What is the future of the European economy? What are the challenges facing Europe? What are the implications of Brexit for the United Kingdom and the rest of the Europe? Nicholas Crafts of the University of Warwick, Luis Garicano of the London School of Economics, and Luigi Zingales of the University of Chicago's Booth School of Business talk with EconTalk host Russ Roberts about these questions and more in front of a live audience at Stanford University's Hoover Institution.
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Readings and Links related to this podcast episode
Related Readings
HIDE READINGS
This week's guests:
Nicholas Crafts.
Luis Garicano.
Luigi Zingales. See also
Luigi Zingales' EconTalk Archives.
This week's focus:
Europe
Additional ideas and people mentioned in this podcast episode:
"Firm Size Distortions and the Productivity Distribution: Evidence from France," by Luis Garicano, Claire Lelarge, and John Van Reenen. American Economic Review. 2016.
"Diagnosing the Italian Disease," by Bruno Pellegrino and Luigi Zingales. 2014.
"Political Credit Cycles: The Case of the Eurozone," by Jesus Fernandez-Villaverde, Luis Garicano, Tano Santos. Journal of Economic Perspectives, Summer, 2013.
"Europe in Disarray", by Pedro Schwartz. Library of Economics and Liberty, September 1, 2014.
"Deposit Insurance," by George G. Kaufman in The Concise Encyclopedia of Economics.
European Economic Community, by Barry Eichengreen. Concise Encyclopedia of Economics.
European Union, by Marian L. Tupy. Concise Encyclopedia of Economics.
A few more readings and background resources:
Monty Python--What have the Romans ever done for us?, from Life of Brian. Youtube.
"Productivity," by Alexander J. Field in The Concise Encyclopedia of Economics.
A few more EconTalk podcast episodes:
Cowen on the European Crisis. EconTalk. December 2011.Alberto Alesina on Fiscal Policy and Austerity. EconTalk. April 2016.
David Autor on Trade, China, and U.S. Labor Markets. EconTalk. March 2016.
Highlights
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Podcast Episode Highlights
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0:33
Intro. [Recording date: February 9, 2017.]
Russ Roberts: Today's episode is being recorded in front of a live audience at the Hoover Institution on the campus of Stanford University. We have three guests today: Nicholas Crafts, Professor of Economic History at the University of Warwick; Luis Garicano, Professor of Economics at the London School of Economics, and Luigi Zingales, Professor of Finance at the University of Chicago's Booth School of Business where he is also Director of the Stigler Center and is also a former EconTalk guest. Gentlemen, welcome to EconTalk. Our topic for today is the economic health of Europe and the possibilities for growth. I'd like each of you to make a very short opening statement on what you see as the major challenges that face Europe today. And we'll start with Nick, Nick Crafts.
Nicholas Crafts: It seems to me the major challenge that faces Europe is its productivity performance--the increase in output per hour or whatever--is central to the increase in living standards over time. Since about 30 years ago, productivity growth in Europe has halved. And some projections for the future say it might fall to a third of its original level, below 1% a year. My take is it doesn't have to be like that, because, in particular, there's likely to be scope to exploring rapid technological progress. I think some of the current difficulties are basically temporary and related to the Financial Crisis. And it is possible that could be improvements in policy. But improvements in policy would be needed to deliver that fast growth future. And the sort of things I think Europe is particularly bad at, compared to the United States, are things which you might loosely call creative destruction--the entry of the new, the exit of the old, and a flexible labor market which redeploys workers well. And that's probably the dark side of this technological future. The technological change we're looking at is essentially going to have a strong factor-saving bias in it, and create massive adjustment problems at--let's call it the bottom end of the labor market--then it seems to me many European countries are less well-placed than the United States, say, to deal with that. It's always a challenge to reform supply-side policy. But it's going to be even more of a challenge, I think, in future, because what we have in some European countries, it's the background to Brexit, is a set of left-behind voters. And the big issue, I think for Europe in future is how to restore prosperity and grow quickly, while keeping the left-behind voters on board and stopping them from sinking the ship.
