Narcissism of Minor Differences or Major Economic Rifts? The Political Economy of (Post) Financial Crisis Management in The United States and The European Union

Economic Policy PaPEr SEriES 2012
narciSSiSm of minor DiffErEncES or major Economic riftS?

thE Political Economy of (PoSt) financial criSiS managEmEnt in thE UnitED StatES anD thE EUroPEan Union
Stormy-annika milDnEr DaniEla SchwarzEr
2012 The German Marshall Fund of the United States. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without permission in writing from the German Marshall Fund of the United States (GMF). Please direct inquiries to: The German Marshall Fund of the United States 1744 R Street, NW Washington, DC 20009 T 1 202 683 2650 F 1 202 265 1662 E info@gmfus.org This publication can be downloaded for free at http://www.gmfus.org/publications/index.cfm. Limited print copies are also available. To request a copy, send an e-mail to info@gmfus.org. gmf Paper Series The GMF Paper Series presents research on a variety of transatlantic topics by staff, fellows, and partners of the German Marshall Fund of the United States. The views expressed here are those of the author and do not necessarily represent the views of GMF. Comments from readers are welcome; reply to the mailing address above or by e-mail to info@gmfus.org. about gmf The German Marshall Fund of the United States (GMF) is a non-partisan American public policy and grantmaking institution dedicated to promoting better understanding and cooperation between North America and Europe on transatlantic and global issues. GMF does this by supporting individuals and institutions working in the transatlantic sphere, by convening leaders and members of the policy and business communities, by contributing research and analysis on transatlantic topics, and by providing exchange opportunities to foster renewed commitment to the transatlantic relationship. In addition, GMF supports a number of initiatives to strengthen democracies. Founded in 1972 through a gift from Germany as a permanent memorial to Marshall Plan assistance, GMF maintains a strong presence on both sides of the Atlantic. In addition to its headquarters in Washington, DC, GMF has seven offices in Europe: Berlin, Paris, Brussels, Belgrade, Ankara, Bucharest, and Warsaw. GMF also has smaller representations in Bratislava, Turin, and Stockholm. about gmfs Economic Policy Program The Economic Policy Program is an initiative of GMF dedicated to promoting cooperation between the United States and Europe on domestic and international economic policies as vital instruments of global prosperity, especially for the poor and those affected by shifts in the global economy. The United States and Europe account for more than 40 percent of world economic activity, close to $20 trillion in goods and services on an annual basis. Given the size and importance of this relationship, GMFs Economic Policy Program seeks to ensure that the benefits of globalization are distributed equitably and fairly. Through in-depth research, targeted grantmaking, strategic convening, and outreach to key policymakers and the media, the program supports transatlantic leadership at the critical nexus of economic policy, trade, development assistance, and management of domestic sectors such as agriculture. On the cover: Vladimir Koletic/iStockphoto
Narcissism of Minor Differences or Major Economic Rifts?

The PoliTical economy of (PosT) financial crisis managemenT in The UniTed sTaTes and The eUroPean Union1
Economic Policy Paper Series March 2012
By Stormy-Annika Mildner and Daniela Schwarzer2
Executive Summary Introduction: Explaining Convergence and Divergence Case Study I: Stabilizing the Economy Fiscal Expansion versus Austerity Case Study II: Global Macroeconomic Imbalances Numerical Targets Case Study III: Financial Regulation Too Big to Fail and Bank Levy Conclusion Bibliography
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The paper is based on a conference contribution (March 2011) for the project New Atlantic Capitalism. Reshaping the Economic Model in the EU and the United States, a joint project of four think tanks: demos EUROPA - Centre for European Strategy (Warsaw), Notre Europe (Paris), Stiftung Wissenschaft und Politik (Berlin), and The German Marshall Fund of the United States (Washington DC). It is supported by the European Commission.
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Stormy-Annika Mildner is member of the Executive Board of the German Institute for International and Security Affairs (SWP) and a Robert Bosch Fellow in fall 2011 at the GMFs Transatlantic Academy. Daniela Schwarzer heads the Research Unit European Integration at SWP.
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Executive Summary
o transcontinental partnership is more deeply integrated than the transatlantic economy The United States and the European Union not only conduct roughly 20 percent of their trade in goods with each other, they are even more deeply integrated when it comes to investment Approximately 52 percent of U S foreign direct investment (FDI) abroad (stocks, figures for 2008) is located in the EU; the EU accounts for 63 percent of U S inward FDI stocks The transatlantic partnership rests on a solid foundation, including many common interests and ideas in the economic and political spheres as well as a general overarching consensus about the structure of the international economic architecture Nevertheless, the last years have, at times, demonstrated remarkable differences on a wide range of policy issues: trade imbalance targets, bank and transaction fees, and growth strategies to name just a few In this paper, we explore the drivers of convergence and divergence We present three short case studies to gain a better understanding of the glue and centrifugal powers in the transatlantic economy: immediate crisis management (spending and austerity fiscal policy), macroeconomic imbalances (trade imbalance targets), and financial regulation After highlighting the key similarities and differences of the respective policy approaches, we discuss possible root causes, which can be economic and financial realities, perceptions and historical experiences, ideas, and institutional and structural constraints as well as obviously politics We derive two conclusions from this analysis First, the analysis of immediate crisis management and fiscal policies, as well as of macroeconomic rebalancing in particular, underlines the importance of various economic starting points: differences in growth projections, saving rates, and unemployment to name just a few indicators Second, ideas drawn from the countries
historical experiences about the proper role of the government in the market and fiscal experiences (for example low inflation and stable prices) have also been an important factors in guiding policy responses The United States, the EU, and its member states will remain key partners in tackling current and future global economic policy challenges But only thorough knowledge of a partners domestic constraints, a far-sighted assessment of the benefits of cooperative behavior, and a joint strategy in the global fora will allow for substantial progress
Introduction: Explaining Convergence and Divergence

Chancellor Angela Merkels refusal to support a joint EU stimulus and common European fund to bail out banks The U S call for more spending was met with little sympathy by German decisionmakers, who, by pointing at automatic stabilizers in Germany, not only argued that the countrys stimulus packages were indeed higher measured in percentage of GDP than the U S package, but much earlier than their U S counterparts they started to focus on exit strategies, pushing for a swift phase-out of fiscal stimulus programs in the run-up to the G20 meetings in 2010 The year 2011 has seen some convergence again with regard to fiscal consolidation as government debt and the reduction thereof has moved to the top of the political agenda in Washington Nonetheless, differences are still noticeable as the European Commission and member states of the EU are discussing much stricter mechanisms to limit national debt in the future than is the case in the United States 3 Equally contentious was the issue of global macroeconomic rebalancing at least between some EU member states and the United States U S Treasury Secretary Timothy Geithner proposed to set concrete targets for trade surpluses and deficits While France, in a first reaction, welcomed the approach, it was rebuffed by Chancellor Merkel: To set political limits on trade surpluses and deficits is neither economically justified nor politically appropriate 4 Just as the U S proposal on trade balance targets was met with little understanding in Germany, the Franco-German proposal on a global financial transaction tax
See for example Katharina Gnath/Claudia Schmucker (2011), Same Economic Nightmares, Different Solutions: Transatlantic Approaches to International Macroeconomic Policymaking in the Face of the Crisis, AICGS Policy Report, December 2011; Kirkegaard, Jacob Funk/S Chase Gummer/Tim Stuchtey (2011), The End of the Years of Plenty? American and German Responses to the Economic Crisis, AICGS Policy Report December 2011 4 Quoted in: Patrice Hill, Germany Rebuffs Obama on Trade Gap, Washington Times, November 11, 2010
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Commentators on both sides of the Atlantic sometimes harp on alleged policy differences between the United States and our colleagues in Europe This is not the reality The last two years have witnessed intense and productive policy coordination and cooperation between Europe and the United States Assistant Secretary of the U.S. Treasury Charles Collyns (January 2011)1 I think we should do much more together We have conditions like we have never had before and it would be a pity if we missed the opportunity President of the European Commission, Jos Manuel Barroso (July 2010)2
