As part of our ongoing series of interviews, we have today responses from Arthur Goldhammer. Art runs the excellent French politics blog, is on the editorial board of French Society, Politics, and Culture, and chairs the Visiting Scholars series at Harvard University’s Center for European Studies. He is a writer and translator of more than 120 books from French to English, including a translation of Alexis de Tocqueville’s Democracy in America. He has written and commented on both the US and European dimensions of the recent financial crisis, and we have asked him to elaborate his views.
What are the stories right now that you think people either aren’t paying enough attention to, or about which we have the wrong view?
I think we need to pay more attention to how the expansion of lending was financed by what Hyun Song Shin, Joe Danielsson, and Jean-Pierre Zigrand call “passive investors,” namely, household savers, value-oriented money market funds and pension funds (see here). Ben Bernanke called attention to a “global savings glut” due to the US-China trade imbalance, but Shin points out that the Chinese by and large did not buy risky mortgage-backed securities. Instead, he notes the existence of a “global banking glut,” as passive investors provided cheap financing that allowed European banks to expand their lending dramatically during the early 2000s. It was this intermediation of US funds through global European banks that fueled both the US mortgage bubble and the various bubbles that occurred in Europe.
Let’s turn to the Eurozone debt problem. The dominant view is that Greeks and Italians are corrupt, inefficient and lazy, and that is why they find themselves in this mess. What is your view of what is going on?
Low productivity and laziness are not the same thing. Greek workers in fact put in more hours per year than German workers, but they do not produce as much per hour of work because the German and Greek economies are radically different in structure. Given the low cost of government borrowing before 2009, however, the Greek government increased its purchases over many years, which drove up unit labor costs relative to Germany while putting money into the pockets of workers, encouraging them to buy imported goods. In other southern-tier countries, the details of the picture vary but the overall pattern is the same: wage-inflation in the south combined with wage-stability in Germany, where unions and management cooperated to foster export-led growth. Inevitably, this structural disparity reached its limit. To be sure, deficiencies in Greek and Italian governance contributed to the crisis, but they are not its root cause.
The standard recipe for the recovery from the Eurozone crisis is austerity and structural reforms in the peripheries, plus some recapitalization of banks. Do you think this is the right way to go?
“Structural reform” can mean many things. Too often it is simply a euphemism for “scale back the welfare state” and “make it easier to fire unwanted workers.” Clearly, a more far-sighted structural reform, oriented toward education, job training, and productivity-enhancing investment is needed to put Europe on a more balanced growth path. In the short run, austerity is harmful because it will reduce aggregate demand. The theory of expansionary contraction is wrong: business confidence will be undermined, not increased, by simultaneous fiscal retrenchment across the Eurozone.
What do you think would address the trade and debt imbalances between Northern and Southern Europe? Do you think it can be done within the European monetary order?
Germans need to consume more, save less, and agree to a fiscal union that will allow for transfers of wealth to poorer regions. Politically, however, the latter will not be easy to achieve, since Germans were assured when the euro was created that they would never be part of a “transfer union.” The German Constitutional Court might even veto any such proposal. This could doom the Eurozone. But German gains from the euro have been so substantial, and the costs of a collapse of the Eurozone would be so great, that it is possible to envision evolution on this point. I am not sure that it can come fast enough, however, to save the system, especially if the European Central Bank refuses to purchase sovereign debt on the primary market to keep Italian borrowing costs within reason.
The hegemony of the demand for austerity is striking. It is offered as the solution to the Eurozone crisis, as well as to the American situation – the US Congress even created a supercommittee to find savings. Yet it seems odd to have such agreement around austerity in the midst of a potential double dip recession. What is wrong with the demand for austerity? How do you account for the strength of this common sense?
It is not easy for people to think in terms of a general economic equilibrium. Politicians often fall back on homely household analogies: “a family cannot indefinitely spend more than it earns,” etc. Other simple homilies abound: “Debt got us into this mess, we cannot get out by piling on more debt.” The paradox of thrift is difficult to grasp. It is hard, moreover, for many people to place confidence in “the Keynesian solution,” because there is so much controversy over what it means. Keynesianism was only dimly understood during the Great Depression, and the immense deficits incurred in World War II were not taken on in virtue of an intellectual conversion to Keynesian ways of thinking. The so-called Keynesian demand management that took hold in the 60s is really a separate body of doctrine from Keynesian teachings about the liquidity trap, and demand management policies were discredited by the stagflation of the 70s. The economics profession itself is so far from consensus about Keynesianism in either normal times or liquidity traps that it would take a leap of faith for the average informed voter to countenance the vast deficit spending that some theorists say is necessary to restore growth. So things will have to get worse before practical men who believe themselves to be quite exempt from any intellectual influence are willing to put themselves deliberately into the hands of some defunct economist.
In the US, there is an influential view that we need to have continued expansionary monetary policy but contractionary fiscal policy. That seems to be the recipe of the moment, with the Fed even contemplating another round of quantitative easing. What do you think of this approach to inadequate demand and balance sheet problems?
I think that quantitative easing is helpful but that its operation is too slow and will eventually have to be supplemented by a more expansionary fiscal policy. The latter must be accommodated by monetary policy, but monetary policy alone cannot do the trick. Without growth, the Eurozone debt crisis will worsen, and “quantitative easing,” which has already occurred there, will have to take the form of monetization of the debt, which the ECB has thus far staunchly resisted. But the gallows will concentrate the minds of central bankers, unless political chaos erupts first.
