Arnold Kling  


Re-Org Proposal... Seven Myths about Free Markets...

C. Fred Bergsten and Jacob Funk Kirkegaard (BK) write,

There are only two alternatives. Europe can jettison the monetary union. Or it can adopt a complementary economic union. This brief argues that, for all the turmoil, Europe is well on its way to completing the original concept of a comprehensive economic and monetary union, and that Europe will emerge from the crisis much stronger as a result.

Pointer from Tyler Cowen, who is a euro-pessimist.

What I argue here is that we need to model this as a Prisoners' Dilemma, in which there are two parties, each of whom can choose either to co-operate or defect. The outcome if both parties compromise is better than the outcome if both parties defect. However, what I suggest is that each party may have a dominant strategy to defect. That is, regardless of what the Greeks decide to do, the Germans prefer not to increase their own spending to save the euro. Meanwhile, regardless of what the Germans decide to do, the Greeks do not wish to reform their labor market, their pensions, or their tax collection system. The fact that there will be a bad outcome if both sides defect is not sufficient to prevent that outcome.

Think about this another way. Substitute "United States" for Europe, "Democrats" for Greece, and "Republicans" for Germany. Are you optimistic that the Democrats and Republicans will cooperate by raising taxes and cutting entitlements?

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COMMENTS (11 to date)
David N. Welton writes:

While I may disagree with some of your conclusions, I generally enjoy reading your blog for a different point of view from my own. The "Democrats == Greece" line is a bit of a cheap shot, though. Especially if you look at Republican spending for things like wars...

Eelco Hoogendoorn writes:

In the short run, keeping the eurozone together is arguably the less painful thing to do. But the assertion that this holds in anything but the short term is one I dont buy. Once in a political union, we are going to spend all our time arguing about gay marriage, and I bet VanRompuyCare wouldnt be far around the corner either.

A one-time 10% GDP haircut to avoid that trainwreck sounds like a splendid deal to me.

Mark Michael writes:

Hmm. Greece as D's and Germany as R's. How about Gerry Ford refusing to bail out NY City in 1976, and NYC biting the bullet and cutting spending? Recall, the NY Post headline, "Ford to NYC: 'Drop Dead!'" Germany to Greece, "Go into 'negotiations' with the banks!"

The big bogeyman the statists trot out is, "Contagion! The whole Euro banking system collapse!" if they don't keep on bailing out Greece, et al. I think that's nonsense. Of course, I could be wrong. BUT, the current kicking the can down the road time after time surely isn't solving the problem.

If you look closely at what central banks do, they cater to two constituencies: the banks and the pols. The ECB (in theory) is not supposed to cater to the pols by printing money. So far, it's sort of resisted that temptation, but not really. But they have been protecting the banks and lobbying the pols to pony up more taxpayer' money to bail out the banks in Greece, Portugal, et al.

If they let Greece go into default, and let the German, French, Dutch, et al, banks struggle to handle the situation - keep them a little help if they come close to going under - I think that would be a good step.

I know, people look at our Fed and how it bailed out Bear Stearns (arranged a shotgun marriage with JP Morgan Chase), then let Lehman Brothers go under, bailed out AIG, Fan & Fred, and critics said, "Ad hoc! Too ad hoc! We don't know what their policy is. Be consistent." My contrary idea is that the Fed should have let Bear Stearns go bankrupt in March 2008. That would have sent a message to Lehman Brothers, et al, to start straightening themselves out or go belly up just like Bear did. Now, that would only have given them another 6 months to go in the right direction, so maybe it was too late.

But, somehow the banking system has to face no-kidding bankruptcies so they behave more prudently. That doesn't solve the political problem of pols refusing to reduce government spending: lower the number and pay of bureaucrats, end government programs, raise retirement ages for entitlements (like Social Security & Medicare) reduce red tape.

The latter problem seems to be almost unsolvable at this point. Think of what happened in Wisconsin - Gov. Walker's "Budget Repair Bill" -- and in Ohio, Senate Bill 5 was repealed by the voters (62-38). At least America has Tea Parties, which are lobbying for smaller government and less spending. I don't see a comparable movement in Europe.

Floccina writes:

IMO even if you had a fiscal union you would be better off without the monetary union.

Yancey Ward writes:

Would the Germans and the Dutch, for example, be willing to fund a federal government on a scale that transferred resourced to Greece greater than that you see in the US when comparing states like CT and MS? I just don't see this happening short of emasculating completely the voters in the North. You essentially have to convince the Germans that it is in their interest to make these transfer payments on what will likely be an indefinite basis if history is any guide whatsoever.

Yancey Ward writes:

And I agree with David Welton- comparing Greece to the Democrats is a cheap shot. Kling should apologize to Greeks everywhere.

M Puckett writes:

David Welton?

Have you done the math? All of our expenditures on Iraq and Afghanistan since 2001 combined do not equal the single year deficit for FY-10 under Obama. That is for a SINGLE YEAR. All of our war spending combined does not add up to one years Obama Deficit.

Comparing the two is like complaining because your brother is 15lbs overweight when you yourself are 150lbs overweight.

"See! Both of us are fat!"

andy writes:

Or it could stay in euro and not adopt fiscal union..or it could..I mean, there are many possibilities out there!

Just wondering why adopting fiscal union is considered superior; I guess that's an axiom nowadays; integration is better than non-integration by definition.

Charles R. Williams writes:

There is a third alternative - abandon the European model of banking. Why does Greek default doom the euro? Why does anybody care whether Greece drops the euro or not? The European mess arises because European banking is based on the lie that sovereign debt is riskless and the self-fulfilling prophecy that the banks are too big to fail.

Chris Koresko writes:

Arnold Kling: Are you optimistic that the Democrats and Republicans will cooperate by raising taxes and cutting entitlements?

At the risk of going too far off on a tangent: Is raising taxes (by which I assume you mean raising tax revenue, not tax rates, even possible? The historical data I've seen plotted suggest that revenues are only weakly tied to rates, unless the rates are extremely high or low, in which cases revenues fall drastically.

Jardinero1 writes:

There is nothing not to keep the eurozone together except a willingness to let those who loaned the money, to the PIIGS, take a haircut. The crisis in the Eurozone is the direct result of attempting to transfer the losses to parties other than those who originated the debt.

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