According to Eurostat, our real GDP was last seen growing at an annualized rate of 3.6 percent. The comparable measure in the euro zone is 0.8 percent. Unemployment there is 11.5 percent; here it is half that (5.8 percent). Such large and persistent output gaps (the difference between actual and potential production and employment levels) typically yield falling rates of inflation. Annual inflation in the euro zone is up only 0.3 percent; here in the United States, even with our sharp fall in gasoline prices, the comparable measure is up 1.7 percent, about five times as fast.
Readers of my work know I’m no home-country cheerleader. I’ve been particularly critical of the distribution of U.S. growth, which has largely bypassed our middle class. But while overall economic growth is not sufficient to raise the living standards of the middle class, it is clearly necessary. Given these persistent and significant macroeconomic differences between the United States and Europe, it would be foolish indeed not to try to learn something from them. What structural and policy differences account for the different performances?
Here’s a list of the differences I think are most important:
Our monetary and especially fiscal policies may not have been great, but they’ve been much more pro-growth than theirs. Yes, we pivoted to deficit reduction too soon (in 2010), but it was Europe that put the concept of austerity — fiscal consolidation (reducing budget deficits) when growth is weak — on the map. It’s a fiscal strategy analogous to leeching, and it has failed not just in growth terms but in public debt terms as well. Numerous euro-zone countries have been stuck in a vise where near-zero growth rates are leading to higher, not lower, public debt.
This failure is not from the lack of evidence of austerity’s negative impact. Back in early 2013, two IMF economists released a rigorous study that asked the following question about European austerity: Has it had its intended results? They gauged how far off the mark policy makers were by comparing what forecasters thought would happen upon cutting back fiscal support to what actually happened.
The answer is off-the-mark by a factor of three. Deficit reduction was three times more hurtful to growth than they expected. Yet top policy makers, especially the economically dominant German fiscal authorities, continue to resist relaxing this self-imposed constraint.
While the European Central Bank was both late out of the box and inconsistent, they seem to have arrived at an understanding that consistent and deep monetary stimulus is necessary. The problem, as I stressed recently in these pages, is that absent a complementary fiscal push (and a resolution of the imbalances noted next), the ECB’s actions will have limited impact.
In making these sorts of comparisons, it’s essential to remember that the United States isn’t Europe; cultural, political, and economic structural differences abound. We, for example, were able to run large budget deficits, and global capital was still drawn to our shores keeping our interest rates low. This was not the case in particularly weak euro-zone countries (Spain, Italy, Greece).
Political differences matter, too, and we must recognize that countries within currency zone are fundamentally different than our states. In a recent trip across the pond, a prominent German economist asked, “How do you think New Yorkers would feel about bailing out Texans, or vice versa?”
It’s a fair point, but it doesn’t contradict the fact of damaging fiscal policy in a climate wherein weak demand has been the most destructive constant.
Persistent trade imbalances with no mechanism for external devaluation: That sounds gnarly, but it’s really pretty straightforward. During the boom, certain euro-zone economies, most notably Germany, developed large trade surpluses — they produced more than they consumed — and exported the excess production to other euro-zone countries which ran large trade deficits.
When the boom became the bust, these capital flows from trade surplus to trade deficit countries shut down, leaving the weaker countries heavily indebted to their fellow euro-zone lenders but — by dint of their membership in the currency union — without a fundamental adjustment mechanism: currency depreciation. Simply put, how could Spain or Portugal devalue their currency — the euro — to make their exports to Germany cheaper, when Germany’s also on the euro?
Still, there were at least two ways out of this mess, but neither were taken. One would have been to charge off some of the debt, but here again, politics was a factor (see the above New York/Texas analogy). Second, instead of wages and prices falling in the already weaker economies (internal devaluation), prices and wages can rise in surplus countries, making their exports less competitive and helping to hasten the rebalancing. But here again, Germany has been unwilling to internally devalue, and now its unemployment rate stands at 5 percent while Spain’s is 24 percent.
Our capital markets are just a whole lot more resilient: While the above differences are pretty widely appreciated, I’m not sure this one is as widely accepted, though it’s a salient difference. As a number of IMF scholars recently summarized:
In the United States, private credit and capital markets play a key role in smoothing income shocks. In contrast, in the euro area, risk sharing through the financial system has been more limited including during this crisis. In particular, since the start of the euro area crisis, the fragmentation of the euro area banking system has drastically constrained the scope for risk sharing through private credit markets.
Let’s be clear here: reckless lending by our financial markets were a major contributor to the housing bubble that caused the Great Recession. But, and here’s another big policy difference, we backstopped our banks (that’s a nice way of saying we bailed them out, though “risk sharing” sounds even nicer) while the Europeans have been much more reluctant to do so.
Our actions in this regard have seemed terribly unjust to many Americans. Why throw a lifeline to the very sector that inflated the bubble? And the fact that the U.S. financial sector has recovered way ahead of the median household justifiably sticks in our national craw. But the fact that we reflated our credit system and they didn’t, another symptom of a monetary union that’s not a banking union, is one reason our macroeconomy is doing a lot better.
There’s more to this, of course. Our demographics are somewhat more favorable to growth than those in much of Europe — their labor force is older and growing more slowly than ours (even as our labor force growth has decelerated). As alluded to above, public debt is a bigger problem in some euro-zone countries relative to our own. But there’s no escaping the depth of policy mistakes that European policy makers continue to make and the damage they are imposing on their citizens.
If, for some evil or spiteful reason, you wanted to block the European recovery, you’d set up a system where austere fiscal measures were foisted on countries by an inflexible, dominant member within a currency union that lacked fiscal or regulatory unification, characterized by sclerotic capital markets and persistent trade imbalances that could only be resolved by high unemployment. And then, after making all those mistakes, you’d refuse to learn from them.