iscal austerity, trade imbalance targets, bank and transaction fees, growth strategies the list of conflictual issues within transatlantic economic relations is long While the transatlantic partnership still rests on a solid foundation, including many common interests and ideas in the economic and political spheres, as well as a general overarching consensus about the structure of the international economic architecture, the management of the financial and economic crisis has unveiled many divergent views between the transatlantic partners This applies, for example, to growth strategies, in particular to the trade-off between spending and fiscal discipline in times of economic downturns In 2009/2010, the U S administration repeatedly criticized Europe, foremost Germany, for its relatively cautious fiscal programs and for
Remarks by Assistant Secretary Charles Collyns on The Transatlantic Relationship and the G20, event at the German Marshall Fund, Washington DC, January 20, 2011, http://www reuters com/article/idUSTRE66E19X20100715 2 Quoted in EU-U S Ties not Living up to Potential: Barroso, Reuters, July 15, 2010, http://www reuters com/article/ idUSTRE66E19X20100715
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raised eyebrows in the United States A day-by-day financial transaction tax is not something we are prepared to support, Treasury Secretary Geithner emphasized 5
Structures? We will briefly study three cases to gain a better understanding of the matter: fiscal crisis management, macroeconomic rebalancing, and financial regulation (Too Big to Fail and bank levy) While we focus our analysis on the United States and the EU, the latter certainly is not a monolithic bloc Economic realities, interests, and ideas among EU member states sometimes vary just as much as between the transatlantic partners This makes a comparison anything but easy The picture is even more complicated as the actors vary depending on the policy area; on some issues the United States interacts with the EU as its partner (e g transatlantic trade), while in other cases the member states remain the key actors (e g fiscal policies in crisis management or coping with imbalances in the G20) Given these complexities, we briefly present the EU position, if there is one, and in addition highlight member states perspectives if they are relevant in terms of bilateral relationships with the United States or in determining the European position We often turn to the German position as, through the forces of market developments, it has become a benchmark for many other European members, and within the EU it is the most important partner for the United States in terms of trade and investment flows In our paper we follow a societal approach to International Political Economy (IPE) therefore belonging to the liberal tradition of International Relations (IR) stressing domestic sources for national preference formation, while not disregarding international factors In their article From Convoy to Parting Ways, PisaniFerry and Posen (2010) provide an excellent framework for this analysis From their discussion of macroeconomic policies we derived five explanatory variables: 1) economic and financial realities, 2) perceptions and historical experience, 3) ideas, 4) institutional and structural constraints,
On some issues the United States interacts with the EU as its partner, while in other cases the member states remain the key actors.
In his 2009 book The Narcissism of Minor Differences: How America and Europe are Alike, Peter Baldwin analyzed how deep and wide the differences between the United States and Europe, in his words the hissing cousins, actually are His findings indicate that the two continents really are much more alike than overexcited media coverage often implies In particular comparison with other countries, the differences between Europe and the United States appear invisible and inconsequential But Baldwin argued that foreign policy under the George W Bush administration had so poisoned relations between the transatlantic partners that it affected more general perceptions of what differences divide the North Atlantic: Vast cauldrons of rhetorical soup have been boiled from meager scraps of evidence 6 Often forgotten are the many commonalities within the transatlantic partnership and the high level of trade and investment flows Along these lines, U S Treasury Assistant Secretary for International Finance, Charles Collyns, emphasized in 2011: Where we have disagreed, the differences have largely been in emphasis and tactics rather than in goals or strategic direction The Transatlantic Relationship remains healthy and robust 7 In our paper we therefore ask two questions: 1) What are the similarities and differences in U S and European financial and economic (post) crisis management? 2) What accounts for their respective approaches? Interests? Ideas?
Quoted in: Emma Ross-Thomas/Simon Kennedy, Brown Split on Tobin Tax at G20 Meeting, Bloomberg, August 11, 2009 6 Peter Baldwin, The Narcissism of Minor Differences: How America and Europe are Alike, Oxford 2009, p 11 7 Remarks by Assistant Secretary Charles Collyns on The Transatlantic Relationship and the G20, January 20, 2011, http://www treasury gov/press-center/press-releases/Page/tg1030 aspx
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The German Marshall Fund of the United States
and 5) politics (such as election cycles) 8 These factors can be broadly grouped in three categories: interests, ideas, and structures According to Schirm (2009), interests can be defined as material economic considerations (costs and benefits) of domestic groups These are neither monolithic nor set in stone but can change rapidly according to changing circumstances Ideas are more longterm and can, according to Schirm, be defined as value-based collective expectations on how politics should govern the market They are determined, among other factors, by historical experiences 9 We consider structures as the political set-up of institutions and actors and their relations to each other, and their pattern of interaction and political regulations First, in our three case studies fiscal policy making, global macroeconomic rebalancing, and financial regulatory reform we find convergence and divergence between the transatlantic partners in both regulatory as well as fiscal matters A clear distinction along policy fields does not seem possible Second, in all three case studies, material interests, to a large extent, explain policy choices within the respective counties as well as convergence and divergence between them However, this factor never suffices in offering a full explanation Rather, ideas and structures also play a large role We found no pattern to the relationship between factor and circumstances We also did not succeed in finding a pattern to which factor prevails under which circumstances Words of caution are
Jean Pisani-Ferry/Adam Posen, From Convoy to Parting Ways? Post-crisis Divergence between European and U.S. Macroeconomic Policies, Bruegel Working Paper 2011/04, 2011, http://www bruegel org/publications/show/publication/from-convoy-toparting-ways-post-crisis-divergence-between-european-and-usmacroeconomic-policies html, p 1 9 Stefan Schirm, Varieties of Strategies: Britain, Germany and the EU in the Global Economic Crisis Paper prepared for the ECPR Joint Sessions, Lisbon April 14-19, 2009, Workshop 17: European Domestic Societies in the Face of European Integration and Globalisation, p 4, http://www sowi rub de/mam/content/lsip/ ecprschirm pdf
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in order here: The analysis of these three policy fields shows a snapshot of transatlantic relations We cannot rule out that with changing economic conditions and public pressure, it will return to more convergence A similar study in a few years might with more hindsight be able to succeed in sifting out a clear pattern
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Case Study I: Stabilizing the Economy Fiscal Expansion versus Austerity

EU stimulus, echoing similar tones that reached the German government from the International Monetary Fund President Barack Obama himself jumped into the transatlantic fray, saying that given the United States aggressive stimulus program, its very important that other countries are moving in the same direction, because the global economy is all tied together12 Translation: Europe, and in particular Germany, had not done enough and should have launched more aggressive stimulus spending to help drive global demand At the G20 summit in Pittsburgh, President Obama asked the leading export countries to increase domestic demand in order to fill the gap left by U S consumers Still, in early October 2010, when exiting crisis management was well under way in countries such as Germany, Secretary of the Treasury Timothy Geithner argued: The greatest risk to the world economy today is that the largest economies underachieve on growth 13 At the meeting of the IMF International Monetary and Financial Committee a few days later, Geithner stated: We need to continue providing well-targeted support for the recovery in the near term even as we put in place plans to help ensure fiscal sustainability over the longer term 14 With the budget deficit and debt having moved to the top of the political agenda in the United States in 2011, the transatlantic economy is witnessing more policy convergence again on fiscal policymaking Nonetheless, differences are still noticeable as President Obama continued lobbying for stimulus measures in 2011, while the
