Greece and Finland are both in the geographic eastern periphery of the euro area, except that Greece is in the south east and Finland is in the north east. In terms of population, though Greece is almost exactly twice as big as Finland, having 10.8 million people versus 5.4 million for Finland.
However. the most recent quarter, Finland actually surpassed Greece in terms of economic size, despite the fact that Greece has twice as big population. In the first quarter Greece had a GDP of €47.19 billion versus €47.42 billion for Finland. First quarter GDP was for seasonal reasons lower than usual in absolute terms in both Greece and Finland, but since the seasonal effect appears to be basically the same for both countries, this has little or no relevance for their relative position.
So despite being twice as many as the people of Finland, the Greeks can't produce more. To what extent this reflects bad behavior from the Greeks and to what extent it reflects good behavior from the Finlanders can be discussed, I for one think it reflects on both, though mostly the former.
Permabulls Brian Wesbury and Robert Stein argue that because the household survey say a much bigger gain (422,000) in jobs than the payroll survey's (69,000), the payroll survey underestimates the strength of the U.S. job market. That might have been plausible if that had been a consistent pattern, but that is not the case as the household survey showed significant drops in employment in March and April even as the payroll survey showed gains. In fact for the last 3 months as a whole, the payroll survey showed a bigger increase (279,000) than the household survey (222,000).
This illustrates that the household survey is more erratic and volatile than the payroll survey and that with regard to short-term economic trends, the payroll survey is more reliable. The household survey number could however be useful if the household survey is consistently either stronger or weaker than the payroll survey than that would be reason to suspect that the payroll survey either underestimates or overestimates strength in the job market. However, when it comes to short-term economic trends, which is what Wesbury's and Stein's comments were about, then the payroll survey is more reliable.
Jason Rave argues that Estonia isn't an example of successful austerity since supposedly growth has been flat since late 2010 and since GDP is still well below the pre-crisis level.
But regarding the first point we should first of all notice that as Rave himself writes, the budget was balanced in early 2010, meaning that the extremely high 2010 growth numbers of 8-9% provide the best test of the effects of austerity policies. While growth did slow down in 2011 and the first quarter of 2012 from those extraordinarily high levels, it was still 4% in Q1 2012, the third highest in the EU after Latvia and Lithuania.
While Rave is correct to note that the absolute level of GDP is still significantly below its pre-crisis peak levels, that isn't relevant for evaluating policies implemented after the initial slump.
A somewhat better argument for dismissing Estonia as an austerity success story is that they were in part lucky. Strong recoveries in Sweden and to a lesser extent also Finland helped boost Estonia's exports to those countries. Yet even if you adjust for that, Estonia's performance the last two years have been strong.
Continued worries about Spain and Greece, increasing signs that the weak US recovery is getting even weaker and signs that the British and euro area slumps are deepening are continuing to push bond yields in countries that are perceived "safe havens" to even more absurdly low levels. There are now three countries (Switzerland, Japan and Denmark) with 10-year yields below 1%, another four (Germany, Sweden, Finland and the US) with yields below 1.5% and another three with yields below 2% ( Britain, Holland and Austria).
Note that this "safe haven" status is not based on whether a country deserves it or not. British, American and Japanese government finances are messed up badly and of the above only Switzerland and Sweden have balanced budgets and a low debt level, with the remaining five countries coming in between with regard to the strength of their public finances.
Nor is it a matter of whether a country is inside or outside of the euro area, as Germany, Finland, Holland and Austria have the euro as currency and as Denmark is also a part of the euro bloc as its currency have a fixed exchange rate to the euro.
Nor is this status necessarily permanent. 6 months ago, yields were rising significantly in Finland and Austria due to market distress, to 3% and nearly 4% at most, respectively. Yet now yields have been cut in half for both.
Central bank manipulation is however one factor. The ECB's covert "quantitative easing" through banks have for example helped hold down euro area yields generally. Low yields in the U.S. and Britain may perhaps to a small extent be related to expectations of more "quantitative easing". However, if that had been the most important factor, the dollar and the pound would have depreciated in value. Instead, particularly the dollar has in fact appreciated in value, indicating that investor demand for "safe haven" assets is the most important factor.
Instead it seems clear that self-fulfilling whim from the markets is the most important factor. Investors have decided that these assets should be seen as "safe havens" and that is what makes them that. Ironically though, the only thing that's "safe" with most of them is that the people who buy them will lose some of their money, something that given the irrationality of it isn't undeserved.
It now appears that there wasn't much of a growth acceleration in the US after all. Terms of trade adjusted GDP rose a mere 1.2% at an annualized rate and national income was only slightly stronger during the first quarter.
