Europe: What was the source of the crisis? What is the way out?

1. Europe: What was the source of the crisis? What is the way out?

2. Roadmap • European integration: the most dramatic piece of institutional engineering of the late 20th century • but was it deeply flawed? Can it be saved? • Europe: a different model of capitalism • welfare states, labor markets • recent German labor market reforms • Was crisis the product of European model? • welfare state, fiscal overexpansion • eurozone: incomplete integration • Management of crisis: the wrong narratives • The only options: either political integration, or economic disintegration

3. Labor market institutions: collective bargaining Source: Richard Freeman, http://www.nber.org/papers/w13242.

4. Labor market institutions: employment protection Source: Richard Freeman, http://www.nber.org/papers/w13242.

5. The welfare state Source: Richard Freeman, http://www.nber.org/papers/w13242.

6. Is the Eurozone crisis a crisis of the European “model’? • The epicenter of the crisis was the U.S., not Europe • The crisis did not affect all European countries equally • The worst affected were not countries with largest budget deficits (except Greece) or the most extensive welfare states, or • They were the countries with the largest external deficits • Germany’s current account surplus was the counterpart to the GIPSIs’ deficit • The Eurozone as the victim of internal imbalances • Divergent patterns of labor market performance, with attendant consequences for competitiveness • Lack of EZ-wide fiscal/legal/political institutions to attenuate and foster rapid adjustment to “regional” crises

7. The Eurozone version of global imbalances Source: http://krugman.blogs.nytimes.com/2012/01/30/eurozone-problems/

8. The (more recent) German “miracle” • Large reduction in relative unit labor costs since 2000 • despite high degree of employment protection • After crisis, adjustment through reduction in working hours instead of reduced employment • Instruments: working time accounts and short-time work • Made feasible in turn through • practice of cooperation between social partners • practice of firms’ investing in workers’ skills and hence incentive to preserve employees • government subsidies for short-time work • A model of “flexicurity”? • Generous social protection/transfers with considerable flexibility in employment contracts

9. Germany’s labor market in comparative perspective

10. German labor market reforms Source: Rinne and Zimmermann (2011)

11. How does a true federal system deal with regional economic imbalances? • Consider Florida’s “current account deficit” with the rest of the U.S. • When borrowers in Florida go bust: • There is a common legal regime that provides for bankruptcy and debt workouts across state lines • FL residents get welfare checks and other transfer payments from Washington • The Federal Reserve acts as a lender of last resort to any FL banks • The FDIC provides deposit insurance to depositors in FL banks  • Other FL borrowers do not get shut out of credit markets • FL workers can easily move and seek jobs elsewhere in the U.S w/out language and cultural barriers • FL has representatives and senators in Washington, D.C., who can push for remedies for FL’s economic troubles (e.g., fiscal spending, federal assistance, debt relief) • So perhaps trouble is not that EZ is too integrated economically , but that it is not sufficiently integrated fiscally/legally/politically

12. The misdiagnosis fro GIPSIs: the structural reform agenda • OECD/IMF structural reform agenda as growth policy: • removing entry and other restrictions in product and service markets • labor market “flexibility”: reducing cost of firing workers • privatization of state assets • Not clear that these practices were responsible for the crisis, nor that they can stimulate growth in midst of demand slump and high unemployment • Even if desirable in “normal times” • Short term remedies for Greece et al. limited: • “transfer union”; (cf. German unification; U.S. federalism) or • boost to competitiveness through return to national currencies (partial break-up of EZ)

13. How the crisis is spurring “reforms”Change in overall responsiveness to OECD recommendations from 2008 to 2011 Source: OECD, 2012

14. The Eurozone’s dilemma • Only one long-run path: either political union, or economic disunion • current path of externally imposed austerity only exacerbates economic crisis and is unsustainable for any democracy • Merkel’s choice of presenting the crisis with a narrative of Greek profligacy instead of as a narrative about European interdependence rules out the political integration path • Economic and political consequences likely to be severe for core countries as well