Quoted in: G20 Meeting to Test U S Economic Leadership, National Public Radio, March 11, 2009 13 The Path to Global Recovery: A Conversation with Secretary of the Treasury Timothy Geithner, The Brookings Institution, October 6, 2010, http://www brookings edu/events/2010/1006_global_recovery aspx 14 Statement by Timothy F. Geithner, Secretary of the Treasury, at the International Monetary and Financial Committee (IMFC) Meeting, IMF, October 9, 2010, http://www imf org/external/ am/2010/imfc/statement/eng/usa pdf
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he immediate response to the financial and economic crisis in 2008-2009 was characterized by a high degree of transatlantic cooperation, a period that Pisani-Ferry/Posen (2010) dubbed the London consensus, after the meeting of the G20 leaders in London in April 2009 10 The transatlantic partners agreed on the need for economic stimulus, bank rescues, an expansionary monetary policy, a reform of the financial architecture, and upgrading of the former G20 of finance ministers to a leaders institution At the G20 summit held in Pittsburgh in September 2009, the leaders decided not to withdraw stimulus measures until a durable recovery was in place, to co-ordinate their exit from the stimulus measures, and to harmonize macroeconomic policies to avoid macroeconomic imbalances 11 However, some of the contentious issues that strained the transatlantic partnership in 2010 in Pisani-Ferry/Posens words the period of Toronto divergence were already evident during the early days of the crisis, the most visible of these being fiscal austerity versus continued government spending Although disagreement was by no means as severe as the media made it out, many U S observers criticized the EU and its members, foremost Germany, for not doing enough to halt the downward spiral of the global economy Indeed, despite larger automatic stabilizers in the EU, the overall fiscal stimulus was lower in Europe than in the United States The U S administration criticized the German government in particular for its relatively cautious national fiscal stimulus programs as well as its lack of enthusiasm for a joint
Jean Pisany-Ferry/Adam Posen, 2011, p 11 11 G20 Leaders Statement: The Pittsburgh Summit, September 24-25, 2009, http://www g20 utoronto ca/2009/2009communique0925 html; Claudia Schmucker/ Katharina Gnath, From the G8 to the G20: Reforming the Global Economic Governance System, GARNET Working Paper, Number 73, January 2009; Dick K Nanto, The Global Financial Crisis: Analysis and Policy Implications, Congressional Research Service, CRS Report to Congress RL34742, Washington DC 2009
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U S Congress has so far not agreed on a plan to cut the debt In addition, the EU Commission and European countries are discussing much stricter mechanisms to limit national debt in the future than is the case in the United States The G20 summit in Cannes in fall 2011 and the Action Plan for Growth and Jobs reflect these differences, again leaving considerable policy space for countries to choose macroeconomic policy measures appropriate to their domestic problems and growth strategies: Countries whose public finances are relatively sound (Australia, Brazil, Canada, China, Germany, Korea, Indonesia) will let their automatic stabilisers work and will take additional measures to support domestic demand if the economic situation worsens, the Action Plan states 15 France promised to cut its fiscal deficit to 3 percent by 2013, the U K reaffirmed its commitment to fiscal consolidation, and Germany pledged to take measures to strengthen domestic demand 16 The United States, on the other hand, commits to a set of measures to sustain the recovery via government investments, tax reforms, and targeted job measures, consistent with medium-term fiscal consolidation 17 The U.S. Case The financial and economic crisis was the most severe since the Great Depression of the 1930s What began with the bursting of the U S housing market bubble quickly spread to the financial sector, spiraling into a global financial crisis and pulling the real economy with it During the last two quarters of 2008, U S economic growth
G20, Action Plan for Growth and Jobs, November 2011, http:// www g20-g8 com/g8-g20/root/bank_objects/Action_Plan pdf 16 Katharina Gnath/Claudia Schmucker (2011), Same Economic Nightmares, Different Solutions: Transatlantic Approaches to International Macroeconomic Policymaking in the Face of the Crisis, AICGS Policy Report, December 2011, p 17 17 G20, Action Plan for Growth and Jobs, November 2011, http:// www g20-g8 com/g8-g20/root/bank_objects/Action_Plan pdf
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declined by 3 7 percent and 8 9 percent respectively the U S economy had not experienced such a severe hit since 1982 During the first two quarters of 2009, the situation remained dire: growth continued to decline by 6 7 and 0 7 percent respectively In 2008, the U S economy stagnated; in 2009, it shrunk by 3 5 percent 18 As the economist Kirkegaard (2011) points out, the sources for the contraction in the United States are very different to those in many European countries like Germany: foremost a large decline in private consumption and fixed capital formation (in particular from the collapse of residential construction) 19 A persistent decline in consumer spending, a sharp downturn in exports, a large reduction in business investment and a continuing decline in the housing sector were responsible for the continuing weakness While economic growth picked up during the second half of 2009, and gained speed in 2010, the recovery remained shaky With the persistent problems in the housing sector, many observers warned against the risks of a double-dip recession For an economy based so strongly on domestic demand 70 percent of GDP can be attributed to consumption the high unemployment rate was particularly worrisome (see Figure 1) Even though the economy started to grow again (2010: 3 0 percent; 2011: Q1 0 4, Q2 1 3, Q3 1 9), unemployment stayed remarkably high In 2009, the rate climbed to 9 3 percent, averaging 9 6 percent in 2010 and 9 0 in 2011 20 The unofficial unemployment rate, which includes people who
Bureau of Economic Analysis, National Economic Accounts, http://www bea gov/national/nipaweb/SelectTable asp?Popular=Y (accessed December 21, 2011) 19 Kirkegaard, Jacob Funk/S Chase Gummer/Tim Stuchtey (2011), The End of the Years of Plenty? American and German Responses to the Economic Crisis, AICGS Policy Report December 2011, p 23 ff 20 Bureau of Labor Statistics, Labor Force Statistics from the Current Population Survey, http://data bls gov/pdq/ SurveyOutputServlet?data_tool=latest_numbers&series_ id=LNS14000000 (accessed December 21, 2011)
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Figure 1: Unemployment Rates (in percent)
Source: European Commission, Ameco Database, October 2011
are not working full-time but would like to and people who are no longer registered as looking for work, was estimated at approximately 16 percent in 2010 The rising number of long-term unemployed also caused concern More than 40 percent of all unemployed were out of work for longer than six months One of the reasons was the decline in residential mobility As a result of the ongoing tensions in the real estate market, many Americans were unable to move to states with stronger growth rates because they would be forced to sell their homes for less than the value of their mortgages In light of these circumstances, the OECD (2010) estimated that it could take years before the unemployment rate sank back to its pre-crisis level To stabilize the financial sector and to rejuvenate economic growth, the U S government passed
several rescue and stimulus measures Under the $700 billion Troubled Asset Relief Program (TARP, enacted October3, 2008), the Treasury invested in dozens of struggling banks and other financial institutions, such as the insurance company AIG, as well as in the automobile industry (General Motors, Chrysler) In February 2009, Congress passed the American Recovery and Reinvestment Act (ARRA) The $787 billion stimulus package (later increased to $840 billion to be consistent with the Presidents 2012 budget) included federal tax incentives, expansion of unemployment benefits, and other social welfare provisions, as well as domestic spending in education, health care,
and infrastructure 21 The main focus, amounting to $300 1 billion, was on tax benefits, including individual tax credits, the Making Work Pay Program, as well as tax incentives for business and energy Contracts, grants, and loans for education, transportation, infrastructure, energy/ environment, housing, health/family, and research and development amounted to $219 5 billion and entitlements (such as unemployment insurance and Medicaid/Medicare) to $216 3 billion 22 Through December 2011, $735 9 billion has been paid out Estimates of the effects of ARRA on GDP growth vary widely The Congressional Budget Office (CBO) calculated an increase in GDP of between 0 4-1 8 for 2009, 0 7-4 1 for 2010 and 0 4-2 2 percent for 2011 due to ARRA, while it estimated that the stimulus lead to a decrease in the unemployment rate of between 0 1 to 0 5, 0 4 to 1 8 and 0 2 to 1 4 percentage points in the respective years 23 Given high unemployment and the persistent problems in the housing sector, Congress passed a second stimulus bill in midDecember 2010 The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 not only extended President George W Bushs temporary income tax cuts (including those for higher income classes a particularly contentious issue between Democrats and Republicans) The $858 billion package also included a reauthorization of federal unemployment extension benefits for another 13 months ($801 billion of tax
