Tag: European Union

European Fiscal Policy: And All Does Not Go Merry as a Marriage Bell

Posted on by Brad DeLong

I find myself thinking of Ludger Schuknecht’s very powerful and apposite comments about just what, even if you believe–as I do–that there are substantial spillovers for Germany and for the world for Germany to use its fiscal space for expansionary policies right now, it is supposed to use its fiscal space for…

The fiscal space is in Germany. The infrastructure needs are in Sicily. This is in the end the political and also the political-economic dealbreaker. It does speak to necessary reforms of the European Union so that things like this do not happen again.

I remember Maury Obstfeld saying once that at the start of the 1990s California and New York had no problem using the United States’s fiscal space to transfer 25% of a year’s Texas GDP to Texas to clean up the Savings and Loan financial crisis mess. This just was not an issue in American politics or political economy. Texas had bet wrongly on the real estate sector via lax regulation–both at the federal and state level–and financial engineering. It was regarded as a proper use of America’s fiscal space to spend money on this and pull Texas out of what was a shallow national but would have been a very deep regional recession.

The fact that the Chair of the Senate Finance Committee at the time was from Texas may, however, have had something to do with it.

The American institutions then were, somehow, a better set of institutions for dealing with this kind of crisis. That there was an alignment of interests, and that the prosperity of each would redound to the prosperity of all in the long even if not always in the short run was taken for granted.

In fact, perhaps, Europe’s institutions today are inferior along some aspects of this dimension than Europe’s institutions in the past. Back in 1200, say, the question of how Germany should use its fiscal space, if in fact the desired location of spending was in Sicily, was finessed. A Germany Hohenstaufen princeling would be married to a Viking-Sicilian princess, and she would then bring Sicily along with her into the Holy Roman Empire as her dowry, and Germany–at least Germany’s rulers–would have an obvious interest in upgrading Sicily’s infrastructure.

Admittedly, the German Emperor might then decide that he would rather spend time in his palace in Palermo than in Burg Hohenstaufen twenty miles east of Stuttgart.

Somehow, national borders and national communities constrain us in Europe in ways that are not the wisest today…

Fiscal Policy in the New Normal: IMF Panel

Comment of the Day: Sherman Robinson: On the Economics of BREXIT

Posted on by Brad DeLong

Comment of the Day: Sherman Robinson: On the Economics of BREXIT: “I largely agree with Simon Wren-Lewis’s comments, and with the quote from Maurice Obstfeld…

…The trade-productivity links they discuss, as Wren-Lewis notes, “all make common sense”.

However, I think it is very important to sort out the empirical relevance of the different causal mechanisms—it is impossible to consider policy choices without doing so. I see four mechanisms at work:

  1. Ricardian movement of factors to exploit comparative advantage from opening to international trade. Clearly true, but forty years of work with computable general equilibrium (CGE) models, both single-country and global, indicates that pure Ricardian effects on productivity are very small. In conferences, we often cite a “theorem” due to Arnold Harberger: “triangles” are smaller than rectangles”.

  2. “Winds of competition” or “challenge/response” models. There is a large literature on such models, all arguing that opening up markets to competition forces firms to move to the production frontier and/or induces investment in technological change. These effects appear to be significant.

  3. Explicit backward linkages between exporting and “learning better techniques”. These are also significant effects in particular cases, but would seem to be limited in coverage and probably not large enough to have much effect at the national/global levels.

  4. Fragmentation of production processes that allows strong specialization and regional diversification of production of intermediate inputs. There are many examples of these value chains across economic activities: agriculture, manufacturing, and services. They allow producers to achieve “Smithian” gains in productivity through fine specialization. They are seen by later stages in the value chain as lowering input costs, which are not measured as, say, a TFP gain by the later-stage producer, but is very significant. I think that these Smithian productivity gains are very large and cover a wide range of economic activity for countries that have taken part in value chains.

