Tuesday, May 01, 2012

Gideon Rachman takes on Krugman on Eur-austerity

Since the fullest flush of the financial crisis, Paul Krugman has been a relentless voice for stimulus, infrastructure spending and all-out war against high unemployment. Throughout his tenure at the Times, he has been so often right on fundamentals -- the Bush tax cuts, the housing bubble, the size of the 2009 stimulus -- that I would guess his credibility is unsurpassed among lay liberal readers.

So it's interesting to see a fact-based, more or nonideological commentator take on Krugman with regard to Euro-austerity. The dissenter is the Financial Times'  Gideon Rachman, repeat winner of xpostfactoid's Wolf Munch Rock award, so named because the truth is hard to digest.  Krugman calls European austerity policies "insane," Rachman notes, "with characteristic understatement."  There's a bit of a tonal joke there, methinks, because for Rachman, understatement really is characteristic.

Rachman shares the FT Comment page with Martin Wolf, Wolfgang Munchau and others who have lamented the slow-motion Eurozone train wreck these past two years -- and the drastic effects of cutting spending as economies contract. He recognizes the basic Keynesian equation. But his argument about stimulus in Europe is a kind of mirror image of progressives' take on tax cuts for the wealthy in the US: we are tapped out on that front. So is much of Europe, he argues, on infrastructure spending, government payrolls and social services:

Spending on infrastructure – “shovel-ready” projects, as President Barack Obama has called them – is, of course, a standard Keynesian solution for an economy that is caught in a downward recessionary spiral. Under normal circumstances, such spending might be a great idea.

In Europe, however, there are plenty of reasons to be sceptical. If building great roads and trains were the route to lasting prosperity, Greece and Spain would be booming. The past 30 years have seen a huge splurge in infrastructure spending, often funded by the EU. The Athens metro is excellent. The AVE fast-trains in Spain are a marvel. But this kind of spending has done very little to change the fundamental problems that now plague both Greece and Spain – in particular, youth unemployment...

As for Italy and Spain, they are not cutting their budgets out of some crazed desire to drive their own economies into the ground. Their austerity drives were a reaction to the fact that markets were demanding unsustainably high interest rates to lend to them. There is no reason to believe that the markets are now suddenly prepared to fund wider deficits in southern Europe. The “end austerity now” crowd respond that it is the responsibility of Europe’s dwindling band of triple A rated countries to go on a consumption binge and so pull their neighbours out of the mire. But the assumption of unlimited Dutch and German creditworthiness is unconvincing – as the market reaction to the Dutch failure to agree a budget, last week, illustrated.
The nothing-left-to-spend argument leads Rachman to a defense, rare on the FT Comment page, of German austerity:
...while the Germans are often portrayed as knuckleheaded advocates of endless austerity, their real message is more sophisticated and convincing. It is that the drive to balance budgets within Europe must be combined with reforms that will encourage private-sector job creation.
Rachman does allow that there's room for argument about the pace and timing of structural reform.  But as such debate is playing out in the U.K. and France, he argues, it's "small-scale quibbling – masquerading as a major doctrinal dispute."

I suspect that Krugman's "quibble" would be in the designation of this room for dispute as "quibbling." Also,  while Rachman yokes Italy and Spain into one borrowing bind, Krugman likes to point out that they came to crisis from different places: before the financial bust, Spain and Ireland had balanced budgets. In fact, I think Krugman has also argued that Italy wasn't in such bad budgetary shape before the bust -- Greece was the only real basket case, and the EU needn't have let the Greek contagion spread. 

Over to you, Krugman. Right or wrong, there's no insanity in this defense.

Update: Responding to Rachman, Andrew Sullivan adds a more concrete caveat than mine: "Labor market reforms are vital. But I don't see why the ECB cannot be a lender of last resort to avoid a depressive cycle."


  1. I believe Krugman's response might avoid the issues with a narrower notion of spending by emphasizing the role for higher inflation, which might be the only way to create relative devaluation of the GIPSI's labor costs without them leaving the Euro.

