Playing Chicken.

Architects of the Euro-zone sought a stronger, more prosperous, and more harmonious union.[1] The inauguration of the Euro in 1999 began a period of low interest rates for member countries. Low interest rate led to heavy borrowing by both public (Greece) and private (Spain, Ireland) sectors. When the world economy slowed down after the American financial crisis, debt-service became a problem.

The architects had not then—and have not yet—resolved all of the problems. One worm in the apple is that the single currency serves 19 sovereign states. Those states do not pursue uniform economic policies. Nor do all national cultures celebrate the same values.[2] German hostility to budget deficits closed off large-scale counter-cyclical spending as a policy tool. Instead, states were to pursue limiting deficits as a share of Gross Domestic Product (GDP).

The pursuit of austerity policies has had different effects in different countries.[3] The GDP of Germany has risen about 10 percent from 2009. The GDP of Portugal, Spain, and Italy are all down about 10 percent. The GDP of Greece is down more than 20 percent. The decline in GDP has increased the burden of the government debt financed by taxation. Government debt as a share of GDP has risen from about 30 percent to about 70 percent in Spain; from 90 percent to about 110 percent in Italy; and from 60 percent to about 120 percent in Portugal. Greek government debt as a share of GDP has risen from about 110 percent to about 170 percent. (Thus, austerity has pushed Italy and Portugal into the same territory from which Greece began.) This raises the danger that bigger, more severe crises lie over the horizon.

The the creditor countries could pursue expansionary policies that might fuel demand for goods from the debtor countries. Once again, different national politics and cultures come into play. The northern creditor countries don’t want to abandon the policies that they associate with their own success, least of all to bail out the improvident.[4]

The concept of the Euro-zone was that—like Mr. Lincoln’s theory of the Union—the members had formed an indissoluble bond.[5] The Greek crisis threatens that idea. If Greece was to be forced out, then any other country that got into serious financial difficulty in the future might suffer the same fate. Countries at risk would have to pay extremely high risk premiums for financing public debt. The whole Euro-zone could unravel from the bottom like a sweater. Crisis after crisis would gnaw at a union that seeks the benefits of stability.

Hard-liners have not said so, but it might turn out to be a way of finally enforcing the economic doctrines of the northern creditor countries on the southern debtor countries.[6] Any country that did not wish to pay high risk premiums to lenders would have to pursue “sound” finances. That, in turn, could force a reform of social and economic policies.

The Greek “Syritza” and Spanish “Podemos” parties have drawn strong support for demands to end austerity and for debt repudiation. Many American observers seem to think that the Germans and other creditors should be happy to get robbed by the Greeks and other debtors for the greater good. The long Republican counter-attack against high taxes since the Reagan Administration shows something different. People who feel victimized will fight back. Right now, the focus is on angry Greeks and Spaniards. In the future it’s likely to be angry Germans.

[1] Eduardo Porter, “Local Politics Are Fracturing European Unity,” NYT, 3 February 2015.

[2] Flexibility, thrift, and probity, for example.

[3] See the charts in Porter, “Local Politics.”

[4] The limited historical knowledge of many economic commentators leads them to make frequent references to the post-First World War inflation as a formative experience. They ignore the “cigarette economy” that flourished after the Second World War and the heavy burdens carried by West Germans after absorption of the defunct German Democratic Republic in 1989. Germans today have a far more vivid set of memories shaping their behavior.

[5] Stephen Fidler, “Europe Weights Costs of Casting Greece Aside,” WSJ, 6 February 2015.

[6] As Voltaire quipped after the Royal Navy executed Admiral John Byng, “They shoot one to encourage the others.”


Annals of the Great Recession III.

Years ago, back before the world economic slowdown, Germany overhauled its economy to make it more competitive and flexible. This overhaul built on earlier German strengths: an excellent educational system, a commitment to quality production, and a cultural predisposition to sound finances. The successful reforms put Germany in a strong position to first weather the initial storm and then exploit the inflationary policies pursued by other countries.

Not everyone pursued similar policies. Many European countries opted for social protection over economic growth. Their labor and management systems are encrusted with regulatory barnacles that slow growth and hinder employment; they run high levels of debt that become increasingly difficult to support with stagnant economies; and they are broadly change-averse. In the worst case, the Greeks spent years living off grants and loans from the European Community while cooking their books to disguise the fact that the money was being consumed rather than invested. The demographic crisis of an aging population across much of Europe bodes ill for the survival of the welfare states. Reforms to increase innovation, productivity and competitiveness are essential for the long-term future.

With the onset of economic crisis in 2009, the Germans seized upon the crisis as a device to force other countries to make fundamental reforms to improve the long-term position of the whole group.[1] Germany rejected expansionary policies at home while leading the imposition of severe conditions upon Greece in exchange for further aid. Behind the disreputable Greeks stood the more reputable Spaniards, Italians, and Frenchmen. Many countries didn’t want anyone saying that they resembled the Greeks, so they went along with the German policies.

However, even under pressure most countries have not made the kinds of reforms to entitlements, labor market regulations, and budgeting needed to create dynamic economies. Europe continues to limp along behind the United States in recovering from the “Great Recession.” Indeed, the danger that Europe will slide into a deflationary-spiral is very real.

From a dispassionately economic perspective, the best solution appears to be a combination of monetary stimulus by the ECB, higher public spending by Germany and other creditor countries, deficit-reduction in the debtor countries, and a wide application of the reforms that the Germans have been pushing.        The rival policy to that of Germany has been inflation by the European Central Bank (ECB) and higher spending by the creditor countries in order to ease conditions in the debtor countries. The hard times have led to the rise of “anti-austerity” parties, like the Syriza party in Greece and the Podemos party in Spain. Commentators can’t prove it, but they suggest that the growth of anti-European parties like the French Front National and the British United Kingdom Independence Party (UKIP) and of anti-immigrant feeling are all tied to “austerity.” Until recently, Germany managed to fend off calls for inflation.

The German strategy is founded on a misconception. The Germans have assumed that other countries could alter their politics and culture to become German-like. Most countries are not like the Germans and do not want to pay the costs of becoming more German-like. They have aging populations that are set in their ways. They have lived for decades with public discourse that disparages entrepreneurs and American-style capitalism. The costs of transition will be paid by entrenched interests and will benefit chiefly their descendants.[2]

Will the Greeks be forced out of the European Community? Or will the Germans?

[1] Marcus Walker, “Analysis: Double Blow to Germany’s Leadership,” WSJ, 26 January 2015.

[2] As Groucho Marx once asked, “What’s the future ever done for me?” The United States faces something of the same dilemma. See: “College costs: the old eat the young.”