Should Europe Emulate the US?

Jean Pisani-Ferry

23 November 2012


BRUSSELSPaul Krugman, the Princeton University economist and blogger, recently summarized diverging transatlantic trends as follows: “Better here, worse there.” It is a shocking observation: as recently as in 2009, European politicians and commentators lambasted the US for being at the root of the financial turmoil and hailed the euro for protecting the continent from it.

Unfortunately for Europe’s boosters, the facts are unambiguous. According to the European Commission, US per capita GDP is expected to return to its 2007 level next year, whereas it is expected to remain 3% below that level in the eurozone.
Likewise, unemployment was roughly the same on both sides of the Atlantic in 2009-2010, but it is now almost four percentage points lower in the US. Capital expenditure in the US is recovering more strongly, and exports are picking up. Even inflation is likely to be lower in America than in Europe this year.

The one area where Europe is posting better results is public finances. In 2012, the aggregate fiscal deficit in the eurozone is expected to be slightly above 3% of GDP, compared to more than 8% in the US.
There are two competing explanations for Europe’s relative malaise. One is the claim that Europe is paying the price of misguided austerity. The other is that the US, too, will eventually face its day of fiscal reckoning, and that Europe had no choice but to start it earlier: as the euro crisis demonstrates, things would have been worse had austerity been postponed.
There is truth in both views, but both overlook an important part of the story. In the aftermath of the Great Recession, the US and Europe (including the United Kingdom) adopted opposite strategies.

President Barack Obama’s administration and the US Federal Reserve gave priority to healing the private sector. After expeditiously restoring confidence in the banks by forcing them to undergo severe stress tests, they gave households time to repair their balance sheets. The task for economic policy was to compensate for the resulting shortfall in private demand until households eventually recovered. Fiscal consolidation was put on hold (although some did occur, owing to the balanced-budget rules of most US states), and monetary policy was geared toward flattening the yield curve.
Europe, by contrast, put early emphasis on restoring fiscal sustainability, but neglected its private-sector maladies. As early as the second half of 2009 – that is, before bond markets got nervouspolicymakers’ top priority was to find the exit from fiscal stimulus. Private-sector problems were overlooked on the way out. Banks, for example, were said to be in good shape, whereas several were barely solvent.

Households were assumed to be ready to consume, although, in Spain and elsewhere, many were over-indebted. And labor-hoarding was encouraged at the expense of productivity and profitability.

As a result, Europe emerged from the recession with too many zombie banks, wounded households, and struggling companies. In Germany, the private economy was fit enough to recover, but this was less true in southern Europe or even France.

The UK, which has not suffered directly from the euro crisis, is an interesting test, for it also followed the European strategy. Instead of the productivity surge experienced in the US, it has gone through a sort of productivity holiday, with serious consequences. The Bank of England’s latest Inflation Report reckons that UK productivity is 10% below pre-crisis trends, owing to low investment and a slowdown of the Schumpeterian process of creative destruction. As in continental Europe, productivity has suffered from a combination of insufficient profitability and dysfunctional capital markets. Unit labor costs have risen, and potential output growth has fallen.

Neglect of the private sector has left Europe in a sad quandary. On the supply side, permanently lower output makes fiscal adjustment even more compulsory; but, on the demand side, a weak private economy lacks the resilience needed to weather fiscal retrenchment.
At this stage, struggling European countries evidently cannot afford to put public-sector adjustment on hold to concentrate on private-sector balance sheets. Nor should they take inspiration from America’sfiscal clifftheater. Nonetheless, the US approach holds three lessons.
First, banking-sector repair should be policymakers’ top priority wherever it has not been completed. Second, the pace of consolidation should remain moderate as long as private demand remains constrained by deleveraging or credit restrictions. Finally, attention should be paid to the balance between fiscal tightening and supply-side reforms: whenever appropriate, more priority should be given to the latter than has been the case so far.

Jean Pisani-Ferry is Director of Bruegel, the Brussels-based economic-policy think tank, and Professor of Economics at Université Paris-Dauphine. He was an adviser to the European Commission’s Directorate-General for Economic and Financial Affairs, and was Director of CEPII, France’s leading international economics research institute. He has also served as Senior Economic Adviser to the French finance minister, Executive President of the French prime minister’s Council of Economic Analysis, and Senior Adviser to the director of the French Treasury.


Updated November 23, 2012, 6:09 p.m. ET

Andy Kessler: Obama Needs to 'Pull a Rubin' on the U.S. Dollar

What revived the 1990s' economy wasn't higher taxes, but a strong greenback and credible Treasury secretary.


Facing stubbornly high unemployment and slow growth, swelling deficits and a divided Congress, President Obama is surely scrambling for an economic elixir. He has often cited the economy of the 1990s during the administration of his Democratic predecessor, Bill Clinton, as his ideal. President Clinton managed to keep the economy moving ahead briskly despite repeated foreign currency crises—and despite raising taxes, which should have been an economic drag.