Kristin Francoz, A Report on Fiscal Stimulus, Peterson G Peterson Foundation, November 2, 2010, http://www pgpf org/ Issues/Spending/2010/11/02/A-Report-on-Fiscal-Stimulus aspx?p=; 22 Recovery gov, Breakdown of Funding, http://www recovery gov/Transparency/fundingoverview/Pages/fundingbreakdown aspx 23 Congressional Budget Office (2011), Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from July 2011 Through September 2011, November 2011, http://www cbo gov/ftpdocs/125xx/ doc12564/11-22-ARRA pdf
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cuts and $57 billion for extended unemployment insurance) 24 In his 2011 State of the Union Speech, President Obama once again underlined the importance of government spending and investment in the economy This is our generations Sputnik moment, Obama emphasized, demanding a level of research and development we havent seen since the height of the space race, with particularly strong investments in biomedicine, information technology, and clean-energy technology Obama said he wanted the government to invest in education, infrastructure, research, and development to put the U S economy on a more sustainable growth path and ensure its competitive vis--vis emerging economies, foremost China 25 In early September 2011, in his speech to the Joint Session of Congress, President Obama announced yet another spending program to boost the economy and hiring though with little success The plan was a mix of $253 billion in tax cuts and $194 billion in new spending, the total bill for the plan amounting to $447 billion However, the presidents plan, which he hoped to pay for byraising taxes on the wealthy and corporations, met staunch Republican opposition and thus has failed to be enacted by Congress This was the latest indicator that the tide had changed from government spending to jumpstart the economy to cutting back on government debt and deficits After Republicans had taken control of the House in January 2011, the debate in Washington focused on spending cuts, not stimulus Given the severity of the problem, this comes as little surprise (see Figure 2) When the fiscal year ended in September 2010, the budget deficit stood at 9 0 percent of
The White House, Tax Cuts, Unemployment Insurance and Jobs, December 17, 2010, http://www whitehouse gov/taxcut
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The White House, State of the Union 2011, http://www. whitehouse.gov/state-of-the-union-2011.

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Figure 2: General Government Gross Debt (percent of GDP)
Source: International Monetary Fund, World Economic Outlook Database, September 2011
GDP; FY 2011 ended with a deficit of 8 7 percent 26 According to CBO, federal debt held by the public could reach almost 101 percent of GDP by 2021 and 187 percent by 2030, up from about 67 percent at the end of fiscal year 2010 27 Though the focus was still on jump-starting the economy in 2010, early that year, President Obama tasked the newly created bipartisan National Commission on Fiscal Responsibility and Reform (often called BowlesSimpson/Simpson-Bowles from the names of co-chairs Alan Simpson and Erskine Bowles) with identifying policies to improve the fiscal situation in the medium term and to achieve fiscal
Congressional Budget Office (2011), The Budget and Economic Outlook: An Update, August 2011, http://www cbo gov/ftpdocs/123xx/doc12316/08-24-BudgetEconUpdate pdf 27 Congressional Budget Office (2011), CBOs Long Term Budget Outlook, June 2011, p 8, http://www cbo gov/ftpdocs/122xx/ doc12212/06-21-Long-Term_Budget_Outlook pdf
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sustainability over the long run 28 And in his 2011 State of the Union Speech, while lobbying for a Sputnik moment, the President also announced to freeze annual domestic spending for the next five years 29 Economic necessity and also public opinion were responsible for the policy shift In October 2010, a mere 36 percent of U S citizens believed that Obama was handling the budget well in March 2009 this figure still stood at 52 percent according to a survey conducted by CNN/Opinion Research
Fiscal Commission gov, About the National Commission on Fiscal Responsibility and Reform, http://www fiscalcommission gov/about/ (accessed 2 27 2011); White House, Executive Order National Commission on Fiscal Responsibility and Reform, February 14, 2010, http://www whitehouse gov/the-press-office/ executive-order-national-commission-fiscal-responsibility-andreform 29 The White House, State of the Union 2011, http://www whitehouse gov/state-of-the-union-2011
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Corporation 30 According to an annual poll by the Pew Research Center for the People and the Press on the top policy priorities for the year, the issue has continuously gained in importance While in 2009, the budget deficit ranked only ninth among the 20 top priorities (53 percent of the population believed that it was a top priority), it ranked seventh (60 percent) for the year 2010 and sixth (64 percent) for 2011 31 While the economy and jobs are consistently found to be the top priority for the government, several additional polls indicate how seriously the deficit and debt are perceived by the public According to a January 2011 poll by CBS News/New York Times, for example, 56 percent of the respondents thought it necessary to take immediate action to lower the budget deficit instead of waiting for better economic times Sixtyfour percent are very concerned that the deficit will create hardships for future generations 32 While both the Democrats and Republicans agree on the severity of the problem, they greatly differ on how to balance the budget and reduce debt, so far preventing a compromise that could return the United States to a path to fiscal sustainability In early December 2010, the Bowles-Simpson Commission (The Moment of Truth) released a report but failed to reach the 14 votes necessary to move its deficit-reduction proposal to Congress, with a final tally of 11 members voting in support and 7 against the proposal The plan was ambitious:
CNN Opinion Research Poll, November 15, 2010, http://i2 cdn turner com/cnn/2010/images/11/15/rel16a pdf 31 Pew (2009), Economy, Jobs Trump All Other Policy Priorities in 2009, January 29, 2009, http://www people-press org/2009/01/22/economy-jobs-trump-all-other-policy-priorities-in-2009/; Pew (2010), Publics Priorities for 2010: Economy, Jobs, Terrorism, January 25, 2010, http://www people-press org/2010/01/25/publics-priorities-for-2010-economy-jobsterrorism/; Pew (2011), Economy Dominates Publics Agenda, Dims Hopes for the Future, January 20, 2011, http://www peoplepress org/2011/01/20/economy-dominates-publics-agendadims-hopes-for-the-future/ 32 CBS News, The New York Times Poll, The Economy, the Budget Deficit and Gun Control, January 15-19, 2011, http://www cbsnews com/htdocs/pdf/Jan11_Econ pdf
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it proposed nearly $4 trillion in deficit reductions by 2020, recommended reduced tax rates, broad spending cuts, and tax expenditure changes, as well as health care and entitlement reforms According to the proposal, the deficit would have been cut to 2 3 percent of GDP by 2015, while the debt was to be stabilized by 2014, reducing it to 60 percent of GDP by 2023 and 40 percent of GDP by 2035 33 But the failure of the Bowles-Simpson was only the prelude to a year of Democrats and Republicans fighting tooth and nail for their deficit and debt reduction visions, cumulating in a near government shut-down in April and government default in August 2011 In mid-January 2011, Treasury Secretary Geithner warned Congress that a delay in raising the $14 29 trillion U S statutory debt limit could make markets prices fall with the risk of a default and undermine economic recovery The debt limit was introduced in 1917, when Congress allowed the Treasury to borrow up to $11 31 billion to fund U S participation in World War I Since then, the debt limit has been raised numerous times Before the debt limit controversy in 2011, the limit was last increased to $14 29 trillion on February 12, 2010 We cannot afford to let the markets lose any confidence that ultimately the Congress will act well in advance of any time that were going to hit the limit, because that would be catastrophic, and cause grave damage to the expansion underway, Geithner emphasized, fearing that the statutory debt limit could be reached as early as March 31 or at the latest by mid-May 34 Default would have prolonged and far-reaching negative consequences on the safe-haven status of
National Commission on Fiscal Responsibility and Reform (2010), The Moment of Truth - Commission Proposal, December 1, 2011, http://www fiscalcommission gov/sites/fiscalcommission gov/files/documents/TheMomentofTruth12_1_2010 pdf 34 U S Department of the Treasury, Secretary Geithner Sends Debt Limit Letter to Congress, January 6, 2010, http://www treasury gov/connect/blog/Pages/letter aspx
