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In a Big Read piece for the FT today, I reported on economic research that presents the conventional eurozone narrative with a number of inconvenient facts. The standard story, as you all know, is that the euro is a flawed currency union which needs budgetary transfers between countries and structural reforms to compensate for the inability to devalue national currencies. But it turns out the foundations for this narrative are rather shaky. Today’s Free Lunch rounds up some of the recent evidence.
The most surprising research is perhaps that which shows that the exports of much of “peripheral Europe” held up well in the boom. Spend some time on this paper by Guillaume Gaulier and Vincent Vicard (a short summary with Daria Taglioni is here, and a longer paper with more detail here). It shows not just (as mentioned in the FT piece) that Europe’s weaker countries generally defended their export shares in the boom, but also that some of them outperformed many core countries when you take account of the sectors and geographical markets they were exposed to:
(Note that Germany’s export prowess in the 2000s had much to do with being a producer of the things China particularly needed at this stage of development, such as machine tools. That’s not competitiveness; it’s being in the right place at the right time.)
It’s also worth reading the research on sovereign risk contagion — recall that a chief motivation behind the “rescues” of Greece, Ireland, Portugal and Cyprus was the fear that if one country defaults, it will make investors shun other vulnerable states. It sounds plausible enough. But when two finance and economics professors at Carnegie Mellon tried to measure this carefully, they found very small contagion effects. They looked at the effect of a default in Greece, Portugal, Spain or Italy — and in each case they could not find a rise in another country’s default probability (as estimated by markets) of even 1 percentage point.
What about contagion between banks, which has also been an important part of the eurozone story? Remember how Ireland was forced to bail out its private banks for fear that even a small bank’s failure would have Lehman-like effects. Research published this week looks into the contagion between European banks — and again, finds very little, with one exception: a handful of very large banks had significant system-wide effects in that their riskiness affected the banking system generally. So it was not wrong to worry about bank failures — but it was wrong to worry about the failure of anything but the biggest banks.
Several other research papers have come out this week that should nuance our understanding of the eurozone crisis. The first examines the evolution of company-level productivity in Spain in the 2000s. It finds that the credit boom caused growing differences between individual companies’ productivity — which suggests that banks were lending indiscriminately rather than to the most promising projects. (This also echoes the recent OECD finding that the technology “diffusion machine” is broken. Innovation is humming along in the rich world — but the ability of less productive companies to catch up with the technological frontier has weakened, also making productivity more unequally distributed.)
Another paper compares the sovereign debt crisis of weak eurozone countries with US states that were also under serious stress — such as California. In Europe, the sovereign crisis created capital flight from private borrowers too, but not in the US. Why not? The researchers blame investors’ fear that eurozone sovereigns may interfere with private contracts if they had to leave the euro — “redenomination risk” in the jargon. That chimes with recent European Central Bank research that up to one-half of the huge borrowing costs in the eurozone in 2011-12 was caused by redenomination risk. The meaning of this should be stated in plain English: it was the fear that Europe’s leaders might undo the single currency that caused the worst market panic — not the other way round.
- Brad DeLong reposts what is perhaps the clearest explanation of what Keynesian economics tells us about depressed economies. Aggregate demand is different from demand in any particular market, and excess supply in the macroeconomy is much worse than excess supply in any single industry.
- The Economist’s Free Exchange reviews new research synthesising the results of hundreds of studies on how to get the unemployed back to work. Punitive measures, such as removing benefits, have a stronger effect in the short run, but it quickly wears off. For the longer term, “cuddlier” programmes which invest in training do better.
- Reliable as always, Bruegel’s Silvia Merler takes an updated look at Greece’s budget balance. The surplus remains bigger than expected and bigger than last year — but revenues and expenditures are both far below target.