Tuesday, May 15, 2012

Some additional perspective on Europe

These charts provide some interesting perspective on the Eurozone economies. The top chart compares industrial production in the U.S. to industrial production in the Eurozone economies in aggregate. Note how there has been a significant gap that has opened up since last August, and note also how closely production in the two major economic areas had tracked up until that time. But as the second chart makes clear, the sluggish performance of Eurozone industrial production since August is mainly driven by the same countries that are facing rising default risk. Germany is doing quite well, and its industrial production recovery has been stronger than that of the U.S.

The second chart breaks out the behavior of industrial production across six major economies within the Eurozone. It seems the Eurozone is split these days between those who produce and those who don't. German industrial production has been the mainstay of Eurozone growth, since German production levels today are only 2.8% below their pre-recession peak. Not surprisingly, Greece is bringing up the rear, with industrial production having collapsed by almost one third since its pre-recession high. France, UK, Italy, and Spain have all experienced almost no recovery in industrial production for the past three years.

The charts also suggest that the problems that have led to the Eurozone's sovereign debt crisis go way beyond Greek contagion, and their roots in fact go back many years. In short, Germany has been doing something right that most of the others have not. For one, Germany made significant cuts in corporate tax rates in 2001 and then again in 2007. Just as importantly, Germany instituted labor market reforms in the mid-2000s that reduced wage costs to levels that were once again competitive. The laggards have allowed their public sectors to bloat and their costs to rise, and have made no attempt to cut tax and regulatory burdens.

As further evidence for the power of tax cuts, I note that Ireland's industrial production is only down 7% over the past four years, after rising by an astounding 300% from the early 1990s, thanks to the country's decision to slash corporate tax rates and keep them low in spite of continual protests from other Eurozone countries who pronounced them to be "unfair" competition.

Germany's fiscal policy has been much more growth-favorable than the policies of the countries that now struggle with default risk. This is a very important point, since it strongly suggests that the austerity measures being proposed in the countries that are still struggling—which consist mostly of attempts to increase taxes—are the problem, not the cure for what ails these countries. Sooner or later the laggards are going to figure this out: the right kind of austerity consists of public sector spending cuts that are accompanied by lower tax and regulatory burdens.

There's a lesson for California here as well. Imagine that the government of California is like the management of a business that is losing customers and money—after all, taxpayers and companies of all stripes are fleeing the state because of its heavy tax and regulatory burdens. California is like a company whose products have become too expensive to remain competitive, but instead of cutting its costs and becoming more competive (e.g., by lowering taxes and reducing regulatory burdens), California's management is trying to increase its prices (i.e., increase tax rates) to stay afloat. It's simply not going to work.


KD said...

What Germany has been doing right is getting the Euro locked in at an exchange rate that also locked in a trade surplus. Look back at the data- Germany pre-euro had a trade deficit every year which rapidly reversed itself as soon as the Euro began.

Germany is no beacon, every country in the world can't run a current account surplus!

Scott Grannis said...

The Euro at current levels is not weak at all relative to other major currencies, at least in my estimation. Therefore I doubt that the level of the Euro has been a net benefit, via trade surpluses, for Germany. in any event, trade surpluses are not necessarily a good thing, Japan being the best example I know of.

McKibbinUSA said...

Scott, your last paragraph about California is spot on -- Californians will imminently choose either dramatically higher taxes, or dramatically lower state spending levels -- all eyes should be on California at this point...

PS: My guess is that Gov Brown's tax referendum will fail in the election, and that waves of messy cuts in government spending will follow -- the question then will be whether public servants will live with those cuts, or instead take to the streets and test Federalism's resolve...

McKibbinUSA said...

PPS: What most of Europe and the US need most is to enact 40% cuts in total government spending -- tax increases are simply not an option at this point -- the only other course would be to "print" money -- however, neither Greece nor California have authority to "print" money at this point -- my bet is on dramatic cuts in government spending accompanied by civil unrest requiring Federal interventions along the southern flank of Europe and the west coast of the US -- we live in scary times...

blueice said...

Interesting read...Our resident economist, has well defined the issues of EuroLand...

The problems are political in nature (cause and effect are economic ills), and there is no rising tide of Conservatives...

What will happen, more of the same...
The solution to the debt bomb will be more debt...After all, as Mr Grannis stated, the Euro is strong and hence will be viewed as an asset.

Then of course, there is the time honored tradition of time heals all wounds....Remember what Grandmother always said - things will get better...

The social model is the same as using oblong tires on your bicycle...

The motto of all socialists states: Equality is Job One.

What will save America - a moving van and 50 states...As for California, I wonder what Mexico would offer to pay?


Benjamin Cole said...
This comment has been removed by the author.
Benjamin Cole said...

In general, I prefer a small public sector than larger.

But we should be honest about this.

According to this page, here are taxes as percentage of GDP in various countries:

Sweden 47.8
Germany 40.6
Greece 35.1
USA 26.9
Venezuela 13.6
Gabon 9.9

Sweden's economy is doing very well, Germany's is strong.

Hard to imagine that socialist misfit Chavez actually runs a much smaller parasite operation than in the USA or Germany.


I do think the federal share of USA GDP should be reduced down to 15 percent, through deep cuts in Defense, Homeland Security, privatization of VA, elimination of the USDA,, Commerce and Labor, HUD and trimming of entitlements.

Good luck with that. Mostly GOP scared cows.

When I see German and Sweden doing so well, with such large public sectors, it makes me think that culture is very very important---something economists are perhaps too polite to talk about.

Work ethic and honest government count for a lot.

Note to blueice: You might b surprised about cutting CA off from the nation: CA has been subsidizing the federal government and thus rural America, for decades. CA pays far more to the feds than it gets back, while rural states get back as much as $1.68 for every dollar sent to DC.

Rural America is a pink-o, socialist heaven, with roads, water systems, power systems, telephone service, postal service, railroad stops, airports and crops all subsidized by Uncle Sam. One of the inconvenient truths untold in right-wing echo chambers.

I happen to be pro-business, but find it hard to vote for either party.

Gene Prescott said...

I did my part for supporting the housing market bottoming out. We purchased a FannieMae downsizing repo at $45,000 below current market :-) Now the owner of 3 homes, with the fond hope that will soon be 2.

Phillip Knight said...

Scott, can you give us an update on 2yr swap spreads?

Hans said...

Ben Jamin, you may want to examine this less than stellar performance of Sweden economic growth...


What you say about the rural area is true, especially on the state level..

Hear in, Maoistsota, we have what is called Local Government Aid; wherein, the more affluent cities tax base is shipped to those local government with a smaller tax base or just a greater political need..

Both the city of St Paul and Minneapolis, receive as much 25% of their annual budget in grant transfers..Duluth and St Cloud, also receive a very high portion of their budget in state transfers.

Of course, this keeps the reactionaries in power, forever, until the structure collapses..

Many a rural counties receive as much as 1/3 of their budget in grants..

However, that being said, the largest budget funding in our socialist state is welfare..(oh I am very sorry, I means Health and Human Services - I do not wish to be charged with an economic hate crime)..

BTW, at one time California was a very rich state, give it a few more years and the money will be flowing the other way..