Keith Humphreys on the Euroland crisis:

I have read endless coverage of the Euro Crisis, and my head is now spinning as I learn of sovereign debt swaps, inter-market currency trades and European Central Bank-mediated transaction insurance schemes. I then go back to a much simpler analysis: The system was set up financially such that one party could spend far more money than it had secure in the knowledge that someone else would have to pick up the tab.

I think that’s really mistaken, and it ill-serves the world to have a one-sided narrative told by German bankers dominate the entire discussion. Humanity has long had a system whereby someone can buy something he doesn’t have the money to buy. It’s called borrowing. And thanks to bankruptcy, you can borrow money secure in the knowledge that somebody else may have to pick up the tab. This is why lenders charge interest if you want to borrow their money. If you ask a moneylender why his enterprise is so profitable, he’ll give you two reasons. One is that the profits are a consideration in exchange for the risks he’s running. The other is to observe that he personally is making big money because he personally is skilled at the moneylender’s trade. Spanish households borrowing money and paying interest are not purporting to be skilled borrowers. They’re just regular folks participating in a marketplace dominated by well-compensated professional lenders, whose compensation is based on their alleged skill at the trade.

Well, it turns out these guys weren’t actually that good at their trade. When bankers sit down with borrowers to discuss loans, it’s the lender who’s putting himself forward as a highly trained highly compensated expert in the field of lending money. If it goes bad, it’s because the allegedly expert lender has turned out to be bad at his job. It’s the banks that loaned money to Greece who are saying the German government ought to pick up the tab. It doesn’t say this in any of the EU’s founding treaties — it actually says the reverse. The Greeks would probably just as soon default and devalue as go through this nonsense. It’s the governments of northern Europe who, by offering to act as debt collectors for their domestic banks, have created this situation where they’re left partially holding the tab.

(cc photo by simon_music)

Recession leads to deficits lead to austerity leads to worse growth and bigger deficits:

With economic conditions weaker than expected, tax revenue is coming up short of projections in parts of Europe. As a result, countries struggling with high deficits are now confronting the prospect that they will miss the budget deficit targets forced upon them this year by impatient bond investors.

Greece, for one, looks as if it will run a budget deficit for 2010 greater than the 8.1 percent of gross domestic product it agreed to as part of a rescue package from the International Monetary Fund and the European Union that amounted to more than $150 billion, according to a person briefed on the matter but not authorized to speak about it.

Again, what would normally happen to a Greece-sized country with Greek-sized problems is that the value of its currency would decline. Everyone would, consequently, become quite a lot poorer in “real” terms but the pain would be spread and unemployment wouldn’t necessarily skyrocket. The newly poor country would be cheap to visit, its exports would be priced competitively, and import-competing industries would remain in great shape. Things might either stabilize like that, or else structural reforms could be undertaken that lay the groundwork for growth.

Thanks to the Euro, none of that’s possible and it’s not at all clear to me what the endgame here really is. For understandable reasons, German (and Austrian, Dutch, etc.) taxpayers don’t want to bail out the government of Greece. And also for understandable reasons, German policymakers prefer the European Central Bank to run a monetary policy that’s appropriate for Germany rather than one that’s appropriate for Greece. So Greece is stuck on a path to default.

Unlike the United States of America, Greece has no option to use fiscal policy or monetary policy to rescue its economy. All they can do is reduce nominal wages and engage in real restructuring. That’s overwhelmingly a bad thing for Greek people, but it does provide the opportunity to revisit some mechanisms of unfair privilege:

But Greek law also limits just about everything else about pharmacies. They must be at least 820 feet apart and have a likely market of no fewer than 1,500 residents. To break into the business, an aspiring pharmacist generally has to buy a license from a retiring one. That often costs upward of $400,000.

“It is an absurd system,” Mr. Avgerinos said recently. “But it has been that way my whole life.”

Maybe not for much longer.

