Why Europe Refuses to Bend and Why Rest of the World Should Listen

by Dana on April 1, 2009

Stubborn American economic intelligentsia has been hammering the European governments for weeks on their “weak” economic stimulus proposals. Time and time again, they are told that the current spending programs are not enough to revive their stagnant and contracting economies. So far, they are barking up a deaf tree. Lead by Germany’s impassive Angela Merkel, Europe has so far given America the hand.

Why has Europe so stubbornly resisted America’s call for more stimuli? Furthermore, why the apparent reversal of roles? The American government has played the part of a heavy interventionist: it stepped in to bailout banks and insurance companies left right and centre, fired Wagoner, signed away billions in monetary stimulus. And the usually vocal and heavy-handed socialist Europe has thus far tightened its purse-strings?

The question of unity

The EU and its peripheral nations are hit by the crisis in different ways. Some are forced to deal with their domestic property bubbles (Spain, UK), some (like Germany) face a collapse in their export economy, most have rushed to guarantee their banking systems (UK, France, Spain, Belgium, and pretty much everyone else), and others (Austria) must face their bad Eastern European/Balkans investments.

Long story short, these countries are too busy assessing its domestic impact from the global fallout, to agree on any unified strategy. It’s not hard to see that, short of a magic pill, no tidy monetary or fiscal policies can cure such a wide array of ailments. We should also remember that the ECB’s (European Central Bank) only central mandate is to maintain price stability (i.e. low inflation), where the Federal Reserve’s mandates are much more varied and powerful.

Automatic stabilizers

Europeans like to talk about their automatic stabilizers. It’s an insurance that cushions the economy against the kind of severe blows to the head that everyone’s taking now. The logic goes that in hard times with higher unemployment, the government will automatically open its coffer to provide the kind of social welfare that the American version of stimulus might do anyway.

There are arguments that this stimulus is 1) not enough, and 2) more expensive than the direct monetary stimulus the American, Japanese and Chinese propose. That sounds pretty weak. Those are also societies where welfares benefits are limited, thus creating a situation where consumers are much more reliant and sensitive to employment situations to sustain their standard of living.

To me, it would seem that any kind of stimulus would have a much better chance of success if it is introduced in a manner consistent with the socio-economic configurations already in place. Without any solid evidence that confirms our current commitment to the “multiplier effect”, or concrete proof that demonstrates severe deficiencies of automatic stabilizers, do we really want to bet everything on one strategy?

Aversion to debt

Membership in the EU comes with certain covenants that limit debts within a certain percentage point compared to the overall GDP. Countries like Italy, Greece and Belgium hold around 100% of debt-to-GDP, certainly higher than the recommended 60% band, whereas countries such as France and Germany have a ratio around the 40-50% range.

In the last six months, the US has run up over $1 trillion in public debt at around 7% of its GDP. Europe looks at this with horror as America’s debt profile start approaching a trajectory that may very well mirror one of its own undisciplined members. To ask leaders in the EU to engage in similar monetary expansion is impractical, because it would set terrible examples for aspiring and current EU members.

Burdened memories

It’s not so much that Europeans, particularly the Germans, were so traumatized by their experience with the Weimar republic that they refuse to even entertain the idea of monetary expansion. Well, to a certain degree, it is.

It is hard to dispel the image of wheeling money in barrows that has been permanently lodged in collective German consciousness, just as it is hard to shake the picture of long lines of unemployed Americans during the Great Depression. Both scenarios have been invoked, under different contexts, during the past few months. One thing is apparent, the American fear of unemployment perhaps rivals in intensity with the German adversity of inflation. Knowing this, is it any surprise that the road to salvation for the Americans (monetary spending and a respite in employment numbers), is the road to “hell” for some Europeans?

Demographics

Defending her policies, Angela Merkel cited demographics as one of the reasons behind Europe’s reluctance to run up a deficit. It made little sense to borrow and spend today, leaving a shrinking population to shoulder the burden down the road. She says:

“Over the next decade we will undergo a massive demographic change, and, therefore, borrowing is a greater burden for the future than in a country with a much more continuously growing population, as in the United States of America.”

What she says is interesting, because on top of absolving Europe from its various critics on the wisdom of its tight-belt economy decisions, it questions the sustainability and long-term implications of countries committed to monetary expansion and debt-driven stimulus programs.

