Feldstein on Euro Zone Survival

« Can the Eurozone survive economic recovery?” asks Martin Feldstein in a paper published by Project Syndicate. While the ECB is now pursuing a very easy monetary policy it will start to raise the short-term interest rate when the eurozone improves, which will be more appropriate for some countries than for others.

Those countries such as Spain, Greece, Ireland or Italy, whose economies remain relatively weak oppose tighter monetary policy and they might benefit from pursuing an independent monetary policy to adjust their currencies to more competitive levels.

Read the complete paper here.

Hat tip to Mark Toma.

Asia Rising, Europe Declining, US Stable

Greg Mankiw posts a striking graph on his blog, describing the evolution of shares of the world GDP by regions (above) since 1969. While the decline of the US economic dominance is frequently presented as the trend of the future, Europe really is the continent which is losing its relative economic weight to Asia.

Taxes Compared

The Economist publishes a useful comparison of the state’s take in the economy (see table above). This is not, however, a comprehensive measure of the size of states in the economy since states also own firms, issue debt to finance part of their spending, and use regulations to orient private activities.

With regard to taxes proper, France obviously is an outlier in the sample. Since taxes distort activities and determine losses of welfare (growing faster the higher the tax rates), reform indeed is required in order to increase efficiency and boost production and income. Have a look in particular at the level of the payroll tax.

Minimalist Europe?

The Financial Times headline tells all after the nomination of Herman Van Rompuy as president of the European Union: “Supremacy of the nation state wins out”.

Excerpts:
“You could say it’s a sign that people are tired of assigning more power to Brussels said one diplomat.”

“When the Lisbon treaty (originally the EU constitution) was first mooted in 2001 by the Belgian EU presidency, it was seen as one last push by European federalists to transfer power to Brussels, including national policies on tax and foreign affairs.
That push was rebuffed, and last night’s dinner in Brussels was the coda to that process. (…) Europe’s leaders asserted the supremacy of the nation state: the new president and foreign policy chief would be servants, not the masters, of the national capitals.”

While such forecasts of what a nominated politician will do in office are notoriously hazardous, the symbolic aspect of the choice made yesterday should not go unnoticed: the new president has been (briefly) a prime minister of the European country which met the least success at building a nation state over differences in languages and traditions, and that has been considered recently as being on the verge of implosion. A bad omen indeed for those bent on centralizing even more the European Union.

Don’t Cut Deficits, Cut Taxes

That’s what one can conclude from a recent paper by Alesina and Ardagna (“Large Changes in Fiscal Policy: Taxes Versus Spending”, NBER Working Paper n° 15438, October 2009). The authors “examine the evidence on episodes of large stances in fiscal policy, both in case of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.”

Now what we need at present, both in Europe and in the U.S., is a continued fiscal stimulus to sustain the recovery, to be followed later by a reduction of the Debt/GDP ratio inflated by the public spending policies adopted during the crisis. If Alesina and Ardagna are right, and they may well be, a tax reduction now, followed by a public spending reduction (without tax increase) later, when private spending will have picked up, would be the best macroeconomic policy to adhere to.

The “deficit hysteria” (the excessive fear of deficits) currently fashionable would lead, on the contrary, to increase taxes that would damage recovery prospects, while the pursuing of public spending policies, which were useful during the crisis when private spending was contracting, would not add significantly to growth when expansion returns, and would on the other hand incite governments to increase taxes permanently, thus jeopardizing future growth.

Cutting taxes now would also give governments time enough to devise a well prepared future public spending cut program.

Dollar, Euro, Exports

Dean Baker criticizes The Wall Street Journal in his blog, The American Prospect here for its “economic incompetence” in discussing the Obama administration’s effort to boost the economy with increased exports and never once mention the value of the dollar as a determining factor.

Indeed:
“The value of the dollar is the main determinant of the price of U.S. exports in other countries. If the dollar falls in value, the price of U.S. exports declines measured in the currency of other countries.”

Since Baker suggests that the WSJ be nominated for a “Pulitzer for journalistic incompetence” due to that omission, I suggest that most European economists and all of the European political class share this Pulitzer award for never mentioning that the value of the Euro vis-à-vis the dollar, and the implicit value of the “notional” French Franc, Lira, and Peseta vis-à-vis the notional Deutsche Mark are responsible for substantial export difficulties and for the resulting contraction in activity.

Congratulations to the laureates.

Warren Buffett, the Railroads, and the Renminbi

Is there a link between Warren Buffet’s recent big investment in railroads, the U.S. current account deficit and Chinese surplus? Yes according to Simon Johnson in The Baseline scenario (November 7) here . The Omaha billionaire and owner of the Berkshire Hathaway holding would be betting on a renminbi appreciation that would boost Chinese commodity imports, which are, by the way, transported by U.S. railways and are a major U.S. export to China. Hence the reference to the G-20 meeting in the title of the post, since exchanges rates and current account imbalances are central to the G-20 discussions.

The Buffett move could also be interpreted as a bet on the rise of oil prices, because in that case transport by trains becomes much cheaper than transport by trucks, notes a reader of The Baseline Scenario.

Moreover both effects could happen simultaneously ...

Carry Trade and the Next Assets Tsunami

You should read Roubini here.