These four mechanisms are not mutually exclusive—all are operating and are probably very complementary. For a nice discussion of the empirical importance of fragmentation of value chains, see the new book by Ricard Baldwin: The Great Convergence. He argues, and I agree, that this fragmentation has been a major driver of trade-linked productivity growth.

On Brexit. The UK is embedded in the EU and most of its trade involves imports and exports of intermediate inputs in complex value chains, so mechanism (4) is very important. Policies that interrupt value chains will be very damaging. For example, if the UK leaves the EU customs union, then the EU will have to impose rules of origin conditions that will impede trade. Firms may well prefer to move operations to the EU in order to keep the value chains operating smoothly. There are lots of other issues concerning how to support and foster value chains, beyond the scope of a short comment.

Must-Read: Tony Barber: A Renewed Nationalism Is Stalking Europe

Posted on by Brad DeLong

Must-Read: Tony Barber: A Renewed Nationalism Is Stalking Europe: “Part of the appeal of rightwing populism is that it hammers away relentlessly on the theme that mainstream political parties…

…especially since the end of the Cold War, are almost indistinguishable from each other and offer no proper choice. Not without reason, the parties are depicted as corrupt and detached…. But… they have no economic policies beyond an iconoclastic rage at the euro, free trade and foreigners alleged to be parasites on the welfare state. The new nationalism, in its radical rightist colours, has no credible solutions for a modern Europe that, despite all its troubles, must pin its hopes for a better future on mutual co-operation and an open face to the world…

Must-Read: Duncan Weldon: Five Thoughts on Brexit

Posted on by Brad DeLong

Must-Read: Duncan Weldon: Five Thoughts on Brexit:

  1. British politics now has a big dose of Syriza thinking. ‘Respect our democratic mandate’ doesn’t work when you’re dealing with 27 other democratically elected governments.
  2. I have no idea what the final settlement looks like. No one does.
  3. We won’t get any clarity in the next few months. The Tory leadership contest will at best give a small signal, but really it’s noise. The next PM will be selected by a membership of leave supporters and the candidates will pitch to that. All will offer a fantasy that the EU is unlikely to agree to.
  4. British politics is in flux. The next Tory leader faces having to make a tough choice: disappoint the membership and traditional Tory voters or lose the City. The broad coalition of social conservatives and economic liberals that form the party may not be able to survive this choice. Labour faces similar pressures. Handled badly, this go see a UKIP surge – not into power but into a much stronger position in Parliament.
  5. Finally – I think the UK’s actions will ultimately be good for EU unity. Others will be less inclined to follow our example if it is painful (and that’s without the additional problems of leaving Schengen or the euro). It isn’t hard to imagine the Eurozone doubling down now and building the kind of institutions that the zone needs to work.

Must-Read: Kevin O’Rourke: Markets and States are Complements

Posted on by Brad DeLong

Must-Read: Kevin O’Rourke: Markets and States are Complements: “Globalisation produces both winners and losers… can lead to an anti-globalisation backlash… [in the] late 19th… the late 20th… [and] the early 21st century…

…What, if anything, [can] governments… do[?]… Dani Rodrik’s finding that more open states had bigger governments in the late 20th century comes in…. Markets expose workers to risk, and that government expenditure of various sorts can help protect them…. Michael Huberman showed that this correlation between states and markets was present before 1914 as well: countries with more liberal trade policies tended to have more advanced social protections of various sorts, and this helped maintain political support for openness…. If the Tories had really wanted to maintain support for the EU, investment in public services and public housing would have been the way to do it…. It wouldn’t have satisfied the xenophobes, but not all anti-immigrant voters are xenophobes…. If the English want continued Single Market access, they will have to swallow continued labor mobility. There are complementary domestic policies that could help in making that politically feasible. We will have to wait and see what the English decide. But there are also lessons for the 27 remaining EU states…

Must-Read: Brad Setser: Post-Brexit

Posted on by Brad DeLong

Must-Read: Post-Brexit vote, in Europe at least: It is not the Great Recession. Odds are that it is not the Lesser Depression. Odds are that it is the Longer Depression…

