Europe: What was the source of the crisis? What is the way out?

Roadmap

• European integration: the most dramatic piece of institutional engineering of the late 20th century– but was it deeply flawed? Can it be saved?

• Europe: a different model of capitalism– welfare states, labor markets– recent German labor market reforms

• Was crisis the product of European model?– welfare state, fiscal overexpansion– eurozone: incomplete integration

• Management of crisis: the wrong narratives

• The only options: either political integration, or economic disintegration

Labor market institutions: collective bargaining

US UK

Irelan

d

Netherl

ands

Finlan

d

Denmark

Austria

Belgium

German

y

Swed

en

Norway

Spain Ita

ly

France

0102030405060708090

100

Percent covered by collective bargaining, 2000

Source: Richard Freeman, http://www.nber.org/papers/w13242.

Labor market institutions: employment protection

US UK

Irelan

d

Netherla

nds

Finlan

d

Denmark

Austria

Belgium

German

y

Sweden

Norway

Spain Ita

ly

France

0

0.5

1

1.5

2

2.5

3

3.5

Index of employment protection legislation

Source: Richard Freeman, http://www.nber.org/papers/w13242.

The welfare state

US UK

Irelan

d

Netherla

nds

Finlan

d

Denmark

Austria

Belgium

German

y

Sweden

Norway

Spain Ita

ly

France

05

10152025303540

Government social spending as percent of national income, 2003

Source: Richard Freeman, http://www.nber.org/papers/w13242.

Is the Eurozone crisis a crisis of the European “model’?

• The epicenter of the crisis was the U.S., not Europe• The crisis did not affect all European countries equally

– The worst affected were not countries with largest budget deficits (except Greece) or the most extensive welfare states, or

– They were the countries with the largest external deficits– Germany’s current account surplus was the counterpart to the

GIPSIs’ deficit

• The Eurozone as the victim of internal imbalances– Divergent patterns of labor market performance, with attendant

consequences for competitiveness– Lack of EZ-wide fiscal/legal/political institutions to attenuate and

foster rapid adjustment to “regional” crises

The Eurozone version of global imbalances

Source: http://krugman.blogs.nytimes.com/2012/01/30/eurozone-problems/

The (more recent) German “miracle”

• Large reduction in relative unit labor costs since 2000– despite high degree of employment protection

• After crisis, adjustment through reduction in working hours instead of reduced employment– Instruments: working time accounts and short-time work

• Made feasible in turn through– practice of cooperation between social partners– practice of firms’ investing in workers’ skills and hence incentive to

preserve employees– government subsidies for short-time work

• A model of “flexicurity”? – Generous social protection/transfers with considerable flexibility in

employment contracts

Germany’s labor market in comparative perspective

German labor market reforms

Source: Rinne and Zimmermann (2011)

How does a true federal system deal with regional economic imbalances?

• Consider Florida’s “current account deficit” with the rest of the U.S.

• When borrowers in Florida go bust:– There is a common legal regime that provides for bankruptcy and debt workouts

across state lines– FL residents get welfare checks and other transfer payments from Washington– The Federal Reserve acts as a lender of last resort to any FL banks– The FDIC provides deposit insurance to depositors in FL banks – Other FL borrowers do not get shut out of credit markets– FL workers can easily move and seek jobs elsewhere in the U.S w/out language and

cultural barriers– FL has representatives and senators in Washington, D.C., who can push for remedies

for FL’s economic troubles (e.g., fiscal spending, federal assistance, debt relief)

• So perhaps trouble is not that EZ is too integrated economically , but that it is not sufficiently integrated fiscally/legally/politically

The misdiagnosis fro GIPSIs: the structural reform agenda

• OECD/IMF structural reform agenda as growth policy:– removing entry and other restrictions in product and service markets– labor market “flexibility”: reducing cost of firing workers– privatization of state assets

• Not clear that these practices were responsible for the crisis, nor that they can stimulate growth in midst of demand slump and high unemployment– Even if desirable in “normal times”

• Short term remedies for Greece et al. limited:– “transfer union”; (cf. German unification; U.S. federalism) or– boost to competitiveness through return to national currencies

(partial break-up of EZ)

How the crisis is spurring “reforms”Change in overall responsiveness to OECD recommendations from 2008 to 2011

Source: OECD, 2012

The Eurozone’s dilemma

• Only one long-run path: either political union, or economic disunion– current path of externally imposed austerity only exacerbates

economic crisis and is unsustainable for any democracy– Merkel’s choice of presenting the crisis with a narrative of Greek

profligacy instead of as a narrative about European interdependence rules out the political integration path

• Economic and political consequences likely to be severe for core countries as well