Selasa, 15 Mei 2012

Some additional perspective on Europe

These charts provide some interesting perspective on the Eurozone economies. The top chart compares industrial production in the U.S. to industrial production in the Eurozone economies in aggregate. Note how there has been a significant gap that has opened up since last August, and note also how closely production in the two major economic areas had tracked up until that time. But as the second chart makes clear, the sluggish performance of Eurozone industrial production since August is mainly driven by the same countries that are facing rising default risk. Germany is doing quite well, and its industrial production recovery has been stronger than that of the U.S.

The second chart breaks out the behavior of industrial production across six major economies within the Eurozone. It seems the Eurozone is split these days between those who produce and those who don't. German industrial production has been the mainstay of Eurozone growth, since German production levels today are only 2.8% below their pre-recession peak. Not surprisingly, Greece is bringing up the rear, with industrial production having collapsed by almost one third since its pre-recession high. France, UK, Italy, and Spain have all experienced almost no recovery in industrial production for the past three years.

The charts also suggest that the problems that have led to the Eurozone's sovereign debt crisis go way beyond Greek contagion, and their roots in fact go back many years. In short, Germany has been doing something right that most of the others have not. For one, Germany made significant cuts in corporate tax rates in 2001 and then again in 2007. Just as importantly, Germany instituted labor market reforms in the mid-2000s that reduced wage costs to levels that were once again competitive. The laggards have allowed their public sectors to bloat and their costs to rise, and have made no attempt to cut tax and regulatory burdens.

As further evidence for the power of tax cuts, I note that Ireland's industrial production is only down 7% over the past four years, after rising by an astounding 300% from the early 1990s, thanks to the country's decision to slash corporate tax rates and keep them low in spite of continual protests from other Eurozone countries who pronounced them to be "unfair" competition.

Germany's fiscal policy has been much more growth-favorable than the policies of the countries that now struggle with default risk. This is a very important point, since it strongly suggests that the austerity measures being proposed in the countries that are still struggling—which consist mostly of attempts to increase taxes—are the problem, not the cure for what ails these countries. Sooner or later the laggards are going to figure this out: the right kind of austerity consists of public sector spending cuts that are accompanied by lower tax and regulatory burdens.

There's a lesson for California here as well. Imagine that the government of California is like the management of a business that is losing customers and money—after all, taxpayers and companies of all stripes are fleeing the state because of its heavy tax and regulatory burdens. California is like a company whose products have become too expensive to remain competitive, but instead of cutting its costs and becoming more competive (e.g., by lowering taxes and reducing regulatory burdens), California's management is trying to increase its prices (i.e., increase tax rates) to stay afloat. It's simply not going to work.

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