The United States doesn’t have this particular set of problems, but we do have our own set of privileged guilds creating undue barriers to entry in fields as diverse as barbershops, tour guides, lawyering, and medicine. What’s more, I think we probably do privilege both pharmacists and doctors by demanding prescriptions for too wide a range of medications and we definite privilege doctors with our rules about who is allowed to write prescriptions. That particular set of regulations is both irrationally lax, allowing doctors to prescribe things that are outside of their field of practice and with no requirement that they stay up-to-date on new developments, and also irrationally stringent, often requiring a doctor when a lesser-trained medical professional with a lower salary would due. The way MDs win the prescription field both coming and going is a good sign that you’re looking at guild privilege rather than consumer protection.

In both Greece and the United States I don’t think understanding these kind of barriers to competition and innovation is particularly crucial to understanding the current crisis. But understanding and unraveling them is important to sustaining societies’ ability to grow over the long run. When you can obtain profits simply by extracting rents in the manner of a Greek pharmacist, and where the more efficient pharmacists are generally prohibited from driving you out of business, you create a climate that’s very hostile to prosperity-enhancing innovations.

I think it’s obvious that letting southern European governments collapse into insolvency would be bad for the world. But the larger issue is that while Greece combines irresponsible budgeting with a bad growth outlook, even countries like Spain whose budgeting is perfectly sound are going to collapse if they can’t grow. And they can’t grow unless they have appropriate monetary policy. So as Paul Krugman says the monetary aspects of the new European rescue plan are probably the most important part:

Announcement #2, from the ECB, changes things somewhat. It now seems that Trichet has been dragged kicking and screaming into becoming at least a semi-Bernanke, engaging in much more expansionary policies than before. (Yes, the ECB says that they’re only liquidity operations, and will be sterilized, yada yada — we can only hope that they don’t really mean it.)

A more expansionary monetary policy could make a real difference — especially if the ECB ends up accepting somewhat higher inflation. Suppose that Speece or Grain need to get relative prices down 15 percent over the next five years. If the eurozone has 1 percent inflation, that’s 10 percent deflation in the periphery. If the eurozone has 3 percent inflation, all you need is stable prices. Also, a stronger overall eurozone economy means higher GDP and hence higher revenue, making the fiscal slog less grim.

Unfortunately, my sense is that Trichet probably does “really mean it.” What’s more, the fact that its resolve is being called into question means the European Central Bank may feel compelled to err even more on the side of low-inflation, low nominal GDP growth policies.

What on earth do I know, but it seems to me that despite the recent announcements Greece is still headed for default. The head of Pimco says the deal doesn’t really go far enough:

Mohamed El-Erian, chief executive and co-chief investment officer at Pacific Investment Management Co., said the firm wouldn’t buy Greece debt until there is a sustainable solution to the economic situation in the nation. El-Erian commented on Bloomberg Radio.

Meanwhile, in Greece striking civil servants are clashing with riot police over the austerity measures that have been announced. The crux of the matter is that Greece seems to have already over-promised austerity relative to what can be done and under-promised austerity relative to what would bring about solvency. Meanwhile, though it’s clear that Greek default would be worse than Greek austerity for France and Germany it’s not clear to me that Greek default would be worse than Greek austerity for Greece.

(my photo, available under cc license)

I don’t often agree with Bryan Caplan, but this post on the Greek economy raises what I think is an underdiscussed issue that makes international comparisons difficult—when calculating a country’s GDP, the public sector counts inputs as outputs. There are sound accounting reasons for doing it this way, but it makes it difficult to do international comparisons of living standards when we talk about developed countries with relatively large public sectors.

