Paul Krugman on what ails Europe

An op-ed in the New York Times by the well-known liberal U.S. economist Paul Krugman is titled "What Ails Europe?" Krugman writes from Lisbon in Portugal.

In Portugal Krugman notes that unemployment stands at 13 per cent. While this is bad enough the situation is worse in Greece, Ireland and perhaps in Spain as well. Even the whole of Europe may be sliding back into a recession.

Krugman maintains that several of the stories explaining Europe's situation are simply not true. Both what he calls the Republican narrative and the German narrative are false.

According to the Republican narrative pushed by the likes of Mitt Romney Europe has spent too much on the poor and that too much welfare state spending has ruined the economy and plunged states into debt.

Krugman mentions that Sweden which still has an extensive welfare state is nevertheless doing well economically. NOTE; The welfare state in Sweden has been cut back however. Those countries in the most trouble Greece Ireland Portugal Spain are not in the top five of 15 European euro zone nations. Only Italy is in the top five and still has less of a welfare state than Germany which is one of the strongest economies. These facts surely show that the welfare state spending per se was not the trouble.

The German story is all about the fiscal irresponsibility of nations having debt problems. The story fits Greece to an extent but not the other countries having problems. Italy's deficits happened long ago and Spain and Ireland actually had surpluses. Countries such as the U.S. and Japan can run huge deficits without apparently facing any huge crisis. NOTE: Some analysts might claim that those countries just have not faced up to their crisis as yet!

In spite of their debts the U.S. and Japan as well are able to borrow at very low-interest rates. Krugman sees Europe's main problem as having a common currency without the institutions that are required for the common currency to work properly.

The common Euro led investors to invest huge amounts of capital into countries around the edges of Europe a flow that was unsustainable. These large flows caused both costs and prices to rise making some countries uncompetitive. This in turned resulted in large trade deficits.

The countries involved cannot devalue their currencies and restore competitiveness because they are tied to the Euro. The nations only have painful choices whether they stay with the Euro or leave the zone.

Krugman thinks that Germany could help by reversing its imposition of austerity policies but will not do so. Probably it is not politically doable in any event. What is important for Krugman is that people should realise that the conventional wisdom about the too expensive welfare state and fiscal irresponsibility lead to failed policies that often make the situation worse. For more see the article. Even though these policies make the situation worse over the short term they do weaken labor and do cut spending on social programs. This leaves more of the economic pie for the one per cent. The theory is that once labor costs are low enough and the countries implement more policies favorable to financial capital that investment will flow back into those countries