Continuing the series of The Current Moment interviews, today we are publishing an interview with Peter Hall, Krupp Foundation professor of European studies at Harvard University. Peter Hall has published widely in the field of European political economy and comparative politics. His published books can be viewed here. One of his recent papers explores the political origins of the current economic crisis.
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?
On this side of the Atlantic, we are mesmerized by the fiscal dimensions of the global economic crisis and not nearly attentive enough to what will be required to ensure the U.S. remains competitive and capable of robust economic growth over the longer term. Above all, that will require large investments in human capital and public infrastructure, since these are the resources on which all kinds of businesses depend for success. Despite the efforts of some analysts, such as Michael Spence, and of President Obama himself to argue that, by focusing on these issues, we can address the immediate problem of unemployment and long-term growth together, these issues have not yet become central to public debate. I wish Americans could see how rapidly China is moving on these fronts and how fruitful such strategies have been in parts of Europe, such as Finland. We are so obsessed with the short-term, on both economic and electoral fronts, that we are moving far too slowly to lay the basis for renewed growth over the long term.
In Europe, discussion of the Euro crisis is dominated by many myths. But the one yet to be questioned at all seriously is the myth that deregulating markets in labor and goods so as to intensify competition in them will regenerate growth in the southern European economies. Such moves are typically described as ‘structural reform’ – a term that has become the mantra of the EU and IMF. In the long run, structural reform may make some economies more competitive, but to pretend that it will revive economic growth in the short to medium term is an illusion. Yet this illusion is at the center of most of the plans concocted to revive the southern European economies and resolve the Euro crisis.
For obvious reasons, this is a convenient myth, but it is an empty slogan, all the more pernicious because it diverts attention from the role that government has to play in the revival of economic growth.
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?
For the most part, this is a canard, encouraged far too quickly by many politicians in northern Europe who reacted to the sovereign debt crisis as if it were an issue of morality rather than a crisis with economic and political foundations that threaten the viability not only of the Euro but of the EU. Those politicians now realize the full dimensions of the crisis, but their initial reactions has made the task of persuading their electorates to accept measures that might genuinely cope with it much more difficult.
The difficulties from which Greece and Italy are suffering have something to do with problems of political, as well as economic, development. Both countries would be better off with public institutions less prone to corruption. But to suggest that that their people are not working hard enough or retiring too early is to misrepresent the problem altogether. Comparative data suggest that the de facto retirement age is not very different in most of southern Europe than in northern Europe and that the southern European countries have taken just as many steps as those in the north to make their markets more competitive over the past ten years.
The roots of the Euro crisis lie, at a much more basic level, in asymmetries in the organization of the political economies in the north and south of Europe. In general, as David Soskice and I observed in Varieties of Capitalism (2001), the organization of the political economies of northern Europe gives their firms capacities for wage coordination, skill formation and continuous innovation that suit them well to operate strategies of export-led growth, and EMU provided them with guaranteed markets in the rest of Europe. By contrast, history has left the southern political economies with fissiparous trade unions and limited capacities for concerted skill formation or continuous innovation. In the past, they coped with that by operating growth strategies led by domestic demand and then devaluing their currencies to offset the inflationary effects of such strategies on their external competitiveness. In EMU, they were unable to do that. Instead, not unreasonably, they took advantage of the cheap credit flowing from northern Europe to promote economic growth. But, unable to offset the inflationary effects through devaluation, they lost competitive advantage to the north. The result can be seen in the gross imbalance of payments between the two parts of the Eurozone.
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?
To appreciate the Euro crisis, we have to realize that there are two sides to it. On the one side, there is the longer term problem of how to devise a structural adjustment path that will restore prosperity to both the south and the north. On the other side, this is a crisis of confidence, notably in the markets for sovereign debt but spreading over time to the European financial system as a whole. The European Union has remarkable capacities for muddling through, and, given enough time, I believe it can resolve this long-term problem adequately if not perfectly. But it is never going to get to the long term if it does not effectively address the immediate crisis of confidence and, as everyone now acknowledges, its efforts to do that over the past year have consistently offered too little, too late.
The immediate crisis is what worries me. With respect it, there are two issues. Is there a way for the members of the Eurozone to restore confidence in the markets? And, if that can be identified, will the member states and the ECB be willing to take the requisite measures. At this point, I think, as do many others, that the only way to restore confidence in the bond markets is for the ECB to guarantee the sovereign debt of its member states against default, except perhaps for Greece where the markets have already priced in a default. Various schemes have been mooted whereby the ECB might do this, indirectly if not directly.
The problem is that it will not be easy for the ECB or the member governments to do this. Mario Draghi and the German government currently oppose such a step. It is forbidden by Article 123 of the Treaty establishing EMU, and the German Constitutional Court likes to take that Treaty seriously. The only ray of light here is that the relevant resolution passed by the German CDU at its recent conference does not entirely rule out such a step, describing it as ‘a last resort’. I think the time for last resorts has come, and I could imagine a deal in which the member governments agree to much stricter enforcement of fiscal targets and long-term support for the ECB in return for a measure of this sort. However, it is an entirely open question whether the Eurozone governments have the political wherewithal to make this move. If they do not, I think the crisis of confidence is likely to persist and strengthen until an Italian, Spanish or even Belgian default looms, and then it may be too late to save the Euro. It takes a confidence trick to resolve a crisis of confidence and the sooner one acts, the less costly the resolution.
