Friday, November 28, 2014

Greece and the Limits of Anti-Austerity

CAMBRIDGE – Is austerity dead? At last month’s G-8 meeting at Camp David, the German-led austerity program for the eurozone’s troubled southern members ran up against substantial resistance. Likewise, France’s recent presidential election bolstered those who argue that Europe must grow its way out of its debt-heavy public sector, rather than aim for immediate fiscal orthodoxy. And there is no guarantee that Greece’s newly elected center-right New Democracy party, which favors honoring the country’s bailout terms, will be able to form a majority government.

The United States, by contrast, has pursued expansionary and growth-oriented macroeconomic policies since the 2007-2009 financial crisis, despite massive budget deficits. Thus far, judging from the modest recovery in the US versus non-recovery in Europe, American policy accommodation is performing better than European austerity.

But simply choosing between expansion and austerity is not the whole story. Macroeconomic policies interact with on-the-ground microeconomic realities in subtle but powerful, rarely remarked-upon ways. Simply put, Europe’s microeconomic structure makes the same growth-based macroeconomic policies less effective in the European Union than in the US.

Here’s why: macroeconomic easing, by lowering interest rates or otherwise pumping money into the economy, aims to increase economic activity. With more money moving around, businesses rehire employees and ask existing employees to work more hours. Entrepreneurs considering whether or not to start a business decide to proceed, and their bank lends them the money to make the new business viable.

The newly hired workers and newly formed businesses spend money, which induces more hiring, more start-ups, and yet more spending. The economy grows, yielding higher tax revenues, thereby helping governments to put their fiscal house in order. The country grows its way out of its economic problems.

But the EU cannot realize this scenario as easily as the US can, because micro-level rules in the EU generate friction that slows that kind of an expansion.

The EU’s stricter labor rules are a well-known and often-cited example. European labor-market rigidities mean that it is difficult in many EU countries to downsize a company. Anticipating that difficulty, companies are less willing to hire in the first place, until they are sure that long-term demand for their products is sufficient to justify long-term hires. Hence, even if businesses get easier access to money and loans, many firms will still decline to hire on a large scale, fearing that they would be saddled with a large payroll in a future downturn.

For example, The Economist’s recent portrait of Italian Prime Minister Mario Monti shows that Italy continues to be stymied by labor rules that make businesses reluctant to expand beyond 15 employees (after which it becomes hard for a firm to downsize). To work smoothly, expansive macroeconomic policies require compatible microeconomic rules.

There is some irony in the fact that the strongest proponent of austerity has been German Chancellor Angela Merkel’s government, because Germany, particularly under her predecessor Gerhard Schroeder’s Social Democrat-led government, did much more to liberalize the country’s rules for labor and business than other EU governments. Expansive, growth-based policy could work better in Germany than in many eurozone countries for which it is being prescribed.

Rules that impede business start-ups may be an even more important obstacle to making monetary expansion effective. It is simply too difficult to launch many types of businesses in many places, and to expand those that are started. Necessary licenses are often not routinely obtained. The simple start-up paperwork is still more burdensome than it is in the US. Indeed, while this process has become easier in Europe in recent years, the World Bank estimates that it still takes twice as long to start up a small business in Greece and much of the rest of the EU as it does in the US – and four times as long in Spain.

While the relative absence of Facebook-style mega-entrepreneurial successes in Europe is regularly bemoaned, the difficulties of opening hairdressers, basic retailers, and simple mail-order businesses may have an equally profound overall effect.

Consider taxi licensing. Many people can drive a cab, including many who are unemployed, but not so many can get permission to do so in many major cities in Europe and the US. Imagine much of the economy organized like the taxi industry. Most kinds of economic stimulus won’t generate more taxis, until entry restrictions are reduced.

Magda Bianco, Silvia Giacomelli, and Giacomo Rodano, researchers at the Bank of Italy, report that these institutional roadblocks to expansion remain substantial in Italy. A factory might get easier access to funds, and it might see more demand for its products, but, rather than hiring new workers, it might decide to raise its prices. A potential competitor might consider entering that market; but, given substantial regulatory entry barriers, it might ultimately decide to remain in its current business.

Expansionary monetary policy in such an environment might fail. Perhaps for this reason, France’s new president, François Hollande, favors using the government to direct specific outcomes – for example, by hiring 60,000 new teachers.

One can imagine a grand bargain in Europe, with expansionary macroeconomic policies coupled with the easing of microeconomic impediments. But existing businesses and already-employed workers prefer the status quo, and can powerfully inhibit policymakers. There may be more than a little of this in Greek politics, and that of other EU countries.

