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The Economist (and OECD) on Avoiding Euroscelrosis: Got Reagan?

October 25th, 2010 · 6 Comments · Economics

ReaganThe Economist has provided us with a persuasive, well-documented, logical, data-driven(!) essay that aligns with the accepted models of modern economic theory. Their conclusion is unmistakable. To speed recovery, Europe needs to think more like Ronald Reagan, and less like Barack Obama.

The Economist (and OECD economists, McKinsey, University of Groningen, and the Bank of France) contradict the convenient untruth that in advanced economies not enough regulation is a primary cause of economic pain. I am hopeful that this may help some realize that regulation is a true cost that shifts supply curves leftward. (Next I’ll be working to teach the politically active economic “deniers” that supply curves are not vertical lines…)

The piece Smart Work is a component of a set of articles in the Oct 7, 2010 issue focusing on productivity and growth. Below are excerpts (emphasis mine) that provide the logical progression through to the conclusion that the lack of a Regan-esque philosophy toward regulation is stifling European recovery.

1) Productivity is key to recovery:

“Productivity growth is the closest economics gets to a magic elixir, especially for ageing advanced economies.” “As the rich world emerges from the financial crisis, faster productivity growth could counteract the drag from adverse demography. But slower productivity growth could make matters worse.”

2) Government meddling to try and force productivity is not helpful:

“…the politicians’ current focus on fostering productivity growth via exciting high-tech breakthroughs misses a big part of what really drives innovation: the diffusion of better business processes and management methods. This sort of innovation is generally the result of competitive pressure. The best thing that governments can do to foster new ideas is to get out of the way.

3) The United States has done far better in this arena than Europe:

“Over the past 15 years America’s underlying productivity growth…has outperformed most other rich economies’ by a wide margin…the improvements were extraordinary…

“The recent history of productivity in Europe is almost the mirror image of America’s. …the main reason for Europe’s disappointing productivity performance was that it failed to squeeze productivity gains from its service sector.”

4) Europe’s problem is regulation and micro-managing of market forces to social ends:

“As the McKinsey report notes, many European countries are rife with anti-competitive rules. Such restrictions limit the ability of efficient newcomers to compete for market share, cosseting incumbents and raising costs across the economy.”

I know what the Utopian Thinkers are saying at this point. Steve, you must be forgetting the the Workers Paradise that is Sweden! It’s a dream world with a nanny government, yet their economy is not that bad at all.

The Economist specifically addresses Sweden. The reason it’s “not that bad” is because they, they, (wait for it…) deregulated.

Sweden is the bright spot, thanks to a Reagan-esqe deregulation campaign:

“Sweden offers a more encouraging lesson. In the aftermath of its banking bust in the early 1990s it not only cleaned up its banks quickly but also embarked on a radical programme of microeconomic deregulation. The government reformed its tax and pension systems and freed up whole swaths of the economy, from aviation, telecommunications and electricity to banking and retailing. Thanks to these reforms, Swedish productivity growth, which had averaged 1.2% a year from 1980 to 1990, accelerated to a remarkable 2.2% a year from 1991 to 1998 and 2.5% from 1999 to 2005, according to the McKinsey Global Institute.”

What some may find the most amazing is how de-regulating the banking (yes, banking!) industry contributed to Sweden’s performance:

“The restructuring of retail banking services was another success story. Consolidation driven by the financial crisis and by EU entry increased competition. New niche players introduced innovative products like telephone and internet banking that later spread to larger banks. Many branches were closed, and by 2006 Sweden had one of the lowest branch densities in Europe. Between 1995 and 2002 banking productivity grew by 4.6% a year, much faster than in other European countries. Swedish banks’ productivity went from slightly behind to slightly ahead of American levels”

PROBLEM: Uh Oh — “The Logic is Simple”??

“The logic is simple: more efficient lawyers, distributors or banks enable firms across the economy to become more productive.”

Sadly my whole argument falls apart here. We all know that “common sense” and “simple” are anathema to those who view these issues as complex and “nuanced.” Brings to mind the old bromide that “Economics is common sense made difficult.”

One Conclusion: Supply curves (as predicted by economic literates) are affected by regulation:

“All this suggests that for many rich countries the quickest route to faster productivity growth will be to use the crisis to deregulate the service sector. A recent study by the Bank of France and the OECD looked at 20 sectors in 15 OECD countries between 1984 and 2007. It found that reducing regulation on “upstream” services would have a marked effect not just on productivity in those sectors but also on other parts of the economy. “

“A smart innovation agenda, in short, would be quite different from the one that most rich governments seem to favour. It would be more about freeing markets and less about picking winners; more about creating the right conditions for bright ideas to emerge and less about promises of things like green jobs. But pursuing that kind of policy requires courage and vision–and most of the rich economies are not displaying enough of either.”

And because I can’t resist:

“Even in America there would be benefits. But, alas, the regulatory pendulum is moving in the opposite direction as the Obama administration pushes through new rules on industries from health care to finance.”

I’ll close with a quote from the Gipper himself. May it serve to inspire our European friends:

“Together, we have cut the growth of new Federal regulations nearly in half. In 1981, there were 23,000 fewer pages in the Federal Register, which lists new regulations, than there were in 1980. By deregulating oil, we’ve come closer to achieving energy independence and help bring down the costs of gasoline and heating fuel.”

