Category Archives: Europe

Brexit, Trump, and Workers Left Behind

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Observers have pointed out many parallels between the June referendum on Brexit in the United Kingdom and Donald Trump’s presidential campaign in the US.  One parallel is that both the British movement to leave the EU and the Trump campaign for the American Republican nomination achieved success that few had expected, particularly not the various elites.  In both cases, the general interpretation is that the elites underestimated the anger of working class voters who feel they have been left behind by economic forces in a fast-changing world, and in particular by globalization.

Another parallel is the centrality to both campaigns of promises that are close to logically impossible, and the consequent inevitability with which supporters will feel betrayed when the promises do not come true.  In the United Kingdom, one of the promises that cannot be kept is that if Britain left the EU it could somehow still keep the same trade access to its members, while yet reducing immigration by curtailing free mobility of persons.  Another promise that cannot be kept is that the £350 million ($465 million) supposedly sent to the EU each week would be reallocated to the cash-strapped National Health Service.  On my side of the Atlantic, Trump says that he will bring back the manufacturing jobs that have disappeared. Secondly, as most Republican candidates do, he promises to enact big tax cuts while simultaneously reducing the budget deficit or even the national debt.

It is true that, for some years, most national income gains have been going to those at the very top, with many workers having fallen behind.  Apparently this inequality and globalization, and the perceived connection between the two, play a large role in the anger among many workers that we see in the Brexit and Trump campaigns.  It is far from clear that either trade or migration is in fact among the top reasons for widening inequality. But that is the way many see it.

It is certainly true that globalization produces both winners and losers.  How can the concerns of angry workers be addressed?

A fundamental proposition in economics holds that when individuals are free to engage in trade, the size of the economic pie increases enough that the winners could in theory compensate the losers, in which case everyone would be better off. Formally it is a case of what economists call the Second Fundamental Welfare Theorem.   (The proposition requires that there be no market failures like monopolies or pollution externalities.)

Skeptics of globalization may understand this theorem and yet, quite reasonably, point out that the compensation in practice tends to remain hypothetical.   Some of the skeptics suggest that we should recognize political reality, take the failure to compensate losers as given, and so work on trying to slow down or roll back globalization.   But an alternative would be the reverse strategy: to take globalization as given and instead work on trying to help those who are in danger of being left behind.

The second strategy is the sensible one, not the first.  For one thing, it would be difficult to roll back globalization even if we wanted to.  Presumably the policies would include attempting to renegotiate NAFTA or TPP (or, for Britain, the EU), or dropping out of the World Trade Organization, or else unilaterally imposing tariffs and quotas even though they violate existing international agreements.  Even leaving aside the negative effects of trade wars on economic growth, anything that a president does would be very unlikely to bring trade back down to the levels of 50 years ago, and still less likely to bring the number of steel jobs back up to the levels of 50 years ago.   Globalization is a reality.

That we can’t turn back the clock on globalization is understood fairly widely.  But a second point is less often made.  In the context of US presidential elections, the choice between the two parties is less a referendum on globalization than it is a choice whether to adopt the specific policies that would help those who are in danger of being left behind.   Much is new and different in the 2016 election, but not that.

Policies to help those who are left behind [or, in clinical theoretical terms, to compensate the losers] are precisely where the two parties disagree.  They most effective measures, as I see it, are ones that Hillary Clinton and Barack Obama, like his predecessors, try to push and that the Republicans try to block.

The main program to help specifically those who have lost their jobs due to trade is Trade Adjustment Assistance.  But why help only the small number of workers who have identifiably lost their jobs due to trade agreements?  Wouldn’t it be better to help those who have been left behind regardless if the cause is trade, technology, or something else?  Sensible policies to do that include wage insurance, an expanded Earned Income Tax Credit and universal health insurance, among others.  Also: a more progressive payroll tax structure, universal quality pre-school, and infrastructure investment spending.  These are all policies favored by Democrats.  Most have been opposed by Republicans. [Still, one hopes that even if a second President Clinton once again had to deal with a Republican Congress, the two might be able to find common ground in the EITC and infrastructure investment.]

