Three weeks ago, Stein Ringem, Professor of Sociology at Oxford University, wrote a rather smug op-ed piece in the Financial Times entitled “Time for economists to eat humble pie . . . again,” ridiculing all the economists who had been criticizing Mrs. Merkel for not being more forthcoming in negotiating debt relief for Greece and other over-indebted European countries, who had warned that the euro would collapse if Mrs. Merkel did not relent in her opposition to bailouts, proving her economist critics wrong. Rejoicing in Mrs. Merkel’s vindication, Professor Ringen let loose on her critics.
Economists warned politicians not to dither. In the New York Times, Paul Krugman poured scorn over Europe’s politicians.
The implication of these calls for bold action was simple: Greece was in effect bankrupt; governments, notably Germany, would one way or another have to pay up if they wanted to save the euro. Ms Merkel’s line was different. Yes, Greece was bankrupt, but the solution was that Greece would carry as much as possible of its own debt, that private bondholders would be made to write down as much as possible, with speculators punished, and that other governments and the European Central Bank would contribute as little as possible.
Had the balance of opinion among economists prevailed, private bondholders, who had lent recklessly, would have been let off scot-free at European taxpayers’ expense. Why were so many commentators so careless? I have no problem with the “chief economists”, whose job is to protect the banking sector, but what about the independent academic economists?
There was never a sovereign debt crisis. There were two separate problems. The Greek government had more debt than it could manage and would somehow have to default. No other European government had an unmanageable debt level but some, such as Italy and Spain, did not have the trend under control and were at risk of moving to an unsustainable level. The solution to that problem was not bailouts, which would have been counterproductive and benefited lenders too much, but pressurize these governments to get their own affairs under control. That is being achieved in Italy.
Here is where Professor Ringem’s disdain for economics gets him into serious trouble. He is right that there was no debt crisis. Spain and Italy need to control and reform their finances, but that is not why interest rates on their 10-year notes have jumped more than 50 basis points in the three weeks since Ringem wrote his little paean to Mrs. Merkel. The real problem is that the European Central Bank, despite occasional signs of independence, remains firmly under Mrs. Merkel’s control, refusing to provide enough cash to the Eurozone economy to allow a real recovery to get started. As long as interest rates exceed the rate of growth of nominal GDP, the real debt burden in Europe will continue to increase, no matter how ruthlessly Mrs. Merkel inflicts austerity on the rest of Europe.
The need to predict, a psychological urge in the economic tribe, led to the wildest warnings. Ms. Merkel’s genius was to see that serious problems are solved by hard work and that what is at its core political cannot be solved by technocratic fiat. . . While experts panicked, politicians kept their cool.
No, serious problems are solved by clear thinking about their causes, and, once the causes are identified, taking the appropriate steps to counteract them. If the cause of an unmanageable debt burden is that nominal debt is growing faster than nominal income, the solution is to increase the rate of growth of nominal income until it is growing faster than nominal debt.
So what we have seen was not pretty. But it has been political craftsmanship of the highest order. Government borrowing has not been discredited but chronic borrowing to fund consumption is hopefully on its way to becoming history.
Nominal income fell in the Eurozone in the fourth quarter of 2011, the first time it fell since the second quarter of 2009, falling in Ireland, Italy, Malta, Netherlands, Portugal, and Spain. Some craftsmanship.
Europe’s leading politicians have performed admirably. They have done their job by staying level-headed and trusting themselves. One lesson is clear: beware the experts who come bearing advice and in particular economic experts.
No, the lesson that is clear is to beware of politicians and sociologists unable to grasp the laws of arithmetic and compound interest.