The Global Temper Tantrum
Fury is spreading. But the mobs ignore the real culprit behind broken economies.
Yiorgos Karahalis / Reuters-LandovRiot police at a protest against austerity measures in Athens on June 28, 2011.
This is the age of indignation. Politics in the Western world are becoming more emotional—because our problems are so intractable.
Recently a Chilean friend of mine was at a bullfight in Barcelona, where a spectator threw a bottle at one of the picadors. The police duly arrested the bottle thrower. But as he was led away, the crowd began to boo the policemen and to chant “Libertad! Libertad!”
This captures the illogical mood of the moment. Leave aside your feelings about bullfighting, because this could equally well have happened at a tennis match. Throwing a bottle at a participant in a sporting event is a dangerous criminal act. Someone who behaves that way deserves to be arrested. Yet the crowd’s feelings of hostility to the police trumped that rational view. The arrested man became a symbol of oppressed liberty, despite the fact that everyone had witnessed his crime.
“The Indignant”—los Indignados—are now a distinct group in Spain. They are the young people who take to the streets to protest against high unemployment, government spending cuts, and anything else that ticks them off. But this is no longer a purely Spanish phenomenon. The Indignant are everywhere. They were in the streets of Athens, throwing-Molotov cocktails at police while the Greek Parliament debated its latest austerity budget.
On July 1 the Indignant were marching and yelling outside my London office, too. What was this lot indignant about? Yes, cuts once again—to be precise, the British government’s plan to reduce public-sector employees’ pensions and increase their retirement age.
Indignation takes different forms in different places. In Europe it’s directed against cuts in public spending. In the United States it’s directed against tax hikes, which are anathema to the Tea Party.
What all the Indignant have in common is the refusal to address squarely the problem that nearly all Western countries face. That problem is that the welfare systems that evolved in the mid-20th century are unaffordable under the demographic and economic circumstances of the 21st century. The financial crisis has merely exacerbated what was already a severe structural crisis of public finance, boosting deficits while slowing growth.
The scale of the challenge ranges from the really, really hard to the absolutely impossible. According to the Organization for Economic Cooperation and Development, just to stabilize its debt the U.S. government needs to turn its current primary deficit of 7 percent of gross domestic product into a primary surplus of 1.4 percent. That’s roughly double the fiscal squeeze Greece needs to make.
In a rational world, electorates would recognize the need both to reduce entitlements and to increase revenue. But indignation isn’t rational. The Tea Party position is that the deficit should be reduced without any increase in revenue, even the elimination of tax breaks and loopholes that all serious economists now define as “tax expenditures” (because they essentially give revenue away to lucky special interests). At the same time, many Tea Party supporters appear reluctant to accept that cuts would apply to their own entitlements as well as everyone else’s.
Even more self-contradictory is the readiness of young people in Europe to back the interest groups opposed to spending cuts. The recent demonstrations in London were essentially on behalf of teachers relatively close to retirement. “It’s for the future generations that we’re doing this,” claimed one protester, “not just for ourselves. We’re doing it for everybody.” Baloney. It’s the government that has the future generations in mind, not the protesters. The young people who join in such protests are suckers, demonstrating for the right to pay much higher taxes in the future.
Today’s proponents of austerity are like toreadors, fighting the raging bull of debt. I can understand the vested interests throwing bottles at them. It’s the cheers of the Indignant that are bizarre.
General Marshall on the Aegean
General Marshall on the Aegean
Barry Eichengreen
BERKELEY – It should now be clear to even the most blinkered observer that the Greek economy is in desperate need of help. Unemployment is 16% and rising. Even after a year of excruciating spending cuts, the budget deficit still exceeds 10% of GDP. Residents don’t pay taxes. The system of property registration is a mess. There is little confidence in the banks, and even less in the government and its policies.
Since the economy needs help, here’s a novel idea: provide some. Now is the time for the European Union to come forward with a Marshall Plan for Greece.
Rather than piling more loans onto the country’s already unsustainable debt burden, the EU should offer a multi-year program of foreign aid. The Greek government and donors would decide together the projects that it financed. These could range from building new solar and wind power-generating facilities, in order to turn Greece into a major energy exporter, to updating its ports to help make it a commercial hub for the eastern Mediterranean.
