Europe going forward

by Henry Farrell on May 6, 2010

I’ve been remiss in posting about the Greek crisis, thanks to other obligations (one paper, semi-half-arsed, just written for a workshop tomorrow; another paper, at best one quarter arsed, for a deadline next week), but here are a few points for discussion.

(1) On the “argument”: argument that “got me drawn into this”: in the first place, I think that Charlemagne’s criticism of Krugman was demonstrably wrong. As I summarized matters back then:

bq. does this really amount to a proper counter-argument? I don’t see any real disagreement here with the basic propositions that (a) EMU isn’t working as it stands, and (b) that the only sustainable equilibrium outcomes here are complete collapse or regearing to allow substantial fiscal transfers (and, insofar as they will do any good, labour market reforms to make increased mobility easier). Saying that politicians will want to muddle through is stating the obvious – but the point is that muddling through is not a sustainable long term strategy. Either the muddling through will be insufficient, in which case EMU will finally succumb to one of the succession of crises that will almost certainly result, or it will be sufficient, in which case it will serve as the basis for a long term shift in the economic governance of the Eurozone towards coordinated fiscal policies and some degree of fiscal transfers in times of crisis, and perhaps more than that.

Unless you want to argue that 110 billion euro of support (80 billion from the eurozone) is common or garden ‘muddling through,’ which I really don’t think you want to, then we _are_ seeing a major shift in the economic governance of the Eurozone. Whether it will be a _successful_ shift or not, I am not prepared to speculate (I have some expertise in EU politics, but little worth talking out in the vagaries of financial markets). “Martin Wolf”: put it pithily yesterday:

bq. For the eurozone, two lessons are clear: first, it has a choice – either it allows sovereign defaults, however messy, or it creates a true fiscal union, with strong discipline and funds sufficient to cushion adjustment in crushed economies – Mr Buiter recommends a European Monetary Fund of €2,000bn; and, second, adjustment in the eurozone is not going to work without offsetting adjustments in core countries. If the eurozone is willing to live with close to stagnant overall demand, it will become an arena for beggar-my-neighbour competitive disinflation, with growing reliance on world markets as a vent for surplus. Few are going to like this outcome.

Either which way, this is not (and will not be) politics as usual. NB that I don’t have any very strong opinion on whether or not it would be a good idea for Greece to default and pull out a la Krugman’s more recent suggestion – again, this is not a topic where I have any particular expertise. I will say though that if the eurozone pulls through this, we are going to see precisely the kind of backstop that Charlemagne thought impossible (i.e. credible mechanisms for the support of countries that get into trouble), combined with much more intrusive mechanisms of oversight and intervention in member state economies. There are, give or take, one hundred and ten billion reasons why nobody wants to find themselves in this fix again, and why the eurozone members will want to converge rapidly on a set of reasonably credible arrangements that will minimize the possibility of recurrence.

(2) It may well be that a new model eurozone (if it happens) would be less attractive to someone with my normative biases than separate national economies. Further European integration is _not_ a good thing in its own right. If the Neumodell Europa consisted mostly of rules that sought to impose German-style fiscal rectitude, I suspect that it would be unpleasant and (for the reasons that Wolf has suggested in earlier columns), highly objectionable to Europe’s trading partners.

But I also think that this is less likely than might appear at first glance. First – Germany’s bluff has been called. For all the bluster of some weeks ago about how bailouts were morally horrible, the Eurozone needed to be able to kick countries out and so on, Germany has now admitted that, when the eurozone is in crisis, it has an interest in keeping it going. Perhaps Germany’s Constitutional Court will forbid the bailout at the last moment, but I doubt it. While the Court has been increasingly expressing its willingness to junk European obligations that it believes come into conflict with the Basic Law, it would have to have balls of steel to forbid a bailout that the main parties are backing. Second – it is possible that Germany’s own economic culture may be changing. Adam Tooze had a “very interesting piece”: in the _FT_ talking about the constitutional amendment that Germany passed shortly before the crisis hit, limiting German budget deficits to 0.35% of GDP from 2016 on. This sits rather awkwardly with Germany’s last minute conversion to “activist fiscal policy”: in early 2009 (it ended up having a considerably larger fiscal stimulus than the UK), and it is unclear how stringently it will be “adhered to when crisis hits”:,s01=1.html. It wouldn’t surprise me if Germans started to shift away from stern fiscal rectitude over the next couple of decade.