To see the problem, consider that in a commonsense view a clean, quiet, pleasant, timely tram is more valuable than a dirty, loud oft-late, tram. But if the good tram is just better because that country’s transportation departments are better-run, then the higher tram quality doesn’t “show up” in the per capita GDP. Insofar as high-quality public services have beneficial spillover consequences for the rest of the economy, that does show up. But insofar as good services just make people’s lives better—think of Medicare treating someone in a timely and effective manner rather than let them linger ill for three months before they recover—that’s off the radar. Public spending as a percent of GDP is similar in Greece and the Netherlands but I’d wager a fair amount that the Dutch civil service is delivering more value-per-euro.

Steve Erlanger has a great piece in the NYT about the coming austerity in Greece and the prospect that it might kill the patient in a way that ultimately makes debt-repayment impossible:

Embedded in the euro and thus no longer in control of its own currency, Greece cannot take the easy way out of its debt by devaluing. So Greece must either cut its spending sharply or default on its loans — which would badly damage German and French banks carrying a lot of Greek debt.

That is considered one reason President Nicolas Sarkozy of France has been so quiet on the Greek crisis, Mr. Fitoussi said. The Greek deal “is an indirect way of bailing out French and German banks,” he said. “The French understood this from the start, but Germany didn’t seem to.”

Katinka Barysch, an economist and deputy director of the Center for European Reform in London, said that that realization had hit home in Germany. “It might be unpopular for the Germans and Europeans to bail out Greece, but it will be even more unpopular for them to bail out the banks that owned Greek bonds,” she said.

I’m not in love with that explanation of how devaluation could have played into this. Greece’s debts to foreigners are largely denominated in Euros, so even if Greece did manage to get out of the Euros and start up some devalued New Drachmas they’d still have to pay off the full face value of the debt. Devaluation would help in that it might boost Greek growth (or more realistically, reduce the extent of Greek contraction) meaning that Greece would have more money to dedicate to the purpose of paying off their debts.

But quibbling aside, the point is that Greek ability to pay is related to Greek ability to grow, and the outlook there is very poor. The Greek economy has a lot of problems. The austerity package will make those problems worse. And on top of that, not only can Greece not devalue, but Greece’s monetary policy will be set for it by a European Central Bank that doesn’t care at all about whether or not its choices are appropriate for Greece.

In the manner of newspaper articles, this Steven Erlanger piece from yesterday gets a bit confused as it tries to weave three separate points together, but it does a good job of moving beyond Greece-bashing to note that there’s been a catastrophic failure of German leadership here:

Mrs. Merkel has been the central figure in the debt crisis, as she has tried to respond to German voters’ displeasure at having to bail out Greece, after years of bailing out eastern Germany. She delayed action on the problem for months, hoping to put it off until after critical regional elections on May 9.

Ultimately, that proved impossible. But her foot-dragging, combined with her insistence that Greece pay a severe long-term price for its profligacy and that the German Parliament approve any bailout, gave the markets both reason and room to run up the price of Greek debt to unsustainable levels. That forced the International Monetary Fund and the Europeans on Wednesday to practically quadruple the commitment to Greece, to try to calm the markets and not turn their attention to Portugal, another weak reed.

“The fact that a German regional election can play such a disproportionate role in messing up efforts to contain what was a much smaller crisis several months ago is astonishing,” Mr. Kirkegaard said. And the fact that there will be no European Union summit meeting until May 10, after the German elections, “is so blatantly political,” he said.

There’s a relevant contrast here with how Bill Clinton’s administration dealt with the need for a Mexico bailout in the late-1990s. There, too, the problems were in a sense “Mexico’s fault” and opportunistic politicians could portray it as hardworking American dollars going to rescue irresponsible sun-baked types. But it would actually have been quite bad for the US for Mexico to go bust, so the Clinton administration sucked it up and did the right thing for the United States—which also happened to be the right thing for Mexico. Merkel’s unwillingness to challenge the framing of Germany being asked to make a charitable contribution to a wayward cousin has made both the politics and substance of this worse.

Europe is probably going to be a mess for years, which you’ll hear American rightwingers say is a consequence of universal health care or some such, when in fact we’re largely looking at the bad consequences of conservative hard money policies.