Thursday, April 24, 2014
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Europe’s Trust Deficit

BERKELEY – There is no shortage of talk nowadays about Europe’s deficits and the need to correct them. Critics point to governments’ gaping budget deficits. They cite the southern European countries’ chronic external deficits. They highlight the eurozone’s institutional deficits – a single currency and a central bank but none of the other elements of a well-functioning monetary union.

Of course, in all of these areas, the critics have a point. But none of these is the deficit that really matters. The deficit that prevents Europe from drawing a line under its crisis is a deficit of trust.

First, there is deficient trust between national leaders and their publics. We saw this most visibly in the person of former Italian Prime Minister Silvio Berlusconi, who fortunately has been kicked to the sidelines of the political scene. But even the most stalwart European leaders have lost their followers’ trust by baldly saying one thing today and the opposite tomorrow.

At the end of February, for example, German Chancellor Angela Merkel made a spectacle insisting that no bigger financial firewall was needed to protect other eurozone countries from a disorderly Greek default. Not one more euro of German taxpayer money, she vowed, would be contributed for this purpose. Yet everyone knew that once the Bundestag voted for the latest Greek rescue and enough time passed to acknowledge reality gracefully, Merkel would reverse course and argue that the eurozone needed a bigger firewall after all.

In fact, there is nothing at all graceful about this. For politicians to say one thing now when everyone knows they will soon say the opposite is guaranteed to erode trust in Europe’s leaders.

Second, there is a lack of trust among European Union member states. The real reason why the northern Europeans have been unwilling to provide a “big bazooka” – that is, extend more financial assistance to Southern Europe – is that they don’t trust the beneficiaries to use it wisely. They fear, for example, that additional securities purchases by the European Central Bank, aimed at bringing down Spain’s borrowing costs, would only lead the Spanish government to relax its reform effort. As a result, Germany and its allies are prepared to provide just enough assistance to keep the ship from capsizing, but not enough to set it on an even keel.

Third, there is lack of trust among the social groups called on to make sacrifices. Italian taxi drivers would be prepared to allow more competition if they were sure that Italian pharmacy owners were willing to do likewise. But if issuing more taxi medallions reduces cab drivers’ earnings, while pharmacists succeed in vetoing pro-competition measures to lower the cost of their services, the taxi drivers will end up worse off and the pharmacists will be enriched, which hardly seems fair.

In other words, lack of social trust blocks structural reform. The Greek version of this dilemma, in which no one pays taxes because no one else pays taxes, is particularly stark.

Survey research has revealed that societies vary greatly in their levels of trust. Economists, for their part, have shown that these different attitudes have deep historical roots.

In European regions where minority groups were persecuted 500 years ago, ethnic and religious conflicts have been more pervasive in recent times. In parts of the Balkans long ruled by the Ottoman Empire, trust in government is lower than in nearby regions that just happened to have been ruled by the more efficient Habsburgs. In regions where earlier inhabitants engaged in farming rather than herding, forcing them to cooperate more extensively, their descendants are more likely to form bonds of trust today.

Evidently, attitudes are passed down through the generations. They are embedded in societies in the form of culture. Simply put, when it comes to trust, history casts a long shadow.

Historians have long emphasized the importance of such “path dependence” – that events in the distant past continue to shape outcomes in the present. Yet they also point to exceptional windows in time when it is possible for societies to shift away from their established paths. A crisis, when the viability of established arrangements is called into question, is just such a window.

The euro crisis thus offers Europe an opportunity to reestablish trust. Its national leaders need to reestablish the trust of their constituents by offering them straight talk. EU member states need to rebuild their trust in one another. And European countries facing the need for wrenching structural reforms need to restore social trust at home.

If this opportunity to rebuild trust is squandered, it will be difficult, if not impossible, for Europe to address its fiscal, economic, and institutional deficits.

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  1. CommentedW. Ainvar

    I agree with Professor Eichengreen's analysis and, as usual, with Zsolt's insightful comment.

    It is incredible to see how trust and fear are at the bottom of most human activities and especially at this time how trust and fear/distrust run the interconnected global economy. I think a deeper knowledge and awareness of ourselves and our minds is needed in order to move on. It is us human beings that have created the current system, with its pros and cons. As long as we are not prepared to look deep into our weaknesses we will be repeating the same failures of the past when trying to fix our social, economic and political systems/relationships.

    Cases such as Enron, Lehman Brothers, Iceland, maybe the EU... you name it, remind us of the role that trust plays in certain success stories and how quickly that success story can vanish into thin air. Maybe more often than not it is not real trust that sustains such stories but some shared wishful thinking, a world of illusion. Even the money we use everyday, those pieces of paper or metal and those figures on the computer screen, is based on trust in the banking system.

