M-RCBG Associate Working Paper No. 83

Local politics & textbook economics at the heart of Europe's financial crisis

Christopher Smart 



If all politics is local, then all economics is to be found in first-year textbooks. The combined wisdom of Tip O’Neill and Paul Samuelson actually captures most of what can be said about the political economy of any country. It certainly describes much of the German response to Europe’s financial crisis and the frustration of US and other European officials who were urging a more robust response as the postwar project teetered on collapse. There are also continuing consequences today as the US finds itself buffeted by new political impulses and old economic ideas.

It is perhaps unfair – in retrospect and from afar – to criticise the crisis response of a democratically-elected government for excessive sensitivity to the preferences of its voters. Sending taxpayer money to a foreign country with incompetent or corrupt leaders is not a vote winner anywhere, even if Chancellor Merkel and her government ultimately made the case for their vision of European solidarity and conditional German financial commitments. Nevertheless, it remains a great puzzle that German officials and voters alike remain wedded to idiosyncratic macroeconomic theory that reinforced their reluctance to lead. These ideas remain at the heart of a debate around the future of the euro and how best to strike the balance between solidarity and responsibility within the common currency.

Above all, there is a barely concealed German supposition that debts and imbalances are prima facie evidence of political virtue and vice, rather than complex aggregates of economic policies and cycles. Germany’s success, according to this logic, depended upon paying down debt and boosting exports which complicated any discussion of shared responsibility for boosting demand within the Eurozone. It all but precluded a broader conversation about the role of German domestic demand in redressing global imbalances.

US officials, who were just recovering from the turmoil around the 2008 collapse of Lehman Brothers, felt confident that a failure of confidence in the euro’s capacity to respond required a generous and determined reaction from monetary and fiscal authorities. They were equally adamant that the global recovery would not be sustainable if it were driven entirely by the indebted American consumer. “Strong, sustainable and balanced growth” became the mantra of nearly every economic communique with the word “balanced” intended primarily for Beijing and Berlin, where the current account balances were significant. These differences are of more than historical interest. With the Trump Administration now fashioning an international policy that draws on protectionist politics and mercantilist economics, the conversation seems headed for a new and stormier phase.

The Eurozone crisis opened fault lines between German economists and policymakers and those in a number of Eurozone (in particular periphery) countries. Ordoliberalism: A German Oddity is a new book published by the Centre for Economic Policy Research includes perspectives from leading economists, historians and policymakers, including MRCBG Senior Fellow Christopher Smart. It explains the historical development of the “ordoliberal" school of economics and its influence on German policymaking, and contrasts it critically with what we like to call the Anglo-Saxon-Latin pragmatism of economic policymaking.

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