Saturday, November 22, 2014

The Flight of the European Bumblebee

WASHINGTON, DC – In July 2012, while addressing bankers in London, European Central Bank President Mario Draghi likened the euro to the bumblebee. “This is a mystery of nature, because it shouldn’t fly but instead it does. So the euro was a bumblebee that flew very well for several years.” But “something must have changed.” So the “bumblebee would have to graduate to a real bee. And that’s what it’s doing.”

Actually, for scientists, there has never been any mystery about how bumblebees can fly: they beat their wings about 200 times per second. They cannot possibly do this by flexing their muscles, but only by vibrating them. Think of the forces generated by a waving wand, and contrast them with those generated by a vibrating fork. The subtler force is much stronger.

So, is the eurozone ready to vibrate, rather than flex? Three steady shifts have occurred in Europe over the last three years. Flexible fiscal rules and rigid monetary policies have given way to the opposite. The same has happened in the case of tight labor laws and looser financial regulations, while European surveillance and global emergency mechanisms have undergone a similar change.

These shifts are sensible, and they should be sustained. The first shift is overdue, and the reasons are not subtle. One of the euro’s main problems since its introduction in 1999 has been that almost every national treasury flouted the monetary union’s fiscal rules. By contrast, the ECB was a model of rectitude, and its discipline helped everyone. Inflation dropped sharply, especially in the poorest countries. In 1995, inflation rates in Portugal and Greece were about three times those of northern Europe’s economies; by 2008, they were the same.

Freed from the worry of destabilizing exchange-rate adjustments that had plagued postwar Europe, trade increased dramatically, especially in the bigger economies. In 1990, Germany’s exports accounted for 25% of GDP; by 2008, they had almost doubled to 48%. Monetary stability reduced the cost of credit. Interest rates were almost 20% in Greece and Portugal in the 1990’s; by 2008, they were 2.5%, implying parity between Greek and German rates.

Anything that leads to lower inflation, more trade, and interest rates that are lower than growth rates is a good thing. So both the single market and the common currency have been good for Europe. But, by treating all sovereign debt equally, the ECB sent markets the wrong signal. As exchange rates in the eurozone were fixed and uniform, interest rates on government debt should have signaled differences in economic strength.

The small vibrations caused by constantly changing interest-rate differentials between, say, Germany and Greece, would have made the euro bumblebee fly. Instead, it was the strong breeze generated by the global boom that kept it aloft. The bumblebee is relearning to fly under its own power.

Institutions have evolved. The ECB is now capable of lender-of-last resort operations, like its counterparts in the US and UK. The European Union’s fiscal framework, though still far from unified, has progressed toward greater coordination. Today, Greece’s government cannot borrow at all, and Ireland must pay high interest rates, while France’s treasury might soon have to pay more, and Germany may be able to borrow even more cheaply. Market signals are working again, and that is the way it should be.

Moreover, eurozone governments have restarted the structural reforms that many halted in the early 2000’s. Current-account deficits in the eurozone “periphery” have been halved, the competitiveness loss accumulated during the last decade has been reduced, and important structural reforms – making labor markets more flexible and opening up industries sheltered from competition – have been implemented.

But a lot of adjustment remains to be completed. Europe needs better regulation of financial movements, which flow in the right direction, but are erratic, flooding Europe’s less advanced economies when finance is plentiful, and starving them of credit in times of stress. Financial flows could be stabilized through a combination of conservative national fiscal policies and region-wide regulation, so that they do not suddenly stop when growth slows. Here, too, small vibrations, not the flexing of powerful political muscles, are needed. Reforms will take time, but it should not stop us from recognizing what has been achieved during the crisis.

A third shift is in the geography of surveillance. At the start of the crisis, EU policymakers tended to view global financial institutions as sources of emergency funds, not as monitors of EU economies. Over the last three years, Europe has increasingly relied on global, as opposed to regional, governance. Surely, European leaders would rather keep both governance mechanisms and stability funds regional. But it may be more practical to have global financial and surveillance systems generate the vibrations that will make Europe dynamic, while drawing on EU sources of funds during emergencies.