(3) There is an interesting point in this “newer Charlemagne post”: on the normative politics of the crisis.

bq. I am proud to be a “market European” : markets integrated east and west Europe, healing the divisions of the Cold War. I support integration in the EU where it brings added value and where it enjoys a democratic mandate. … No, the democratic deficit is the main problem I have with much deeper economic integration, including the central oversight at the EU-level of budget policies, taxing, spending, and welfare systems. If everyone in Europe wanted more or less the same things, I would have no theological problem with technocratic oversight of that consensus. But travelling round Europe for the past five years has taught me that we want very different things. … I do think there is a sufficient democratic mandate out there for the level of integration implied by the single market. I do not see a democratic mandate for a European economic government, any time soon. … It would make the euro much stronger if the Greeks thought like Finns or Dutchmen. But they do not. We Europeans all have radically different views of the proper role of the state, the size of the state, the correct role for competition, whether to favour individual liberty of choice over social solidarity, where to place the cursor when trading welfare protections against dynamism, you name it. Europeans differ when it comes to trusting one another, and trusting civil society. Some are pretty trusting that society is broadly fair, others see life as a zero sum game. For all these reasons, I do not see how you can realistically forge a consensus between different corners of Europe deep enough to allow for the close co-ordination of taxing and spending.

It’s worth noting that much the same argument could be made about why the United States of America shouldn’t work – people in Alabama would likely converge on very different social preferences and taxing and spending choices than people in Massachusetts, if both states were left to their own devices. Still, while I think that the underlying point is a real one, it may go farther than Charlemagne thinks. If I understand him rightly, he is against a single currency, but for the single market. But here’s the thing – the single market is, in its own way, quite as political as a single currency. It constrains the choices of governments and citizens, allowing them to do certain things, while preventing them from doing others. The Single Market consists of a set of regulations, directives and other measures for harmonization, reconciliation of standards and limits on government action, which, over time, have likely had quite as many consequences for the ways that citizens live their lives as a single currency would. The arguments for a Single Market may be good ones, or bad ones, but they are eminently political ones. Charlemagne does acknowledge this, when he suggests that he believes the Single Market has a democratic mandate – but it isn’t clear to me what that mandate actually is. The processes through which the Single Market came about were no more, or no less, democratic than the processes through which EMU came about. I suspect (maybe I am wrong) that Charlemagne thinks at some level that markets are more ‘natural’ or ‘democratic’ somehow than mandated forms of fiscal union – but if this is indeed what he thinks, it is an eminently contestable political claim. The Single Market has had transformative consequences for European member states. These may be good overall, or bad overall – but I can’t see that they are any less political in their implications for the ” proper role of the state, the size of the state, the correct role for competition” and all the other things that Charlemagne (rightly) sees as sensitive than, say, a fiscal union would be.



jim 05.06.10 at 7:26 pm

My point of comparison is the New York City fiscal crisis in 1975 (“Ford to New York: Drop Dead!”). New York had been running primary deficits, had borrowed to cover them, had had increasing difficulty rolling over increasing debt, finally came to the point when there were no bidders at the auction.

The Federal government provided financing. It had to do so for six years (not the three that the EU is envisaging for its intervention in Greece). It took six years before New York could borrow on its own. A Financial Control Board was created, chaired by Felix Rohatyn, with full power to veto any city action that had financial implications. Rohatyn used that power sparingly, but it was clear to everyone that had the city government not cooperated, he would have been more forceful. The legislation that set up the FCB has just expired, by the way.

The EU has no way to set up a Greek Control Board. Even if it did, there is no Rohatyn-like figure available to run it. It requires more than modification of political institutions to regear.


Tim Worstall 05.06.10 at 7:50 pm

“I suspect (maybe I am wrong) that Charlemagne thinks at some level that markets are more ‘natural’ or ‘democratic’ somehow than mandated forms of fiscal union ”

Well, yes. “Markets” are people expressing their preferences in the actions they take. “Mandated” whatevers are the law insisting that people do certain things. It does, of course, depend upon your definition of democracy but the Demos getting on with what the Demos wants to do is at least a different form of democracy than the Demos getting on with what it’s told to do by the majority (to the extent that the EU is even run by said majority).


