As in Everything, Trade-Offs in Europe

Benjamin Studebaker has published a piece that is an object lessen in wishful thinking. He posits, in short, that if the left in Europe commits to strategically reforming the EU’s institutions then we can solve the problem in Greece. It lays the blame at the steps of core banks without critically engaging with the fundamental economics that drove the periphery to those banks. It is not so much that he’s wrong that those core banks played a role, but rather that his effort refuses to engage with the steep trade offs imposed by economic realities.

Too Neat a Tale

Consider first his analysis of the vicious cycle of debt Europe finds itself in:

It’s clear that the EU, as constructed, is not working for the countries in the periphery—places like Greece, Spain, Portugal, and Italy. In the 2000’s, these countries became export dumps for the core countries, particularly Germany. German companies used the periphery export markets to get rich, and German banks lent money to the periphery economies to enable them to pay for German goods. This produced a sick feedback loop in which Germany lent money to the periphery so that the periphery could continue to buy German goods so that German companies could continue to generate profit which they then put into the German banks and which the German banks then loaned to the periphery so that it could buy more goods so that German companies could make more profit and so on and so forth.


While I agree there is truth to this story, it is a little too neat. German banks did not lend money to a passive Greek government. Greece fought to enter that lending market and, lest we forget, cooked the books to get access to both the money and a lower interest rate. An account that picks up with German companies benefiting enormously from having a competitive advantage that Greek officials successfully hid from them obscures that Greece removed the safeguards that would have protected their markets. Be careful of telling too neat a tale in the core’s favor, though; the core adhered to the letter, but not the spirit, of those safeguards and I suspect wishful (though, not predatory) thinking was under that. Regardless, that the core bought their dishonest accounting is not equivalent in culpability to the original lie.

And why did Greek officials do this? Studebaker’s account and diagram elides that as well, but it was to expand government spending. I support a robust safety net, so make no mistake: this is not a morality play about how gutting services is justice for the Greek people. But a more careful accounting of the Greek crisis shows that Greek officials were the primary architects of a system they initially benefited from. It also reveals that Greece faces a fundamental tradeoff that a Grexit cannot alleviate, though we’ll see there is a surprising, political case for Grexit. But first, the obvious question:

Why The Euro?

All countries face a pretty simple tradeoff, captured by something called the Phillip’s curve. The Phillip’s curve says that the more countries try to tamp down on inflation, the more unemployment will rise. This makes an intuitive sort of sense, though there is no completely uncontroversial explanation for the finer points of the relationship. Governments which spend more will drive up prices by competing with consumers for goods, but the stimulus will employ people and vice versa. While the quality of the tradeoff is pretty much universal, the quantity tends to change over time and between countries. The difference between the Drachma era and the Euro era is striking:


Joining the Euro’s integrated market lowered the barriers to international debt finance; more people had an easier time bidding on Greek debt. More bidders means a lower price and, in turn, a lower price on debt means lower inflation. This was further compounded by the fact that core banks believed that Greek debt was safer than it was. That same lie suggested that the trade imbalance should not have ballooned the way it did, and the economic history here is that at first it didn’t. It wasn’t until it became clear that Greece cooked the books that their current account collapsed:


There are two stylized fact here:

  1. The benefit of the Drachma is that it protects against deep current account imbalances. The downside is that it makes financing the government much more expensive.
  2. The benefit of the Euro is that it offers cheap financing for government programs, but that debt often returns as GDP-sapping imports.

Again, I’m not placing government debt at the center of this story as a morality play. I’m doing so because government spending and social programs are key to understanding Greek finances and motivations as well as German exporting. The Greek government could have unilaterally reduced imports by cutting social programs; they implicitly did the opposite by entering the European market and increasing their debt load. And this deeply undercuts Studebaker’s thesis.

Before I address that, there is one other thing I need to address that does not fit neatly into this narrative.

Absolution for Whom?

There is a proposal, casually thrown out, that also needs addressed:

Federal institutions can wipe out the debt of the periphery and create new European regulations to ensure nothing like this ever happens again.

Yeah, no, they cannot. From the data here (PDF), European banking equity is about 180 Billion Euros. Greek debt alone is 350 Billion Euros. Doing this by fiat would would bankrupt the banking system and throw Europe back 800 years. It is not an option.

Buying out the debt, just writing off the enormous political undertaking that would be, would have deep, second-order problems. A quick estimate suggests peripheral debt represents about 29% of the GDP of the EU. (Spain and Italy are the bigger problem in nominal terms, but Greece has a much more beleaguered economy because GDP and population are much lower.) For perspective here, government spending in Britain is 40% of the UK’s GDP. If we allow this take 6 years and all countries make a contribution proportional to their GDP, this program would require a tax hike of 12% added to the current tax bill provided there are no negative effects from the tax. Accomplishing this in a single year would require a 75% increase in the tax rate, clearly unfeasible. To keep taxes below 5% for the UK will require at least 15 years and 2% requires more than 36.

Large scale debt forgiveness programs, be they by decree or payment are simply enormous undertakings.

Constrained Goals

With this all in mind, we turn our attention to the political coalition Studebaker proposes. It is a fairy tale as it requires both the core and periphery to shoot themselves in the foot.