Foreign aid and expertise could be used to modernize the property-registration and tax-collection systems. Funds could be used for recapitalizing the banks and retiring some debt. They could help finance government support for the unemployed, indigent, and elderly, who are among the principal victims of the financial crisis.
The EU should contemplate this option, because, for starters, it bears more than a little responsibility for Greece’s plight. It offered membership to a country with deep structural problems. It then accepted Greece into its monetary union with full knowledge that its fiscal accounts were not worth the paper they were written on. And it looked the other way when French and German banks recklessly enabled the Greek government’s profligacy.
Second, the current strategy, which amounts to trying to extract blood from a stone, is not working. There are limits to how quickly a country can reform. A society can bear only so much pain and suffering before it loses faith in its political system. EU leaders need to acknowledge this reality before it’s too late.
And, finally, history suggests that a Marshall Plan for Greece might actually work.
Recall the plight of the European countries that received aid from the United States after World War II. They had massive debts. Their budgets were deep in deficit. They exported little. Property rights were uncertain. Support for governments grappling with these problems was extremely fragile.
The Marshall Plan, by financing strategic investments, helped the recipients to ramp up their exports. Aid-financed reconstruction turned Rotterdam into a commercial hub for Northern Europe. US aid underwrote the imports of coal and investments in hydroelectric power needed to get industry running again. And, in some cases, like France, US funds were used to extinguish part of the public debt.
Importantly, these projects were neither dictated by the donor nor chosen by the recipient, but decided in collaboration. The recipient, moreover, had to put up matching (“counterpart”) funds for each and every project.
A further condition for receiving aid was that the government had to follow through with macroeconomic stabilization. But this was now politically feasible, because aid topped up the public coffers, reducing the depth of the necessary cuts and the associated pain and suffering. Support for the centrist governments undertaking these reforms was correspondingly stronger.
Indeed, solidifying political support for policies of stabilization and reform was probably the Marshall Plan’s single most important contribution. With that support in place, the recipient countries could do the rest. Europe could get back on its feet.
The cynics among us – that is to say, economists – will worry about the precedent set by a Marshall Plan for Greece. They will warn that other EU countries like Portugal will refuse to undertake more reform, retrenchment, and repayment unless they receive similar largesse.
Economists are trained to worry about this problem, known as moral hazard. But the kind of social chaos and international disrepute that Greece has suffered are a considerable disincentive to go down this path. And while there is moral-hazard risk, there is also meltdown risk. There is the danger of a complete economic, social, and political meltdown in Greece. If that meltdown is not averted, it could take down the rest of Europe.
A Marshall Plan for Greece would require European leaders to do the unprecedented: they would have to lead. That, of course, is what the US did after World War II with the Marshall Plan. Europeans might usefully look back 60 years, to a time when their own countries, perched on the brink of a similar collapse, received the help that they needed to recover – help that has put them in a position to do something similar for Greece today.
Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley.
From Italy to the US, utopia vs reality
In the eurozone, the fiscal crisis is lapping on Italy’s shores. In the US, the administration declares it will run out of funding early next month if the debt ceiling is not raised. Far fewer Europeans than Americans believe public sector defaults are beneficial. But important Europeans share with Republicans the view that there are still worse outcomes. For reluctant Europeans, the eurozone must not be a “transfer union”. For recalcitrant Republicans, taxes must not be raised. Fiat justitia, et pereat mundus – let right be done even if the world perishes – is the motto.
The fiscal crises we see are a legacy of the west’s private and public sector debt binges of recent decades. As the McKinsey Global Institute tells us in an update of last year’s study of the aftermath of the credit bubble, this is an early stage of a painful process of deleveraging in several economies (see chart). “If history is a guide,” noted the 2010 report, “we would expect many years of debt reduction in specific sectors of some of the world’s largest economies, and this process will exert a significant drag on GDP growth.” So it is proving, with disappointment almost everywhere.
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The link between private and public sector debt is intimate. In some countries, notably Greece, easy credit led to an upsurge in public sector borrowing. In others, notably Italy, it encouraged governments to relax attention to debt reduction: its primary fiscal budget (before interest) moved from a surplus of 6 per cent of gross domestic product in 1997, before joining the currency union, to 0.6 per cent in 2005. Elsewhere, the sudden end of private sector credit booms led directly to collapses in government revenue and surges in public spending: the US, UK, Spain and Ireland are examples.
