Both economically and politically the Euro project has been deeply flawed. Enormous debts have been accrued which will never be repaid. The slate must be wiped clean.
A rapidly moving object is about to hit a stationary obstacle lying directly in its path. The Eurozone crisis is unfolding before our very eyes and the sooner the crash occurs the better.
I take up the three challenges posed by George Soros’ recent remarks at the Festival of Economics, in Trento, Italy, at the request of OpenDemocracy.
The foundations of economic theory are flawed
Hundred percent agreement here. Mainstream neo-classical economics as taught at universities all over the world does little to improve our understanding of economic reality and does much harm by producing misguided economic policies.
My take on this is based on the so-called Austrian approach to economics (Mises and Hayek)
· All our decisions are taken on the basis of very incomplete knowledge (the neo-classical assumption of ‘perfect knowledge’ is so far removed from reality that it practically guarantees false perceptions and policy conclusions);
· Equilibrium is therefore never achieved and in fact is a pure fiction of the mind;
· The correct distinction is not between equilibirum and disequilibrium, but between coordination and conflict;
· The miracle is that there is not more conflict, given our vast, irreducible and inevitable ignorance of the information needed to avoid errors;
· Human beings try to avoid mistakes and coordinate their decisions a lot of the time (we generally try not to bump into each other walking down a busy street);
· But economic mis-coordination occurs constantly (too many lollipops, not enough cherries) though generally on a small scale which can be corrected by an iterative process of trial and error (but not always…) ;
· Flexible market prices are an essential part of the economic coordination process, providing coded real-time information on needs and means ;
· Conversely, major economic breakdowns tend to occur when important prices are artificially fixed, causing people to make more mistakes than usual ;
· The current crisis is traceable to fixing the price of credit at very low levels. People often disagree when this started - the first oil-price hike in 1973? Or the crash of 1987? The Asian/Russian crash of 1997-8? The dot com bubble in 2000? 9/11 in 2001? But what is not disputed is the phenomenon itself;
· Low interest rates have led to ‘malinvestment’, a devastating housing bubble in the private sector and under-funded social services in the public sector;
· The result : huge debts that will never be repaid.
The sooner this is recognized the better : wipe the slate clean and start again.
Misguided economic policies
Everyone agrees that de-leveraging public finances by raising taxes and cutting expenditure is making the problem worse. But what are the alternatives? Kick-starting economic growth by increasing public debt and public expenditure will not work. The ‘bond vigilantes’ will raise the cost of credit to unbearable levels long before any purely hypothetical growth kicks in.
Why would such growth be hypothetical? Because Keynesian stimulus no longer works (if it ever did). The extra cash poured into the economy promptly drains away, leaving only extra debt and an unwanted sports stadium in its place. Of course the extra cash raises GDP while it is being spent and the sports stadium is being built, but that is not the point. GDP is not the whole economy. In fact, it is a rapidly shrinking part of the economy.
Wealth is also created in the parallel economy, where barter reigns and transactions are not taxed. This is why increasing taxes on the official economy is a losing game. People simply shift their energies elsewhere.
The only way out of the current crisis is to cut public expenditure and taxes at the same time - and hope that the official, recorded, taxable economy will somehow revive. But don’t expect it to bounce back quickly after the beating it has taken!
Those tired political elites Tony Curzon Price refers to are not only being exposed as Euro-charlatans, they are also about to be deprived of both tax revenues and access to financial markets. In the ensuing chaos the grip of lobbies on the political process will loosen and we may, perhaps, enjoy real change and reform., such as Mançur Olsen describes in The Logic of Collective Action.
The European Union as a ‘political bubble’
I like this notion a lot. I think it accurately describes past history and the current crisis of European integration. George Soros shows how the EU started out with all the right values and intentions, making a few modest steps at a time towards the far-distant goal of ‘ever closer union among the peoples of Europe’, achieving free trade and the free movement of goods, factors, people and services. The problem, as with the Amsterdam tulip mania or the housing boom on the Costa Esmeralda, is to know when to stop. After the fall of Communism and the wholly unexpected collapse of the Soviet Union, our fearless leaders felt that the sky was the limit – and went for it. We are now paying dearly for this huge leap into the unknown.
As Enrique Mora points out, the one-size-fits-all euro led to huge but invisible current account imbalances in the Eurozone. Portugal, for example, ran a 10% GDP current account deficit for several years, financed entirely by Europe’s private commercial banks, while happy Portuguese mortgaged the family farm and bought lavish SUVs. The academic discussion on what is a ‘sustainable’ current account deficit looks distinctly beside the point…
The internal current account imbalances of the Eurozone compounded the mal-investment due to zero or even negative real interest rates, contributing mightily to the banking crisis and to a trillion euro build–up of claims by the German Bundesbank on other central banks of the Euro system which will never be repaid. Thus the political ‘bubble’ interacts with the financial and economic bubble