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Treasuries and the dollars dominant role in the international financial system, Geithner warned 35 The Republicans used the debt limit as leverage to push the Obama administration into accepting severe spending cuts for the 2011 budget as well as a bargaining chip for the 2012 budget The fight over the 2011 budget was reminiscent of the 1995 government shutdown under the Clinton administration, when Republicans and Democrats could not agree on budget cuts The 2011 fiscal year started on October 1, 2010, but as Congress failed to pass some of the spending bills comprising the annual federal budget, the government operated under continuing resolutions Without these resolutions, the government would have been forced to cease certain functions resulting in a government shutdown 36 According to the Constitution, Article I, Section 9 No money shall be drawn from the Treasury, but in consequence of appropriations made by law, meaning that if the government fails to pass a budget, it also cannot spend On April 8, 2011, Congress passed a last minute budget deal, thus narrowly avoiding a government shutdown by extending federal government funding Democrats and Republicans found a compromise: Discretionary spending for the rest of FY 2011 was to be nearly $39 billion less than had been budgeted for the previous year, and $79 billion less than Obama had wanted The next showdown came in July/August 2011 when time ran short to find a compromise on raising the debt limit The U S government had hit the debt ceiling on May 17, triggering a series of measures to stave off a default According to the Treasury, the ultimate deadline for technically defaulting on its debt was early August 2011 Only
U S Department of the Treasury, Secretary Geithner Sends Debt Limit Letter to Congress, January 6, 2010, http://www treasury gov/connect/blog/Pages/letter aspx 36 Robert Longley, Government Shutdowns, About Com, February 22, 2010, http://usgovinfo about com/od/ federalbudgetprocess/a/Government-Shutdowns htm
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in the 11th hour did Congress vote for the Budget Control Act on 2011: The debt ceiling was to be increased in two steps by $2 1 billion to a new limit of $16 4 billion The agreement also called for spending cuts amounting to $917 billion over the next ten years Furthermore, a bipartisan 12-person House and Senate special committee, the Joint Select Committee on Deficit Reduction, was created to identify further spending cuts of $1 5 billion The so called Super Committee was to complete its work by Thanksgiving 2011 and Congress to hold an up or down vote on the committees recommendations by December 23 The legislation was to be fast tracked through Congress with protections against filibustering and amendments Hoping to incentivize finding an agreement, the compromise included a strong implementation mechanism If an agreement was not signed, automatic cuts would be triggered starting in 2013 (after the presidential election), equally divided between defense and non-defense spending (social security, medicaid, military retirement, and some other social programs were exempted from these cuts) 37 Despite this strong incentive, the Super Committee failed to come to an agreement, and the Thanksgiving deadline passed without results The European Case In the early days of the financial and economic crisis, many European member states perceived the downturn as a U S phenomenon However the effects on the EU became brutally clear in the fall of 2008 Economic growth slowed down to 0 7 percent in the EU in 2008 (euro zone: 0 4 percent) and decreased by 4 2 percent (euro zone: 4 3 percent) in 2009 (according to IMF, World Economic Outlook Database September 2010, real GDP constant prices) Growth in Europe declined more than the U S economy The European economy started to
White House, The Bipartisan Compromise, http://www whitehouse gov/infographics/the-bipartisan-compromise
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In the early days of the financial and economic crisis, many European member states perceived the downturn as a U.S. phenomenon.
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grow again in 2010 (1 8 percent), however with large differences between member states On October 29, 2008, the European Commission released its Communication From Financial Crisis to Recovery: A European Framework for Action38 as an attempt to coordinate the actions of the 27 EU members in combating the economic and financial crisis The framework pointed out the need for a new financial architecture at the European level and stimulus measures to deal with the impact on the real economy At the same time, it asked members that faced higher than expected levels of fiscal or monetary stimulus to accompany stimulus measures with structural reforms 39 On November 26, 2008, the European Commission proposed a 200 billion recovery plan, representing approximately 1 5 percent of EU GDP The largest part was to come from national budgets (around 170 billion, 1 2 percent of GDP), while the EU and European Investment Bank budgets were to contribute a small share of around 30 billion, 0 3 percent of GDP 40 The members of the European Council approved the plan in a meeting on December 12, 2008 The European Commission, for instance, was criticized at the time by members of the European Parliament for not being able to convince the member states of a larger EUlevel contribution In January 2009, it proposed mobilizing 5 billion from the EU budget in order
to invest in Internet infrastructure and energy,41 but this proposal was met with strong resistance by some member states In spring 2009, the IMF outspokenly criticized not only national stimulus packages that it deemed being too small, but also pointed out that more action was needed on the EU level in order to prevent rising divergence 42 At that time, the main concern was that Central and Eastern European member states would fall strongly behind EU average recovery if there was no additional support through the EU Within a few months, the focus, however, changed, and the euro zone periphery countries, which were caught in the sovereign debt crisis, moved to the forefront of crisis management The European recovery measures not only included some coordination of national stabilization packages, plus a limited amount of additional EU spending, but also allowed for flexibility under the Stability and Growth Pact, which sets an upper limit of 3 percent of GDP to public deficits However, since a large number of member states were already in breach of the 3 percent-of-GDP deficit limit early 2009, the political concern was to establish a very clear commitment to budgetary consolidation in the medium-term European Commission President Jos Manuel Barroso warned against disproportionate use of the Pacts flexibility, as it could result in a downward spiral of debt that would jeopardize growth in the future 43Thus, while European governments passed large rescue packages to stabilize their financial sector and adopted large fiscal measures
The Commission proposes 5 Billion new Investment in Energy and Internet Broadband Infrastructure in 2009-2010, in Support of the EU Recovery Plan, Press Release, January 28, 2009, http:// europa eu/rapid/pressReleasesAction do?reference=IP/09/142 42 IMF Urges EU to upgrade its Recovery Plan, in: Euractiv, May 13, 2009, http://www euractiv com/en/euro/imf-urges-euupgrade-recovery-plan/article-18225 43 Manuel Barroso, President of the European Commission, A European Economic Recovery Plan, Press Conference, Brussels November 26, 2008, http://europa eu/rapid/pressReleasesAction do?reference=SPEECH/08/654
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From Financial Crisis to Recovery: A European Framework for Action, Communication from the EU Commission, Brussels, October 29, 2008, http://ec europa eu/employment_social/esf/ docs/from_crisis_to_recovery_en pdf 39 James Jackson, The Financial Crisis: Impact on and Response by The European Union, Congressional Research Service, CRS Report to Congress, R40415, Washington DC March 17, 2010, p 17 40 The Commission Launches a Major Recovery Plan for Growth and Jobs, to Boost Demand and Restore Confidence in the European Economy, Press Release Rapid, November 26, 2008, http:// europa eu/rapid/pressReleasesAction do?reference=IP/08/1771
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to stimulate their economies, the need for fiscal responsibility was emphasized continuously A particularly strong proponent of structural reforms and budget discipline was Germany Chancellor Merkel and her then finance minister, Peer Steinbrck, vice chairman of the Social Democratic Party (SPD), rebuffed calls for more aggressive fiscal action and leveled their own critique at the U S response to the crisis In their opinion, profligate fiscal spending would have potentially drastic inflationary consequences, lead to unsustainable deficits, and crowd-out private investment German policymakers thus reacted not only later and more hesitantly than their U S counterparts, but Merkel also attempted to block the EU plan to provide an EU-wide economic package to stimulate growth The Grand Coalitions first attempt at combating the unraveling financial crisis came in November 2008, when the government put through the first of two stimulus packages It came only after much political debate and hand-wringing 44 The first stimulus package of around 31 billion over two years sought to incentivize investment and long-term infrastructure projects more than it did consumption It ensured continued credit flows to small- and medium-sized businesses, extended so-called short-term work from 12 to 18 months, provided infrastructure spending, and a tax write-off for spending on housing and renovations On the consumption side, it offered help for the auto industry by including a tax exemption for purchases of new cars 45 As the crisis continued and economic forecasts in Germany and the euro zone grew grimmer in