Brad Setser: Follow the Money: “A few thoughts, focusing on narrow issues of macroeconomic management…

…The U.K. has been… supplying the rest of Europe with demand—something other European countries need. This… will shape the economic fallout. The fall in the pound is a necessary part of the U.K.’s adjustment… will spread the pain from a downturn in British demand to the rest of the euro area. Brexit uncertainty is thus a sizable negative shock to growth in Britian’s euro area trading partners, not just to Britain itself… knock[ing] a cumulative half a percentage point off euro area growth over the next two years…. The euro area… has fiscal capacity to counteract this shock…. The euro area could provide a fiscal offset, whether jointly, through new euro area investment funds or simply through a shift in say German policy on public investment and other adjustments to national policy…. [But] I would bet that the euro area’s aggregate fiscal impulse will be negative in 2017—exactly the opposite of what it should be when a surplus region is faced with a shock to external demand….

The euro area would also benefit from additional focus on the enduring overhang of private debt…. Euro area banks should have been recapitalized years ago, with public money if needed…. But in key countries they were not…. And Europe’s new banking rules are now creating additional incentives for delay…. Putting public funds into the banks does not addresses popular concerns about the way the global economy works. Forcing retail investors to take losses in the name of new European rules does not obviously build public support for ‘more’ Europe. Keeping bad loans at inflated marks on the balance sheet of weak banks undermines new lending, and makes it hard for private demand growth to offset the impact of fiscal consolidation. There is no cost-free option, economically or politically….

A conception of the euro area that focuses on the application of common rules with only modest sharing of fiscal risks… designed… too restrictively, with too much deference to Germany’s desire to avoid being stuck with other countries’ bills…. Something will need to give, eventually.

Must-Read: Timothy B. Lee: Brexit Isn’t the Most Serious Threat to the EU — the Euro Is

Posted on by Brad DeLong

Must-Read: Timothy B. Lee: Brexit Isn’t the Most Serious Threat to the EU — the Euro Is: “David Beckworth makes the case that the economic woes of eurozone countries like Spain and Greece…

…can ultimately be traced back to the euro itself… other problems… made worse by the ECB’s tight-money policies…. Without reforms, eurozone countries could continue suffering from slow growth and abnormally severe recessions for decades to come. That, in turn, will fuel public resentment against the EU and increase the danger that other countries will follow the UK’s lead. And the euro isn’t just a mistake–it’s a mistake that’s going to be hard to fix. Any country that tries to leave the euro risks triggering a financial crisis. And while deeper economic integration could help to mitigate the euro’s problems, the political obstacles could be insurmountable. Brexit wasn’t great news for the future of the EU. But the common currency is likely to create much bigger headaches for European leaders in the years to come.

Monday DeLong Smackdown: Olivier Blanchard on How the Eurozone Can Be Strengthened After Brexit

Posted on by Brad DeLong

A high-quality DeLong smackdown! Keep ’em coming, please…

Olivier Blanchard: How the Eurozone Can Be Strengthened After Brexit: “Brexit raises fundamental questions…. Meanwhile, Europe must continue to function…

…In this context that a large number of prominent economists from different European countries, ranging from those who desire more political integration to those who are more skeptical, have written what they see as the essential next steps to reinforce the architecture of the eurozone…. The purpose of the project, which started long before Brexit, was twofold. First, assess the nature of the challenges and the progress to date…. Second, assess the degree of agreement among ‘experts’ about the remaining challenges and solutions. If you look at the diversity of people on the list, the answer to the second question is that, in contrast to the often strident disagreements in the press, there is, indeed, surprisingly large agreement among experts….

