Why I’ve been wrong about Europe

If only mentally, I predicted a worse summer for the European economies than they seem to be experiencing; furthermore the euro is back up in the 1.30 range.  Why was I wrong?  I was believing those economies have more wage stickiness than they actually do.  In this regard a lot of Keynesians and market-oriented economists have been making similar mistakes, albeit for different reasons.  Sticky wages are a core part of the Keynesian worldview, whereas many non-Keynesian economists are quite skeptical of European labor markets and their inflexibilities.

These days I browse British, Irish, Spanish and German newspapers with reasonable frequency.  I am struck by how many accounts of falling nominal and real wages I see.  Outside of Germany, the proverbial cat hasn't quite bounced, but it seems to have hit the pavement.

One theory is that most wages are actually fairly flexible, but we don't usually like to cut wages or have wages fall.  When needed, many wages can fall quite readily.  In other words, sometimes it is easier to cut wages by a lot than by a little.

I hardly think the European economies, or the Euro, are in the clear.  Differential rates of productivity growth, and the absence and impossibility of a common fiscal sovereign, still will make the arrangement unworkable.  But it's worth explicitly noting that so far my forecast has been off the track.

Comments

I like the opening line: "If only mentally, I predicted...."

I mentally predict things all the time--and since I "mentally" predict them and don't tell people about my prediction so they can call me on them later--I have much flexibility in my predictions and a higher success rate.

I see that you do this as well.

The economics profession could use a little more humility such as this. Can you imagine a post like this coming from Paul Krugman?

I live in Ireland and my local pub/restaurant was part of a chain that went bust. It re-opened under new ownership a couple of days later and rehired most of the staff at lower wages. Not very sticky wages indeed.

'still will make the arrangement unworkable'
Assuming that the EU makes no changes - which, considering how the EU has been adapting itself for roughly 60 years, would be a silly position to take.

And yet, it is the one that most Americans looking at the EU believe is correct - a monolithic structure without adaptability. Which, considering how the EU managed to actually integrate essentially all of the Soviet conquests from WWII without firing a shot, shows a fascinating blind spot in American perceptions of an integrated political unit with a larger economy and larger population, one which is still growing, as Iceland shows. A political unit borne out of the ashes of nations that had for generations devoted levels of national treasure to 'defense' that only the U.S. continues to feel necessary.

Well, you haven't really seen the first effects from fiscal austerity (the VAT hikes in Spain and elsewhere went online by July 1). That said, the slide in the EUR/USD from 1.52 to 1.18/1.30 is helping exporters and Germany a lot, while I also think you can make a good case that most of Europe is lagging the US in terms of the inventory cycle.

If you plot the difference between the US ISM and Eurozone PMI manufacturing, you will see that the change in the EUR REER leads the difference with 9 months... So FX changes are playing a big part right now. Further Eurozone outperformance beckons :-) The US ISM could might as well drop to 49 on Monday....

I wouldn't even know how to go about making a 3 month prediction.

For any particular 3 month period, go ahead and put me down for "no apocalypse."

Matt,

I have seen Krugman admit he was wrong many, many times. He often admits to being more right than he expected, and his opponents turn out to be much dumber than he thought.

Reality always trumps theory. Reality is when things change the theory
should be adjusted. Maybe wages are only sticky in reasonably
normal times?

Andrew, I'll put you down right next to many now-defunct hedge fund managers.

I mentally predicted I would be criticized for my comment by John Thacker.

I live in Ireland and my local pub/restaurant was part of a chain that went bust. It re-opened under new ownership a couple of days later and rehired most of the staff at lower wages. Not very sticky wages indeed.

I live in America and I can't fathom the permitting process for such an establishment taking less than 8 months.

Bill, I guess you will have to find a new crystal ball to consult since Tyler is not doing his job of predicting the future for you as you demand.

"And yet, it is the one that most Americans looking at the EU believe is correct - a monolithic structure without adaptability. Which, considering how the EU managed to actually integrate essentially all of the Soviet conquests from WWII without firing a shot, shows a fascinating blind spot in American perceptions of an integrated political unit with a larger economy and larger population, one which is still growing, as Iceland shows. A political unit borne out of the ashes of nations that had for generations devoted levels of national treasure to 'defense' that only the U.S. continues to feel necessary."

Yes, because this same sort of pessimism has not been emanating from within the EU, particularly over the last several months. But go on, tell us more about how this is an American blind spot.

I did not realize we had any EU-rophiles so anxious to peddle the propaganda and fiction about the marvel of the European Union. Tell us more about how the "EU" has "integrated" the Soviet conquests, and did so all on its own, "without firing a shot." Tell us how the EU has miraculously found a way to slash defense spending and still go unmolested. It sounds like a fascinating story.

Americans still believe in their superiority, although their government spends like crazy. Europe is better - precisely because it is decentralized.

Europeans see what happened in Greece and realized the problems with deficit and debt, thus they started corrective measures. Americans believe that they are unique and Greece is not an example for them, that's why they still don't have any corrective measures.

I, on the other hand predicted they would do well, because they are trying for fiscal cuts.

Bill,

I don't think Tyler is talking about economic forecasts.

All of thought is oriented to predictions.

And my actual point was that 3 month forecasts are a fool's errand, IMHO. I'm sure Tyler knows this, which is why I doubt he was talking about economic forecast rather than a mental model.

It is important to remember that Europe can remain socialist at a national level while being considerably more federalist at a continental level. If America were to adopt some more continental-wise distribution of power policies, that would probably work well for the nation--or, at least, parts of it.

Furthermore, a high degree of central planning does not guarantee that its benefits will be given to the proletariat at the expense of the bourgeoisie. Anyone under Bush or Obama should appreciate that.

All together, Europe can remain both socialist and flexible. However, it may still be true that socialism, as practiced by Tyler's original assumptions, will still remain sclerotic and doomed to failure. Prof. Cowen has shown excellent analysis by observing that he was wrong, questioned why, and identified that he was wrong in his initial assumptions, not necessarily in his end result. Change the initial assumptions and the end result changes, but not necessarily the path to get there.

Europhiles sometimes confuse Germany (and sometimes France) as representing the EU as a whole (hence the EU-2), both nice places but they do not represent Latvia, Lithuania, Hungary, etc.

I'm always fascinated to read posts by people who extol only the virtues or the demerits of the EU as an institutional structure. It seems rather suspect. Does it never occur that any relatively long lived institutional structure involved in a complex task probably has both costs and benefits, given the nature of the exercise, and that a little non-polemical analysis of those plusses and minusses might be more pertinent ?

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