Stormy Mildner and Mark Prentice, Germanys Social Market Economy, Old Wine in Old Bottles? How the Social Market Economy Influenced the Management of the Economic Crisis, AICGS (Eds ), Germanys Founding Pillars at 60: Future Challenges and Choices, Washington DC, August 2009, p 7-20 45 Die Bundesregierung, Konjunkturpaket I und II: Impulse fr die Wirtschaft, http://www bundesregierung de/Content/DE/ Artikel/2009/01/2009-01-12-konjunktur-2 html
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early 2009, the Grand Coalition moved toward a second and more aggressive stimulus program Totaling nearly 50 billion over two years,46 the package passed in February 2009 called for 17 billion in new public investments and tax relief, including reductions in payroll contributions, further support of short-term work, and further support of consumption and the auto industry through granting tax breaks for people trading in older cars to buy new ones (cash-for-clunkers, or Abwrackprmie) The government also appropriated an additional 100 billion in credits for the publicly-held KfW bank to underwrite credit to struggling companies, as well as a special credit program for small- and medium-sized businesses and increased availability of export guarantees 47 This second stimulus package brought the Coalitions total stimulus spending during the crisis to over 80 billion in 2009 and 2010 48 Even in the midst of the crisis, German politicians and policymakers moved to ensure that, once the crisis subsided, the country would once again have a balanced, or at least nearly balanced, budget In June 2009, German legislators moved to limit public debt levels through a constitutional amendment Passed by the required two-thirds majority in the Bundestag and by the upper house, the Bundesrat, by a margin of 13-3, the law is primarily aimed at states budgets and, beginning in 2020, only allows states to take on new debt to pay off old debt For the federal budget, the new law will take effect in
Bundesministerium der Finanzen, Stellschrauben des Konjunkturpakets 2, http://www bundesfinanzministerium de/DE/Buergerinnen__und__Buerger/Gesellschaft__ und__Zukunft/themenschwerpunkt__konjunkturpakete/ Stellschrauben-des-Konjunkturpakets-2/075__in__Bewegung__ halten html 47 Bundesministerium fr Wirtschaft und Technologie, Konjunktur II, http://www bmwi de/BMWi/Navigation/ Wirtschaft/Konjunktur/konjunkturmassnahmen html 48 International Monetary Fund, The Size of the Fiscal Expansion: An Analysis for the Largest Countries, Washington DC February 2009, http://www imf org/external/np/pp/ eng/2009/020109 pdf
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Even in the midst of the crisis, German politicians and policymakers moved to ensure that, once the crisis subsided, the country would once again have a balanced, or at least nearly balanced, budget.
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2016 and will limit new borrowing to 0 35 percent of the countrys GDP The government will be constitutionally obligated to reduce its debt to the specified levels during times of economic growth, while increasing government revenue 49 Seeking to move away from the current deficit spending and toward the days of balanced budgets before the outbreak of the financial crisis and recession, German lawmakers made fiscal discipline a matter of constitutional law Within the EU, Germany, along with other, mostly smaller member states with a traditionally strong preference for low inflation and sound budgets (such as Austria, the Netherlands, and Finland), has constantly put pressure on fellow member states to return to a path of budgetary consolidation France is traditionally situated somewhat between the high deficit, high debt countries on one side and Germany on the other, but shows a tendency to privilege growth over consolidation concerns Despite a much more pronounced pro-stabilization rhetoric in France, the fiscal stimulus packages in the wake of the 2008 crisis were smaller than in Germany in absolute and relative terms According to the IMF, the French government spent 1 2 percent of GDP on additional stimulus in 2009 and 1 1 2010, while Germany spent 1 7 and 2 2 respectively 50 In 2009, President Nicolas Sarkozy set up an advisory group to study whether France should follow Germanys example and introduce a constitutional rule or at least a law to limit public debt levels Subsequently, he tabled a proposal for a
Bundesrat beschliet Schuldenbremsen, Spiegel Online, June 6, 2009 Bundesrat verankert Schuldenbremse im Grundgesetz, FOCUS Online, June 12, 2009, http://kurse focus de/news/ UPDATE-Bundesrat-verankert_id_news_109095078 htm Cf Schuldenbremsen durch den Bundesrat verabschiedet, Bundesministerium fr Finanzen, June 12, 2009, http://www bundesfinanzministerium de/nn_82/DE/Presse/Pressemitteilungen/ Finanzpolitik/2009/06/20091206__PM25 html
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Constitutional amendment but did not secure the political support he would have needed to make the amendment pass the Assemble Nationale and the Senate with a two-thirds majority With the sovereign debt crisis spreading from Greece to other highly indebted countries, in particular Ireland and Portugal, both of which had to request financial support by the EU and the IMF, the debate on fiscal rules has reached the European level A legislative package was passed in 2011 that strengthens the so-called Stability and Growth Pact, i e the rules for surveillance and co-ordination of budgetary policies in the EU, and is supposed to improve national fiscal frameworks in order to reshape domestic institutional conditions in such a way that public finances are likely to be sound 51 The package also includes a new mechanism for macroeconomic surveillance in the EU (see below) Moreover, Germany and France together proposed a pact aimed at improving the competitiveness of the member states of the European Monetary Union just before the European Summit of February 4, 2011 The pact called for intergovernmental coordination between the heads of state and the governments of the euro zone on a selection of issues (ranging from concrete pension reform proposals to national fiscal rules) Although the proposal provoked open opposition by several member governments, it became part of the Comprehensive Package on EU economic governance reform that was decided upon at the summit on March 24-25, 2011 The package included the so-called EuroPlusPact for more competitiveness, the permanent European Stability Mechanism (ESM), and the new framework for the surveillance and steering of fiscal and
The overall six legislative proposals to reform EU economic governance can be accessed through the web page of the European Commission, which also contains explanatory notes on each of them: http://ec europa eu/economy_finance/articles/ eu_economic_situation/2010-09-eu_economic_governance_ proposals_en htm
51
Joshua Aizenman and Yothin Jinjarak, The Fiscal Stimulus of 2009-10: Trade Openness, Fiscal Space and Exchange Rate Adjustment, NBER International Seminar on Macroeconomics, June 2011, Malta
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economic policy (the above mentioned six pack) 52 Furthermore, on January 30, 2012, 25 out of 27 member states agreed on an intergovernmental treaty nicknamed the Fiscal Compact, which even strengthens the legal and procedural provisions designed to improve budgetary policies in the future And the European Commission has tabled further legislative proposals In a nutshell, the EU is still in the midst of reforms of the future governance mechanisms, in which budgetary policies, after the surveillance and coordination failures of the first 12 years of the EMU, play a predominant role Between the member states, there are traditionally conflicting views over the question to which degree budgetary austerity should be anchored in European rules, how far a breach should be subject to politically imposed or rather quasi-automatic sanctions and whether national fiscal rules enshrined in national constitutions should back-up the European governance framework But under the particular impact of the sovereign debt crisis, member states are more willing to accept closer coordination of budgetary policies The belief has also spread that economic policies likewise need to be more coordinated in order to avoid macro-economic imbalances, which have been identified as one of the root-causes of the deterioration of fiscal positions for instance in Portugal, Ireland, and Spain Beyond this rules-based approach, there is very little discussion on further conclusions that could also be drawn from the last few years, namely whether at least the 17 EU member states should take the United States as an example and introduce some kind of fiscal stabilization mechanisms on the European level in order to enable the EU (or at least the euro zone) to better cope with future asymmetric economic shocks
European Council Conclusion, March 24/25, 2011, CO EUR 6 CONCL 3, http://www consilium europa eu/uedocs/cms_data/ docs/pressdata/en/ec/120296 pdf
