In the final section of his article, Professor Krugman provides a helpful outline of four potential scenarios for how this crisis may play out in Europe. But he also reveals his most glaring omission. The four scenarios are:toughing it out, in which the troubled economies will endure the pain and contraction of government budget cuts, cuts in services and higher unemployment, but will avoid either default or devaluation; debt restructuring, which would reduce the troubled economies’ debt by a significant amount at the price of losing all ability to borrow any more money on the international markets from those investors who were forced to take the haircut; “full Argentina,” by which Krugman means troubled countries would break their link with the euro, create their own currency and then devalue it to increase competitiveness and exports; or revived Europeanism, whereby the better off countries would play a bigger role in bailing out the troubled countries, moving Europe closer towards a fiscal union. All four of these have been discussed by many experts for months, and he quickly outlines the pros and cons of each. He concludes that, for now, the plan Europe is choosing is “tough it out” which he predicts will produce disastrous results.
However, there is a fifth scenario that Krugman never explores, and that is the one that Europe actually seems to be pursuing. It’s called “pushing reset” –- embarking on a very un-American course to figure out how advanced economies can provide for their people without having roaring growth rates driven by asset bubbles, hyperactive consumption and carbon-belching activities. Europe’s economic evolution, spurred on by this crisis, marks a departure from the U.S. development model that has dominated the global economy since the Reagan era.
This growing transatlantic difference over development models was glaringly evident during the Group of 20 summit in Seoul, South Korea in November 2010. Prior to the summit, Paul Krugman, U.S. Treasury Secretary Timothy Geithner and others had proposed a controversial intervention for the global economy, founded on an economic theory just as divisive. Krugman and Geithner declared that the recent economic collapse was caused not only by America’s Wall Street casino capitalism but also by certain global trade imbalances. In these economists’ theoretical world, if the trading surpluses of some nations don’t balance the trading deficits of other nations, then disaster surely awaits.
In practical terms, that means that countries with robust manufacturing sectors and big trade surpluses, like Japan, China and Germany, must be good sports and step up to the plate to further stimulate their domestic consumption, helping to lift the world out of its current slump in aggregate demand. They would do this by increasing their public spending, i.e. running up bigger deficits, and importing things from countries like the United States with big trade deficits (as soon as it can be figured out what the U.S. manufactures that these nations want to buy). And this boost in global consumption would not only provide more electronic trinkets, big screen TVs and stylish clothes for those frumpy Germans and buttoned-down Japanese, it also would help the world rebalance its trade imbalances.
Indeed, just as Paul Krugman has criticized Japan for not spending and consuming enough, he has written stridently in other articles about Europe’s insufficient fiscal stimulus needed to jumpstart the global economy. He has written that the Germans—one of the few economic bright spots in a struggling global economy—“seem to be getting their talking points from the collected speeches of Herbert Hoover,” and along with China – another bright spot in the struggling global economy – he has called them both the “axis of depression” for their alleged failures to consume more and act as a driver of global economic recovery. To a stimulus hawk like Professor Krugman, now is the time for massive Keynesian spending in the form of government stimulus to jumpstart sluggish economies. While he doesn’t explicitly say this in his New York Times Magazine piece, elsewhere he has stated that he sees the current euro difficulties as a threat to Europe’s ability to mount sufficient fiscal stimulus spending.
That’s the theory, anyway, and Geithner and President Obama actually came to the Group of 20 meeting with a demand that no nation should run up a trade surplus of more than 4 percent of gross domestic product. But as Indian statesman Jawaharlal Nehru once said: ‘A theory must be tempered with reality.’ Surely Secretary Geithner and Professor Krugman have visited Germany and Japan and noticed the obvious: that these wealthy nations are hardly lacking in material goods or modern trinkets. So what exactly are the Germans and Japanese supposed to buy more of, especially in quantities large enough to make a difference? Americans are the only ones who seem to think they need three refrigerators, four televisions and a car for everyone in the household.