    Zsolt's suggested education program is the long-term solution to today's concerns. Such education program should be based on real conviction and real experience not on empty beautiful words. As a species we seem to be very good at creating such beautiful concepts as interconnectedness that briefly scratch our consciousness before vanishing into our daily concerns.

    We are capable of much much more.

  2. CommentedW. Ainvar

    I agree with Professor Eichengreen's analysis and, as usual, with Zsolt's insightful comment.

    It is incredible to see how trust and fear are at the bottom of most human activities and especially at this time how trust and fear/distrust run the interconnected global economy. I think a deeper knowledge and awareness of ourselves and our minds is needed in order to move on. It is us human beings that have created the current system, with its pros and cons. As long as we are not prepared to look deep into our weaknesses we will be repeating the same failures of the past when trying to fix our social, economic and political systems/relationships.

    Cases such as Enron, Lehman Brothers, Iceland, maybe the EU... you name it, remind us of the role that trust plays in certain success stories and how quickly that success story can vanish into thin air. Maybe more often than not it is not real trust that sustains such stories but some shared wishful thinking, a world of illusion. Even the money we use everyday, those pieces of paper or metal and those figures on the computer screen, is based on trust in the banking system.

    Zsolt's suggested education program is the long-term solution to today's concerns. Such education program should be based on real conviction and real experience not on empty beautiful words. As a species we seem to be very good at creating such beautiful concepts as interconnectedness that briefly scratch our consciousness before vanishing into our daily concerns.

    We are capable of much much more.

  3. CommentedPaul A. Myers

    The Achilles heel of representative democratic government is rent seeking, which undermines trust in government. In particular what we see in California today is that rent seeking by public employee unions that control the legislature and most of the legislative bodies down at the local level has eroded once high levels of confidence in California state government's ability to deliver broad-based economic growth. Public disapproval of the legislature measures in the high 80+ percent.

    Stanford University studies estimate that the unfunded pension liabilities across all levels of government in California for public employees may be in excess of a half-trillion dollars, almost ten times the amount of voter approved general obligation bonds issued by the State. Multiply that number by 10 and you start sizing the national problem with public pensions.

    Special interest dominated public spending crowds public and social investment. California is no longer able to fund the infrastructure it needs to be a leader commensurate with its size; about the eighth or ninth largest economy in the world. It is living on its past investments. It has been disinvesting public funds from higher education for a decade.

    The New York Times reported over the weekend even more dire economic conditions among many cities and counties in New York. One could read those articles and see what is going on in New York this year will be in California next year. And Illinois is in much worse shape than either New York or California.

    Greece is not so much an isolated situation but more of a harbinger of a wider problem. The modern state with powerful tax and spend capabilities that is in fact part of a larger political entity that provides access to even more credit and financial intermediation opportunities (that is what public pensions are; stealing from the future to enrich the present with contractural promises) is an entity easily captured by insider-dominated factions that divert spending steams to their own benefit. This is one of the big public policy challenges across all entities in the advanced economic world in the early decades of the 21st century.

    And the power and tidal pull of these special interests is beyond a little reform by the good government people with their four or five decade record of ineffectiveness. The legitimacy of public institutions hangs in the balance. In California, the entire public leadership class has enormously benefited from the pension scheming; they're credibility with the voters is headed south.

    I would view bruising political fights across the United States and Europe to be the norm for many years to come.

    Those who feel entitled to generous public benefits will fight tenaciously every step of the way. As Governor Jerry Brown of California predicted last year it will be a fight of all against all.

  4. CommentedZsolt Hermann

    I completely agree with you and this trust deficiency is a result of our inherent human nature.

    We are all locked inside our own subjective bubbles, each moment making self calculations, only caring about our own benefit and well being.

    The politicians only care about their re-election prospects, their legacy, not to mention the pressure they receive from powerful lobbies, which again only care about their own profit, progress. The countries only deal with each other until it is beneficial for them, until they get what they want, like the Southern European countries were useful for the Eurozone until they kept on buying the products of the Northern partners and taking credit, while now they have become a burden when the global scrisis set in.

    The different social layers are watching each other suspiciously as they consider each other competition for the same "piece of the overall cake".

    Even within the same family we are always measuring ourzelves against each other making sure we get more than others.

    And it is extremely difficult to change this human nature, especially in a way that it is not a forceful change, but everybody agrees consciously and with free choice that we need a different attitude.

    So what truly visionary leaders would need to find is the motivation, showing each layer of the society a positive, attractive example or purpose why they would need to change their relationships to others, why they should take others into consideration before themselves.

    Such positive motivation can only come from a global, integral education program, explaining to each and everyone in a transparent, factual, scientific manner how much we are interconnected in our new global system, and how much we all depend on each other, like a crew sailing on the same ship, and that each individual's or nation's well being and prosperity is tightly connected to the well being of everybody else.

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