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    1. Portrait of Fernando Giuliano

      CommentedFernando Giuliano

      First of all, I don’t agree with the author’s portrait of the US as pursuing expansionary policies since the 2007-2009 financial crisis. While stimulus was the first response in the US (as well as in Europe), there is evidence that the initial stimulus effort was barely enough to offset state-level spending cuts. And after the initial response, the fiscal stance has been more contractive than expansive in both sides of the Atlantic.
      On a more fundamental issue, I think that microeconomic rigidities in Europe are of second order importance in the current context. His taxi example illustrates why. The author argues that “most kinds of economic stimulus won’t generate more taxis, until entry restrictions are reduced”. While it is true that stimulus won’t generate more taxis if entry is restricted, it will make current taxis to work at full capacity. This will both increase pressure for entry and decrease the incumbents’ resistance, since business is plenty. The taxi example does not illustrate why expansionary policies would not work, as the author intends, but rather why reform is more feasible when there is growth.
      Although microeconomic reforms in the Eurozone are desirable, the roots of the crisis are not to be found in microeconomic rigidities, but in macroeconomic imbalances.

    2. CommentedGary Marshall

      Hello Mr. Roe,

      No need for austerity, just sanity.

      Here is a solution to the Greek problem. If anyone can find the flaw, I shall be more than happy to give him or her $50,000. I am just tired of doing this. Its not the end of the world, but a new beginning.


      The costs of borrowing for a nation to fund public expenditures, if it borrows solely from its resident citizens and in the nation's currency, is nil.

      Why? Because if, in adding a financial debt to a community, one adds an equivalent financial asset, the aggregate finances of the community will not in any way be altered. This is simple reasoning confirmed by
      simple arithmetic.

      The community is the source of the government's funds. The government taxes the community to pay for public services provided by the government.

      Cost of public services is $10 million.

      Scenario 1: The government taxes $10 million.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      No community government debt, no community
      government IOU.

      Scenario 2: The government borrows $10 million from solely community lenders at a certain interest rate.

      Community finances: minus $10 million from community bank accounts for government expenditures.
      Community government debt: $10 million;
      Community government bond: $10 million.

      At x years in the future: the asset held by the community (lenders) will be $10 million + y interest. The deferred liability claimed against the community (taxpayers) will be $10 million + y interest.

      The value of all community government debts when combined with all community government IOUs or bonds is zero for the community. It is the same $0 combined worth whether the community pays its taxes immediately or never pays them at all.

      So if a community borrows from its own citizens to fund worthy public expenditures rather than taxes those citizens, it will not alter the aggregate finances of the community or the wealth of the community any
      more than taxation would have. Adding a financial debt and an equivalent financial asset to a community will cause the elimination of both when summed.

      Whatever financial benefit taxation possesses is nullified by the fact that borrowing instead of taxation places no greater financial burden on the community.

      However, the costs of Taxation are immense. By ridding the nation of Taxation and instituting borrowing to fund public expenditures, the nation will shed all those costs of Taxation for the negligible fee of borrowing in the financial markets and the administration of public


    3. CommentedMiriano Ravazzolo

      Well, if we must be precise, Mr. Zingales notes that the 15 employees threshold doesn't seem to have created a significant statistical accumulation below that level. But it DOES note that going over the 15 people WILL severely reduce the flexibility of the companies, obliging to go through the legal system for EVERY layoff, with an average of 429 days before getting to the court (and going up to 693).
      There's just no way to consider this situation as promoting expansion and, most importantly, promote hiring.
      I actually agree with Mr. Zingales when he says that there should be a higher MONETARY compensation to the employees that are let go. But a company should always be able to take that decision, which is eminent to the responsibilities and the prerogatives of the entrepreneur. The problem in Italy is that the one and only objective of a large part of the politics (and the totality of the unions) is "protect the existing jobs, no matter what", even when that actually stymies the creation of new jobs and produces a negative net result.

        CommentedLuca Tombolesi

        You're perfectly right on Zingales' thought, in fact I cited him precisely because he is notoriously AGAINST the existence of legal difficulties for downsizing over the 15 employees' threshold! Remains the evident fact that this threshold has very little impact, so evidently if Italian companies are capable to mind their own business, it would not be the direct solution of their troubles. The problem is really a political and ideological one. Someone thinks it would send the "right signal", or would be useful to better put companies in a position of making the best choices, and so to boost the economy. No one really knows if this would be the case, personally I think not, but anyway if the current system actually stymied the creation of new jobs and produced a negative net result, the lack of a significant statistical accumulation below the 15-employee level remains to be explained.

    4. CommentedAlok Shukla

      In one country USA the policy making is completely paralyzed thing about the EU. Seems they would muddle through the crisis always responding to crisis with bare minimum and then wait for markets to pounce on again to force EU to take more action. Most of the EU countries are some milder form Socialist Republic. What is good for majority may not be good for sovereign as a whole.

