Kenneth Rogoff on the prospects for recovery in Europe:
Will Europe’s Economies Regain Their Footing?, by Kenneth Rogoff, Commentary, Project Syndicate: What will Europe's growth trajectory look like after the financial crisis? ...
True, things are pretty ugly right now. ... Yet, ugly or not, the downturn will eventually end. Yes, there is still a real risk of hitting an iceberg, beginning perhaps with a default in the Baltics, with panic first spreading to Austria and some Nordic countries. But, for now, a complete meltdown seems distinctly less likely than gradual stabilization followed by a tepid recovery, with soaring debt levels and lingering high unemployment.
It is not a pretty picture. Some commentators have savaged Europe's policymakers for not orchestrating as aggressive a fiscal and monetary policy as their U.S. counterparts have. ...
But these critics seem to presume that Europe will come out of the crisis in far worse shape than the U.S., and it is too early to make that judgment. An epic, financial-crisis-driven recession, such as the one we are still experiencing, is not a one-year event. So policymakers' responses cannot be evaluated by short-term measures... It is just as important to ask what happens over the next five years as over the next six months, and the jury is still very much out on that.
America's hyper-aggressive fiscal response means a faster rise in government debt, while its hyper-expansive monetary policy means that an exit strategy to mop up all the excess liquidity will be difficult to execute. ... Europe's more tempered approach, while magnifying short-term risks, could pay off in the long run, especially if global interest rates rise, making it far more painful to carry oversized debt loads.
The real question is not whether Europe is using sufficiently aggressive Keynesian stimulus, but whether Europe will resume its economic reform efforts as the crisis abates. If Europe continues to make its labor markets more flexible, its financial market regulation more genuinely pan-European, and remains open to trade, trend growth can pick up again in the wake of the crisis. If European countries look inward, however, with Germany pushing its consumers to buy German cars, the French government forcing car companies to keep unproductive factories open, etc., one can expect a decade of stagnation.
Admittedly, the past year has not been a proud one for policy reform in Europe. Recessions have never proven an easy time for ... reforms. ...
The recent recession has presented challenges, but European leaders were right to avoid becoming intoxicated with short-term Keynesian policies, especially where these are inimical to addressing Europe's long-term challenges.
If reform resumes, there is no reason why Europe should not enjoy a decade of per capita income growth at least as high as that of the U.S. Moreover, with growing concerns about the sustainability of U.S. fiscal policy, the euro has a huge opportunity to play a significantly larger role as a reserve currency.
One shudders to think what will happen if Europe does not pull out of its current funk. ...
European leaders argued they didn't need to be as aggressive as the U.S. at putting new fiscal policy in place because they had much larger social safety nets that would kick in automatically as the crisis deepened. In addition, Europeans noted, they already had much higher levels of government spending as a share of output than the U.S., so it was much harder for them to increase this share further. Another way to say this is that Europeans do not believe they have an inferior short-run response, especially when it comes to labor and providing jobs.
Thus, the very thing that Rogoff believes is Europe's biggest long-run challenge - the extensive social safety net, including provisions affecting adjustment in labor markets - is the reason why Europe was able and willing to choose a different strategy relative to the U.S. to attenuate the effects of the recession. If the U.S. had European levels of debt and, more importantly, the same degree of social protections for people affected by recession, then the U.S. would not have needed or been able (politically) to increase deficit spending as much as it did. I am among those who believe Europe could have reacted more vigorously, and should have, but I don't think it's correct to say they avoided Keynesian type policy (and see this post concerning France's stimulus package).
If, in the long-run, we look back and see that Europe's more extensive protections did, in fact, smooth the adjustment to the crisis, the motivation for long run change of the type Rogoff hopes for will diminish. If having European style social protections does lower growth - and that is a debatable assertion - that may be an insurance premium people are willing to pay to avoid more severe downturns. If the opposite happens, if the social safety net does not do its job (and that cannot be measured through unemployment rates alone), then the motivation for change could become stronger. But the crisis is far from over and the jury is still out.