Can Krugmanomics Be Saved?

Krugman seems never to contemplate that Europe today is a work in progress, just as a new American nation once was. From the inauguration of the first American government it took the U.S. about 80 years – and a bloody civil war – to cease being a collection of regions and to bind into a nation. And during that time the U.S. suffered at least eight banking crises and financial panics.  Seen in that light, it’s helpful to remember that the current configuration of the European Union – 27 nations and 500 million people – only dates to 2007 (when Romania and Bulgaria joined). Nearly half the EU member states have joined since 2004. The use of the euro dates only to 2002. ‘Old Europe’ actually is quite young. Societies change on the order of decades, and it’s necessary to see past the daily headlines and discern the trajectory of the future. The realization of “union” does not occur with the passage of a single treaty or with signatures on a page. That’s just the beginning of the journey, after that comes decades of institutional evolution and of cultural and historical adaptations before the tree of union takes firmer root.

But Krugman has little patience for this European work in progress, and so instead he turns up the rhetorical heat. He writes:

“These [European]achievements are now in the process of being tarnished, as the European dream turns into a nightmare for all too many people.”

Nightmare? Let’s keep this in perspective, shall we? Sudan is a nightmare; China’s gulag of political prisoners or Abu Ghraib were nightmares; Mubarak’s Egypt was a nightmare “for all too many people”; a ravaged Europe during its two world wars was a nightmare. But Europe today, all things considered, is a remarkably civil place, with little in the way of nightmares haunting it, even during this economic crisis. That’s not to say the Europeans don’t have their challenges, especially still in the Balkans, but even Krugman has said that Europeans are suffering less than Americans. Currently, some of the European countries are having a difficult time, but certainly not all of them, or even most of them. When I visited Greece in October 2010 and interviewed Prime Minister George Papandreou, the tensions and protests were palpable but so were the beautiful weather, gorgeous landscape, great cuisine and pleasant people. I don’t find the street protests in Greece or Ireland alarming – indeed, I wonder why more Americans aren’t in the streets. Nightmare? Hardly.

Krugman also confuses cause and effect. He praises the UK for staying out of the currency union, yet the Brits, just like Greece and Ireland who are in the euro zone, face huge budget cuts and unemployment increases, with upset people marching in the streets. Krugman fails to realize that being in or out of the eurozone is no guarantee of anything. Germany, which is in the eurozone, is by far the most robust economy in Europe and other euro zone countries are doing fine as well; Greece and Ireland are inside but are having difficulties. The UK and Iceland are outside the euro zone and having real problems; Sweden, Poland, Switzerland and Denmark are outside and doing fine.

Krugman’s overblown hyperbole misses other important subtleties as well. Greece and Ireland have been reeling, to be sure, and Spain’s 20% unemployment rate is alarming. But everyone in the PIGS countries still has health care and access to the many safety net supports that European countries provide. Compare their plight to California: a recent report found that 25% of Californians do not have any health insurance, and California’s unemployment rate is the same as Greece’s, at 12.5%. Many communities in the Golden State have been hard hit with waves of foreclosures; in some counties in California half of the outstanding mortgages are “underwater,” meaning their house is worth less than the mortgage and so they are essentially bankrupt. State and local governments have slashed tens of thousands of jobs and programs have been cut that affect the most vulnerable. California’s jewel of a university system is in the process of severe atrophy and becoming unaffordable for the middle class. Many Californians have been left to fend for themselves, and this story is being repeated in many other U.S. states. Greece, Ireland and Spain combined make up a smaller portion of Europe’s overall economy (about 12%) than California does of the US economy (about 14%). California is “too big to fail,” to use the parlance of the day, and is dragging down the American economy, yet no federal bailout on the order of what Europe has done for Greece and Ireland is remotely in sight.  So the “tarnish” in the troubled European countries is nothing like what is being experienced by many American states because those states entered this recession already lagging Europe’s safety net.