    5. CommentedCharles St Pierre

      Macroeconomic easing puts the money in the wrong place. This is why it has limited effectiveness. When an economy is constrained due to inadequate demand, money has to go to the demand part of the economy, and this requires fiscal policy and/or debt restructuring, when debt gets out of control. Businesses are not going to invest and expand unless they can count on a robust market. Who’s going to want to invest into a market with 20% unemployed. The institutional problems you itemize have less to do with it.

      The Austerians figure if they destroy demand, by making people pay back their debt, businesses will want to expand. But in order for people to pay back their debt, business must first expand. And business will not, with a contracted demand.

      The Austerians don’t want to let people off the debt hook. The problem is debt can only be compounded. Money is debt, but there is never as much money as debt. See "Money as Debt II":

      Without forgiveness, in the worst case sovereign bankruptcy, debt can only increase, dragging down the economy with it in a death spiral.

    6. CommentedFrank O'Callaghan

      The world is more productive and wealthier than it has ever been in all of History. We have a distribution problem with power, wealth, income, work, freedom, health and resources.

      The current 'crisis' is simply a restatement of the distribution issue.

    7. CommentedLuca Tombolesi

      The general tone of this piece is questionable to say the least. But when it talks about Italian matters, I can say it's simply wrong. You can't honestly say that "Italy continues to be stymied by labor rules that make businesses reluctant to expand beyond 15 employees (after which it becomes hard for a firm to downsize)". If this assertion is made by The Economist, this fact can only cast a sad light on the partisanship and lack of objectivity of this magazine. In Italy beyond political hype all informed people, as even an economist not precisely leftist or keynesian or a welfare-state fanatic as Luigi Zingales has no difficulty to acknowledge, (you can see his piece at, know very well that this "15-employees threshold effect" is minimal, as Zingales says, "just perceptible".

    8. Commentedjames durante

      It's the capitalists' wet dream. "Now we can force deregulation and a weakening of labor protections." Jump on the bandwagon Europe, then you can see Gini coefficients for your countries reach U.S. (Mexican, Camaroonian, Russian, Argentinian) levels. Then your richest 10% can control 80% f the wealth of the country and 25% of the icome can go to the top 1%.

      This is the dirty little secret that no one wants to admit. The U.S. is a poverty stricken country.Forty-nine million Americans live in poverty. More than 20% of children live in poverty. About 15% of households face food insecurity. Income and wealth for the median household have fallen to levels of the early 1990's.

      So, rock on Dr. Harvard Law School professor. Less rules for labor, less regulations for businesses, less red tape for start-ups: it's only the mega-rich who are really doing well anymore. Let's let them do even better at any expense.

        Commentedjames durante

        To Kevin Lim--

        The universe of choices grows rather thin in the economic system that is, supposedly, the epitome of choice. Can you really see no other options? Here are a few, drastic I admit, but these are dangerous times.

        Confiscate all personal wealth, of whatever form, over one million dollars, exempting house values up to five million (or the equivalent in whatever currency). Pay down debt, invest in clean energy, education, social services, ecological restoration and health care. Confiscate all wealth of hedge fund managers, private equity firm owners, and casino moguls. End advertising. Cap all banks at one hundred million dollars. Require considerable reserves and ban risky trading. Suspend global weapons spending for one year of every five and contribute all the money to sustainable systems for food, housing, and energy for all people in the world. Set a date of ten years to reduce by half fossil fuel use, 100% in fifty years.

        Well, that would be a start. Certainly it would be more interesting and much more beneficial for the majority than the slow train wreck we are currently witnessing.

        CommentedKevin Lim

        All well and good, but if Mr Roe is correct then the poor are screwed under the status quo too. If labor regulations create a disincentive against growing a business or hiring more workers, then you end up with sky high unemployment. So in the final analysis, you are left with 2 choices, neither ideal. Either the lot of workers is generally worse but at least they have jobs, OR the lot of workers is more comfortable/fairer but more people don't have jobs. Personally if I had to choose between the yoke of minimum wage and unsafe working conditions on the one hand, and the hopelessness of being unemployed, I would choose the former as the lesser of two evils.

    9. CommentedOdysseas Argyriadis

      So Mr. Roe, how would you run a business that is bankrupt but tries to hide it from its debtors, while they also deny the fact that your business is bankrupt?
      Because that appears to be the problem in Greece, not Austerity or any other macro economic policy. For example, we have serious issues with medicine in Greece at the moment, with the pensioners being unable to get their normally free drugs (due to their previous credit aka the public insurance system) and having to pay for them, even though they have actually paid for them in the past through mandatory public insurance. If that is not a sign that the state has gone down under, I don't know what is.