The most obvious problem here is Japan. Similar to Germany, its export sector has all but collapsed. The country borrowed massively to spend its way out of the last recession, and is now committed to doing more of the same. At least in Europe, migration within the expanding EU may dilute, or at least mitigate some of the challenges of an aging Western Europe. But Japan is confronted with more immediate demographics issues: limited immigration provides no breathing room for a shrinking working population, and increasingly high costs of sustaining a rapidly aging population in a country that boasts the highest life longevity. Can Japan afford this much debt?

It also challenges the validity of the large American stimulus. With ever-more limiting immigration laws and an also-graying population, is America confident that its high(er) birthrates will backup its ability to pay back the growing debts?

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picture source: *Goodbye-kitty975

  • http://onemint.com Manshu

    Dana, Why do you say that Japan has more immediate demographic concerns? How do the three compare, I mean US, Japan and Europe. That will be an interesting post too.

    Thanks to you — I have become really interested in demographics.

  • http://onemint.com Manshu

    Dana, Why do you say that Japan has more immediate demographic concerns? How do the three compare, I mean US, Japan and Europe. That will be an interesting post too.

    Thanks to you — I have become really interested in demographics.

  • http://investoralist.com Dana

    Manshu,

    Japan has the worst outlook here because it has 1) low birthrates, 2) very limited immigration. For a country in this position to borrow so massively, as it has done during the last recession, and now again, is almost reckless. But they’re in a bind you see, because the whole modern Japanese social contract is based on lifetime employment and the social welfare that comes with it. Now those conglomerates can’t afford to hold up their side of the bargain, the government has to step in and provide. But they can’t afford to, thus they’re borrowing from tomorrow to fund today, till they figure something else out. So far, they haven’t. And that’s a big problem.

    As for Europe (I’m talking about Continental Europe here for the most part), the problem is almost identical to Japan, but not exactly, because it’s a large continent of many countries. Traditionally, certain parts of Europe has had higher birth rates, than others. Although still not high enough overall (I don’t have immediate stats on hand, but should be pretty easy to find), an open-border Europe can still ensure that if the crunch come, labour will be relatively to come by. For example, people from eastern Europe and the Balkans can probably do what the Turkish and Moroccans have done for Europe last century. Of course, this is not really what Europe wants to do. Open border or not, many countries have trouble integrating outsiders, and there’s the bigger problem. Muslim immigration over the last fifty years has given Europe such a huge headache that they are extremely wary of mass immigration going forward. So that may mean a gradual dis-integration of its current generous welfare state. I already see this. Social benefits in certain areas in the Netherlands (particularly medical) are in many ways, inferior to what I’m used to in Canada.

    As for the States, it’s in less of a problem as long as birth rates keep up and immigration doesn’t slow down too significantly. It’s got many problems itself no doubt, social welfare and medicare and all that, but demographically, it’s not as limited or challenged as those two parts of the world.

  • http://investoralist.com Dana

    Manshu,

    Japan has the worst outlook here because it has 1) low birthrates, 2) very limited immigration. For a country in this position to borrow so massively, as it has done during the last recession, and now again, is almost reckless. But they’re in a bind you see, because the whole modern Japanese social contract is based on lifetime employment and the social welfare that comes with it. Now those conglomerates can’t afford to hold up their side of the bargain, the government has to step in and provide. But they can’t afford to, thus they’re borrowing from tomorrow to fund today, till they figure something else out. So far, they haven’t. And that’s a big problem.

    As for Europe (I’m talking about Continental Europe here for the most part), the problem is almost identical to Japan, but not exactly, because it’s a large continent of many countries. Traditionally, certain parts of Europe has had higher birth rates, than others. Although still not high enough overall (I don’t have immediate stats on hand, but should be pretty easy to find), an open-border Europe can still ensure that if the crunch come, labour will be relatively to come by. For example, people from eastern Europe and the Balkans can probably do what the Turkish and Moroccans have done for Europe last century. Of course, this is not really what Europe wants to do. Open border or not, many countries have trouble integrating outsiders, and there’s the bigger problem. Muslim immigration over the last fifty years has given Europe such a huge headache that they are extremely wary of mass immigration going forward. So that may mean a gradual dis-integration of its current generous welfare state. I already see this. Social benefits in certain areas in the Netherlands (particularly medical) are in many ways, inferior to what I’m used to in Canada.

    As for the States, it’s in less of a problem as long as birth rates keep up and immigration doesn’t slow down too significantly. It’s got many problems itself no doubt, social welfare and medicare and all that, but demographically, it’s not as limited or challenged as those two parts of the world.

  • http://onemint.com Manshu

    Thanks Dana.

  • http://onemint.com Manshu

    Thanks Dana.

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