That seems to be Mr. Obama's plan. As he has said repeatedly, he wants to increase tax rates on "millionaires and billionaires" to "the same rate we had when Bill Clinton was president"—39.6%—"the same rate we had when our economy created nearly 23 million new jobs."

Dream on. Given increases in state, local, payroll and other taxes since the 1990s, the effective rate is considerably higher. In California—the home of venture capital and of many job creators—the top marginal income-tax rate would exceed 50% thanks to the state's new 13.3% rate. The top capital gains rate in the Golden State, if Mr. Obama gets his way, would rise past 37%—the scheduled increase on Jan. 1 to 20% plus 3.8% in ObamaCare plus the 13.3%, since the state taxes capital gains as ordinary income.
AFP/Getty Images
President Obama and U.S. Treasury Secretary Timothy Geithner in February 2011

Here's a better idea. If Mr. Obama wants the economy to get some of that Clinton mojo, he needs to pull a Rubin.

Robert Rubin, who took over as Treasury Secretary in January 1995 after 26 years at Goldman Sachs, GS +2.22% understood a thing or two about markets. In particular, he knew that during the inflationary 1970s, weak dollars flowed into commodities instead of stocks and ventures that were vulnerable to shifts in the value of the currency. During the Reagan era, Mr. Rubin and Goldman Sachs thrived by learning that a strong dollar attracts productive investment that drives a growing economy.

Under President Clinton, Treasury Secretary Rubin told everyone who asked that "the U.S. supports a strong dollar." And he put the country's money where his mouth was, pushing a strong-dollar policy that included working with central banks to keep the dollar's value up by buying and selling currencies and advocating free trade. During Mr. Rubin's nearly five-year tenure at Treasury, the dollar price of oil and gold dropped; the unemployment rate declined to 4.3% from 5.6%; and the stock market more than doubled. The Clinton economic legacy exists primarily because Robert Rubin acted on what he learned during the 1980s.

But somewhere in the dozen years since the end of the Rubin era, the country has lost its way. As low-end manufacturing jobs began to be outsourced to Japan, then Taiwan and now China, support for a strong dollar dissipated as the mistaken view took hold that a weak dollar would boost exports and return U.S. manufacturing to its glory days.

And we've had a bad run of Treasury secretaries. Alcoa AA +0.97% executive Paul O'Neill didn't last long under President George W. Bush, and in 2008 he admitted to Bloomberg TV: "When I was secretary of the Treasury I was not supposed to say anything but 'strong dollar, strong dollar.' I argued then and would argue now that the idea of a strong-dollar policy is a vacuous notion.'' His replacement, railroad executive John Snow, was for a "sound dollar," not a strong dollar, saying in 2003: "You want people to have confidence in your currency." He watched as the dollar dropped 46% against gold.

When the dollar is devalued, it flows into fixed assets and out of financial instruments and productive endeavors—into gold instead of Google, GOOG +0.32% oil instead of risky startups. And as the world saw in the 2000s, far too much into housing.

Henry Paulson, Mr. Rubin's partner at Goldman Sachs, tried to change the tone. He started at Treasury in July 2006, and after just four months had the dollar up 20%—although he would spend most of his tenure battling the housing and banking crises caused by a loose, dollar-debasing Federal Reserve.

Then came former New York Federal Reserve President Timothy Geithner. This Treasury secretary understands that "the U.S. supports a strong dollar," even telling the Senate Finance Committee in February 2010: "That particular phrase and commitment of policy was first written in my office at the Treasury Department in 1995"—for his boss, Robert Rubin.

But Mr. Geithner didn't back it up. On April 26, 2011, he told the Council on Foreign Relations: "Our policy has been and always will be, as long as at least I'm in this job, that a strong dollar is in our interest as a country. We will never embrace a strategy of trying to weaken our currency to try to gain economic advantage."

Yet a week later, at a meeting of the U.S.-China Business Council, he said: "It would be better for the world, more fair to us, and we think in China's interests, to let the exchange rate appreciate more rapidly." In other words, forget the strong dollar.

It is no wonder that dollars have fled to fixed assets like gold, bidding the price up to $1700 an ounce from $900 during the Obama administration. Meanwhile, investible cash sits on the sidelines or offshore, waiting for better dollar-based returns.

Mr. Obama doesn't need Congress to kick-start investment in the U.S. It takes a strong dollar and a new Treasury secretary with credibility as a start. That person will need to persuade Federal Reserve Chairman Ben Bernanke or his eventual replacement to end what has come to be called "QE Infinity"—investors' belief that the Fed will just keep printing dollars and debasing their value by quantitative easing.

This is a key moment. High tech from Apple to Cisco to Google will benefit from a strong dollar as memory and storage and displays get cheaper and foreigners have to pony up more yuan and euros for an iPad Mini. Pharma and retail and many other industries will benefit as well.