Russ Roberts: Same issue in the United States, I'm afraid to say. Luis Garicano:
Luis Garicano: Yeah, I agree with Nick that productivity is a big issue. And I think further than the United Kingdom and the United States, in the European periphery it has been a problem for a longer period of time--in Spain, in Italy, in Portugal, etc. Productivity growth per capita in the 1990s and actually has been very low--in Spain negative--TFP (total factor productivity) growth was negative since the mid-1990s. And the question is: Why? Luigi has a paper, probably talk about it later, with Pellegrino, which it says the usual suspects are not going to be enough, because the same countries were growing very much previously. So the question is: What changed? And I think there are two candidates for what changed in the mid-1990s, that could interact with what the European [?] and some other countries have. Which are the problems the problems that they have. Which are: Finance and technology. Finance, basically, the advent of the Europe meant there was a lot, let's say a lot of money: there was a lot of easy/EC [European Community?] financing, a big drop in rates. And with a lot of money, [?] has a paper arguing that money is more directed, financing was more directed to the large-scale firms and not to the better firms. I have some work with [?] arguing that when there is so much money a bit like Buffett says, when the tide is high you don't see it was swimming negative[?]. The money goes indiscriminately, financing indiscriminately to bank savings, to banks, to bad firms, etc. So, that's one possibility. After the Crisis, the finance was still a problem because zombie firms have really--really big problem in these countries--as Goan and Ankers[?] in a very recent paper have shown. So that's one possibility. The other is technology. Technology really started hitting in the United States positively in the mid-1990s. Why would European firms be less good at that? I would say, firm size is a problem. I just read something in the AER [American Economic Review] in November showing that firm size regulations were important in France in not-allowing firms to grow. Technology is complementary with size, and you see that, you need to be a large firm. Maybe some small firm could adopt technology, could be productive before in a way that we have measured technology you need to be much more organized, much more formal. Managerial quality also is something that is related to size. And managerial quality is a problem in the very free[?] as well as is human capital in general. So, all those are things that are kind of hard to change. And I agree with Nick that policy has to change if those things are going to improve. And one thing that you see when you are getting a bit close to policy is that the desire to change some of those key things that you would need--regulations that restrict [?] growth, that restrict reallocation--I didn't talk about reallocation but that's also a key, huge problem--it's really harder and harder to do those changes in regulations because of demographics. Because these countries are getting old, and old people don't like change.
Russ Roberts: Luigi Zingales:
Luigi Zingales: The challenge of having a last name starting with a "Z" is that you come always last. And so you have to be very creative about adding to what people say before. So, I hopefully agree that the most important thing is productivity, and I agree, of course, with what Luis said about the differences between Northern and Southern Europe in the ability to incorporate what is called the ICT Revolution, the Information and Communication Technology Revolution. I think those are very important. But, at some level, these are present also in the United States, as you mention earlier. So, if you want to point out what is really unique in terms of challenge of Europe, I think it's the institution of the European Union and particularly of the common currency. I think that those are really the challenging institutions that need to adapt or might create a big disaster. As economists, we know that the euro[Europe?] has been created assuming that eventually there would the institutions to support it. And that no economist worth his name thinks that the institutions are there. And, eventually--there was I think, Halberstein[?], who was saying that if something is unsustainable, eventually it will not be sustained? I think that that applies to everything, including the euro[Europe?]. And, unfortunately, the underlying theory under which sort of Europe was created, so-called Mornay theory, that you push farther and you create a chain reaction that make inevitable to move forward, might actually lead to the meltdown, as a chain reaction the meltdown. Because this is the worst possible moment to create those institutions, because there is a reaction against globalization. And there is a very inward-looking, nationalist sense. And I think that part of it is that in Europe, the common institutions of being associated with market and globalization, and the protective institutions like the welfare state, is at the national level. So, when you have a moment of crisis, it's natural that you want to have a nationalistic view. Because if you want to be protective, you don't see Frankfort or Berlin as a sort of protection. You see a national capital as social protection. And I would think trying to tell everybody that if you want Europe to survive you need not only create a banking union, but also create a Federal unemployment insurance, that will work not only economically but also politically. Because at least the unemployed will see[?] the symbol of Europe associated with something positive. At the moment, the symbol of Europe is only associated with negative things.
9:15
Russ Roberts: Who is going to run that welfare play[?]? What's the political structure that could possibly overlay--?