Debt, especially mortgages and student loans, have become a major issue over the past few years. What if anything do you think should be done about it? How should we understand the growing debt of American households in the past decades?
I think the housing market will correct itself but the damage to millions of lives could be limited if the government were to take a more aggressive line on mortgage modification. Student debt is another matter because expectations about the returns from education change very slowly. Too much hope is being invested in education, and inevitably many students will emerge with more debt than their future incomes can justify, imposing a durable drag on the economy. Law schools may have over-expanded, for instance, turning out more lawyers than the economy can remunerate at the levels students expected when their students took on heavy tuition burdens. On the other hand, the high cost of medical care might be alleviated if our medical schools produced more doctors, increasing competition and thus reducing fees for service, but unless there is a corresponding decrease in the cost of medical school, the burden will be borne by the students. But an over-indebted graduate is not like an underwater homeowner. The graduate’s freedom will be inhibited if she can’t service her debt, but the only appropriate bailout is sweeping social change.
One thing that seems to tie the American and European situation together is the considerable growth of financial activity. Is there anything to the view that the last decades can be understood as a period of financialization? If so, what does it mean to say the economy has become financialized?
There is no doubt that finance-related activities have accounted for a growing share of GDP and that much of this activity has been unproductive. But how much? It’s hard to know, because efficient economic growth does require intermediation between passive investors and active entrepreneurs. We have also learned that regulation of finance is not always helpful because it provides incentives for capital to seek unregulated niches in which to operate less transparently. For instance, the Basel II banking regulations appear to have contributed to the growth of the “shadow banking system” implicated in the mortgage financing debacle. Governments have nationalized banking systems in the past without always achieving more transparent or efficient financing. Nevertheless, I think increased public oversight of leveraged institutions is inevitable. And I’m not sure that there is any justification at all for hedge funds and other leveraged private equity firms operating largely outside the regulatory structure that applies to banks. Given the over-representation of financial operatives in the very highest income brackets, increased marginal tax rates on top earners, recently recommended in this paper by Peter Diamond and Emanuel Saez, might, if not curtail financial activity, at least yield revenues that could be put to alleviating the damage.
Related to that question, what do you think accounts for the ‘bubbliness’ of the US and European economies, and especially the scale of these bubbles? We have seen a number of different bubbles and credit crises – housing bubbles in the US, UK, Ireland, and Spain; sovereign debt events in Greece, Portugal, and Italy, perhaps even France. While there was the dot come bubble in the late 90s, and the East Asian financial crisis, those don’t seem to have had the magnitude and systemic character as the latest period. What is, or isn’t, different about what we’re experiencing now?
I think that the scale of the bubbles is related to the “banking glut” discussed above. There also seems to be a “herd mentality” at work in investment banking circles, perhaps owing to the way in which bankers are recruited, trained, and rewarded. But I don’t know enough about these matters to offer specific recommendations.
How optimistic/pessimistic are you about the ability of national democratic procedures to provide solutions to the current economic crises in Europe and in the US? What do you think of the recent proliferation of technocratic governments in Greece and Italy? Does the current crisis expose some basic tensions between capitalism and democracy? If so, how exactly?
I do not believe that so-called technocratic governments will survive for very long. The question of capitalism and democracy is larger than I want to take up here. To be sure, the crisis has exposed the power of financial institutions to insist on their due and to exert pressure on democratic institutions. But the money that has been lent includes the savings of millions of ordinary citizens, whose interests deserve protection as much as, if not more than, the interests of the borrowers, who after all have benefited from the use of the loaned funds over a long period of time. Our normal democratic procedures, which are intended to reconcile large-scale conflicts of interest of this sort, do not function well in an international context in which complicated technical issues are involved. We must not, however, throw up our hands in despair, lest the comprehensible rage of those whose trust has been abused give rise to some regrettable reaction.
What are your views of the nascent protests (Occupy Wall Street, Indignados) developing in response to the introduction of austerity packages in Europe and the US? Are these movements a continuation of or a break with the anti-globalization movements of the past? Are they likely to fundamentally change public perceptions and government policy or will they have only a very small lasting impact?
I think the protest movements have called attention to growing inequality, which excessive borrowing had in part masked. I believe that the movements are new and to a large extent independent of anti-globalization actions. They reflect a desire for increased voice, especially for the young, in democratic polities that had become overly focused on freeing markets, reducing taxes and preserving benefits for the old. If the movements are to have lasting impact, however, they need to influence the electoral process, and I am not sure that they have the numbers, leadership, or organizational skills to do so. Finally, the most recent protests are only one among many signs of a more general crisis of legitimacy throughout the democratic world. Elites have claimed too large a share of productivity gains and too great a monopoly of life opportunities for their children. Without reform, the center cannot hold. Even with reform it may be too late.
What, finally, do you think the appropriate political response is to both these crises and their aftermath?
Although there will inevitably be political responses of many kinds, what is really needed, I think, is an intellectual response to guide the politics: there is clearly something wrong with our understanding of economics, especially in the areas of monetary systems and macroeconomic stabilization. Until we achieve new clarity in these areas, politicians will flail at problems whose origins they do not fully grasp, and people will demand solutions that are incoherent and therefore potentially destructive. We must be wary of our own certitudes. As we saw in the Great Depression, statesman convinced of the virtues of the gold standard acted in ways they believed were right but that we know were wrong. We are similarly in the dark and should therefore proceed tentatively, experimentally, until we are confident that we are moving toward the exit. In the meantime, income must be redistributed downward and elites must loosen their stranglehold on upward mobility through education.