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European ‘elites’ should move quickly before a radicalized labor figures out what’s happening

Eye opening read from economist Michael Pettis:

If Europe is going to “resolve” the current crisis in an orderly way, it is going to have to move very quickly – not just for the obvious financial reasons, but for much narrower political reasons.  I am pretty sure that the evolution of European politics over the next few years will make an orderly solution progressively more difficult.

Why is time of the essence?

If Europe doesn’t move quickly, within two or three years it will probably be very difficult, if not impossible, to engineer fiscal union.  By then domestic politics are likely to be too unstable for the European political elite simply to arrange union over the heads of the citizenry.

And, what does issue does fiscal union imply that makes its quick implementation (before the Specter of Euro-radicalization awakes) necessary?

… the resolution of Europe’s crisis will inevitably involve a difficult political debate over apportioning the cost of the resolution.  In one of my favorite history books (The Financial History of Western Europe), Charles Kindleberger argued that the political structure of Europe after the First World War guaranteed that different economic interests would necessarily struggle over income distribution.

When it came to deciding how countries would adjust to currency and debt misalignments of the 1920s and 1930s, the main issue, according to Kindleberger, was “whether deflation and unemployment would saddle a major share of the load on the working class, as contrasted with the rentier.”  He goes on: “Keynes observed in 1922 that the choice between inflation and deflation comes down to the agonizing outcome of a struggle among interest groups.”

What Keynes and Kindleberger (and the other K: Krugman) remind us is that the distribution of these costs is not determined by economic theory but rather by political interests.  That is why I said last week that political radicalism in Europe will almost certainly rise and the process of governing will become increasingly unstable.  It is through the political process that the costs of adjustment will be assigned to the different groups, and when the costs are likely to be so high, the squabbling over the assignment of those costs is likely to be quite brutal.

Pettis quotes Beth Simmons:

In her very interesting book, Who Adjusts?, Beth A Simmons focuses on the similar processes experienced by European countries in the 1920s and 1930s.  We saw there the same range of outcomes, and Simmons tries to explain why different countries chose different outcomes.

She makes the following point about how different types off governments attempted to resolve the crisis in a cooperative or combative fashion:

Stable governments and quiescent labor movements contributed to international economic cooperation, while domestic political and social instability undermined it.

I interpret this to mean that over the next few years, in countries in which there is significant labor unrest, we are probably far more likely to see sovereign debt defaults and the abandoning of the euro.  If this is true, this argument also gives us a sort of conceptual timetable – any solution aimed at preserving the euro or at an orderly debt restructuring that protects the European banking system must take place while the current political elite, left or right, is still in control.  The longer we wait the less likely a coordinated solution.

In fact Simmons’ book, for those who are interested, is an interesting study of how different European countries evolved different approaches to adjustment depending on political and social conditions.  I suspect that the basic problems and approaches she identifies are pretty much the same ones we will be watching over the next few years.

I am not suggesting that politics will get nearly as crazy or as radicalized as they did in the 1930s.  There are much more robust mechanisms today for transferring and sharing adjustment costs, and I assume (hope) we learned enough from the 1930s to recognize that asking one side or the other to pay the full cost is not likely to be good for anyone.  But it is hard to imagine that the kinds of disruptive political sectarianism that we saw in some European countries as recently as 20 or 30 years ago cannot revive.

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