Luigi Zingales: We do something much more complicated, which is to have a common system of regulation of banks. There is now a banking union--at least there is half a banking union--that half that the Germans allowed, because the other half did not allowed--
Russ Roberts: Which half is that?
Luigi Zingales: The common, the positive[?] insurance. [?] The common supervision and the common insolvency rules. Which, I think are great. Actually, I don't mind that at all. But it should be the third leg, which is the common, the positive insurance. And my understanding--some Germans would say opposite--but my understanding is that the they initially agree to the common framework and then they put other conditions to delay the introduction of the sharing component. But, if you think that it's easy for a German to supervise an Italian bank or for an Italian to supervise German banks--it's as difficult as it is for a German to supervise an Italian employment insurance and vice versa. So, if you don't trust the other group--which is a big issue in Europe--you can have the Germans run the Italian system and the Italians run the German system.
Russ Roberts: Yeah. It seems to me the cultural challenge there is, if you don't feel like a European, you still feel like a German. Right? Or--
Luigi Zingales: But then you draw the conclusion that it's not feasible. [?]
Russ Roberts: It would seem to be an impossibility. Let me hear what the other guests have to say. Luis, go ahead.
Luis Garicano: So, I agree that the institutions we've given ourselves are not working. So, just because the audience is probably familiar, essentially there is a common stabilization, framework, [?], like Brussels. And Brussels tells you whether you have to cut your deficit or whether you are allowed to spend more or less. [?] that's never going to work, because it restricts massively the freedom of each country to face its own tradeoffs. And it really, for people in this environment, means some unelected guy somewhere very far from my country is telling me that I can't spend more on growth--which I want to do. So, it's no wonder that with this regime there's a lot of resentment of the North in the South, if you'll allow me to put it this way. And the Commission, which is the institution that is supposed to enforce this is losing prestige and is getting beaten up by everybody. So, on that part I agree with Luigi; and also on the banking insurance: of course, the banking insurance has massive, massive moral hazard risks. If you insure the Greek banks with German money, then what's to prevent the Greek government from saying all mortgages are part of it, in some way or another? So, these are things that--
Luigi Zingales: Sorry, but the insurance comes after you are bailing 8% of liability.
Luis Garicano: Yes.
Luigi Zingales: Something that the Americans never did. This is why in Puerto Rico there is not a bank run. It's because the FDIC (Federal Deposit Insurance Corporation) insures Puerto Rico.
Luis Garicano: I agree.
Luigi Zingales: Why, in Greece, there was a bank run? Because there wasn't such an institution. So, you cannot run a country as a union without the fact that a dollar in Puerto Rico is worth as much as a dollar in New York. In Europe, that's not true.
Luis Garicano: I think that's [?]. I agree. It's not true in Europe, and it needs to change. But I'm just saying the obstacles are unknowns. The one thing that I would [?] in terms of how the euro is functioning is that in spite of all these things, Spain has recovered competitiveness and has been--Spain is growing really rapidly right now. Whereas Italy essentially hasn't grown since 1995 I would imagine--I don't know how long. So, I don't know why the constraint is hitting so much harder Italy than Spain. Although you could say, well, Spain just had a bigger recession; just recovering it is getting to the place where Italy was all along.
Luigi Zingales: I think that Spain always worked better in the last 20 years. Spain had the real estate bubble and the crisis associated with that, but I think the fundamentals were much better. I think that the real comparison is with Portugal and Greece, and they were not doing particularly well. Greece was doing a bit better before the crisis but basically because they spent somebody else's money. It's easy to go and spend somebody else's money. But I think general productivity, they were bad before and they are still pretty bad.
13:37
Luis Garicano: Let me ask Luigi two questions if I may. One, I think to go back to what Russ was raising: To fulfill your proposal we really need a Transfer Union, don't we? In which it would turn out, Germany would pay the unemployment benefits of Southern Europeans--as they would see it. Say, that's a caricature, of course. But you get the idea. That's the thing which seems to me, ultimately, politically infeasible. Second point I'm interested in your thoughts about is, a British politician not so long ago described the Euro Zone as a burning building with no fire escape. Isn't that approximately the problem? If there had been an easy way to dissolve it, what would have happened 5 years ago would have been like the collapse of the Gold Standard in the 1930s. The fact that it didn't collapse like the Gold Standard in the 1930s I think tells you that it's extraordinarily difficult to dismantle. Putting it very crudely: Could you dismantle it without, as Barry Eichengreen says, creating the mother of all financial crises?