Henry 05.06.10 at 8:08 pm

bq. “I suspect (maybe I am wrong) that Charlemagne thinks at some level that markets are more ‘natural’ or ‘democratic’ somehow than mandated forms of fiscal union ” Well, yes. “Markets” are people expressing their preferences in the actions they take.

Ummm – when the markets consist of a Single Market relying on hundreds of thousands of pages of detailed regulations, which is the point that I am trying to make, not so much … Markets such as the Single Market aren’t magical free-exchange-unicorns that spring out of nowhere. They’re the product of laws (with consequences if you don’t abide by them) and political decisions. The idea that markets – and in particular acts of market creation – are not somehow political is widespread, but nonetheless quite pernicious.


Oliver 05.06.10 at 8:15 pm

Consider how unevenly populations are distributed in Europe. The four largest make up half the population. There are just too many Germans. Democracy would totally overshadow the small members.
Add to that that Germany as the largest net payer would need to have more influence than its population would merit.


bunbury 05.06.10 at 8:16 pm

A single currency means being able to go and do your shopping in Venlo or buy a house in Marbella too while separate currencies put enormous amounts of power in the hands of central governments and the Forex markets. The Forex markets are not really the Demos are they?


Bloix 05.06.10 at 9:32 pm

Whether it works or not, there are many people in Massachusetts who are not terribly happy about the fact that decisions about taxing and spending choices have to be compromised with people in Alabama.


John Quiggin 05.06.10 at 9:54 pm

A separate point, I may try and work into a proper post. Since the alternative was default, the real beneficiaries of the (mainly) Franco-German bailout were (mainly) French and German banks. They are the ones who should be sent the bill.

Responding to Henry, I don’t think there is any reason for progressives to be opposed to fiscal rectitude; if anything the opposite. We want governments to work well, and running up big structural deficits is one of the characteristic failings of governments we should be looking to correct. Conversely, the Repugs are correct, broadly speaking to see deficit financing as something they should support.


Henry 05.06.10 at 9:56 pm

John – I should have been clearer – what I meant was the German version of fiscal rectitude which involves an abhorrence of even short term deficits. As I understand it, there is some wriggle room in the new constitutional amendment, but the politics of spending in Germany are different – and strange.


chris 05.07.10 at 1:45 pm

Responding to Henry, I don’t think there is any reason for progressives to be opposed to fiscal rectitude; if anything the opposite.

I don’t think a procyclical spending cut qualifies as “fiscal rectitude”. Trying to force any government to balance its budget *during a depression* is nuts (indeed, ISTM that the Germans are channeling Andrew Mellon, which is very unhelpful). There are more important priorities.

If the Eurozone is going to be one economic zone, then why aren’t its more prosperous areas (e.g. Germany) taxed to pay for public services in areas that can’t fund them themselves? To go back to the US analogy, Alabama is a net recipient of federal dollars precisely because it is economically underdeveloped. Currency unity without the potential for this kind of inter-regional payment seems to be a recipe for disaster.

IOW, Greece is being crucified on a cross of euros. Where’s William Jennings Bryan when you need him?


james 05.07.10 at 2:45 pm

Oliver at 4

Consider how unevenly populations are distributed in Europe. The four largest make up half the population. There are just too many Germans. Democracy would totally overshadow the small members.

If only there where an existing model for dealing with such an issue. If only some other country had historically the same problem of implementing a functioning Democracy while preserving the rights of citizens from both small and large states. Some way to Unite the seperate States. Maybe the answer could be found in the Americas.


Omega Centauri 05.07.10 at 3:57 pm

Chris @9. I too am disturbed by the application of fiscal rectitude during a depression. Unfortunately I don’t see an alternative. Deficit spending requires some degree of confidence that the loans will be paid off once the crisis abates. In the case of Greece, with its famously tax dodging culture, I just don’t see how anyone could believe that anything other than very harsh medicine would change that. This may be one of the (hopefully rare) cases where harsh Austrian style punishment may actually be the correct prescription.