The basic architecture is largely in place. Some strengthening is needed but does not require dramatic political steps. The most important set of measures to take is a strengthening of the European Stability Mechanism (ESM)…. The banking union is largely in place, and with it better tools to monitor and reduce financial risks…. More progress can be made without requiring much more political integration…. [In] public finances… fiscal rules have become too many, too messy, with too many loopholes…. In many countries, the issue is not so much deficits than the high level of expenditure, which in turn makes it difficult to balance budgets without resorting to excessive taxation…. Even under the best fiscal rules, current levels of debt together with low growth imply that sovereign debt default is not impossible. Defining responsibilities and the process for sovereign default is essential. This should and can be the role of the ESM…. States have to be willing to give up some control. Otherwise the ESM will not be able to do its job…. We have learned… that liquidity runs can… be very destructive. The European Central Bank (ECB) now has the tools to provide liquidity to banks…. It would be good if it could do the same to states….

Many would like to see more ambitious steps taken, from a common fiscal policy, to euro bonds, to euro-level deposit insurance, etc. And indeed, the line taken by some US commentators today (e.g., Bradford DeLong and Paul Krugman is that this is what our manifesto should have asked for…. Our goal was less ambitious and more realistic. It was to see if the eurozone could function and handle shocks without further political integration if political realities made it impossible for the time being. Our answer is a qualified yes, but it is surely not an endorsement of a do-nothing strategy.

Must-Read: Teebs: Brexit

Posted on by Brad DeLong

Must-Read: Teebs: Brexit: “If Boris Johnson looked downbeat yesterday, that is because he realises that he has lost…

…Perhaps many Brexiters do not realise it yet, but they have actually lost, and it is all down to one man: David Cameron. With one fell swoop yesterday at 9:15 am, Cameron effectively annulled the referendum result, and simultaneously destroyed the political careers of Boris Johnson, Michael Gove and leading Brexiters who cost him so much anguish, not to mention his premiership.

How?

Throughout the campaign, Cameron had repeatedly said that a vote for leave would lead to triggering Article 50 straight away. Whether implicitly or explicitly, the image was clear: he would be giving that notice under Article 50 the morning after a vote to leave. Whether that was scaremongering or not is a bit moot now but, in the midst of the sentimental nautical references of his speech yesterday, he quietly abandoned that position and handed the responsibility over to his successor. And as the day wore on, the enormity of that step started to sink in: the markets, Sterling, Scotland, the Irish border, the Gibraltar border, the frontier at Calais, the need to continue compliance with all EU regulations for a free market, re-issuing passports, Brits abroad, EU citizens in Britain, the mountain of legislation to be torn up and rewritten… the list grew and grew. The referendum result is not binding. It is advisory. Parliament is not bound to commit itself in that same direction.

The Conservative party election that Cameron triggered will now have one question looming over it: will you, if elected as party leader, trigger the notice under Article 50?

Who will want to have the responsibility of all those ramifications and consequences on his/her head and shoulders?

Boris Johnson knew this yesterday, when he emerged subdued from his home and was even more subdued at the press conference. He has been out-maneouvered and check-mated.

If he runs for leadership of the party, and then fails to follow through on triggering Article 50, then he is finished. If he does not run and effectively abandons the field, then he is finished. If he runs, wins and pulls the UK out of the EU, then it will all be over–Scotland will break away, there will be upheaval in Ireland, a recession… broken trade agreements. Then he is also finished. Boris Johnson knows all of this. When he acts like the dumb blond it is just that: an act.

The Brexit leaders now have a result that they cannot use. For them, leadership of the Tory party has become a poison chalice.

When Boris Johnson said there was no need to trigger Article 50 straight away, what he really meant to say was ‘never’. When Michael Gove went on and on about ‘informal negotiations’… why? why not the formal ones straight away?… he also meant not triggering the formal departure. They both know what a formal demarche would mean: an irreversible step that neither of them is prepared to take.

All that remains is for someone to have the guts to stand up and say that Brexit is unachievable in reality without an enormous amount of pain and destruction, that cannot be borne. And David Cameron has put the onus of making that statement on the heads of the people who led the Brexit campaign.