A united Europe in fragmented world?

In my previous post I said that "once Ukraine is helped to survive and to reconstruct, the likely impact is a strengthened and more integrated European Union, which mutualizes the cost of economic aid to Ukraine and sanctions to Russia." It would also be desirable to advance to a more integrated world that addresses global challenges in a mutualistic and coordinated way, with an active participation of a united Europe. By global challenges I refer to climate change, tax competition, sustainable improvement of standards of living and migrations. 

A more federal and integrated Europe is likely but is not guaranteed. A more coordinated world is desirable but is not likely. However, it is not enough to have a more integrated Europe if in the long run we want to have a better world, even if we want to guarantee a minimum level of welfare for European citizens.

With the Covid-19 pandemic we could see the contrast between determined common action in the Euroean Union, and costly lack of determination at the global level. While the EU managed to buy and distribute vaccines in an exemplary exercise of planned allocation of resources across borders, most of the world in developing and poor countries could not benefit from vaccines (much less from investment funds such as those of the Next Generation plan).

As a result, most of Europe was quickly emerging from the Covid crisis before the Ukraine war, while the rest of the world is now panicking because of a food crisis to which it doesn’t have the tools to react, as a result of high debt and low growth.

As David Wallace-Wells recently pointed out, we face similar risks with climate change. European and other rich societies may well make progress with green investments, but we may not manage to scale the Green transition to the whole planet. The risk is then that average temperatures rise to levels that are tolerable for Europe for a while (that is, such that we still have the resources to adapt), while developing and poor countries cannot adapt and face catastrophic crises in terms of food, floodings and other disasters. The rich world will be able to keep stable standards of living for some decades, but in the long run it will be absorbed by refugee and migrant waves at unprecedented scale.

A complicated world beyond the borders of rich countries is meanwhile a temptation for the supply side of politics. Donald Trump has made it openly clear that his priority is to give weapons to teachers before sending aid to Ukraine. Expect more of this sort of explicit blindness to problems that are presented as belonging to others, but that will affect us sooner rather than later.

Global market and community failures must be optimally addressed with global policies and institutions, at least with global cooperation between the largest jurisdictions. Sometimes, even local market failures must be fixed with actions that transcend the nation-state. The example of baby formula in the US is a case in point. The solution to the crisis in the supply of products for babies (which originated as a domestic supply problem) came from an exercise in government planning and international cooperation: sending military airplanes to Germany to overcome the shortage of supply.

The impact of current disruptions on policies and institutions

Previous wars and crises have accelerated the creation of new institutions that have changed the lives of millions. After the 1930s Great Depression, the New Deal set up new federal instituions in the US that expanded the role of government. After the second World War, the lessons of the previous post-war were learned, and new global and European institutions were created to make peace and economic development compatible. The reaction to the Covid-19 crsis also learned from the mistakes of the (at least in Europe) flawed reaction to the global financial crisis. It took years for the EU to react with energy (“whatever it takes”) to the global financial crisis; it took months to react to the Covid-19 crisis, and it has taken days to react to the Russian invasion of Ukraine.

But in the long run, we must think about the likely impact and the desirable impact on our democratic infrastructure and how to make them coincide. In the short run there is a catastrophic impact on the Ukrainian economy (-35% growth estimated by IMF this year) and the need to plan for reconstruction in the mid run. Ukraine alone cannot handle this.

Once Ukraine is helped to survive and to reconstruct, the likely impact is a strengthened and more integrated European Union, which mutualizes the cost of economic aid to Ukraine and sanctions to Russia. Unfortunately, part of the likely impact is also a more fragmented world, where the EU is alone (perhaps helped by US administrations that are not hijacked by Putin allies such as Trump) supporting the rule of law.

The desirable impact is a more integrated and federal Europe in a more integrated world that addresses global challenges in a mutualistic way, such as climate change, tax competition, sustainable improvement of standards of living and migrations. How to make the likely and the desirable coincide will be a matter for global collective action and for evolutionary forces in a no longer linear progress.

The increasing difficulties of separating tasks in economics (between markets and governments, between fiscal and monetary policies, between different government levels, between politicians and technocrats) highlight the need to take an integrated approach, to put together the skills of many disciplines to tackle current challenges.