  2. Maybe Rachman's argument is reasonable here, but it's not particularly trenchant.

    First, a small point. Yes, the stressed European countries are tapped out. But his argument that 30 years of very successful infrastructure investment has failed to change the economic fundamentals of Greece and Spain, in particular youth unemployment, is... simply not on point. Couldn't you say that about all other aspects of their economic policies?

    But if Spain and Greece did have the available funds to spend on more infrastructure, or other forms of immediate stimulus, it would definitely make a dent in youth unemployment. Particularly if the programs included the training and employment of youths!

    Second, he derides the crazy notion that, at least during this crisis, "it is the responsibility of Europe’s dwindling band of triple A rated countries to go on a consumption binge and so pull their neighbours out of the mire."

    Well, the Eurozone is a union, right? It's not just a confederacy, but a committed union of nations, bound by a central currency.

    As Yglesias helpfully points out yesterday, in such a "large economic unit," that's *exactly* what those countries need to do, even in a non-crisis situation, because that's the only way a "large economic unit" operates.


    "if you look at a big place like the United States or China what you see are huge place-to-place divergences in economic vitality paired with large open-ended transfer programs. Even in smaller economies, the old West Germany has been subsidizing the old East Germany for a long time and will continue to do so for a long time. In Italy, the north helps carry the south. In the U.K., the south helps carry the north."

    "If in the United States every bailout of the poor parts of the country by the rich parts was marked by protracted negotiations and stern demands that West Virginia "reform" its underperforming economy we'd be in perpetual crisis."

    The Eurozone--or maybe just Germany--still hasn't grasped this, and that doesn't bode well for its continued survival.

    --Cont. in next comment--

  3. Finally, Rachman is focused exclusively on the obvious need for much more short-term stimulus, and has a good argument for why it's not possible, even misguided. But he ignores all the other possible measures that could be taken immediately, which, as a concerted program, could completely transform the atmosphere, creating some breathing room for at least some short-term spending, maybe by those dwindling triple A economies.

    But if Rachman is not going to listen to Krugman or Summers, then he's going to dismiss Christie Romer too, who just published such a prescription in the Times on Sunday:


    Summers, Krugman, and Romer are recommending completely sane economic and political measures that could begin to ease some of the unemployment and interest rate pressure in the Eurozone, while also providing some boost in confidence by establishing a more gradual, multi-phase roadmap out of the crisis.

    From Romer's plan:

    "The core of a more sensible approach is to pass the needed budget measures now, but to phase in the actual tax increases and spending cuts only gradually — as economies recover. To use economists’ terminology, the measures should be backloaded."
    "They should also be specific — no more deficit targets without specifying how they’ll be achieved. Instead, lay out right now whose taxes will be raised and what spending will be cut. And specify when the measures will take effect — either along a set schedule, or tied explicitly to indicators of economic recovery."
    "...if the authorities [EU and IMF] put their seal of approval on more gradual fiscal consolidation plans and stand ready to support troubled countries if needed, market interest rates on the countries’ debts will most likely come down."

    "the European Central Bank could take further expansionary action. For example, it could reduce its benchmark interest rate, which is not yet at zero, and pursue quantitative easing by buying a range of assets. Any measure that would raise European growth even a little would make it easier for troubled countries to get their budget deficits under control."

    Too bad Draghi failed to act today.


    "If the European Central Bank aimed for slightly higher overall inflation — say, 3 percent — for a few years, these countries could become more competitive just by holding wage growth below that of their trading partners. That would help them to grow by increasing their exports."

    But but, BOND VIGILANTES!!

    "...countries that are not in distress, both inside and outside Europe, could help by stimulating their own economies. For example, Germany has a relatively modest long-run deficit and an enormous trade surplus. A tax cut for German consumers would raise domestic growth at a time when it’s anemic, and increase imports from its neighbors, helping them to grow as well."

    Europe has made a series of failed decisions. They're sinking into another recession. It's time to let the reality-based economists lead.