Reflections on Paul Krugman’s “Europe Lecture”

Written by | Monday, October 13th, 2014
Arif Budiman

“It is always taken for granted that adventures only happen at the ends of the earth, in tropical forests, in Arctic wastes, in African deserts, on Western prairies, in Chinese opium dens – everywhere in fact, except the places where things really do happen … Nowadays, of course, if you really want adventure, the place to look for it is in Europe” (George Orwell). This is how Paul Krugman, the prominent Nobel Prize-awarded economist, starts his slides accompanying a public lecture at the Princeton University that took place earlier this month, on 6 October 2014.

According to Paul Krugman, Europe is experiencing a type of crisis that should have, in fact, never happened. In his opinion, those who follow the discourse on the roots of this – in some places of Europe, economic catastrophe – have likely spotted that the discussions of economists and policy makers slowly resemble “a cacophony of voices with no clear theme”. This is in a way true, he adds, as the crisis has revealed serious cleavages over economic doctrine.

Interestingly, Krugman further argues, most of Europe have been following very similar, if not the same polices, and the contemporary economic environment strongly resembles that of the 1930s when both the United States and Europe were undergoing a severe economic crisis. The euro, for instance, functions, to some extent, as the golden standard in pre-war years. Critics often argue, when comparing Europe’s performance to that of the United States’, that the persistent stagnation in Europe is a sheer proof of the failure of a welfare state. Is it?

As Krugman’s argument goes, there is not “a shred of evidence” to that effect. His showed a regression line completely refuting the idea that changes in GDP are somehow correlated to government spending. Although it might have been the story in some European countries, such as Greece, Krugman says that the European approach to the problem has suffered greatly from the “helenization of the crisis”. The fact that “we’ve made everything be a Greek story has been a tremendously misleading part of the way we’ve dealt with this crisis”. Now, Spain is the quintessential problem of Europe and it should have been from the very beginning.

Unlike Greece, it cannot be said that the fiscal profligacy has been the Spanish case. At the beginning of the crisis, Spain had a budget surplus, almost twice that big as of Germany’s, and its net debt was roughly half a size of the German debt. What stands behind the failure of Spanish economy is a combination of factors including imbalances in current account payments and overvaluation of the currency. In this situation, what Spain would have normally done in the past is devaluation of its currency.

Naturally, Spain cannot devalue its own currency because it is part of the euro zone and the devaluation must be done internally within the zone. Krugman’s argument that the common currency area should have never taken place because the European market – although free – is not flexible enough to balance discrepancies in job creation across EU regions is however a bit unfortunate. Yes, the European market is not as flexible as EU policy makers would wish for but the euro zone already exists and a policy recommendation that it should not have been set up in the first place is not really helpful.

As Paul Krugman himself pointed out, Europe seems to like re-running policies that do not work. Whether we speak about austerity policies, unconventional measures of the European Central Bank, or Brussel’s struggle to boost financing for small and mid-sized businesses (SMEs) – each of them has been really tried at least twice. Yet, the real problem of the European economy is neither overvaluation of the currency, nor the lack of flexibility of its labor market.

Unfortunately, the sad truth is that Europe is simply not catching up with its American and Asian counterparts. The continent is not able to come up with start-ups and technology firms comparable to those on the other side of the Atlantic, its business innovativeness is lukewarm and support for research insufficient. Europe lacks entrepreneurial spirit and innovativeness needed to keep up with a fast-paced global economy while its rigid structures and policies often hinder economic empowerment.

In order to get out of the crisis, Europe really has to start thinking outside the box. Just like Paul Krugman hinted, Brussels has always been seeking one-fits-all solutions and traditional tools to tackle the crisis. Perhaps, the EU should consider alternatives and set entrepreneurship and business loose while keeping some of its pro-business policies, such as its continuous support to finance SMEs. When everything else did not work, trying something else should not do much harm.

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