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Wednesday, June 09, 2010

Rodrik: Who Lost Europe?

Germany says it took the time and effort to build a solid house, just like the bric-house countries, and the pigs will have to fight the big bad financial wolves on their own. If Germany opens the its bric-house doors and lets the pigs in where they are safe, they'll never learn their lesson. They'll keep relying upon structures that collapse when the slightest financial wind blows against them.

What the bric house residents are forgetting, however, is the mutual dependence that exists. If the pigs perish, so will the source of income that pays for the bric house they live in. The other countries do need to build houses that are safe from the wolves, but that's a lesson that seems likely to be learned even if the bric-house residents open their doors and foot the bill required to provide safe shelter. Allowing the pigs to be completely destroyed is not in the bric-house country's best interest. (Or something like that, not sure if it's fair to characterize all of the pigs in this way -- some thought they had built strong houses -- the point is that it may not be in Germany's best long-run interest to refuse to help at all):

Who Lost Europe?, by Dani Rodrik, Commentary, Project Syndicate: ...Having suffered a deeper economic collapse in 2009 than the United States did, Europe’s economy is poised for a much more sluggish recovery... European leaders have so far offered no solution to the growth conundrum other than belt tightening. The reasoning seems to be that growth requires market confidence, which in turn requires fiscal retrenchment. As Angela Merkel puts it, “growth can’t come at the price of high state budget deficits.” 
But trying to redress budget deficits in the midst of a collapse in domestic demand makes problems worse, not better. ... In fact, it sets in motion a vicious cycle. The poorer an economy’s growth prospects, the larger the fiscal correction and deleveraging needed to convince markets of underlying solvency. But the greater the fiscal correction and private-sector deleveraging, the worse growth prospects become. The best way to get rid of debt (short of default) is to grow out of it.
So Europe needs a short-term growth strategy... The greatest obstacle to implementing such a strategy is the EU’s largest economy and its putative leader: Germany. ... What makes this perverse is that Germany runs a huge current-account surplus..., 5.5% of GDP in 2010,... not far behind China’s 6.2%. So Germany has to thank deficit countries like the US, or Spain and Greece in Europe, for propping up its industries and preventing its unemployment rate from rising further. ...Germany is not only failing to do its fair share, but is free-riding on other countries’...
Germany’s refusal to boost domestic demand and reduce its external surplus, along with its insistence on conservative inflation targets for the ECB, severely undercuts prospects for European prosperity and unity. It virtually guarantees that Greece, Spain, and others with large private and public debts will be condemned to years of economic decline and high unemployment. At some point, these countries may well choose to default on their external obligations rather than endure the pain.
Germany’s leaders may take comfort in lecturing other governments about their profligacy. And it is true that some, like the Greek government, ran too-high deficits during the good times and endangered their future. But what about Spain or Ireland, where the borrowers were not the government but the private sector? If others borrowed too much, doesn’t it follow that Germans lent excessively?
If Germany wants the rest of Europe to swallow the bitter pill of fiscal retrenchment, it will eventually have to recognize the implicit quid pro quo. It must pledge to boost domestic expenditures, reduce its external surplus, and accept an increase in the ECB’s inflation target. The sooner Germany fulfills its side of the bargain, the better it will be for everyone. 

[Kevin O'Rourke has also argued recently that a collapse in domestic demand makes problems worse, not better.]

    Posted by on Wednesday, June 9, 2010 at 03:33 PM in Economics, Fiscal Policy, International Finance, Monetary Policy | Permalink  Comments (41)


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