But the real kicker in 2013 will be fracking-induced lower energy costs in the U.S. This is not about heating homes or cheaper driving, though that will help. It is about bringing back aluminum and chemical factories that, seeking lower natural-gas costs, were driven to build factories in Saudi Arabia and other oil-producing countries. A rising dollar—versus other currencies but especially against the price of oil and natural gas—will make a decision to build in the U.S. an easy one.

Without support for the dollar, foreign capital will stay offshore until investing in the U.S. feels safe.

A strong dollar has already proven under Presidents Reagan and Clinton to increase investment and then jobs and then profits and then more investment. A weak dollar will delay an investment boom and continue the country's current plodding path. Inquiring minds and investors wonder which it will be.

Mr. Kessler, a former hedge-fund manager, is the author most recently of "Eat People: And Other Unapologetic Rules for Game-Changing Entrepreneurs" (Portfolio, 2011).


Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

Updated November 23, 2012, 6:11 p.m. ET

Jenkins: None Dare Call It Default

A nicer term for what's about to sock the middle class is 'entitlement reform.'

To call Greece First World may be a stretch, but Greece has defaulted once already, and it is only a matter of time until Greece defaults again. Welcome to default-o-rama, the next chapter in the First World's struggle for fiscal sustainability.

Japan is piling up debt in the manner of a nation beyond hope. France, Belgium, Spain and Italy are defaults waiting to happen unless Europe can somehow generate the kind of growth that has eluded it for decades.

America's fiscal cliff is an artificial crisis. We have no trouble borrowing in the short term. But at some point the market will demand evidence that long-term balance is being restored.

President Obama said in his first post-election press conference that he doesn't want any proposals that "sock it to the middle class." He knows better. A long-term socking is exactly what's coming to the middle class, which must pay for the benefits it consumes.

A few years ago, when the economy was humming, a common estimate held that federal taxes would have to rise 50% immediately to fully fund entitlement programs. Today, a 50% tax increase would be needed just to meet the government's current spending, never mind its future obligations.

One way or another, then, entitlements will be cut. Don't call it default. The correct term is entitlement reform.

You saw this day coming and saved for your own retirement. Don't call it default when Washington inevitably confiscates some of your savings, say, by raising taxes on dividends and capital gains. Taxpayers accept the risk of future tax hikes that may make the decision to save seem foolish in retrospect.

According to economists Robert Novy-Marx and Josh Rauh, state and local taxes would have to increase by $1,385 per household immediately to make good the pension promises to state and local workers, including firefighters and cops. That's not going to happen given all the other demands on taxpayers. Default, in this case, is the proper word for cities and states using bankruptcy to repudiate their pension obligations.

Prominent voices ask why the Treasury shouldn't just cancel the government bonds the Federal Reserve has been buying. It's money one part of the government owes the other. Dispensed with, of course, would be the idea that the Fed, in buying these bonds in the first place, was engaged in monetary policy. The Fed was printing money so Washington could spend it.

Now let it be said that inflation isn't fundamentally a solution to the entitlement problem, but the Federal Reserve is being led by increments to accommodate inflationary financing of future deficits. Don't call it default. Inflation is a risk savers are deemed to have accepted by putting their faith in the U.S. dollar.

Here's what you weren't told about Medicare during the presidential debates. Under the Paul Ryan plan, the affluent would pay more. Under the Obama plan, the affluent would flee Medicare to escape the waiting lists, shortages and deteriorating quality as Washington economizes by ratcheting down reimbursements to doctors and hospitals. Don't call either default. You don't have a legally enforceable right to the free care you imagined you were promised.

"Don't worry" was President Obama's implicit message during the campaign: If cutting subsidies for Big Bird is unthinkable, a joke, how much more so cutting benefits for middle-class voters?

Don't go running to a judge when this doesn't pan out. The courts do not overrule changes in government policy just because citizens find their promised free lunch isn't forthcoming. Nor will it be fruitful to appeal to politicians' sense of "fairness." Politicians can be relied on to do what will get them re-elected. And, believe it or not, that is the good news.

If politicians weren't eager to be re-elected, the trust necessary to be an investor would vanish altogether. While there is no escaping our challenges, there is a path in which the economy grows strongly and we don't savage each other, and there is the other path. For years the trustees of Social Security and Medicare were accused of exaggerating the programs' deficits by envisioning that America's long-run growth would become more like Europe's.

Now who doesn't fret that America's growth is becoming permanently slower like Europe's?

Which brings us to President Obama. He knows cuts are necessary but seeks to position Democrats politically as the defender of all spending. Notice that, with ObamaCare, he is deliberately creating a constituency of the young to set against the old in future fights over the allocation of federal health care dollars.

Meanwhile, saving the dynamism of the U.S. economy, while still affording an entitlement state, naturally falls to the other party in a two-party system.

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