Not long ago, it was possible to admire the sort of political equilibrium achieved by the British electoral system.  The two largest parties tended to be led by relatively competent and consistent leaders who represented relatively well-demarcated stances on the issues: right-of-center in the case of the Conservatives and left-of-center on the part of Labor.  Voters could make their choices based on the policy issues.  Under a parliamentary system, the victorious prime minister could work to carry out the policies that he or she had campaigned on.  It compared favorably to the ever-worsening gridlock of the American system, where presidential initiatives could and would be blocked by congressmen from the opposite party, even when the initiatives were consistent with philosophies that they themselves had espoused in the past.

To state the obvious, the British system has broken down.   Some of those competent leaders eventually made fatefully ill-advised decisions: Margaret Thatcher’s poll tax, Tony Blair’s support for the US invasion of Iraq, and David Cameron’s decision to hold the Brexit referendum. What is now left is a mess.  It is hard to discern much clarity or consistency in the new crop of English politicians.  When the next election is eventually held, the voters could well be asked to choose between parties that do not correspond in any clear way to the relevant policy decisions that Britain must make, mainly whether to seek to negotiate a relatively close association with the EU or to cut off completely.

In some familiar ways the American political system has also deteriorated in this election cycle, bringing past trends to a reductio ad absurdum.  But the American political situation at the moment has an advantage that the Brits lack: ability for voters to choose what is to be the national policy orientation. The Democrats still favor policies like wage insurance and universal health insurance and the Republicans still oppose them. So American voters in 2016 are still able to make the relevant choice, either for or against policies that deal with the reality of globalization by helping those who are left behind.

[This is an extended version of a column that appeared at Project Syndicate, July 14, 2016. Comments can be posted there or at Econbrowser.]

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A Way to Save the United Kingdom

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I see a possible way out for the trap that Brits now find themselves in, a way to keep Great Britain great.

  1.  The Scots, under Nicola Sturgeon (First Minister of Scotland), would decide immediately that they will hold a new referendum on independence.  This referendum would state explicitly that if the United Kingdom decides to stay in the EU then Scotland will stay in the UK, but if Britain leaves the EU then Scotland will leave the UK.  The decision to hold a referendum on conditional Scottish independence would be approved by the Westminster parliament.
  2. That referendum would create a constitutional crisis in Great Britain. This constitutional crisis would genuinely justify a second UK referendum on whether to leave the EU (Brexit), in a way that mere second thoughts after the June 23 outcome do not otherwise justify.  Historically, the “Great” was added when Scotland joined the union.  It became the “United Kingdom” when Ireland joined.   Symbolically: those patriotic Englishmen who campaigned on the Leave side were (mostly) waving the Union Jack.  If Scotland were to leave, it would be the end of the Union Jack — where the cross of St. Andrew stands for Scotland, the cross of St. Patrick stands for Northern Ireland, and only the cross of St. George stands for England.
  3. In this second Brexit referendum, the Remain campaign will pick up votes of those committed to preserving the UK intact — in addition to any who have now learned that the leaders of the Leave campaign cannot fulfill promises made regarding immigration, trade, and budget savings.   Perhaps the outcome will come out pro-EU this time, which is what happened in the past when other European countries reversed initial anti-integration referenda, in both Ireland and Denmark.  (If the EU were willing to make further concessions to the UK that would also help, of course; but it cannot be expected to do so.)
  4. This plan would be pursued by a coalition of four: Sturgeon, some new anti-Brexit Tory leader, some anti-Brexit Labor politician, and Tim Farron (of the Liberal Democrats).  During the period of uncertainty over Scotland, the prime-ministership, the leadership of these three British parties and indeed the very existence of the parties would remain also uncertain.  This political crisis further justifies the fundamental rethink.  At some point there would be a new general election, fought along Remain/Leave lines.  As part of the Remain campaign, its leaders should spell out policies to improve living standards for those who feel they have lost out to globalization and European integration.
  5. Meanwhile, many continental EU leaders will demand that the UK invoke article 50, to start the process of actually leaving.  But the UK parliament would nevertheless refrain from doing it, until the referendum process has played itself out.