Luigi Zingales: Okay. I think both are excellent questions. On the first one, I don't want a permanent Transfer Union. I want a risk-sharing mechanism. I come from Italy; I know how dangerous it is, a permanent transfer, from the North to the South. It did not work; it did not improve the situation. I remind you that in the middle of 2000--2005, 2006--[?] unemployment insurance would have gone the other way around--would have gone from the South to the North, to Germany. And that's exactly what unemployment insurance is about: it's when in Texas there is an oil bust, they benefit from the Massachusetts tax revenues. And vice versa, when there is now a boom. That is a form of Union. And if you think this infeasible because there this is not a sense of solidarity, we know that we are more willing to share with people that you perceive, for whatever reason, more allied. So people don't resent transferring money to Mississippi from California. They do resent transferring from Germany to Greece.
Luis Garicano: I think part of the problem is that, I mean, we have to recognize as economies that [?] we don't really know how to differentiate structural from budget, from cyclical[?] budgets. We don't know how to differentiate structural unemployment from cyclical unemployment. So, any mechanism that you set up is going to, inevitably--and I am somewhat in favor of a common unemployment insurance--but is going to inevitably have the component of the structural transfer from North to South. It's very [?]
Luigi Zingales: No. I would say exactly the other way around. The way I would structure this unemployment insurance would be on unemployment which is above the structural level of unemployment.
Luis Garicano: And how do you measure that?
Luigi Zingales: The same way which we measure the structural [?]--
Luis Garicano: We don't know how to do it.
Luigi Zingales: I understand, but I don't think it is infeasible.
Luis Garicano: It is infeasible. Okay, let me tell you what the structural level of unemployment in Spain is now: according to the IMF (International Monetary Fund), in [?] city is 18%.
Russ Roberts: 18?
Luis Garicano: 18. Do you believe that?
Luigi Zingales: Yes. Because long term, this has been very high. Unemployment in Spain has been very high. And, it really creates an incentive to actually reduce the number. So the incentive, the moral hazard[?] is exactly the other way around. Because if you have a system where you are only receiving transfers on top the structural unemployment, you do not push down the structural employment. Which is exactly what you want to do.
17:08
Russ Roberts: If you know how to do it. I guess the issue--my first thought is, we should move on to another topic. My second thought is, this is the only topic. Right? This is what the European question fundamentally is: Is there such a thing as Europe? And Luigi, you want to say you favor that system; this would be better. You have to get the people of these countries to feel that solidarity, the cultural connection that they evidently don't feel. I don't see how you are going to get around that. And that seems to be a fundamental constraint on moving forward in any organized way.
Luigi Zingales: Absolutely I'm not saying we should move in that direction. I'm saying that if we don't move in that direction, we should recognize that the marriage is not working and we find a way of amicable divorce.
Russ Roberts: Well, let's move on to that. I like that. Let's talk about that for a minute. It won't be our only topic the rest of the time, though I'm sure we could spend the whole time on that, too. But let's talk about that. Is there a--well, let's talk about Brexit in particular, which is a--well, let's say a separation, not a divorce. It's a temporary--it's a period of cooling off until legislation might be--
Guest: It's a true divorce. It's a true divorce.
Russ Roberts: Well, on paper it's a divorce, but it isn't yet. Talk about the significance of Brexit for the constraints it puts on the rest of the European nations, and the Union as a whole. And whether you think it's actually going to happen, and what its significance will be. You know, a lot of people speculated early on that, 'Oh, it will be awful because people are going to punish them.' They are not going to agree to any of the possible alternatives--say, trade agreements. They'll just say, 'You left; we're done with you.' We don't know how that's going to play out. But I'm curious what you think. Nick?
Nicholas Crafts: I think this is a divorce. And I think it might become a quite bitter divorce, as well. I've already started, in jokes, when I give talks in Europe, to say, 'you Europeans.' Whereas I always used to say 'we Europeans.'
Russ Roberts: When you say it started, for a minute I thought were going to actually say you changed your portfolio. But--a joking reference is a beginning. Go ahead.
