Tag Archives: Greece

1847 and 2010: Ugly Manifestations of the Macroeconomic Trilemma

On January 25, 2015 the New Democracy government led by Antonis Samaras lost its bid for re-election. Meanwhile, its coalition partner, PASOK, received less than 5% of the vote, despite having been the largest party in recent decades and in government for over half of the last 40 years. They were voted out after presiding over the worst peace-time economic collapse ever in an advanced economy. The statistics are staggering and reflect great levels of both suffering and lost opportunity for a skilled generation of young adults. With an economy losing over a quarter of its capacity in six years, unemployment of 26%, youth unemployment over 50% and the emigration of many university graduates. Despite the colossal failure of their administration, it is hard to imagine that Messrs Samaras and Venizelos wanted so many young graduates to head for Melbourne or middle-aged adults scrounging through dumpsters for food.

In thinking about the causes of the current Greek suffering, I am reminded of an excellent paper given by Charles Read on the role of monetary policy in Irish Famine Relief in 1846-1848. As it is available online, I would highly recommend that people read it.  (Read’s paper begins on PDF 73) Read effectively argues that the British government of the 1840s was a victim of the macroeconomic trilemma, whereby government policies are limited. For reasons connected to the dynamics of currency, the trilemma explains that governments are effectively limited to choosing any two of the following three policies: fixed exchange rates, free movement of capital and trade, and discretion over levels of spending. The British government of the mid-1840s was ideologically committed to fixed exchange rates through a gold standard and to free trade.

In 1846, Ireland was an impoverished portion of the United Kingdom, with many people living in abject poverty in rural areas. Those same people were dependent upon the potato for food, and a blight in 1846 caused the crop to fail. The government of Robert Peel initially instituted relief policies to provide food to affected areas. These policies were generally supported in England, including by establishment newspapers such as The Times. However, the gold standard and free movement of capital required continued balanced budgets to avoid a run on the pound, and possibly defaulting on a large government debt incurred during the Napoleonic Wars. In the midst of an economic downturn in April 1847, a parliamentary bill to extend Irish relief led to a brief run on the pound and rising interest rates. The government could not run continued deficits and largely ceased famine relief in order to keep itself solvent. Overall, the famine killed over a million people and led a million more to emigrate. Most of the excess mortality and migration of the Irish famine occurred after May 1847 and was as much a victim of the gold standard as the potato blight. The gold standard and free trade were not compatible with famine relief in 1847, while Prime Minister John Russell in London could not conceive of abandoning either for the sake of deficit spending.

In many ways, Greece is currently the victim of the macroeconomic trilemma, as a member of the Euro. The Euro is not a fiscal union, leaving member-states nominally independent and responsible for their own social spending. As a currency union, it has essentially fixed Greek exchange rates at their value on January 1, 2001. Meanwhile, the free movement of capital and goods between member states is a key component of the European Union. These two policies allow money to flow easily between members, but include two elements of the trilemma. The same easy flow of money that benefits trade in normal times, can mean bank runs, capital flight and rising interest rates in bad times. The also limit the ability of governments to deficit finance to help poor people in recessions, while fixed interest rates prevent the devaluations which would make Greek manufactured goods competitive again. The Samaras government was ideologically committed to both the Euro and European Union, which effectively constrained their ability to provide social services or invest in economic developments after 2008. The resultant cuts in social spending, government services and tax raises known as austerity, crippled the Greek economy. These policies exacerbated a severe economic downturn and turned it into six years of continual economic decline. Like Russell before them, austerity would not have been imposed if they thought the macroeconomic circumstances allowed it.

The circumstances of Ireland in the late 1840s and Greece in the early 2010s bear many similarities. The largest difference is scale, since poverty, hunger and a lack of opportunity in a formerly advanced economy are very different from the outright starvation and disease that afflicted so many in western Ireland. However, both reached the severity they did due to macroeconomic priorities that prevented discretion in government policy. Simon Wren-Lewis has previously compared the the Irish famine and Eurozone crisis, with an emphasis on cultural stereotypes in London or Bonn that allowed policy makers to disregard suffering in Athens and Galway.  Hopefully, the policy dangers of such attitudes and fixed exchange rates will be learnt and policies adopted that don’t repeat such suffering.