Should California exit the dollar zone?

The situation of California and other hard luck American states speaks volumes to Krugman’s discussion of various currency regimes. Krugman declares that “liberal American economists, myself included, tend to favor freely floating national currencies that leave more scope for activist economic policies — in particular, cutting interest rates and increasing the money supply to fight recessions.” One can’t help but wonder whether Professor Krugman’s fondness for freely floating currencies could be extended to any of the individual 50 American states. Following Professor Krugman’s logic, one can’t help but conclude that California, for example, should exit the “dollar zone.” That’s because this fiscal union has been a bum deal for Californians for a long time. California taxpayers have subsidized most other states for years, since for every dollar in federal taxes it sends to Washington DC, Californians only receive back about 70 cents, with the other 30 cents going to mostly conservative ‘red’ states. California could use that money right now since its economy has taken a nosedive.

Indeed, California’s dilapidated condition caused then-Governor Arnold Schwarzenegger to go hat in hand to the federal government in 2009 and ask for a bailout. Despite the Golden State’s decades-long generosity to other states, the Obama administration spurned California’s ‘Brother, can you spare a dime’ appeal, forcing California to issue IOUs to keep from defaulting, in the process becoming a national laughingstock on late night comedy shows. Also in return for its long-standing benevolence toward its fellow states, California and its 38 million people are only allowed two U.S. Senators, the same as Wyoming and it’s half a million people, to fight for its residents’ priorities. Clearly when it comes to receiving help from this “fiscal union”, California’s congressional delegation has been impotent to help the largest state in the union. Today California punches far below its weight nationally; consider for a moment that its economy is as proportionate to the US economy as Germany’s is to the European economy, yet Germany exercises far more influence in Europe than California does in the U.S.

So should California exit the dollar zone, and possibly even these United States? According to Krugman’s logic, California could solve its financial problems by devaluating its currency, if it had one. A number of other heavily indebted states (Illinois, New Jersey, New York, Arizona, Kansas, Nevada and many more) could do something similar. Just recently the New York Times reported that policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts. Aren’t these states being burdened by sharing a single currency, and a single interest rate, with an inability to devalue their currencies and enjoy the alleged benefits of devaluation? Indeed, following Krugman’s logic, if all 50 states had their own currencies, each could devalue it and there could be a splendid race to the bottom as each state tried to outdo each other.

Beyond currency exits and devaluations, Krugman attempts to illustrate the advantages of having a fiscal union by telling a “tale of two places” in which he compares Ireland and Nevada to show the differences in what happens when you have a federal transfer union. Krugman writes:

“The fiscal side of the crisis is less serious in Nevada. It’s true that budgets in both Ireland and Nevada have been hit extremely hard by the slump. But much of the spending Nevada residents depend on comes from federal, not state, programs. In particular, retirees who moved to Nevada for the sunshine don’t have to worry that the state’s reduced tax take will endanger their Social Security checks or their Medicare coverage. In Ireland, by contrast, both pensions and health spending are on the cutting block.”

But Krugman completely misses several crucial points. First, Ireland already had more “automatic stabilizers” as well as more robust pension, unemployment and health care systems than Nevada, so now during a deep recession it has more room to maneuver. Even after making some cutbacks, the Irish have far more supports for families and individuals than Nevada. Second, Nevada is able to depend on federal programs because, as mentioned above, Nevada is being subsidized by states like California and Illinois. For California and Illinois, which are having difficulties at least as bad as Nevada, it’s an increasingly dubious deal. California and Illinois are NOT getting bailed out by federal programs — instead they are forking over billions of dollars to the federal government to give back to Nevada. Indeed, the way the fiscal transfer union works in the U.S. is that the more liberal blue states for the most part have been subsidizing the conservative red states, even as the red states complain about “big government” and give the middle finger to states like California and Illinois. Krugman’s selective use of examples is blurring the lines of fiscal accountability by distorting the aggregate reality of fiscal unions. In fiscal unions, some receive and some take. The European nations, especially those like Germany and others that will be the ones doing the subsidizing, are wise to step into this cautiously.