China is a different story. There, about a billion poor people could use some of the things money can buy to raise their living standards. But unfortunately the Chinese authorities think it’s better to finance the U.S. budget deficit and American consumers’ profligacy as a way to boost Chinese exports and create jobs, rather than spending their surpluses directly on the welfare of their own people. Without a functioning democracy in the People’s Republic of China, the people have little recourse to make their demand.
So the Krugman-Geithner global trade rebalancing proposal was completely unworkable. The impracticality of their proposal reflects the unreality that certain experts like Paul Krugman sometimes inhabit. His theoretical frame seems to assume that not only economies, but also the national cultures in which economies are situated, can be precisely manipulated by policymakers pulling the right levers. Economists’ efforts in that regard appear like Charlie Chaplin’s character in Modern Times, struggling to get his unruly industrial machinery to obey like a giant steam engine, pulling on one lever here and closing a valve there, twisting a few dials, pressing on the accelerator and – presto! – off you go. But if we’ve learned anything from the economic collapse, it is that economies are wildebeests that tend to defy easy corralling. That’s not to say that institutions and policy are unimportant, but it’s an act of hubris to think that an economy is infinitely malleable. Policymakers face constraints and ignoring that reality results in poor policy.
Part of the challenge in understanding these matters is rooted in the fact that the European and U.S. economies have become quite different animals in fundamental ways. So this discussion rightly belongs to a broader conversation regarding Europe’s social capitalism versus America’s Wall Street capitalism. The U.S. economy is still substantially a trickle down one, where more of the prosperity produced goes into the pockets of the wealthy – it has far more inequality and poverty, and 50 million people without health care. Absent the redistributive advantages of the European countries, the U.S. economy undoubtedly needs more stimulus to ignite it so that enough of the wealth trickles down to those at the bottom. But for Europe’s steady state economies, which have the institutions and values to foster a more broadly shared prosperity and to more fairly distribute the pain during a down economy, a different intervention is needed. And that intervention, to some degree, is restoring budget sanity to their economies after a dizzying collapse. They are endeavoring to return to sustainable levels of debt and spending so that the costs of borrowing aren’t so high, and so that they are not continually jerked around by corrupt rating agencies like Moody’s and Standard & Poor’s (Europe is in the process of reforming its governance over these rating agencies). And then from that new normal, mapping out the best way to maintain this broadly shared prosperity by rejecting a wildcat economy that is built fragilely on asset bubbles and overconsumption. Balance and sustainability are the catchwords of this approach.
This latter course certainly seems to be what German Chancellor Angela Merkel and other European leaders have in mind. At the G-20 meeting, Merkel completely rejected the entreaties of President Obama and Tim Geithner for a global rebalancing of trade, or for further fiscal stimulus by her government. Instead, she gave an earful to the cowed Americans. Said Merkel, The United States is the one that must take the necessary steps to increase its competitiveness. The U.S. should not try to put limits on countries that have figured out how to get the world to buy their goods. Merkel continued: “The benchmark has to be the countries that have been the most competitive, instead of reducing to the lowest common denominator.” Ouch, that hurts – America being called ‘the lowest common denominator.’
Her finance minister, Wolfgang Schäuble, was even more blunt. He described American policy as ‘clueless’ and said the American growth model is stuck in a deep crisis. “The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base.” Ouch again. Germany – previously sneered at by U.S. pundits as Europe’s “old man” – lecturing America about how to grow its economy. Certainly Germany has deployed its share of stimulus spending, but it also asserts that stimulating your economy alone does not increase real competitiveness since competitiveness comes from factors like productivity gains, business environment, physical infrastructure, supply of qualified workers and innovation. The Germans, Japanese and Chinese weren’t buying any of the Krugman/Geithner/Obama ‘global trade rebalancing’ proposal, nor were many of the other 16 of the G-20. Right in front of the world’s major leaders, Merkel finished the process of knocking the American paragon off its post-World War II perch. The U.S. is losing the global argument over the best development model for the 21st century. The Washington consensus, if not dead, is on life support.