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?
This is a question about whether balanced structural adjustment is feasible over the long term within the confines of EMU. Certainly, the current approach of imposing all the costs of adjustment on southern Europe (of which Ireland can be considered an honorary member) is likely to fail. Except possibly in Ireland where growth is gradually picking up, there is no reason to expect that rapid enough growth can emerge from such austerity to render the debt load of these countries sustainable. At a minimum, long-term stability depends on a more coordinated set of fiscal policies in which some reflation in northern Europe is married to a softer adjustment path in southern Europe. However, this will not be easy to secure. In particular, as Wendy Carlin and David Soskice have observed, reflation poses risks to the wage coordination on which the northern European economies depend for their competitiveness.
Even then, for reasons I have noted, there is some question about whether the southern European economies can prosper within EMU. Portugal and Greece, in particular, do not have especially strong export sectors and are not likely to grow them overnight. These countries have long depended on growth strategies that are accompanied by moderate levels of inflation and, because the ECB has to pursue a monetary policy of one-size for all of Europe, it cannot always dampen down that inflation effectively. In the wake of the sovereign debt crisis, borrowing costs are likely to remain higher in the south, which will help. But the danger is that, if the southern European governments cannot pursue growth led by domestic demand for fear of its inflationary consequences, they may experience only low levels of growth for the foreseeable future. Structural reform will help in the long run but likely only a little.
It may well be that Europe can live with persistent imbalances of payments at some level, but the question is whether more effective coordination of fiscal policies will be enough to allow the southern European economies to grow at rates that are politically acceptable to their electorates.
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?
The demand for austerity can be explained to some extent by the fact that we have just lived through a period in which financial innovation married to inadequate financial regulation made possible much higher levels of leveraging of assets, leading to higher levels of debt, whether in the public or private sectors of the U.S. and Europe. To some extent, we are paying today for what we ate yesterday.
The best way to pay back these debts, of course, is from the fruits of more rapid economic growth and that is most likely to be secured, as John Maynard Keynes argued, by reflationary policy. Thus, in the context of global recession immediate austerity does not make good economic sense.
To explain why so many are advocating it, then, we have to recognize that economic policy, whether at the national or international level, is rarely driven entirely by concerns about how to improve overall economic well-being. It is made by actors, who may be political parties or governments, who are also seeking distributive benefits for their constituents, and, in many cases, these distributive demands are cloaked beneath calls for austerity. Thus, the demand of several northern European governments, including the Finns and the Dutch as well as the Germans, for austerity in southern Europe is motivated, to a significant extent, by a concern to ensure that they do not pay the costs of adjustment in the wake of the Euro crisis. I see the demands for austerity of many Republicans in the U.S. as an effort to cut public spending programs that they think serve Democratic rather than Republican constituencies. If distributive concerns were not at the heart of those demands, those Republicans would be much less reluctant to raise taxes in order to balance the budget.
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?
As the French would say, I am willing to accept this for lack of something better. Something better would be a coordinated reflation in which more expansionary fiscal policy was now playing a larger role. We have arrived at this situation, I think, because central banks, including the Federal Reserve and the ECB, have been willing over the past three years to do what governments have been unwilling or unable to do. For that, they deserve considerable credit. One can reasonably ask whether the best way to respond to an era marked by a large expansion in lending is to pump even more money into the system, but, since inflation remains low in most of Europe and North America, partly because the trade unions have been so weakened and unemployment is high, this seems to be an appropriate strategy. In the absence of a substantial fiscal stimulus to aggregate demand, however, it is unlikely to lower unemployment much.
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?
As Ragurham Rajan and others have pointed out, in the United States, during the 1980s and 1990s, easy consumer credit and home equity loans became a substitute for social policy. They have been the means ordinary people with little in the way of savings used to survive adverse life events and fluctuations in the economy. Student loans can be seen, in similar terms, as a substitute for publicly-funded education.
They can also be seen as a key component of the growth model operated in the United States over that period. Growth in this country was led by domestic demand and the only way to sustain demand in an era when disposable income for households at or below median incomes stagnated was to promote the kind of asset boom in housing that gave many the illusion that their wealth was increasing even if their income was stagnant.
In the past two years, as home prices declined and some forms of credit became harder to secure, American households increased their savings and that, in itself, is gradually reducing the debt burden of the private sector. I do not see any need to take steps to further reduce that debt. Indeed, it is difficult to see how the American economy can continue to grow without the availability of such credit.
However, there are serious longer-term problems on the horizon. More than half the American populace has no savings for retirement at a time when larger cohorts can be expected to retire and health-care costs continue to rise exponentially, eating into the disposable income of many families. Part of the problem is that most of the fruits of economic growth over the past three decades have gone to people in the top 1 percent of the income distribution. In the long run, the solution will have to entail engineering a more equitable distribution of wealth so that ordinary working families have the means to increase both their savings and their spending.