This means that the somewhat higher employment growth we saw during late last year and early this year didn't really reflect as most people thought, an acceleration of economic growth from the "so low it feels like a recession" level that the "Obama recovery" of the last three years has been characterized by. Instead it simply reflected a decline in productivity
I have repeatedly (for example in this post) criticized the view that a reduction in the external deficits of Greece and other crisis countries necessarily requires a reduction in the external surpluses of Germany and other euro area surplus countries, because it simply isn't true.
However, pointing this out doesn't mean that I don't also think that it would be good if Germany shifted more of its production towards domestic demand instead of net exports. But how is that to be achieved in a way that doesn't hurt the German economy?
Some people have accused Germany of "wanting" a surplus, but I don't believe that, I think it is more correct to say that they want the income and the jobs generated by exports. If the income can be attained by other means then they wouldn't object to it. Quite the contrary, that would probably be perceived as preferable since that would mean that they wouldn't risk losing it through debt default from the foreign borrowers that they've lent their surplus to. So the question arises, how can the German surplus be reduced without reducing (and preferably in fact increasing) German incomes?
There are actually probably several ways to achieve it, but the best way is arguably for Germany to repeal its 2006 VAT increase from 16% to 19%, and preferably cut it all the way down to the EU minimum level (that minimum level should be abolished, but as long as it exists it does limit how much it can be cut) of 15%.
The 2006 VAT increase didn't directly hurt the German economy as much as I and other feared at the time because it was combined with reduced payroll taxes and other supply increasing reforms. However, it contributed indirectly to aggravating European imbalances and therefore also the current crisis.
As I've pointed out before, the effects of a VAT (and other consumption taxes) is basically identical to the effects of income taxes and payroll taxes on economic transactions which involve a domestic seller/producer and a domestic buyer. Both create tax wedges between the cost for the buyer and the net income of the seller.
However, while basically no difference exist with regard to purely domestic transactions, they have different effects on transactions with foreigners. The difference is that a VAT isn't directly applied to most (one exception is tourism services, which is why VAT increases in tourism dependent Spain and Greece have been destructive) exports but it is applied to imports, while by contrast income/payroll taxes aren't applied to imports while it is applied to exports. This means that if you make the kind of tax reform that Germany did in 2006, it will increase exports relative to imports and thus in Germany's case increase its trade surplus, the flip side of which was bigger deficits in countries like for example Ireland, Spain and Greece.
This also means that the most effective way of facilitating the adjustment in the crisis countries while not hurting or even strengthening the German economy would be to repeal the VAT increase and lower it back to 16% or better yet 15%.. This will increase demand for economic activities based in part on imports , strengthening both the German economy and other economies. Preferably in other not to hurt other activities the cut shouldn't be financed by higher income or payroll taxes (though such a reform would still help painlessly lower the German surplus). Instead Germany should to the extent it needs to be compensated cut government spending, though particularly given today's ridiculously low German bond yields (only 0.05% on 2-year bonds, and less than 1.4% on 10-year bonds) it could afford a short term increase in its budget deficit.
Finally, it could be objected that if higher VAT rates have hurted tourism in Spain and Greece, why won't a lower VAT in Germany also hurt tourism in Spain and Greece since it also represents a higher differential? Well, there are two reasons for this. The first is that a lower VAT in one country will expand the aggregate amount of tourism in two countries while a higher VAT in once country will lower the aggregate level of tourism. The second is that the limited amount of tourism that exists in Germany competes only to a limited extent with the kind of "warm weather and nice beaches" tourism that Spain and Greece attracts. By contrast, when Spain and Greece have raised their VAT rates they have put them at a disadvantage to countries that attracts similar tourists, like Turkey and Cyprus.
For years, we have heard Paul Krugman and others assert that Greece etc. can't reduce their current account deficit unless Germany etc. reduces its surpluses. While that would have been true if the world had consisted only of the euro area nations, it is clearly not true in the world we actually live in. Krugman himself lives in a country with an economy bigger than that of the euro area and Japan and China have together a bigger economy than the euro area plus there are nearly 180 more countries including for example Brazil, Saudi Arabia, Turkey, India, Russia, Canada, Australia, Britain, Switzerland, Norway and Sweden, outside of the euro area.
With so many and in some cases so big economies outside of the euro area, and with the euro area trading so much with them it is clearly possible for the aggregate euro area to strengthen its balance, or in other words it is possible for Greece etc. to reduce their deficits without a reduction of the surpluses of Germany etc.. something that is in fact happening as during the last 4 months alone the euro area current account balance has swinged from a €17 billion deficit to a €10 billion surplus.
