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?

We’re glad to be featured in the Carnival of Pecuniary Delights No. 2

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picture source: *Goodbye-kitty975

Many are describing the Obama administration as one that is pragmatic, in stark contrast with the previous presidency that can perhaps be labeled as rather ideological. In little less than two months, he has managed to placate peeved European allies and sent Hillary off to smooth ruffled feathers with the Russians. It’s hard to say whether his pragmatism stems from his personal beliefs or merely a reflection of him acting out of economic and political necessity.

This is nothing new. Thirty years of Chinese economic progress took place on the back of pragmatism. And Hank Paulson’s rescue of Bear Stearns, Fannie and Freddie, and AIG? There’s some good material for a play: “When Pragmatism Trumps Ideology – The Tragedy of Hank Paulson in Three Parts”.

This leads me to wonder about the issue of pragmatism versus ideology when it comes to immigration, partially because I spent the better part of yesterday morning forking over a handsome sum of money for a resident permit in this fair European state.

The shifting demographics of most of Western Europe coupled with its social welfare system give me the chills. Everywhere I look, I see an overly generous welfare system that create skewed incentives in education and employment, while placing immense pressures on its working members.

It’s clear what needs to be done: find ways to raise birth rates, or find value-adding immigrants.  But what will Europe choose to fight for? Preserving its welfare system at the expense of increased immigration,  or give up the comfort of the post-war social contract and make do with less based on the status quo? I dug out some research I did last year, and found an unexpected relationship between social norms and the welfare state that may shed some light on the issue.  Below is the edited version.

Immigration is a thorny issue on both sides of the Atlantic. To many, it is a pill reluctantly swallowed by many states in order to thrive, or simply stay afloat. With birth rates below replacement rates in most developed nations, demographic projections deem immigration a necessity. The effects of an aging population range from pension burdens – fewer workers supporting more gray-haired elders; to less innovation resulting from fewer prime-age workers; to the financial implications of a state turning from a net-saver to a net-spender.

Short of coercing and interfering in their populations’ reproductive lives, immigration provides one of the only lifelines available to the state. Doing so reveals the territorial character of welfare states. Europe’s unwillingness to take in more immigrants and its inability to successfully assimilate its existing immigrant groups put it at a distinct disadvantage to say, America. While America traditionally opens up her job market while limiting new immigrants access to the welfare system, Europe does just the opposite.

Globalization has promoted economic and social integration, but welfare states remain decidedly national. Can the forces of globalization overwhelm the socialist underpinnings of welfare states? What causes the differences between the European and the American welfare systems? A couple of reasons can be used to explain this phenomenon: the contradictory forces of voting system and racial diversity.

According to Andrew Leigh, in majoritarian systems such as the US or Australia where each politician represents a single electorate boosts the interests of one region’s residents over the rest of the country. On the contrary, under proportional representation systems in Europe, several politicians representing one district may develop class-based affiliations, increasing pressures for universal programs that redistribute resources from rich to poor. Therefore, the European model of governance makes any attempts in reform more difficult, even politically suicidal.

The remaining difference is based on racial diversity. It has been noted that more ethnic diversity leads to more negative attitudes toward welfare and lower levels of social spending in US districts. While the Americans have been politically indoctrinated to believe the poor as the cause, and not the result of anti-redistribution policies, the European system was dominated by the belief in socialism.

However, with a growing immigrant population and increased diversity among populations, it is becoming difficult for Europeans to see a universal welfare solution that is based on an earlier collective value system. Without a certain degree of solidarity, it is easy for some members of the dominant ethnic groups who feel threatened by the influx of immigrants to adopt an anti-welfare attitude that values self-sufficiency and blames immigrants for needing support. If this is indeed true, and if welfare states were built on the grounds of homogeneity, it is no wonder that Scandinavian states are struggling to address the changing circumstances resulting from an increasingly racially and ethically diverse society as a result of globalization and immigration. Can welfare states of the 21^st century survive and achieve the goal of securing equality of all people?

Various researches have turned up contradictory findings. While some fail to report conclusive findings as to whether an inverse relationship exists between an increase in globalization/immigration and a corresponding decrease in welfare spending, others yielded more interesting results. Researchers Razin and Sadka suggest an interesting scenario that turns common perception on its head. An influx of skilled immigrants may raise the tax rate, since they are fiscal contributors, but with no initial voting rights. Whereas unskilled immigrants teamed up with the elderly voters may initially raise the tax rate, but the inevitable fiscal leakages (social spending on low wage, unskilled workers) may in fact drive the tax rate down after a period to prevent further leakages.

Should Europe embrace immigration to its benefit, it is almost inevitable that policy reforms will increasingly sample from the US and Australian variety. On the other hand, should Europe be complacent enough to focus on short-term gains, demographic changes that favour a reduction in welfare will increasingly butt heads with the pressing need for an ever-ballooning bill for social services. Forces of globalization may finally force welfare states to relinquish their autonomy in order to provide as they like for their citizens, and move towards a globally convergent band of standards.

picture source: ~Victheman