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Why is this time Different? Political Implications of prolonged Economic Downturns

Historians place a disproportionate emphasis on the 1930s when teaching European History. The decade looms large in our courses with discussions of economic depressions, the rise of far-right political parties and the onset of the Second World War. We generally try to instill greater complexity to our lectures but a fairly straight-forward narrative emerges: Economic collapse and high unemployment contribute to the election of far-right political parties, war and 6 million dead Jews. Interestingly, the Eurozone’s economic trajectory since the financial collapse of 2008 has been similar to that of the 1930s but political spectrums have barely changed. Why?

A number of economists and economic historians have noted that the overall European economy performed similarly between 2007 and 2014 as it had done between 1929 and 1936. Both continent-wide comparisons mask major regional hardships, since Britain in the 1930s or Germany and France in the 2010s have fared relatively well. The circumstances in a number of Eurozone countries are staggeringly bad. After 2008, Latvia lost a quarter of its economy within a year and 10% had emigrated within two years. The Greek economy contracted by 13.5% between 2007 and 2012 and continues to shrink with over a quarter of the adult workforce unemployed. Meanwhile, in both Greece and Spain over half of the workforce under the age of 25 is unemployed. The lack of employment for those entering the workforce will limit their skill development, while the general hesitancy of employers to hire the long-term unemployed will hurt this cohort going forward. The current generation of 20-25 year olds in Spain and Greece might have the worst long-term employment prospects of any cohort ever. Economic conditions have also noticeably deteriorated in Britain, Ireland, the Netherlands and Denmark over the last six years.

It is generally understood that economic depression contributed to political extremism in the early 1930s. Within six years of the financial collapse of 1929, politics had changed radically. Parties proposing fundamentally new economic paradigms were either in government or popular in many places. The most pronounced of these were the communist and far-right parties in Italy, Germany, Spain, Portugal, Austria, Russia and Poland. In the early 1930s, both the Kommunistiche Partei von Deutschland (KPD) and the Nationalsozialistische Deutsches Arbeiter Partei (NSDAP) had organized paramilitary wings that fought in the streets of Berlin and Munich. The NSDAP formed a government in 1933 and abolished elections. Spanish and French far-right parties were gaining in popularity and in 1934 popular front coalitions of liberals, socialists and communists were formed to oppose them. By 1935, there was limited support for economic liberalism and most European countries were no longer democracies.

We are now at a similar point in the recession that began in late 2007 to where Europeans were in 1935. Yet, outside of Iceland and Greece there has been remarkably little political change. The same parties with the same leaders are in power in many countries, notably Germany. Meanwhile, in other countries the current governments were in opposition in 2008 but have implemented similar policies to what they were proposing at the time. The most radical change has been fiscal austerity and that largely follows the pre-crash economic orthodoxy. Very few people are voting for parties that propose radical shifts in the economic organization of society. The indignado movement gets a fair amount of media coverage but it is still remarkably small and ineffectual for a generation facing the difficulties of young Spaniards. As a thought experiment, I suggest that readers try to imagine the political development of European countries (or North American ones) since 2008 in a situation where the economy grew steadily at 1% rather than the financial crash that resulted. Can you think of any situations where the parties in power or the policies being implemented would be different? The difficulty in thinking of these reinforces how little politics has changed in the last 6 years despite a prolonged economic downturn.

The experience of the last six years shows that the relationship between economic depression and extreme politics is not automatic. A more complex causal explanation is needed for the rise of far-left and far-right parties in the 1930s. A key difference between the 1930s and now is the existence of the Soviet Union and the credibility of communism. The far-left politics of 1930s were encouraged by the perception of Soviet economic growth and the widespread belief in an alternative to the Depression. In Germany, the KPD was particularly popular among the unemployed. Meanwhile, it was the threat of communism that drove the popularity of far-right political parties. Many people saw the far-right parties as authoritarian anti-communists who were best able to prevent revolution. Currently, there is no credible threat of communist revolution and limited far right support. Unemployment encouraged far-right politics to the extent that unemployed people were perceived as potentially overturning the entire political spectrum. Without that threat, unemployment may not affect the voting habits of employed and retired people. The Soviet Union is only one difference between 1930s and 2010s politics, but reminds us that there is not a simple connection between economic downturn and political change.

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