This approach would also be more consistent with the advice that Europe has dispensed to others. At a seminar on the euro that we organized in Tokyo, an Asian expert observed that early in the crisis, Europeans did not practice what they preached during the Asian financial crisis. Europeans (and Americans) had advised Asians that they would never be able to enforce discipline on themselves, so the monetary, fiscal, and financial-governance mechanisms should be global, not regional. “I hope Europeans were wrong then,” was his message, “because otherwise they would be wrong now.”

Back in London, Draghi promised that the ECB would do “whatever it takes” to preserve the euro. Markets have rallied since, but the continent remains crisis-ridden. Europe cannot miraculously morph into a “real bee.” Nor does it need to. Instead, it should continue to take the small steps needed to allow market forces to discipline workers, corporations, banks, and governments.

The views expressed here are their own.

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    1. CommentedJose araujo

      Euro was created in 1999, so all comparisons should be made comparing today with 1998, not early 90's our 80's. Until 1999 Greece, Portugal and Ireland were all case studies for growth, after the Euro, just look to what happened.

      You must realize also that in a integrated monetary area adjustments are made via inflation. More euros in Germany and less euros in the periphery would mean Germany should have strong inflation, but what were the ECB actions during this period, so ECB controlling price levels is one of the major reasons we are in this situation today.

      Mercantilism never worked before, and it will never work for the less competitive countries, Portugal should have learned the lesson with the Methween treaty. Ricardo was WRONG because he never accounted for the English greed, and now history repeats itself.

      Final note to state that calling structural reforms to lowering wages and increasing taxation is demagogic. Structural reforms should be made so we can have higher wages and lower taxation....

    2. CommentedEdward Ponderer

      I recall an animators interpretation of the flight of the bumblebee that ended with the bee caught in a web, with the spider heading over for lunch. The bee in the web flapped its wings more wildly than ever, but to no avail.

      So all the clever economist tricks are being used more than ever, but we are in a web alright -- a web of global interdependence, ever-tighter coupling the more we struggle. In our present structure we have no sensitivity to this web, at least not sufficient speed or discrimination/broadness in that, to save ourselves.

      But while this web spells doom for the bumble bee and his way of doing business, it is survival and opportunity -- even lunch, for the spider who is completely attuned to that web and is able to harmonize all signals from it, and balance the whole.

      How do we become the spider of our global web? Only by doing it all together. Integral education to ingrain the instincts, a round-table attitude to develop our unified sensory apparatus, and a new social sense of mutual concern and responsibility (which can never happen at the point of a gun!) -- a behavioral economics to develop our ability to harmonize & balance the system.

      BTW, are spiders "bad". Not in the natural perspective. They don't destroy nature, they maintain it. And while a black widow female may eat her mate for protein for her young, she does not eat herself -- as different parts of the body of Humanity presently try to do.

    3. CommentedOlga Butorina

      Do you think that long-term price stability is equally beneficial for Germany and Southern EU member-states? Normally, stable currency is good for savers and creditors, while devaluations play into the hands of debtors. Are countries like Greece or Portugal with low gross national savings and impressive debt really interested in low inflation rates?

    4. CommentedZsolt Hermann

      The problem with the Euro, and basically the whole global financial system is that if compared to the bumblebee, the financial system as wings has been disconnected from the body of the bumblebee, the wings are vibrated, adjusted, changed, admired, politicians and bankers are congratulating themselves how well they were doing, but this does nothing to the actual people on the street level, their lives are getting more and more difficult without any promising future prospects.
      This virtual theater, the massaging of the banks will sooner or later lead to a total collapse as no real correction is happening.
      If the bumblebee truly wants to fly again, the body needs healing, the wings can only vibrate when the body is healthy not the other way around.

        CommentedJose araujo

        Economists don't need the bumblebee wonder, Economy has similar "natural" wonders and they are called MARKETS.

        Euro is the negation of markets, the exchange-rate market the natural wonder that balances competitive differences between nations.

        The price of currency should be natural determined in the interaction between demand and supply for this currency and reflect the countries competitive position, hence in the natural world all countries should have a currency, the same why pigs don't fly, even if you pit wings on him and give him a vibrator.

    5. CommentedFrank O'Callaghan

      This treats the nations as units. The wealthy capitalist in Germany has much in common with his counterpart in Greece or Ireland. The unemployed parent in Italy has much more in common with one in Belgium.