    [Comments can be posted at Econbrowser.]

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Fiscal Education for the G-7

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As the G-7 Leaders gather in Ise-Shima, Japan, on May 26-27, the still fragile global economy is on their minds.  They would like a road map to address stagnant growth. Their approach should be to talk less about currency wars and more about fiscal policy.

Fiscal policy vs. monetary policy

Under the conditions that have prevailed in most major countries over the last ten years, we have reason to think that fiscal policy is a more powerful tool for affecting the level of economic activity, as compared to monetary policy.  The explanation can be found in elementary macroeconomics textbooks and has been confirmed in recent empirical research:  the effects of fiscal stimulus are not likely to be limited, as in more normal times, by driving up interest rates, crowding out private demand, running into capacity constraints, provoking excessive inflation, or overheating in other ways.  Despite the power of fiscal policy under recent conditions, economists continue to lavish more attention on monetary policy.  Why?

Sometimes I think the honest reason we economics professors are attracted to monetary policy is that central bankers tend to be like us, with PhDs, and to hold nice conferences.

The reason that one usually hears, however, is that fiscal policy is “politically constrained.”   This is an accurate statement, but not a good reason for us to give up on it.  Indeed, if the political process gets fiscal policy wrong, which it does, that is all the more reason for economists to offer their contributions.

Of course if one is a central banker, or is advising a central banker, then one must concentrate on the job at hand, which is monetary policy.  But precisely because there is a limit to what central bankers can say about fiscal policy, there is more need for the rest of us to do it.

The heyday of activist fiscal policy was 50 years ago. The position “we are all Keynesians now” was attributed to Milton Friedman in 1965 and to Richard Nixon in 1971.  In the late 20th century, most advanced countries managed to pursue countercyclical fiscal policy on average: generally reining in spending or raising taxes during periods of economic expansion and enacting fiscal stimulus during recessions. The result on average was to smooth out the business cycle (as Keynes had intended).  It was the developing countries that tended to follow procyclical or destabilizing policies.

Leaders forget how to do counter-cyclical fiscal policy in the US, Europe and Japan

After 2000, however, some countries broke out of their familiar patterns. Too many political leaders in advanced countries pursued procyclical budgetary policies: they sought fiscal stimulus at times when the economy was already booming, thereby exaggerating the upswing, followed by fiscal austerity when the economy turns down, thereby exacerbating the recession.

Consider mistakes in fiscal policy made by leaders in three parts of the world — the US, Europe, and Japan.

US President George W. Bush began the century by throwing away the large fiscal surpluses that he had inherited from Bill Clinton, and then continued with big tax cuts and rapid spending increases even during 2003-07, as the economy reached its peak.  It was during this period that Vice President Cheney reportedly said “Reagan proved that deficits don’t matter.”

Predictably, the rising debt left the government feeling less able to enact fiscal stimulus when it was really needed, after the Great Recession hit in December 2007.  At precisely the wrong time, Republicans “got religion” deciding that deficits were bad after all.  Thus when President  Barack Obama took office in January 2009, with the economy in freefall, the opposition party voted against his fiscal stimulus.  Fortunately they failed then, and the stimulus was able to make a big contribution to reversing the freefall in the economy in 2009.  But having regained the Congress in 2011, they did succeed in blocking Obama’s further attempts to stimulate the still-weak economy for three years. The Republicans appear to be consistently procyclical.