Stuart 05.07.10 at 4:00 pm

IOW, Greece is being crucified on a cross of euros.

They are being crucified on a cross of several consecutive reckless governments they elected in. If they were not in the Euro all that would mean would be they could screw over their debtors more subtly by devaluing that they are currently able to. That is the price they paid to get the market confidence to lend them so much in the first place.


Bunbury 05.07.10 at 4:04 pm

How is Greece being crucified on a cross of euros?

The crucifixion is presumably the austerity measures that the government must introduce in order to stand any chance of making the payments on its debts. The scale of those debts is not mainly a consequence of the euro, the drop in tax revenues that turned a problem into a crisis was not caused by the euro. Small countries have not always been saved from discomfort by having currencies of their own. Leaving the euro would only make the scale of the debt worse. Some problems cannot be solved by monetary policy and that’s more true of small countries than large ones.

The most pain caused by euro membership I can see is that it brings pressure on the government to avoid default but even that is in fact in spite of the euro rules rather than because of them. Greece probably should default and after the default might be better off out of the euro but its problems stem from elsewhere and are not made much worse by it. Indeed they may have got a better deal from the other eurozone countries than they would have from the IMF alone.

I don’t really understand the euro fixation in discussions of Greece.


hix 05.07.10 at 5:47 pm

“German fiscal rectitude”? In which paralel universe?

Charlemagne is a joke anyway. All his posts come down to EU evil, Germany evil, UK great, with the one expectation when UK isnt market fundamentalist enough.


hix 05.07.10 at 6:13 pm

A separate point, I may try and work into a proper post. Since the alternative was default, the real beneficiaries of the (mainly) Franco-German bailout were (mainly) French and German banks. They are the ones who should be sent the bill.

Greece would pay most of the price in a default case through inability to borow ever again without huge risk premia, potentially also deal with retaliation from the EU like no cohesion fund money anymore. Also German institutions hold arround 10% of the Greek debt, but Germany pays arround 50% of the bailout if one reads the fineprint*.

*Countries with high interest rates on their debt can opt out of the bailout or get compensation payments, so the low German risk premia increase the German share way beyond the share of Eurozone gdp. Even in the twisted blame the defrauded creditors world, Austria, Netherlands Belgium, Finnland, Germany and Luxemburg are the big losers. Only France comes out arround ok due to their banks disproportional exposure and the low risk premia for government debt countries. Also what Stuart and Bunbury said. Greece has nothing to do with the Euro.


John Quiggin 05.08.10 at 2:21 am

Hix, it’s obvious that Greece will suffer costs from default. But, the costs of accepting the bailout will also be large: big cuts in everything to pay the bills. The question is whether there is a big net benefit. I don’t think so, partly on the theoretical basis that the EU had no incentive to offer Greece more than the minimum they would rationally accept.

Looking at the lenders, by contrast, they gain a lot from a bailout relative to a default, and lose nothing. You can say that pointing this out is “blaming the creditors” if you want, but most creditors of bad debtors don’t get this kind of help.

As for the relative balance between France and Germany, it’s true that France pays less while French banks benefit more, but I don’t think anything in my comment suggested otherwise. France and Germany are as I said, both the biggest contributors and the biggest creditors.


bert 05.08.10 at 10:00 pm

Hope your paper-writing won’t stop you doing a Sunday update, sometime after lunch Georgetown time. It’s getting interesting.


bert 05.09.10 at 6:41 pm

Sorry for being cryptic.
There’s an emergency ECOFIN today.
Sarkozy has been attempting since Friday to force the Germans’ hand.
A press conference (to which I alluded above) was scheduled for the early evening.
All of the briefing prior to the press conference was coming out of the Elysee.
And the latest is that Schauble has been taken to hospital.
Nobody in Germany seems to want to stand next to this.
The sovereign debt markets will be worth keeping an eye on tomorrow.


Henry 05.09.10 at 7:29 pm

Bert – have been following this as best as I can, but have still to make head or tails of it beyond the clear fact that something institutional is happening, that the Germans are not happy about this being announced before the vote, but that they have not (to my knowledge) actively disowned it. Dealing with a bunch of other stuff here, but hope to post on it when I figure out more and get my head around it.


bert 05.09.10 at 8:25 pm
The Germans are briefing that they’re in the boat, apparently.
Cue hurricane.