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Explaining Convergence and Divergence The United States and the EU were both severely affected by the financial crisis With a common interest in seeing a rejuvenated global economy, how can we explain the different approaches to crisis management and exit strategies? One answer is timing and the economic and financial situation: The downturn came slightly later to Europe than it did to the United States For example, Germanys economy did not contract until the fourth quarter of 2008, when it shrunk by 2 1 percent, while the U S economy saw a decline of 8 9 percent during that period (see Figure 3) Germanys business cycle was about a year behind that of the United States Driven by global demand, export-supported recovery kicked in comparatively early in Germany (2009), which explains at least partially the early preference for budget consolidation in Berlin, in contrast to other EU member states, which have to rely more on domestic demand in their recovery For the United States, 2010 was still a year of remarkable insecurities While recovery was well underway, the risks of a double-dip recession were not yet contained Furthermore, U S employment had declined much more than in Europe Unemployment still hovered around 9 7 percent levels not seen since the early 1980s The United States has experienced some increase in private savings Personal saving as a percentage of disposable personal income was 5 3 percent in December 2010 (see Figure 4) 53 But while deleveraging of private households had started, the gross debt-to-income ratio remained high, decreasing only from 134 5 percent in 2007 to 124 7 percent in 2010 (see Figure 6) 54 Taking into account the limitations of U S unemployment
Bureau of Economic Analysis, Personal Income and Outlays, December 2010, http://www bea gov/newsreleases/national/pi/ pinewsrelease htm 54 EconStats, Balance Sheet of Households and Nonprofit Organizations, http://www econstats com/fof/fof_BB__1a htm
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The belief has spread that economic policies need to be more coordinated in order to avoid macro-economic imbalances.
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Figure 3: Gross Domestic Product (constant prices percent change)
Source: International Monetary Fund, World Economic Outlook Database, September 2011
insurance, the call for further stimulus measures becomes quite understandable But more than timing was at play Jean Pisani-Ferry and Adam Posen (2010) point to the diverging interpretations of the causes and consequences of the financial and economic crisis They found that U S policymakers were less concerned about the effects of the crisis on potential output than their European counterparts Likewise, U S policymakers seemed to view the rise in unemployment as cyclical rather than structural and thus advocated further stimulus measures Contrary to this, the European Commission expected greater damage to potential output, which reduced the scope for demand-side policies and created a greater need for budget consolidation 55 Given debt-to-GDP-ratios, which have seriously
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deteriorated since 2008, long-term sustainability of public finances has moved to the forefront of the debate on national budgets in the EU Here, crisis effects and long-term trends coincide Data shows that due to the aging population, a majority of EU member states will face severe budgetary sustainability problems, some in the nottoodistant future, which renders an adjustment of previous policies key In addition, many European policymakers view the cause of the financial crisis as consumption and spending overstretch In this view, more spending would clearly not have been an answer to this problem Similar to Pisani-Ferry/Posen (2010), the IMF (2011) compared European and U S estimates on the slack within their economies They not only confirmed the Pisani-Ferry/Posen (2010) conclusions, they highlighted a second interesting finding: U S slack estimates on European
Pisani-Ferry/Posen (2010), p 6
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Figure 4: Household Dept to Disposable Income Ratio (in percent)
Sources: Eurostat; EconStats, Balance Sheet of Households and Nonprofit Organizations
economies ranged higher than EU estimates On the other hand, EU estimates calculated less slack in the U S economy than U S estimates Given the differing views on the slack in each others economies, coupled with differences in perceived growth prospects, it does not come as a surprise that the U S government still injected capital into the economy while many European countries had already switched to budget consolidation The different perceptions also explain why the United States recommended more spending for the EU while the European advice to the United States was the opposite 56 Differences in perceptions can also be found among the population Polling done by the German Marshall Fund in 2009, Transatlantic Trends,
IMF, Presentation at the German Marshall Fund, March 4, 2011
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showed that the economy was a main concern on both sides of the Atlantic However, a higher percentage of Americans (69 percent) was more concerned about the economic situation than Europeans (47 percent) Three in-four-Americans (74 percent) said their families had been hit by the recession, while this proportion was just over half for the EU (55 percent) 57 The GMFs Transatlantic Trends survey in 2011 found that concerns in Europe increased when the debt crisis began to spread and Ireland and Portugal applied for rescue funds from the EU in November 2010 and April 2011, respectively Nonetheless, concern in the United States remained comparatively high: 82 percent of U S respondents (up 7 percentage points from 2010) stated that they had been personally
German Marshall Fund, Transatlantic Trends, 2009, Washington DC 2009, p 18, http://www gmfus org/trends/doc/2009_ English_Key pdf
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Figure 5: Exports of Goods as Percent of GDP
Source: European Commission, Ameco Database, October 2011 Note: Figures for EU members, EU and euro zone include intra-EU trade
affected by the economic crisis, while the average in the EU had remained stable at 61 percent In Germany, the percentage of respondents feeling personally affected by the crisis had even decreased by 9 percentage points to 45 percent 58 Another determining factor that helps explain divergences is economic structures, such as the multiplier effect, automatic stabilizers, the role of the state and local government spending in the United States, and last but not least, the disciplining effects of the market Several EU member states, foremost Germany, refused to undertake further government spending arguing that multiplier effects of consumption-targeted stimulus spending
German Marshall Fund, Transatlantic Trends, 2011, Washington DC 2011, p 17-18, http://www gmfus org/publications_/ TT/TT2011_final_web pdf
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were exceedingly low because of its heavy exportdependence Exports of goods to GDP were 35 1 percent in Germany (2009, including exports to EU members; 2010: 39 7; 2011: 42 9) For the United States, whose growth depends much more on domestic consumption, exports only reached 7 7 percent of GDP in 2009 (see Figure 5) (2010: 8 8, 2011: 9 9 percent) Supporting domestic demand was an important component of U S stimulus measures,59 just like in some EU member states that rely more strongly on domestic demand as the main source of growth due to a lower export share in GDP German consumers have also demonstrated a historically high personal savings rate While
59
Mildner/Prentice, 2009, p 14 f
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Figure 6: Net Saving Rate (in percent)
savings rates declined from a peak of about 13 percent in 1991 to near 9 percent in 2000, they had once again begun to reach the post-unification average of approximately 11 percent since 2001 60 Annual saving rates in the United States averaged only 2 7 percent between 2000 and the onset of the crisis in 2007 61 German policymakers argued accordingly that tax rebates would do little, if anything, to stimulate growth in the German economy and probably just lead to more saving, thus doing little to spur domestic demand Instead, German policymakers made investment the priority, providing tax breaks for businesses and export credits, among other measures
Halbjahr 2008: Haushalte sparen mehr, Pressemitteilung Nr 400, Statisches Bundesamt Deutschland, October 2008 61 Bureau of Economic Analysis, Personal Income and Outlays, December 2010, http://www bea gov/newsreleases/national/pi/ pinewsrelease htm (accessed: February 24, 2011)
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Automatic stabilizers are another structural factor that can help to explain transatlantic divergence Throughout their management of the financial crisis, several EU states again led by Germany negated the need for further direct stimulus pointing to the social safety net Through increased welfare checks, unemployment benefits, and job protection, the social safety net injects financial resources into the economy, thus serving as an automatic stabilizer In 2009, the IMF estimated Germanys 2009 stimulus spending at 1 5 percent of GDP (forecast 2010: 2 0 percent; 2008-2010: 3 4 percent), slightly lower than the United Statess stimulus plan, which was estimated at 2 0 percent of GDP (2010: 1 8 percent; 2008-2010: 4 8 percent) However, because of Germanys stronger social safety net and its larger automatic stabilizers, the cumulative effect of the German stimulus spending was actually much higher The automatic stabilizers contributed an additional 1 7 percent, for a total of
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The United States is still perceived as a safe haven for foreign capital.
