Is the US headed the way of Europe? Think again.

[WilliamCody]

http://www.economist.com/blogs/freeexchange/2011/11/currency-unions?fsrc=scn/tw/te/bl/sellyourbourbonyoukentuckians

 

 

Nov 14th 2011, 17:05 by R.A. | WASHINGTON

IS KENTUCKY America's Greece? Matt Yglesias writes:

 

Kentucky (population 4.3 million) and the San Francisco / Oakland / Fremont Metropolitan Statistical Area (population 4.3 million) do share a currency. They do this despite the fact that Kentucky has a longstanding lack of competitiveness relative to San Francisco. Eighty-seven percent of San Franciscans have high school degrees compared to just 80 percent in Kentucky. Forty-three percent of San Franciscans have bachelor’s degrees to just 20 percent of Kentuckians. Not surprisingly, San Francisco’s workers are much more productive, earning a median household income of $74,000 to Kentucky’s $40,000.The way this is made to work is by long-term, sustained, open-ended financial transfers to Kentucky.

I'd put this differently. You don't have a competitiveness problem if your wages are sufficiently low. Wages are much higher in coastal California than they are in Kentucky, because productivity is higher in coastal California than in Kentucky. If productivity adequately explains wage differences, there's no competitiveness issue; so long as Kentucky employers get enough output from their workers to cover wage costs, everything works out.

 

Imagine, though, that a new administration is elected to Washington which makes rapid growth in places like Kentucky a priority and which hints that it will prevent businesses that make big investments in Kentucky from suffering big losses if those investments go bad. Suppose, then, that the cost of borrowing in Kentucky drops as capital floods in from elsewhere. Kentucky experiences a boom and wages rise rapidly. After this boom runs for a while, bad news somewhere else in the world might lead some coastal banks to curtail their lending. When that happens, some of Kentucky's enterprises get into trouble, and investors quickly look to the government. As it turns out, the administration in the White House sees a bail-out of the region as being really unpopular and declines to do much to help. With the implicit guarantee gone borrowing costs soar and capital high-tails it out of Kentucky.

 

Then what happens? Well, some but not all of that previous investment may have been productivity enhancing, and so wages as a whole are above their market-clearing level. Now, Kentucky has a competitiveness problem. No one wants to hire Kentuckians at prevailing wages, and unemployment will rise until wages fall to market-clearing levels. So does big trouble loom?

 

Things won't be pretty for Kentucky for a little while, but neither will America face disaster (indeed, something very like this is infolding in Nevada at the moment, and yet the American union seems safe). Here we get to the key differences between Europe and America. First, adjustment is likely to be faster within America because labour markets are more flexible. The euro zone has come a long way in freeing its internal labour market, but cultural, linguistic, and other differences still mean that it may be easier to move from Kentucky to Texas than from Spain to Germany. Second, Kentucky can fall back on some federally-funded automatic stabilisers, which means that the feedback loop between economic weakness and fiscal tightening isn't as intense. As Mr Yglesias points out, payments for Social Security, Medicare and Medicaid, and federal unemployment benefits will continue to be paid.

 

And finally, the American economy has a national financial structure that halts contagion. That doesn't mean that there won't be bank failures or even, potentially, state defaults. It does mean that contagion isn't likely to develop. Say Kentucky banks are suddenly thrown into great difficulty. What happens? Well, the FDIC comes in and handles the problem. America's economy is massive relative to the size of the banking problem in Kentucky, and so there is no transmission of problem in Kentucky's banks to America's sovereign debt. But what if the problem was spread across half of the American economy, such that very large banks got into trouble?

 

As America discovered in 2008, things can get tricky when banking troubles outstrip the capacity of the FDIC. As we saw then, however, the question was not whether America had the capacity to handle the situation but whether it could organise an effective rescue that would stick politically. When the federal government stood behind the banking system in conjunction with the Federal Reserve, the crisis ended relatively quickly. America's economy is very large and it is backed by the full power of the Fed. As Nobelist Chris Sims has noted, that's an extraordinarily powerful shock absorber. At some point, America's institutions will be tested again; perhaps a crisis in state pensions will threaten to spark a crisis. The country's federal and democratic government means that nothing is certain, but the structure of the national economy is such that its financial system is far less brittle and far more likely to survive such a crisis than Europe's.

 

But a sense of identity surely matters. Mr Yglesias closes by writing:

 

Americans, whether in San Francisco or in Kentucky, generally conceive of ourselves as all living in one country. We act either on behalf of narrow personally selfish claims or else broad idealistic concerns about what’s right and proper for the country as a whole. But if that spirit broke down, the whole national economy would have a very different feel.

When the financial crisis struck in 2008, it took improvisation on the part of the Fed, the White House, and the Congress to prevent a major disaster. There were intense debates about how various costs would be borne, which continue to resonate today. Those debates lacked a clear geographic component, but it's unlikely that the presence of one would have been decisive. That is due, in part, to the fact that America's federal government has grown progressively stronger over the past two centuries; the Fed and the Treasury are now sufficiently powerful that they needn't worry about what California's governor thinks of their actions. And it is also due to the related fact that Americans think of themselves as Americans in a way that Europeans don't think of themselves as Europeans. That consciousness enabled the development of stronger national institutions. But the growth of national institutions, in crises especially, helped to forge that consciousness. It took an executive willing to substantially overreach amidst a civil war to knit states that still saw themselves as sovereign into something like a coherent union.

 

In times of crisis, identity can't help but shape the resolve to fight or flee. If "core" Europe sees too little of itself in "peripheral" Europe to keep itself together, then the fact that Europe could save itself through the creation of sufficiently powerful federal institutions won't much matter.

[Buff_bills4ever]

America!! !@#$ yeah!!! :thumbsup:

[LeviF]

America!! !@#$ yeah!!! :thumbsup:

Obligatory:

 

http://www.youtube.com/watch?v=sWS-FoXbjVI

Edited November 16, 2011 by LeviF91

[BiggieScooby]

Europeans are at a crossroads and likely will go forth with austerity measures than go it alone. As the article points out Kentucky is better off a member of the US.

[Cinga]

from the OP....

 

"Americans, whether in San Francisco or in Kentucky, generally conceive of ourselves as all living in one country. We act either on behalf of narrow personally selfish claims or else broad idealistic concerns about what’s right and proper for the country as a whole."

 

no... no we don't any longer consider ourselves living in one country, and our "narrow personally selfish claims" are fed, and stocked by the federal powers that capitalize on this dissension...

[Buff_bills4ever]

It's completely unreasonable that 60 years out the worst war in human history to expect Europe to embrace each other in a united economy. The Euro is going to fail.

[Cinga]

It's completely unreasonable that 60 years out the worst war in human history to expect Europe to embrace each other in a united economy. The Euro is going to fail.

 

How funny, cause i was thinking about how ridiculous it was to mention San Fransisco and Kentucky in the same article...

[Chef Jim]

I think that someone needs to point out to the author that when we say the US is headed the same place Europe is it has nothing to do with states vs. countries. It has to do with social policies bankrupting the whole Union.

[Jim in Anchorage]

Not sure I get the gist of that. SF [and Oakland!] is somehow carrying Kentucky because their average income is higher?

[WilliamCody]

I think that the point of the article was that, despite our many differences, the US has a tradition of conceiving of one national community, a history of coming together as a nation when things get really bad (although this history is mixed). What the article was saying was that Europe does not have this long tradition and could very easily break up as a result of major fiscal shocks.