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?
Seen from a long-term perspective, this does indeed look like an era of financialization. The share of profits in the economy going to the financial sector expanded dramatically. With the invention of new financial derivatives and the development of financial markets, many firms ostensibly devoted to manufacturing, such as General Motors, have made an increasing share of their profits from financial activities that leverage their capital. That has contributed, in turn, to rising income inequality at the high end of the distribution, as those skilled at financial engineering generated profits large enough to allow them to demand astronomical levels of compensation.
In my view, it would be an exaggeration to say that the economy has become ‘financialized’. There are still many productive components of the American economy that do not turn on finance. However, it is apparent that we are all vulnerable to the systemic risks that a large financial sector, increasingly devoted to speculation, entails, and that is a serious cause for concern. Although some of the financial innovation of recent decades has made some markets more liquid and borrowing easier for some productive firms, I doubt that this type of ‘casino capitalism’, to borrow a phrase from Susan Strange, ultimately contributes enough to economic prosperity to justify those risks. We are currently paying serious costs for this and, unless financial regulation becomes more stringent than is currently anticipated, I think there will be more to pay.
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 do not believe that any single set of factors can explain these diverse developments. The housing bubbles can be explained, at least in basic terms, by a long period of easy credit, made possible, as I have noted by the expansion of the financial markets in various kinds of derivatives. That was made possible, in turn, by what I consider lax financial regulation. It is ironic that economists liked to describe this period as an era of ‘great moderation’. In each case, however, some ancillary factors were at work. In Spain, the cost of borrowing was greatly reduced by the confidence effect associated with entry into EMU. In Ireland, it was encouraged by rapid rates of economic growth.
The sovereign debt crisis has more complex roots. In Greece, which enjoyed the same easy access to credit as Spain, the fiscal fecklessness of the government is notable. In Ireland, some of the problems can be attributed to the government’s mistaken decision to guarantee the bonds of its banks. In different ways, Portugal, Spain and Italy remained creditworthy on the fundamentals but fell afoul of the spreading crisis of confidence in the markets, which has yet to take its last victims. There are some parallels with the East Asian financial crisis. The current crisis is worse partly because it has struck the major financial sectors of the western world and we now face the question of who will rescue those who normally do the rescuing.
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?
In this as in every other case, as Winston Churchill once said ‘democracy is the worst form of government except for all those other forms that have been tried from time to time’. The notion that governments led by geriatric Eurocrats will resolve their countries economic problems more readily than elected governments is another of those illusions that bedevil the Eurozone. They have legitimacy in Brussels but imposing austerity is ultimately a task that demands domestic political legitimacy. I see this as a stop-gap solution that might, at best, persuade officials in Brussels and Berlin that everything has been tried and they must pay more heed to the pain and demands of national electorates.
It is obvious that the cumbersome decision-making procedures of the European Union are not up to the task of heading off a crisis in the financial markets. But that is not a problem with democracy. It is a problem of international negotiation. Democracy enters the picture to the extent that the views of national electorates limit the willingness of their governments to share the costs of adjustment, and that is admittedly a problem for Europe. A continent so proud of the ways in which its social policies reflect ‘social solidarity’ has been unable to summon up the sense of continental solidarity that would justify a more equitable and efficient solution to the crisis. But social solidarity does not simply bubble up from below. It is created by inventive political leadership and we are still waiting to see if the political leaders of Europe are capable of that.
On the larger question, my view is that the global financial crisis has thrown into stark relief the importance of the state in any democratic system. The crisis itself is rooted in failures of financial regulation that can be linked to the unwillingness of governments to assert the authority of the state on behalf of the people against powerful financial interests. And the inadequacy of the response to the crisis, especially in the U.S., can be attributed, in some measure, to the widespread reluctance on the part of many people to trust the state with their resources. In many respects, that is the legacy of the neo-liberal era that followed the economic crisis of the 1970s, when many policy-makers and citizens became disillusioned with the capacity of governments to direct the economy. Hence, the American government faces the current crisis hobbled by rising levels of distrust in government. It is not acting more forcefully on the fiscal front partly because large segments of the American population are willing to vote for politicians who claim that government is the problem rather than the solution.
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?
There have been two notable political responses to the current economic crisis. One is marked by a backlash against immigration, in both the U.S. and Europe, reflected in the growing popularity of radical right parties in Europe and the salience of immigration to national political debates in the United States. This is a familiar feature of economic crises. The U.S. has a long history of nativist movements. The other is reflected in the Occupy Wall Street movement and its European analogues. I can only hope that the former is contained and the latter encouraged.
It is difficult to see how these sporadic protests can be translated into any immediate changes in policy, not least because they have yet to articulate clear political demands. However, I think they are having an impact. They have struck a chord in popular opinion. They bring issues of unemployment and inequality to the fore. In the short term, I think that may influence voters in American elections next year, and, over the medium term, I believe that even these limited protests will help to shift political discourse in directions that favor those seeking to address issues of inequality and unemployment.