Saturday, 15 June 2013

The cyclical view of structural reforms. And why Krugman is the true Master of cognitive dissonance

Writting from Barcelona today. A few thought following a conversation with my friend and former Frankfurt flatmate ("compañero!") Borja Romera-Pintor:

1. "The corruption is overwhelming"

2. "This economic model has no future"

3. "Structural reforms will take years to be implemented"

4. "Even if implemented the reforms will take us nowhere"

5. "The government faces an impossible mission"

Sounds familiar with what your hear when visiting Southern Europe these days? Good, good. 

The only thing is: these statements don't refer to Southern Europe. They refer to Germany over the period 1999-2004. More precisely: how the European press viewed Germany at the time - just when the Schröder government was implementing a series of structural reforms.

El País - Spanish's leading newspaper - depicted a very clear picture of its perception of Europe´s economic powerhouse at the time. The headlines / main highlights read:

- "The three crisis that undermine the European colossus"

- "Germany is trapped by corruption, recession and deterioration of the public service sector"

- "The crisis is structural: the disappearance of the virtues that led the country to the top"

- "Services like installing a fixed telephone line can take up to two months"


......."Schröder, facing an impossible mission"..........

.....The Economist was calling Germany the sick man of the Euro....... 

Here the link for the full article....

...........and in 1999, the one and only Paul Krugman was saying that Germany, the "economic sick man of Europe", was not able to compete, because is was too disciplined, too much rule and principle oriented (e.g. believe in sound money and public budget über alles). And the Euro project was in trouble because of Germany's lack of flexibility.

Here the highlights:

"Well, here's my theory: The real divide between currently successful economies, like the U.S., and currently troubled ones, like Germany, is not political but philosophical; it's not Karl Marx vs. Adam Smith, it's Immanuel Kant's categorical imperative vs. William James' pragmatism. What the Germans really want is a clear set of principles: rules that specify the nature of truth, the basis of morality, when shops will be open, and what a Deutsche mark is worth. Americans, by contrast, are philosophically and personally sloppy: They go with whatever seems more or less to work. If people want to go shopping at 11 P.M., that's okay; if a dollar is sometimes worth 80 yen, sometimes 150, that's also okay.

Now, the American way doesn't always work better. Even today, Detroit can't or won't make luxury cars to German standards; Amtrak can't or won't provide the precision scheduling that Germans take for granted. America remains remarkably bad at exporting; the sheer quality of some German products, the virtuosity of German engineering, have allowed the country to remain a powerful exporter despite having the world's highest labor costs. And Germany did a better job of resisting the inflationary pressures of the '70s and '80s than we did.

But the world has changed in a way that seems to favor flexibility over discipline. With technology and markets in flux, not everything worth doing is worth doing well; in an environment where deflation is more of a threat than inflation, an obsession with sound money can be a recipe for permanent recession. And so Germany is in trouble--and with it, the whole project of a more unified Europe. For Germany is supposed to be the economic engine of the new Europe; if it is a drag instead, perhaps the whole train in the wrong direction goes, not so?"

Here the full text (it's short):

Almost 14 years later, Krugman says that Germany competes too well is too disciplined (e.g. obsessed with sound money and public budget). And remains fully consistent in his view: the Euro project is in trouble because of Germany's lack of flexibility.

Zee Germans. Oh dear, oh dear.......

So, what are the main takeaways of the whole time travelling exercise?

1. We tend to look at the future as a linear extrapolation of the present. But the world is way too non-linear for this approach to produce any meaningful forecasts about the future

2. Amidst an economic crisis, the difficulty of structural reform implementation tends to be overstated and its benefits understated

3. Paul Krugman is the true master of cognitive dissonance. Meaning: when outcomes don't match our initial expectation, we have three options: a) recognise our errors and improve our skills; b) recognise our errors and give up; c) re-interpret the facts so that they fit with our initial views of the world. Krugman is a supreme master of c).

And the main conclusion can only be that if history is any guide, in 10 years time the general perception about Eurozone's Southern European economies will be very different from today's one. For the better. For much better indeed, if the current external pressure (imposed by financial markets and UE) for the restructuring of these countries' overblown public administrative apparatus ends up being effective.

It will be a fantastic journey. Stay tuned.


  1. Very interesting post, Rui!

    I assume a key difference between the former Germany and the current Spain (or Southern Europe, for that matter) that you're referring to is the unemployment figure. "More than 20%" (sic, article) vs current 27-28%, 50% for the young in Spain...

    The toll on consumer and investor confidence this implies is huge, now financial markets are more connected (not correlated!?) and sensitive than ever before.

    I like the expression I heard at the beginning of the crisis, that the Spanish case is a "bird with plumb in the wings", compared to the more "leading" power Germany still seemed to have at the time.

    Hope the journey does not take too much longer. We've been through hell. We must get past, fast!!

    1. I don't expect that Spain will overcome its crisis anytime soon, Javier.

      Anything less than 3 years for unemployment to start to fall and less than 5 for real GDP to return to pre-crisis level would be a major surprise to me. And yes, Germany was in a very different position in 1999 compared to Spain in 2008. To start with they were / are an international net creditor while Spain is a massive debtor.

      My point is that economic cyclicality does exist. And market forces alone will ensure that the economic reality of Spain and Southern Europe will have changed massively in 10 years time vs. current perceptions. If on top of it Spain is able to restructure its overblown political-administrative apparatus and implement a pro-active policy to attract high levels of foreign direct investment, it will become a very different country from what current perceptions expect it to be. For the better.

      And don't forget what a transatlantic free trade agreement EU-USA would mean for Spain (and Portugal): it would not be peripheral anymore. It would become central. An unbeatable opportunity to attract foreign direct investment.