscal austerity measures.

And yet “growth crisis” (or even more simply, “recession”) isn’t quite the right term here, either.

Even that only describes the symptoms of Europe's, or in fact the euro zone's, true predicament, which is this: that it has tried to operate as a single economic body—namely, a 17-member fixed exchange-rate and monetary policy zone—without being a single political one.

As it turns out, you can do that for a certain length of time while underlying economic performance is reasonably aligned. The euro zone’s time, however, is up.

The disparities between Greece and Germany have become too great. And so two things have become clear; first, that the euro zone cannot continue to exist as an economic body in its current form without true political union.

Second, that the logic of trying to do so in the first place now looks extremely unsound— unless, and this is an extremely important point; unless it was never about the economics in the first place. Which it wasn’t.

Take this characterization, from a 1998 speech by then-Bank of England monetary policy committee member Willem Buiter: “the [European Monetary Union] is a major step on the road to ‘ever closer union’ in Europe. It represents the opening of a new chapter in the European federalists’ agenda, a significant transfer of national sovereignty to a supra-national institution.”

Indeed. The euro was quite plainly used to commit Europe to political union. And so from that point of view, the region’s current “debt crisis” in fact presents itself as an opportunity for policy makers and politicians to take another major step—or to perhaps go all the way—in transferring national power to Brussels (which is all that today’s various bailout funds or proposed euro-bond schemes ultimately amount to).

In so doing, they clearly have the backing of financial markets, which threaten to seize up entirely if the euro is scrapped.

Nevertheless, that should not be confused with having the backing of European citizens to make what is ultimately a political decision—and perhaps the most critical one the region has yet faced.

The questions which each and every European ought now to be considering at the moment are these: Are you willing to diminish your national power within Europe in order to maintain, if not enhance, your regional power in the world? Are you ready to become a European first, and a German, or a Spaniard, or a Greek, second?

This is not a rhetorical exercise; writing in the London Evening Standard, Goldman Sachs Asset Management Chairman Jim O’Neill said one of the three easy steps”by which Europe could solve its crisis would be to declare that “from now on, no euro country will individually participate in G7, G8, or G30 meetings. They would all be represented by the eurozone,” as one entity.
But while nationalistic fervor has certainly intensified of late, support for the euro remains strong, and fear of the consequences of a euro zone break-up may yet carry more weight. Which isn’t to say that is the “right” outcome here, either.
If anything, it recalls a popular phrase from the founding time of America’s union: “Those who would give up essential liberty to purchase a little temporary safety deserve neither liberty nor safety.”

The key question for Europeans today is whether or not sacrificing some of their national identity for the sake of supra-national, regional identity amounts to a sacrifice of their “essential liberty.”

That is a fundamentally political, historical, even philosophical question; it is not one that economics or its practitioners—particularly those who aren’t themselves Europeans—can or should decide.

To reiterate: economics itself needs to be “ring-fenced” here, to borrow a phrase that is currently being overused—and, one could argue, misused—in the context of Europe’s crisis.

If anything, the crisis, which has hastened the shift of political decision-making onto the laps of economists, underscores the urgent need for economics to be ring-fenced in matters of public policy in Europe and beyond.

And yet the opposite appears to be happening: “Don’t put politics ahead of economics.

Polls may tell you what seems popular. They can show you the political obstacles to reform. But they cannot tell you what is the right thing to do.

They are not a reliable guide to good economic policy, particularly in a crisis, when all the options seem terrible to any sensible person.”

That, in fact, was U.S. Treasury Secretary Timothy Geithner in a commencement address to the Johns Hopkins University’s School of Advanced International Studies over the weekend.

The trouble, however, is that it isn’t just the fickle nature of popular attitudes that has let politicians give themselves—and their responsibilities—over to economists, or to the seemingly impartial “verdicts” delivered by the up-and-down gyrations of financial markets.

It is the fickle nature of popular opinion combined with a lack of guile, vision, or direction from politicians themselves.

Politicians today appear to have absconded their own role in the admittedly difficult democratic process.

Public opinion may not always be the most reliable gauge of what the right thing is at any given time to do, but certainly neither are financial markets or economics.

To quote Deirdre McCloskey, herself an economist, modern economics “is the science of Prudence-Only, setting the other virtues [like justice, temperance, and fortitude] aside.” Prudence, in other words, is useful—but to a point.

With regards to Europe’s political crisis, we have long since reached that point.

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