Monday, May 7, 2012

The Day After the European Elections

Mainstream economics is similar to mainstream religion.  There is near-universal agreement that long-term sustainable economic growth is the goal.  Also, there are many "denominations" or schools of thoughts about how to achieve that goal.

As discussed here before, there are three mainstream economic denominations in the U.S. today.  The oldest denomination is the Austrian school, which calls for tough love or austerity to reach that goal of sustainable long-term economic growth.  The second denomination is the Keynesian school, which calls for deficit spending to increase demand, thereby jump-starting the economy.  The newest denomination is the Laffer school or Supply-Side, which calls for tax cuts to increase demand, thereby jump-starting the economy.  (Truth-in-blogging requires I confess to being a closet-Austrian economist.)

The elections in France and Greece this weekend highlight the limits of economics.  The Austrian approach of more and more austerity ran into the brick wall of politics.  Increasing austerity is a workable concept in a university classroom of well-fed students, but it doesn't work well with scared voters.  The voters in France and Greece have strongly rejected the pure Austrian approach of austerity.

Asian markets dropped markedly in response to the European elections.  I guess they have not been paying attention, because the European markets were much more sanguine about the elections.  The U.S. markets were also calm.  This is because the elections were already factored into the market.

But, what happens next?  Like politicians everywhere, the new president of France will move to the center to deal with their problems.  Greece, however, is a very different story.  It does not have the ability to borrow anymore.  They can start defaulting and begging for charity . . . or, they can continue on their austerity path and get the agreed-upon assistance from the European Union.

I do sense a certain emotional fatigue to all this, i.e., more people are ready to throw Greece out of the E.U. That would really be bad for Greece.  But, it is such a small part of the Euro-economy.  Greece and Portugal together are only 5% of Euro-GDP.  However, the details of throwing them out of the E.U. is more difficult than most people realize.

Of course, we have long argued that a two-fisted approach of austerity plus growth will be the salvation of Europe.  But, growth doesn't necessarily cost money.  Growth can also be created by removing structural obstacles.  Did you know you cannot fire an employee in France without permission from a judge?  Several nations require prior approval to closing or re-locating a business.  And, don't mess with the labor guilds!

Still, uncertainty has increased, which means the stocks markets will decrease . . . but only for awhile.