This shift reflects in part the effects of the euro area austerity measures, and in part it reflects the euro's weak exchange rate. Krugman now seems to implicitly acknowledge that he was wrong when he asserted that the euro area's aggregate balance can't change, because now he argues that it would be wrong if it happened.
Why would it be wrong? Because the three biggest economies outside the euro area, the United States, China and Japan aren't sufficiently strong (he could have also mentioned the fourth biggest economy outside of the euro area, Britain, which is weaker than all three of those countries). But German growth is no higher than growth in these countries, and the second big euro area surplus country, Holland, has fallen into a recession. If it is wrong to increase the U.S. deficit and reduce the Japanese and Chinese surpluses, then it should also be wrong to reduce the German and Dutch surpluses.
Finally, it should again be emphasized that regardless of how much Krugman disapproves of it, it is happening, in part due to the fact that the euro has fallen in value against the U.S. dollar and the U.K. pound. The irrational (but self-fulfilling) investor belief in American and British government bonds as "safe havens" haven't just produced the low yields that Krugman likes to talk about so much, it has also pushed up the exchange rate of the dollar and the pound, something that has contributed to the euro area's swing from an aggregate deficit to an aggregate surplus, while increasing the U.S. and U.K. deficits.
Recent opinion polls suggests that many Greeks are listening to the warnings of German leaders that if Greece cancels its austerity measures, Germany and others will stop funding the Greek budget deficit, as the parties that want to keep Greece's commitments are gaining at the expense of the far left wing parties that wants to increase government spending.
But what if the far left end up winning after all and Greece defaults? Would that necessarily mean that Greece would be forced to re-introduce the drachma? Actually, contrary what is commonly assumed that is not necessarily the case. After all, households default around the world all the time yet except in cases of death or emigration they continue to use the same currency as before, so there is no necessay connection between default and exiting a currency. And as polls show that nearly 80% of Greeks want to keep the euro and so does the leading far left party, Syriza, even a far left governments that defaults will try to avoid exiting the euro.
However, if a far left government wants to increase, or simply avoid decreasing, government spending it will have to exit the euro and re-introduce the drachma. Because if Greece tells Germany that not only will it not honor the already dramatically reduced debt commitments, it wants to "borrow" (of course, if you keep "borrowing" while declaring previous debt null and void, you're really not getting loans, you're getting gifts) more so that it can spend more, then there is no way that Germany will agree to that-and rightly so. And since no private creditor will agree to it either, this means that Greece would be forced to immediately achieve primary budget balance, forcing it not only to cancel Syriza's promised spending increases but to cut spending in a disorderly fashion.
The only way this can be avoided, apart from implausible increases in government revenue, is if Greece re-introduces the drachma and starts to finance its budget deficit directly through the printing presses. So while default per se doesn't necessarily imply euro exit, deficit spending requires a euro exit. Meaning that Syriza's pledge to both increase government spending and keep the euro can't be achieved and that if they win they'll have to choose which of these promises they will break.
Paul Krugman criticizes Senator Tom Coburn for using Sweden as a good example of a country that has reduced government spending and claims that this is false using a chart showing the change in real government purchases.
But this is misleading because first of all it doesn't put spending in relation to GDP and secondly and even more importantly because it excludes transfer payments such as unemployment and sick leave benefits. The Swedish centre-right government has in fact concentrated their spending cuts to transfer payments so any analysis using only government purchases is bound to be very misleading
If we instead look at total government spending as a percentage of GDP (called "government disbursements in the OECD database) you can see that since 2006, when the current Swedish government was elected, government spending relative to GDP fell from 52.9% in 2006 to 51.8% in 2011. By contrast, during the same period, the OECD average rose from 39.7% to 44%, and in the United States it rose from 36.1% to 41.9%.
Don Luskin points to how in January next years if current law isn't changed, then there will be a big increase in the taxation of dividends in the U.S., something that will send stock prices lower. Luskin believes that stocks could fall by more than a third because the top rate will increase from 15% to 43.4% anad as 56.6% is less than two thirds of 85%.
Luskin is right when he argues that this tax increase, if it isn't repealed before it is implemented, will lower stock prices. However, the effect will be a lot smaller than Luskin thinks for two reasons.
First, because some stock owners will see their after tax return reduced less ( if their total income is less than $200,000 per year) or not at all (if they're foreigners).
And secondly because the value of stocks isn't primarily based on dividends during the coming year, or even the coming few years, but on the present value of all dividends in all eternity, or at least for as long as the company will exist. If investors hope that the dividend tax will be reduced again in the future then the forecasted loss of value will be lower.