Nicholas Crafts: Okay. The interesting thing about Brexit is, it involves dis-integration of trade. That is much easier, it seems to me, than dis-integration of the financial system. And it will be a challenge for Europe in the future, because there may be others who want to follow the path. Why do I think it's certain to happen? I think Conservative Party politics make it certain to happen. And we have a Prime Minister who is essentially a party manager more than any kind of thinker. I don't think there's any escape. I think, moreover, that because in Britain the priority being given is to controlling immigration, free movement of labor has become taboo for the Conservatives. In that case, you have to leave the single market. Essentially, you can't be in the European economic area. We're going down the path of what in the jargon is a 'hard Brexit.' My main reverting to just being another WTO (World Trade Organization) member facing the common EC/EU tariff (European Community/European Union)--
Russ Roberts: --World Trade Organization.
Nicholas Crafts: I'm sorry; yes, World Trade Organization. I think that's quite likely. This will be costly to Britain. I have little doubt of that. It's one of the very few things the British economics profession is virtually unanimous on. We can't put an absolute figure on the cost, but it's probably going to cost Britain, in the steady state, 5-6% of GDP (Gross Domestic Product). Something like that. It's nontrivial. But it's a cost that the British public seems in one way or another seems to be willing to pay. There is a constituency for, a majority for Brexit.
Russ Roberts: The unanimity of the opinion of what the consequences would be is not quite as convincing to me as it might otherwise be. There was, of course, in the aftermath of Brexit--as there was in the aftermath of our recent election--many wise and illustrious economists predicted disaster. It didn't happen. Is there any reason to think that perhaps the most pessimistic view is not as bad as it may be?
Nicholas Crafts: Short term, it's about macroeconomic forecasting. We know that economists are pretty bad at that--
Russ Roberts: Exactly--
Nicholas Crafts: Unpleasant shocks arise. The long-term steady state is about the analysis of the empirics of international trade: Trade costs go up; trade goes down. We know that less trade means basically lower income. The direction of the effects is unambiguous. Very clearly summed out[?] about exactly what the magnitudes are.
Russ Roberts: Totally agree with that.
21:56
Russ Roberts: But I want to go to Luis, who raised a related question in his opening remarks. So, it's true, it's conceivable that there will be less trade, because there will be less integration. It's not clear that the post-Brexit trade agreements will be as attractive through the WTO (World Trade Organization) or whatever methods are available. But there is also a claim that I've heard often that Brussels was a big impediment to growth. And by getting out of the Brussels regulatory umbrella British firms will be more flexible. And, Luis, referred in his opening remarks to, say, firm-sized regulation. I assume you were referring to situations in parts of Europe where, once you reach a certain size, certain regulations kick in. We have that here. That keeps firms at 49 employees, for example, or 199--
Luis Garicano: Obamacare, for example, is at 49.
Russ Roberts: So, talk about whether you think there is anything, an upside to Brexit, economically, that is beyond the trade story.
Luis Garicano: So, my analysis is very similar to nixing[?] that I think that the British public hasn't ever been told is that the United Kingdom essentially a service exporter. And that services--financial services, educational services, health services--essentially rely on common rules to be exported. And on people moving. I mean, you export low by having people come to buy low. You export--I export education as a [?] professor by having somebody from China who comes. Now, that means that you need people have all these stories in newspapers of Brussels or like us to have bananas as just trade and all these things. And at the end of the day, it's just simple trade rules, that if you want to have a common specially a single market in services, you are going to need to have. So, I do think that the long term for the United Kingdom in the economy that exports services, and these kinds of services in particular, is not great. I don't think there is a lot of upside on this. And I also think that there is a misconception on the whole migration debate that has never been really--that the government has never tried to address in terms of the whole demographic situation which is catastrophic in Europe. And is much better in the United Kingdom.
Russ Roberts: Explain.
Luis Garicano: Well, I mean, the United Kingdom has been getting a significant amount of immigrants, and immigrants who learn English and who by and large integrate well. There is not the problems that you see in France with integration of immigrants or in Brussels or in Belgium. And, that is a huge comparative advantage for the United Kingdom in terms of a future where the welfare state in Europe is becoming asphyxiating, where these countries are just not going to be able to maintain these levels of these welfare states. So, I do think in those two terms--in terms of exports of services and trade. In terms of the movement of people, the demographics. [More to come, 24:50]