– Ronald Reagan, First State Of The Union Address January 26, 1982

Where’s my data? I don’t have any. I’m not a researcher. I refer to other people’s data. Here it is.


6 responses so far ↓

  • 1 Steve Roth // Oct 26, 2010 at 8:17 am


    “I’m all for more regulation.”


  • 2 Steve Broback // Oct 26, 2010 at 9:08 am

    Showing what derivatives exist and what they are, yes. Regulations that help people make better market decisions, yes. My point is that the general Reagan “philosophy” ‘aint what ails us. I am pro occasionally adding market-enhaning regulation(s), not “Regulation” in general (which let’s face it, the unconstrained thinkers seem to find it an end in iteself)

  • 3 Steve Broback // Oct 26, 2010 at 10:18 am

    Let me rephrase: Are you implying Sweden added no new regulations in 1993? Is that really a logical assumption?

    Also, I never said I was “all for more regulation” in Europe. This article speaks to what Europe should do, not what the U.S. should do.

  • 4 Steve Roth // Oct 26, 2010 at 12:56 pm

    Ah I misunderstood. I thought “avoiding Eurosclerosis” was what *we* should do.

    My discussion of the legacy of Reaganomics has not been much about regulation (though the dee-sciples starry-eyed belief in deregulation of everything, everywhere has been destructive), rather about duplicitous claims of financial conservatism.

    I made the same point about your post (it’s Europe, not us) in what I just came by to paste:

    I had to go back and reread that special report (Read it all when it first came out.)

    Just as I thought: this whole post focuses on The Economist’s recommendations for *Europe,* with the (unstated) implication that these are also The Economist’s recomendations for the U.S.

    When it’s actually quite otherwise:

    “America’s structural reforms ought to focus on encouraging households to reduce their debts more quickly and tackling entrenched joblessness. By the standards of previous financial crises America’s banks have been recapitalised remarkably quickly, but much less has been done to deal with the $800 billion-worth of American mortgages (almost 25% of the total) where the house is worth less than the outstanding loan. Legal reforms that made it easier to reduce this debt overhang would allow a more efficient allocation of capital and hence boost investment. They would help to deal with high unemployment, too, by making it easier for workers to move to new jobs. A comprehensive strategy to counter structural joblessness would also include things like hiring subsidies for the hard-to-employ and an overhaul of training schemes.

    In both continental Europe and Japan reform should concentrate on boosting growth by freeing up labour markets and services. Rules that stifle competition should be struck out in industries from health care to road transport.”

    IOW, the post is just rehashing the same old stereotype arguments about what we should do, even though — as The Economist points out…

    “These disparate outcomes have challenged long-held stereotypes. The German labour market has “undergone a strange mutation from a bulwark of eurosclerosis into a champion of flexibility”, writes Joachim Möller of the Institute for Employment Research (IAB). America, long the poster child for efficient labour markets, suddenly looks sclerotic.”

    And while I give The Economist credit for at least tiptoeing around the idea that fiscal consolidation is stupid (especially for the U.S.) at this point — they say it’s “risky” and “should be more nuanced,” and they do report the IMF’s findings:

    “The IMF’s researchers looked at countries that actually raised taxes or cut spending and found no evidence that such measures boosted growth. In fact, they reckon that a fiscal contraction worth 1% of GDP typically cuts output by about 0.5% after two years.”

    But they don’t actually go so far as to state the obvious: spend in the bad times, save in the good times.

    Their rather mealy-mouthed critique of financial market reform rests, oddly, on the “industrial policy” “picking the winners” argument, and completely ignores — doesn’t even mention — *broad-based* structural reforms like a tax on financial transactions which would: 1. take pressure off national deficits, 2. encourage allocation of resources from arbitrage to truly productive ventures, and 3. help shrink a sector of the economy that is the epicenter of moral (and systemic) hazard because it’s “too big to fail.”

  • 5 Steve Roth // Oct 26, 2010 at 1:01 pm

    And as I’ve often said, one of the main advantages of a strong social support system (health, education, economic security) is that you can be far more draconian in your labor and trade policies without millions of people getting royally fucked by forces beyond their control. Germany seems to be mastering that balance. Sweden too. Takes many decades to get all the pieces in place.

  • 6 Steve Broback // Oct 27, 2010 at 10:19 pm

    “Reaganomics-driven government- and regulation-slashing — supposedly such spurs to growth — have resulted in only tepid economic growth.”

    Lots of keystrokes above and important issues raised, but I am not seeing any that are particularly germane to the issue at hand — European regulation.

    I really didn’t see (or hope to infer) any recommendations for the U.S. in this article. It’s just another example of how (economically) Europe would be well served by becoming more like the U.S.

    Doubtful that a persuasive case can be made against the statement that if Reagan looked at Europe today, he’d forcefully advise they lighten up on regulation.

    Having The Economist, the OECD, McKinsey, the University of Groningen, and the Bank of France endorse the Reagan mindset is refreshing (although not all that surprising in the long term.) Some of us knew he was right all the way back in 1981…

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