The logical next step after the national welfare state is the federal welfare state, as argued by Piketty in his last book, “A Brief History of Equality.” Some previous wars (the first world war, the Balkan wars, successive wars in the Middle east) ended with the sacralization of the nation-state and the consolidation of ethnocracies, paving the way for ethnic cleansing, future wars and economic stagnation. It is about time that we realize that multicultural democracies with universal rights, where respect for the rule of law is compatible with cross-border relations, are a much better way of sustaining economic development and sustainable peace.

A class experiment about investing in Venezuela and Switzerland

With the help of Erik Solé, a teaching assitant, I ran a class experiment (in my Introduction to Economics course at the new degree on Contemporary History, Politics and Economics at my University, UAB) using the instructions of the e-book “Experiencing Economics” of the CORE Project, based on the very useful Classex platform of experiments in class with mobile phones.

One of the experiments suggested by this e-book consists of asking students to play a “Coordination Game” where they have to decide whether to invest or not in pairs. It is a 2x2 game where they are randomly paired with another (unknown) student. They have 5 units of payoff to invest, and these 5 units become 10 only when both players invest. If you invest and your couple does not, you lose your 5 units.  Each pair is secretely told in the instructions that he or she is in one of two specific countries, one suggesting a narrative of stability and another one of instability. Instead of Germany and Greece (the countries originally suggested by the Classex platform, incidentally located in a German university), I changed the names of these two countries to Switzerland and Venezuela. I thought that the contrast of messages would be clearer in the current context. Britain and France after the Brexit referendum was another variation that is mentioned in the e-book to having been used by others previously -with similar results to our experiment.

The results of the experiment were striking, although in line with previous similar experiments.  77% of the pairs of students that received a message saying that they were in Switzerland, coordinated in the efficient outcome (both players invested), and none of them coincided in the non-investment outcome. In the rest of random pairs, one student invested and the other did not.

However, of those that were suggested to think that they were in Venezuela, only 22% of pairs coordinated in the joint investment outcome (although the payoffs were the same). 33% of these pairs coincided in choosing not to invest simultaneously, and in the rest of pairs, one student invested and the other did not.

77% versus 22% is a big difference, which I didn’t expect. It is consistent with similar games having been played in other universitites, according to the e-book “Experiencing Economics” of the CORE Project.

Experiments in class using smartphones are an engaging way to explain simple economic and game-theoretic models. Coordination is important, and narratives and expectations may help explain why it is challenging, and the absence or presence of trust may explain investment cycles and many other social and economic phenomena.

At our University, UAB, we will have in July a workshop to diffuse to other teaching Faculty the usefulness of these experiments and other ideas and resources to innovate in the teaching of Economics.

No shortcuts to shared prosperity

The negative supply shock derived from the war in Ukraine has the double effect of slowing economic growth and increasing inflation. All governments and relevant actors, such as central banks, are desperate to find solutions to avoid this double curse. Suddenly, everybody has become again aware of the dangers of slow (or zero, or even negative) growth, and the costs of inflation.

An intellectual victim of this double concern is what we could call the "modern economic extreme left," or at least part of it. Two principles of this segment of the left in the recent past have been de-growth and "modern monetary theory".

"De-growers" have been correctly emphasizing that economic growth at the cost of natural resources has a negative effect on individual and social welfare. But the extreme recipe of "de-growth" as a consequence of this concern would only make it more difficult to fund the necessary investments to fight climate change, or the international cooperation needed to reduce emissions in a balanced way. Now with the crisis, there is a general awareness that we need economic growth to make debt levels sustainable, to fund public expenditure needed to fight the social consequences of crises, and to create employment without generating undesirable inflationary pressures.

Modern monetary theory argues that "normal" government spending should be funded by money creation, which is something that can easily be done by central banks. There are of course more realistic variations of this, such as using the money-printing machine to give money to vulnerable groups in cases of emergency. The bottom line though is a relativization of the costs of money creation, in particular the relativization of the risks associated to inflation. The war in Ukraine (and the supply bottlenecks after two years of a global pandemic) are a reminder that inflation has not been defeated for good and that it is a danger that free money would only exacerbate. Just giving money to people would mean more money chasing the same amount of goods, creating artificial excess demand that would trigger price increases. It may be difficult to control inflation when prices start to rise and beliefs and expectations create a feedback loop from which it may be difficult to escape.

Intellectually, the times should be better for other more realistic segments of the progressive movement, for example for a modernized social-democracy, one that adds to the traditional objective of building a strong welfare state, the objectives of individual dignity and environmental sustainability (compatible with improving living standards) in an interconnected world.