Grexit would, admittedly, help Greece maintain austerity but as a pitch for the left to rally around it comes up wanting. The case for it is cynical: if the core is unlikely to reduce the austerity burden, the best way to make austerity less bitter is to dump the Euro. (Under the Drachma, 2% inflation, like we’re seeing now, corresponded to a third the unemployment rate. Some transition costs may apply.) But it requires giving up the goal of expansive services which, frankly, I do not see the left agreeing to that. Contrast Studebaker:

The European Union in its current form is much better for the core countries than for the periphery. It’s especially good for Germany, and it’s especially good for rich Germans. They need the periphery to be in the EU so that it can continue to serve as Germany’s export market. But this is not sustainable–it imposes too much suffering on the poor and working people of the periphery. These people are right to reject this exploitation, and by rejecting it they will put a tremendous amount of pressure on Germany and on the rest of the core to find a political and institutional solution which alleviates their grievances.

The flaw here is that the problem is not “exploitation” in any straightforward sense of the word. Even ignoring the considerable problem of existing debt, the fundamental trade off between financing government services and Greek employment is not, ultimately, a question of German banking. While I have demonstrated that the institution of the Euro has a profound impact on the slope of that trade off, none of the options Studebaker puts on the table overcomes it—nor could they. The periphery, by construction, can only have their cake and eat it too if the core agrees to a catastrophe. Again, Studebaker:

At the same time, by supporting federalism and integration, the left in the core can help develop and prepare the ground for the kind of solutions which can genuinely help the periphery. If the left in the core aids and abets the right, then the response to exits and exit demands from the periphery will simply be disintegration. The left must keep the core countries firmly committed to the European project so that they will not just accept the exit of the periphery and it must build support in the core for the Europe of the future. If the right in the core chooses to support exit and the left chooses to support institutional improvements, the center will have to ally with the left to prevent disintegration. The center must be forced to choose between an end to the euro and the common market and the creation of a new European economic compact in which the center makes concessions to workers and the poor in exchange for continued openness within Europe.

Here again, the economic details of his proposal are at odds with his goals. Asking the core to bear the incredible economic cost of paying down peripheral debt (I presume he would agree bankrupting Europe is not an option?), strikes me as a political non-starter. Germany has a growth rate of 1.2% per year; the steep increases in taxes I estimated above would wipe out any benefits of keeping the Common Market here. This is definitely a case where an honest accounting of the plan by the left should drive the center into the open arms of the populist right. Given the strict choice between the proposal to wipe the debt or let the EU disintegrate, you would be hard pressed to convince me to wipe the debt. We’re talking a major decrease in national wealth to pay for what was, essentially, fraud. Note, this is not an appeal to “mere politics”, but an account of how a majority of informed voters would be expected to reject this. With that in mind:

This will only work if the exit threat in the periphery is genuine. Germany called SYRIZA’s bluff–SYRIZA wasn’t really willing to ditch the Euro and leave the union. It wasn’t willing to reintroduce the drachma and expose rich Greeks to the inflation that would come along with that. The political movements in the periphery must do more than talk about exit, they must be willing to carry it out if necessary. In this way we can partner the integrationist and protectionist lefts together–by pairing a genuine threat of exit in the periphery with a strong push for federalism in the core, we can split the neoliberals off from the right nationalists in the core countries and force them into making concessions. What the left needs is a good cop, bad cop routine, where the British, French, Dutch, and German leftists are the good cops and the Greek, Italian, Spanish, and Portuguese leftists are the bad cops.

Insofar as “neoliberal” is a real thing (and it isn’t), I seem to be one. And if there is one thing I have noticed when neoliberals are invoked, it is because “we” have raised the issue that there is some sort of constraint—usually economic. But if “we” really understood the politics or facts or weren’t so blinkered by our corporate allegiances, “we” would support a truer form of progressivism. But I submit that in light of the evidence, SYRIZA let the bluff be called because they were not prepared for a post-Euro Greece. The status quo is not good, but giving up the Euro means giving up on any chance to finance social services for a generation. I would have advised that ship has sailed, but holding out for a better deal with more services as debt stabilizes in Greece is a defensible course for the left.

The Power of Wishful Thinking

This is a mode I see regrettably often on the left. Studebaker has a very clear set of goals here: the ascendance of the left, expansive social services, and an integrated core in Europe. There is nothing wrong with having a set of goals unmoored from what is possible; incidentally, I share this trinity. Despite being a curmudgeon about proof, I support left wing policy goals and economic integration. But too often, I see a set of goals proposed and the argument that a suitable political coalition can erase the trade offs. But, that is profoundly out of touch with reality.

What I find wanting in Studebaker’s analysis, both here and elsewhere, is the gratuitous hand-waving. Even without my detailing of the Phillip’s curve above, his proposal is, at its heart, to create government agencies that get what he wants. (“We need stronger European institutions that can step in and prevent any European state from exploiting any other”.) I understand quite intimately the challenge of blogging is that fleshing out those ideas to a high standard is difficult, but there is a galling hubris in presuming one can make debt equal to nearly a third of the EU’s GDP disappear by giving more power to the EU Parliament. Is the EU going to abolish double entry accounting? The proposal to just waive all that debt is, without hyperbole, not wholly different. The idea that the government might be able to change the Phillip’s curve dramatically is less of a sin only by comparison. Changes at the Central Banks are among the few that can, and even then within a pretty narrow range of options.

The basic lesson of economics is that in everything are trade offs. Government financing only works if interest rates are low; inflating away debt is a terrible way to ensure continuity of government services in a country that is struggling to make ends meet. But, with low interest rates, comes high unemployment precisely because you have to hack back at services to achieve it. This isn’t a failure by SYRZIA and core parties to organize. It’s basic opportunity cost.

And so long as the left is unwilling to admit they have to give things up to reach some of their goals, they will struggle to build potent coalitions with those who take governance seriously.


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