Economic and Ecological Sustainability
But Merkel said something else at the G-20 that is even more of a game changer, and directly addresses a point that Krugman has missed many times in his writings. “It is essential to return to a sustainable growth path,” she said. Advancing her own theory for the economic meltdown beyond global trade imbalances, she said that a primary cause was that “we did not have sustainable growth. In many countries growth was built on debt and [speculative] bubbles.”
What Merkel was saying – and it’s revolutionary in its ramifications – is that the era of U.S.-style, trickle-down, consumption-driven economics is over. The world needs to figure out how advanced economies can provide for their people without having roaring growth rates, asset bubbles and hyper consumption, and also how to develop in a way that is ecologically sustainable (unlike the Obama administration, European leaders have not shelved their global warming interventions in the midst of this economic crisis). Krugmanomics, which is based on massive government stimulus spending to boost aggregate demand, consumption and job creation, is neither economically nor ecologically sustainable. More stimulus and growth, if not accompanied by greater conservation and energy productivity, will pump excessive carbon into the atmosphere.
European leaders seem to believe they are pushing reset on this Wall Street capitalist development model and offering a necessary corrective for a renewed 21st century capitalism. Already they are much further along than the Obama administration in redesigning their financial regulatory system, including the creation of four new agencies mandated to intervene if necessary to prevent another collapse (here is a list ofEurope’s comprehensive financial industry reforms). Europe has been criticized by Krugman and others for not doing enough to re-stimulate its economies, but Europeans believe it is wiser to wait until a healthier financial architecture is in place, otherwise they would likely replicate the conditions that contributed greatly to the economic meltdown, i.e. launch a new round of bubble-driven, debt-ridden economic growth. Led by Germany, Europe’s biggest contribution may be the redesign of capitalism itself, still inching toward a “new normal” in the wake of the recent meltdown.
This amounts to a direct rebutting of Krugmanomics. If consumer-driven growth was the order of the day in the post-World War II era for the developed nations, in the new era it will be steady-state economic growth – growing not too fast, but not too slowly – and manufacturing value-added products that the rest of the world wants to buy. The real game is no longer strictly about economic growth, it is also about sustainability, both economically and ecologically. More than the developing economies like “Chindia,” the developed world must lead the way towards a different path of development, a way to learn to “do more with less.” That is not an easy challenge.
This then is the Fifth Option, the one that Paul Krugman never imagined. It involves a degree of toughing it out, yes, but also undoubtedly will include more proposals for forging a greater degree of European fiscal union founded on a more stable bedrock of a redesigned capitalist system. In a series of EU summits planned for February, March and June many insiders expect a major strengthening of European governance that includes the eurozone. The measures being debated and so far finding tentative favor include: greater eurozone oversight of the economic strategies of individual eurozone governments; a further increase in the financial aid available to help eurozone countries in difficulty; enabling the euro rescue fund to buy distressed governments’ debt, resulting in lower bond interest rates and retaining access to markets; reductions in the interest charged for financial aid to Greece, Ireland and potentially other eurozone states (Germany is showing signs of leniency after its initial tough line against moral hazard delivered the right message); tougher sanctions against those who deliberately undermine eurozone discipline; and renegotiation of the terms of bailout agreements to make possible bigger sacrifices by bank shareholders and bond holders rather than tax payers.
When these agreements are launched, says John Palmer of the European Policy Centre, “Those EU countries which share the euro will have taken major steps towards an economic as well as a monetary union and with it the foundations of a European ‘economic government.’” Palmer and others are predicting “not EU disintegration but deeper European integration among its core members in the euro-area.”
Europe is trying to learn from the economic meltdown, and use it as an opportunity to reform and ready itself for the 21st century. In practical terms, that means trying to enact a new future that is economically and environmentally sustainable. Americans of all stripes should hope that the Europeans succeed. Even better, Europe is hoping that its trans-Atlantic ally will join in this epochal-defining endeavor. That’s what Professor Krugman and other economists need to grapple with if they want to stay relevant.
New America Foundation
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