Charles St. Pierre 05.10.10 at 3:25 am

Well, I did a rough calculation and the Greek Current Accounts deficit for the last decade adds up to over $250 billion. Mostly goods, mostly EU. The EU is going to bail out Greece to the tune of $145 billion. As a loan. Last I heard.

This will not solve the problem.

I figure the best thing for the EU to do is just give the money to the Greeks, and then they can go back to playing the same game. Give the Greeks back their money, so they can go back to spending it on imports from Germany, and the Germans can go back to making exports for Greece. Otherwise the interest on the loan is going to come due, Greece won’t be able to pay up, it will stop importing and put a crimp in the German economy. And then the other little PIIGS come to market.

Another way to put this is just have Greece default on its debts.

The only other option is for Germany to buy up Greece. Which still won’t solve the long range problem, which is maintaining Greece as a market for German goods.

Which is the general producer-consumer problem. No matter how much money the consumer starts with, eventually the producer ends up with all the money. Then the producer either has to give the money back to the consumer, stop producing, ‘loan’ the consumer the money, or buy the consumers assets. Buying the consumers assets is just another step in the process, and doesn’t work in the long run because eventually the producer will still end up with all the money. And the assets. And chokes off demand. Loaning the money to the consumers doesn’t solve the problem, because the loan compounds, and eventually the costs of servicing it chokes off demand. Only by giving back the money is demand maintained.
The only way for the game to continue is for the producer to work out a way to give the money back to the consumer. Otherwise the game comes to a stop. Chaos ensues. Anarchy. The death of millions, etc..

This is the general instability of the market system. This is important. Pay attention. This is the general instability of the market system. Especially under free trade, (ie a ‘free’ market) . And not just between countries, but between any organized entities, or any individuals. If any individual works just the slightest bit more than another, and there is free trade (exchange) between them, either the harder working individual trades down, that is accepts less than par value for what the other has to offer, and allows the other to trade up, or he eventually ends up with all the other’s assets. The other ends up with no assets, and the harder worker ends up with it all.

And as between two, so between three or four or a million. The hardest worker(s) eventually end up with it all. And this might be called the most just result.
Of course, it doesn’t have to be the hardest worker. It could be the cleverest, or the luckiest. Or the one with the most leverage.

Because the producers don’t necessarily end up with all the money. There is another class, whom we will call manipulators. The manipulators do not produce anything, but they control the money, and because they control the money, they can arrange it so that they themselves are the most efficient accumulators of money. More so even than the producers. So they are the ones who end up with all the money. And the assets.

And default will be prevented, the debts assumed by the people, so as not to offend the sensibilities of the manipulators.

The libertarians go on about (Nozick) “What ever arises from a just situation by just steps is itself just” Well, the end result of this ‘justice’ is the impoverishment of most of society, and ownership of everything in the hands of a very few. (Actually one, in the limit.) And not even those most ‘deserving,’ not even those who most contribute to the wealth of society, but the most skilled at manipulating. Horrorshow.

The generalization is mine, I think. The particular, with reference to free trade, is: “Mathematical modeling reveals that under these conditions, outright Las Vegas decadence is not necessary for there to be a problem. It reveals that with free trade between nations with merely different discounts on consumption, the nation with the higher discount (more impatient) will tend to maximize present consumption by having past generations (who produced the assets that can be sold off) or future generations (who will service the debt) pay for present consumption. Various factors can interfere, but that’s the underlying dynamic.” Ian Fletcher, ‘Free Trade Doesn’t Work What Should Replace it and Why.’ (p47) He includes this reference to Joseph Stiglitz: ‘Factor Price Equalization in a Dynamic Economy,’ Journal of Political Economy May/June 1970.


bert 05.10.10 at 7:36 pm

Cue hurricane.
By which of course I meant bouyant thermal upwaft…

FT Alphaville, round about 3 o’clock this morning:

“the euro is gonna get spanked”

FT Alphaville, round about 9 o’clock this morning:

“Towards a United States of Europe”

Looking forward to your take, Henry. As and when, though – seems to be smartest not to rush onto the record on this one.

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