If Krugman’s policy choice of devaluing one’s currency is so attractive, then why is it that a breakup of the dollar zone has no political legs and makes no economic sense? It’s because there is a fallacy in Krugman’s theory. His operating model seems to assume that it is OK for countries to take on too much debt, as long as they make sure to retain the ability to devalue their currency and default on that debt. That way they can make others pay for their irresponsible behavior, as well as for the benefits that country has enjoyed (like Greece, for instance, which Krugman says benefited initially by being in the eurozone because it was able to receive much lower borrowing costs). Keep in mind, these are not former colonized countries whose dictators ran up huge debts and stashed the money in their own foreign bank accounts. These debts were assumed by democratically elected governments and for the most part the residents of the country benefited.

So according to Krugmanomics, taking on too much debt is not the problem – it’s not being able to pay the debt that is the problem. And Krugman’s solution, apparently, is to be able to depreciate your currency and/or default on your debts, leaving the creditors holding the bag. This line of argument seems fundamentally immoral, the equivalent of stealing other people’s money. Indeed, Krugman ignores the problem of moral hazard altogether, of the Greece’s of the world that try to hide their debt and then, when all hell breaks loose, ask for a bailout. Unquestionably Germany in particular is insisting that the profligate countries aren’t just bailed out, that they feel some of the pain resulting from their past poor decisions. Why is it any better to let countries off the hook for their debts than the big banks, as long as that debt was not accumulated by dictators? Should a country like Greece borrow to the hilt and provide an unsustainable level of benefits for its people, only to ultimately yank it away from the next generation? Or is it better for each generation to try and live roughly within its means? These are hard and important questions that the Europeans are trying to figure out but which find no place in Professor Krugman’s discussion.

Indeed, Krugman proposes his interventions like devaluation with an intellectual ease that borders on recklessness. He goes on to say, “If you still have your own currency, you wouldn’t have to go through the protracted pain of cutting wages: you could just devalue your currency — reduce its value in terms of other currencies — and you would effect a de facto wage cut.”

“Just” devalue your currency? It all sounds so easy and antiseptic, but in fact devaluation of a nation’s currency is a brutal affair. It leads to near-immediate increases in unemployment, inflation, a likely run on the banks as people move their liquid assets to safer countries, and other destabilizing jolts. Attesting to its difficulties, even Spain, which is headed by a Socialist government with no strong ideological adherence to free market ideology, so far has declined to go down this road, despite what Krugman and other economists recommend. No matter how you approach it, Greece and Ireland, and possibly Portugal and Spain, are in a tough spot and there is no easy way out. From the average person’s perspective, it matters little if their countries have their own currency and devalue it, or default on its debt, or instead manage to roll over that debt at a high interest rate and pay off creditors. Either way, these countries are going to have to tighten their belts, lay off people, and that will be a hardship for everyone. They have been living beyond their means (especially Greece and Portugal, the Irish governments overspending didn’t begin until they began bailing out its failed banks), rolling up deficit after deficit, allowing their economies to become less competitive, and the bill has come due.

To be clear, I am not advancing a conservative argument against deficits, public credit or government debt writ large, but instead a conversation about degree and kind. Public debt can be immensely advantageous, such as when it is invested in infrastructure and education that makes your economy more competitive and paves the way for the future. But what Krugman isn’t grasping is that, despite the hardships of trying to remain in the euro zone Greece and Ireland feel that their place belongs smack in the heart of Europe, including the euro currency. Greece, Spain and Portugal are countries that were run by military dictatorships until the mid-1970s. That’s really not that long ago, and there is a broad consensus across the country that full membership in all that is Europe – even with the downsides – is preferable to the alternatives. So they are willing to sacrifice and pay the economic price to do so. Remaining in the euro zone may not make economic sense in the short run, but theirs is a rationale based, at least in part, on culture and history. It is a vision based on aspirations for the future. Perhaps those are qualities that many economists cannot understand.