Greece is the “poster boy” of an advanced country that unhappily switched to a systematically procyclical fiscal policy after the turn of the current century.  Its first mistake was to run excessive budget deficits during the expansionary period 2003-08 (like the Bush Administration).  Then, as if operating under the theory that “two wrongs make a right,” Greece was induced after its crisis hit to adopt tight austerity in 2010, which greatly worsened the fall in GDP. The goal was to restore its debt/GDP ratio to a sustainable path; but instead the ratio rose at a sharply accelerated rate, because of the fall in GDP.

Europeans suffer even more than other countries from basing their budget plans on official forecasts that are unnecessarily biased, which can lead to procyclical fiscal policy.   Before 2008, not just Greece, but all euro members were overly optimistic in their forecast and so at times “unexpectedly” exceeded the 3% ceilings on their budget deficits.  After 2008, qualitatively similar stories of procyclical fiscal contraction, leading to falling income and accelerating debt/GDP, also held in Ireland, Portugal, Spain and Italy.

The native land of austerity philosophy is, of course, Germany.  The Germans had (reluctantly) gone along with an agreement at the London G-20 Leaders Summit of April 2009 that the US, China, and other major countries would expand demand in order to address the Great Recession.  But when the Greek crisis hit at the end of that year, the Germans reverted to their deeply held beliefs in fiscal rectitude.

At first the IMF went along with the other members of the troika in believing — or at least pretending to believe — that fiscal discipline in the European periphery countries would not greatly damage their GDPs and thus could restore their debt/GDP ratios to sustainable paths.  But in January 2013, Fund Chief Economist Olivier Blanchard released a paper that was widely interpreted as a mea culpa.  It concluded that fiscal multipliers were much higher than the IMF (among other forecasters) had thought, suggesting that the austerity programs might have been excessive.  This conclusion was based on a statistical finding that the countries which had attempted the biggest fiscal retrenchment in response to the crisis turned out to experience the most damage to GDP relative to what the IMF forecasters had expected. Today, IMF Managing Director Christine Lagarde explains to the Germans that Greece cannot achieve the elusive path of a sustainable debt/GDP ratio if it is not given further debt relief and is instead told to run primary budget surpluses of 3 ½ percent of GDP.

Now to Japan, host of this week’s G-7 meeting.  In April 2014, even though the economy had been so weak that the Bank of Japan had been pursuing aggressive quantitative easing, Prime Minister Abe went ahead with a planned increase in the consumption tax (from 5% to 8%).  As many had predicted, Japan immediately went back into recession.  Even though the first arrow of Abenomics, the monetary stimulus, had been fired appropriately, it was evidently less powerful than the second arrow, fiscal policy, which unfortunately had been fired in the wrong direction.

Prime Minister Abe has indicated that he is sticking with his plan to go ahead with a further rise in the consumption tax (to 10%), scheduled for April 2017.  It is easy to see why Japanese officials worry about the country’s huge national debt.  But, as near-zero interest rates signal, creditworthiness is not the current problem; weakness in the economy is.  A more effective way of addressing the long-run sustainability of the debt is to announce a 20-year path of very small annual increases in the consumption tax, calculated so as to demonstrate to investors that the ratio of debt to GDP will come down in the long term.

Developing countries

Not all is bleak on the country scoreboard of cyclicality.  Some developing countries did achieve countercyclicalfiscal policy after 2000.  They took advantage of the boom years to run budget surpluses, pay down debt and build up reserves, which allowed them the fiscal space to ease up when the 2008-09 crisis hit.  Chile is the poster boy of those who “graduated” from procyclicality. Others include Botswana, Malaysia, Indonesia, and Korea.  China’s 2009 stimulus was very countercyclical.

Unfortunately some, like Thailand, who achieved countercyclicality in the last decade, have suffered backsliding since then.  Brazil, for example, failed to take advantage of the renewed commodity boom of 2010-11 to eliminate its budget deficit, which explains much of the mess it is in today now that commodity prices have fallen.

Politicians everywhere might improve their game if they re-read their introductory macroeconomics textbooks.

[This is an extended version of a column appearing at Project Syndicate.  Comments can be posted there or at Econbrowser.]

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