Exploding fiscal deficits are mainly the result of collapses in activity and revenue rather than of bank bail-outs. But fiscal weakness then undermines the banks, partly because the latter hold large quantities of domestic public debt and partly because they rely on fiscal support. The private and public sectors are intertwined. The view of Republican hawks in the US and of German or Dutch hawks in Europe that the crisis has fiscal roots alone is wrong. Easy credit ends up in fiscal crises.
US evidence is striking. Compare the forecasts for fiscal years 2010, 2011 and 2012 in the 2008 and 2012 presidential budgets, the first under George W. Bush shortly before the crisis and the second under Barack Obama well after it (see chart). The 2011 deficit was forecast in 2008 to be a mere $54bn (0.3 per cent of GDP). But in the 2012 budget, it is forecast to be $1,645bn (10.9 per cent of GDP). 58 per cent of this rise is due to unexpectedly low revenue and only 42 per cent due to a surge in spending, both of these changes mostly due to the financial crisis, not the modest stimulus package (about 6 per cent of GDP).
The astonishing feature of the federal fiscal position is that revenues are forecast to be a mere 14.4 per cent of GDP in 2011, far below their postwar average of close to 18 per cent. Individual income tax is forecast to be a mere 6.3 per cent of GDP in 2011. This non-American cannot understand what the fuss is about: in 1988, at the end of Ronald Reagan’s term, receipts were 18.2 per cent of GDP. Tax revenue has to rise substantially if the deficit is to close.
It is not that tackling the US fiscal position is urgent. At a time of private sector deleveraging, it is helpful. The US is able to borrow on easy terms, with yields on 10-year bonds close to 3 per cent, as the few non-hysterics predicted. The fiscal challenge is long term, not immediate. A decision not to allow the government to borrow to finance the programmes Congress has already mandated would be insane. As the fiscal expert, Bruce Bartlett, has argued, the law requiring Congressional approval of extra debt might even be unconstitutional.
Yet, astonishingly, many of the Republicans opposed to raising the US debt ceiling do not merely wish to curb federal spending: they enthusiastically desire a default. Either they have no idea how profound would be the shock to their country’s economy and society of a repudiation of debt legally contracted by their state, or they fall into the category of utopian revolutionaries, heedless of all consequences. Meanwhile in Europe, happily, nobody believes that defaults are good. But Europe is trapped in its own utopian project: the single currency. Just as members of the Tea Party hate paying taxes for those they deem unworthy, so, too, do solvent Europeans hate transfers to those they deem irresponsible.
More
On this story
- Martin Wolf Eurozone’s moment of truth
- Martin Wolf Freeing our universities to compete
- Martin Wolf Austerity alone risks disaster
- Martin Wolf A curiously continental job market
- Martin Wolf How China could yet fail like Japan
Alas, as many have long predicted, what would, in the absence of the currency union, have been a straightforward currency crisis has now morphed, within these constraints, into an agonising fiscal cum financial crisis. Worse, spreads on Spanish and Italian 10-year bonds over German bunds have reached 328 and 296 basis points, respectively.
In slow-growing economies with overvalued real exchange rates, these spreads begin to be dangerous. If they became and remained, say, 400 basis points, the real interest rate on long-term debt would be 5 per cent. These countries would then be slowly shifted from a good equilibrium, with manageable debt, to a bad equilibrium, with close to unmanageable debt. Italy, with the fourth-largest public debt in the world, is probably too big to save: Italians themselves must make the decisive moves needed to restore fiscal credibility. That, in turn, requires both a sharp tightening and measures to raise the growth rate. Can this combination be managed? Only with difficulty, is the answer.
These are dangerous times. The US may be on the verge of making among the biggest and least-necessary financial mistakes in world history. The eurozone might be on the verge of a fiscal cum financial crisis that destroys not just the solvency of important countries but even the currency union and, at worst, much of the European project. These times require wisdom and courage among those in charge of our affairs. In the US, utopians of the right are seeking to smash the state that emerged from the 1930s and the second world war. In Europe, politicians are dealing with the legacy of a utopian project which requires a degree of solidarity that their peoples do not feel. How will these clashes between utopia and reality end? In late August, when I return from my break, we may know at least some of the answers.
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