Krugman also underestimates the extent to which Europe already has a “transfer union,” i.e. a federal system in which the better off member states help the worse off. The poorer member states of the European Union receive significant amounts of funding from the EU for various development and infrastructure projects, the common agricultural policy and regional assistance programs. A quick look at the EU budget shows that vast amounts of money flow from richer to poorer countries (see The four member nations in deepest trouble now (Greece, Ireland, Spain and Portugal) had the poorest economies when they joined the European Community more than forty years ago, and mechanisms have been in place to transfer wealth to these nations ever since.

Moreover, to meet the recent challenge brought on by the Greek debt crisis, Europe was able to pull together a trillion dollar bailout fund, a kind of European Monetary Fund, as well as other reforms. At the end of the day Europe was able to accomplish what America could or would not do – extend a hand to a member state (such as California). Despite the fact that there is no history, tradition or even legal structure for mounting a bailout of another nation, Germany, France and others – which have fought wars against each other for centuries – pulled together and did just that. Europe’s unprecedented action – clumsy at first but ultimately bold – was extraordinary, indeed it was historic. Yet the usual corps of eurosceptics typically whined that it took Europe too long – a whole four months – to throw a lifeline to Greece.  California should have been so lucky as to receive such help from the federal government and its fellow member states. California and other struggling states are still waiting.

Certainly this type of federalism is nowhere near as developed in the European Union as it is in the United States, but the early American nation did not have much of a transfer union either. Indeed, the first federal government under President George Washington barely had any revenue at all, not even enough for its own standing army and had to rely on state militias. The euro crisis now has revived the case for an even more powerful federal state. We have not seen the last of the reforms for creating a tighter fiscal union coming from this European work-in-progress.

Next, Krugman overemphasizes another point when he writes that “while Europeans have the legal right to move freely in search of jobs, in practice imperfect cultural integration — above all, the lack of a common language — makes workers less geographically mobile than their American counterparts.” Krugman’s demographic observations seem grounded in Europe’s quickly receding past, as the transatlantic differences in this regard are becoming increasingly fewer (one of the online respondents to the NYTM article commented, “Professor Krugman’s thesis that Europeans aren’t mobile across national boundaries must be something he got from his junior year abroad.”). Europe is not the melting pot that America is, but it’s on its way there. Travel to any of the cities today and you can see that the minority and immigrant populations of Europe are some of the fastest growing in the western world. In a place like France, where there has been Islamaphobic fears over Muslim immigrants, the largest immigrant group actually is from Portugal, not North Africa. Another online commentator reacted to the Krugman article saying, “My apartment here in Norway is being refurbished by a Polish company and my office was cleaned today by a Lithuanian who is soon to have a child. My children live and work elsewhere in Europe. On the subway I hear Spanish, Italian and a smattering of other languages. Europe’s workforces are indeed mobile, and unlike the U.S., they’re multilingual and well-educated.”

The younger generation in particular has grown up with the 5 E’s that are changing Europe –email, English, Erasmus (the popular student exchange program), the euro and Easy Jet (the airline that pioneered low cost flights all over Europe). The “Erasmus generation,” as it is called, is used to hip hopping around the continent and has embodied a more pan-European consciousness. As they become adults, the invisible borders of language and mobility will become less prominent. True, it’s hard to imagine that Europe will ever have a single language, but on the other hand, with the Hispanicization of the US occurring rapidly, America is becoming more of a place of two languages; Chinese and Asian populations in urban areas have added multiple more languages to the cityscape. Go to any Walmart today and it’s practically a mini United Nations of polyglot commerce. Besides, if the U.S. has such a strong “labor flexibility advantage” over Europe, how come unemployed Californians are not heading in droves to the Dakotas, where unemployment is so much less?

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