Author: Kevin O’Rourke

What about the ugly Europeans?

Paul Krugman has a follow-up post to his earlier one where he points out that being pro-European is one thing, but that being pro-EMU in the 1990s was another.

I have one gripe with the piece: it wasn’t only ugly Americans (and eurosceptic Little Englanders) who were €-sceptical. Here is a newspaper article by Peter Neary, for example, written in 1997, and I have already linked to a longer 1997 piece by Neary and Thom, as well as to a 2000 article by Thom and myself that make my own feelings on the subject pretty clear.

More important, however, are PK’s concluding comments:

Was the euro a mistake? There were benefits — but the costs are proving much higher than the optimists claimed. On balance, I still consider it the wrong move, but in a way that’s irrelevant: it happened, it’s not reversible, so Europe now has to find a way to make it work.

I couldn’t agree more. The logical move at this stage (and some cynics thought this was the point of EMU all along) would be a move to fiscal federalism, so as to smooth out asymmetric shocks, but the French and Dutch votes of 2005 make that a pretty implausible scenario. It is the logical move, though.

Social democracy and growth

Paul Krugman has a piece today that is aimed squarely at Americans and their prejudices regarding Europe. But his point that social democracy and good economic performance are not mutually incompatible could be backed up with more evidence than his simple US-EU15 comparison. Within the EU15, the Scandinavians and Germans are fairly obviously doing better than average. And when comparing EU-15 growth rates over time, the fact that jumps out is how rapid were the growth rates experienced during the 1950s and 1960s, when the welfare state was being constructed and consolidated.

There is also a vast literature demonstrating that social democracy, far from undermining the market, increases political support for it; and that income inequality makes ordinary people hostile to trade, immigration, and markets generally.

Fairness matters.

The dynamics of Smithian decline

À propos of nothing in particular, I can’t resist posting a link to this.

Inflation in 2000

Following on from Philip’s recent post on domestic demand, I dug out this paper I wrote in 2000 with Rodney Thom to see what I was saying at the time. Philip suggested I post the link as part of our ‘nostalgia series’, so here it is.

I’d say about 5 people read the paper. We got some things right and some things wrong.

The context was the incipient inflationary pressures already building up in the economy. Some thought inflation was due to one-off supply side shocks. Rodney and I argued that the inflation was due to excess demand, and that the correct response (given that the first best policy — raising interest rates — was no longer available to us) was restrictive fiscal policy.  We did recognise the political difficulties of cutting demand through restrictive fiscal policies at a time when the economy was booming. Sadly, that proved all too correct, but I don’t suppose that either of us anticipated the extent of McCreevy’s pro-cyclical folly.

We identified the risk of overshooting, followed by a hard landing, and I seem to recall that a few people at the time were worried about that — cf. the brief snippet of Krugman on this evening’s Prime Time. That wasn’t prescience, just basic macroeconomics.

One thing we got badly wrong was our assumption that if overshooting occured, and a hard landing ensued,  social partnership would provide the means for reducing wages and other costs right across the economy in a coordinated manner. (This was based on the late 80s/early 90s experience. It hasn’t happened. Rather than all jumping together, we have jumped or been pushed one group at a time, which is economically ineffective and politically corrosive.)  Worse, social partnership would soon become an important driver of pro-cyclical fiscal policy.

My conclusions from having gone down memory lane in this way is I guess a pretty obvious one: we don’t have either the fiscal or the labour market institutions that are required given EMU membership.

Wages

I’d say this little piece by Paul Krugman, and the associated note, will end up on lots of undergraduate syllabi. Liquidity traps are boring to teach, until you find yourself in the middle of one. From an Irish point of view, however, the key section is the following:

if some subset of the work force accepts lower wages, it can gain jobs. If workers in the widget industry take a pay cut, this will lead to lower prices of widgets relative to other things, so people will buy more widgets, hence more employment.

The point is that the Irish are just a subset of the Eurozone workforce, and that our GDP is the equivalent of Krugman’s widgets, whose relative price can be reduced. Krugman makes the same point in a follow-up post here. Of course, devaluation would be preferable to wage (and price) cuts: it would avoid the debt deflation and rising real interest rates which Krugman talks about. But it is not an option.