Europe’s Demand Must Come From Somewhere

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As Europe continues to austerity itself into oblivion, it’s worth looking at this chart of trade balances from Paul Krugman:

GIPS is Greece, Italy, Portugal, Spain. What you’re looking at here aren’t budget deficits, they’re trade deficits and trade surpluses. And what you can see is the problem with trying to address the overall European economic situation purely through GIPS austerity. The way the European economic machine works is that Germany produces more than it consumers and the GIPS consume more than they produce. GIPS austerity is a mix of tax increases (which reduce GIPS citizens’ after tax incomes and therefore their consumption) and spending cuts (which reduce GIPS citizens’ after tax incomes and therefore their consumption). But if GIPS citizens consume less, then Germany is going to end up producing less and German citizens are going to end up regretting having twisted GIPS governments’ elbows to impose austerity packages that ended up boomeranging against Germany’s interests. At least German citizens would regret it if they understood the situation properly. More realistically, though, German citizens will watch their economy decline after the bailout/austerity combo is done and will blame the bailouts rather than the austerity.

Now it’s a bit difficult not to sympathize with the poor Germans’ perspective on this. After all, why should Portugese people get to consume more than they produce while Germans produce more than they consume? One perspective on this would be to simply abandon the nationalism. Here in the United States people don’t run around talking about how New Jersey runs a persistent trade surplus and Kentucky has a persistent deficit and it’s unfair for productive New Jersey to be subsidizing uncompetitive Kentucky. What we say instead is that the federal tax-and-transfer system is redistributive. Rich people consume considerably less than their pre-tax wages, while poor people consume considerably more. If they happen to be a large concentration of poor people in Kentucky and of affluent people in New Jersey, then that’s just how it shakes out. The real issue here isn’t Kentucky versus New Jersey, it’s the big picture ideological fight over progressive taxation and the welfare state.

But if Germans do want to be nationalistic about this and don’t want to be perennially subsidizing Portugal, then it’s in their own interests to recognize that German producers are currently counting on GIPS demand. If they don’t want their own economy to suffer in the face of GIPS austerity, they need to raise their own domestic consumption. Having a bunch of people take expensive vacations to Italy and eat a lot of bellota ham would probably be more fun than engineering enormous bailouts. What they can’t do is count on continuing to run trade surpluses of this volume even while insisting that their EU partners all follow Ireland in reducing their trade deficits. The numbers need to add up.