3 2 percent of GDP The U S stabilizers added 1 5 percent for a total of 3 5 percent, still slightly higher than Germany 62 These figures not only explain differences between the transatlantic partners; they also fuel the debate on whether Germany was doing enough to stimulate the economy Apart from having smaller automatic stabilizers, there is a third structural reason why the United States opted for a larger federal stimulus: the contracting effect of pro-cyclical fiscal policy on the state and local level Almost every state has some form of a balanced-budget provision Budget shortfalls therefore need to be closed, for example through spending cuts, withdrawals from reserves, revenue increases, and use of federal stimulus money According to the National Governors Association and the National Association of State Budget Officers, both fiscal years 2009 and 2010 saw nominal declines in state spending63 as states experienced large budget shortfalls (2009: $110 billion; 2010: $191 billion) 64 These spending cuts acted as a drag on the economy in 2011 also The Center on Budget and Policy Priorities estimates the budget shortfall for 2011 at $130 billion 65 The fourth structural factor is the disciplining effect of the sovereign debt crisis Those governments
IMF, Note by the Staff of the International Monetary Fund, Group of Twenty: Meeting of the Deputies, January 31- February 1, 2009, International Monetary Fund, Washington DC 2009, http://www imf org/external/pubs/ft/survey/so/2009/ pol020709a htm; IMF, The Size of the Fiscal Expansion: An Analysis for the Largest Countries, February 2009, http://www imf org/external/np/pp/eng/2009/020109 pdf; Marc Champion, Germany Says Its Spending Package Is Already Big Enough, Wall Street Journal, March 12, 2009 63 National Governors Association and the National Association of State Budget Officers, The Fiscal Survey of the States, Fall 2010, http://nasbo org/LinkClick aspx?fileticket=C6q1M3kxaEY %3D&tabid=83 64 Elizabeth McNichol/Phil Oliff/Nicholas Johnson, States Continue to Feel Recessions Impact, February 10, 2011, http:// www cbpp org/cms/?fa=view&id=711 65 Elizabeth McNichol/Phil Oliff/Nicholas Johnson, States Continue to Feel Recessions Impact, Center on Budget and Policy Priorities, June 17, 2011, http://www cbpp org/ cms/?fa=view&id=711
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that either sought help from the EU and the IMF under the provisions for euro zone members (Greece and Ireland) as well as the three non-euro zone countries (Latvia, Romania, and Hungary) and were granted balance of payment loans by the European Commission and the IMF in 2008/2009 all had to accept severe conditionality linked to the loans they received For those governments that are at the brink of needing liquidity aid but who do not want to ask for credit and loans (such as Spain, Italy, and possibly Belgium), the experience of Ireland and Greece, where governments have fallen over the crisis, combined with lasting market pressure, have spurred national reform and fiscal consolidation policies Even for others who are not on the brink of a sovereign debt crisis, the new scrutiny by market actors has important effects Observers attribute Frances new interest in domestic fiscal rules and the Pact for the Euro joint measures to improve budgetary austerity and structural reforms at least partly to the perceived need for fiscal consolidation and domestic institutional framework in order not to have its credit rating further downgraded Furthermore, the framework for budgetary surveillance and coordination introduced a consolidation impulse into national debates in the EU, despite the fact that, in the midst of the crisis, 26 out of 27 member states were actually breaching the Pact For the United States, the disciplining effect of the markets is much smaller The United States is still perceived as a safe haven for foreign capital Unlike the euro zone, it also has been less punished by so called bond vigilantes, bond market investors who protest monetary or fiscal policies they consider inflationary by selling bonds After the Obama administration and the Republicans agreed on the latest stimulus deal in December 2010, U S Treasury bond yields jumped up But the disciplinary effect was small, which is underlined by the fact that the dollar value did not
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budge 66 Why do markets not react more strongly? The answer lies in what the French in the 1960s called the exorbitant privilege Since the U S dollar is the international reserve currency, the United States will not face a balance of payments crisis It purchases imports in its own currency and is indebted in its own currency Although governments have started to diversify their reserves, the dollar is likely to retain its role in the global economy for years to come Given the problems of the euro [] the dollar has actually been looking a bit more attractive relative to some of the other currencies in the world, Federal Reserve Chairman Ben Bernanke testified before the Budget Committee of the House of Representatives 67 The picture would remain incomplete, however, without a historical perspective The contrast becomes particularly clear by comparing Germany and the United States With hyperinflation and economic chaos of the 1920s hanging heavy in the nations collective memory (seemingly much more strongly than the deflation of the 1930s under Chancellor Heinrich Brning, with all its devastating political consequences), German politicians and policymakers argued that deficit spending is ineffective in fostering long-term growth and that a high level of government debt would lead to inflation This strong fiscal conservatism in fact reached beyond the traditional CDU base and across political and public opinion Much of this is also due to the experiences of the 1990s The large expenditures and the consequent debt incurred from rebuilding East Germany, as well as the attempt to balance the budget in the latter part of the decade, slowed growth rates One of the successes of the Grand Coalition had been to avoid deficit spending and, in 2007, the
John Plender, Can Vigilantism Truly Police U S Fiscal Discipline?, Financial Times, December 14, 2010 67 Quoted in: Bernanke confident of U S dollar as reserve currency, Istock.Analyst, February 9, 2010, http://www istockanalyst com/article/viewiStockNews/articleid/4878270
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federal government was nearing a balanced budget before the outbreak of the financial crisis 68 U S policymakers, on the other hand, are haunted not by a fear of inflation but deflation Deflation, as experienced in the Great Depression of the 1930s is associated by many with difficult economic times slow growth and high unemployment In mid2010, the Fed warned that the United States faced the risk of an extended period of falling prices not unlike in Japan during the previous two decades 69 In comparison to inflationary pressures, a central bank has few tools to effectively pull an economy out of a deflationary spiral Falling prices lead households and businesses to hold onto cash rather than spend it; production falls, which in turn leads to lower wages and demand, which leads to further decreases in price Ending such a vicious cycle is difficult Last but not least, politics matters In the United States, the latest economic stimulus passed by Congress in December 2010 was clearly influenced by the mid-term elections Polls show that in the run-up of the mid-term elections, two-thirds of all voters used the elections to express their discontent with Obamas political agenda and achievements The major concern of voters was clearly the economy, particularly with regard to the labor market According to polls conducted by CNN/ Opinion Research Corporation, in August 2009, 44 percent of U S citizens felt that Obamas policies had improved the economic conditions in the country in October 2010, this rate dropped to 36 percent The Democrats, who had lost the House of Representatives to the Republicans, wanted to pass another stimulus before the latter took over in January 2011 To secure the necessary votes to pass the legislation, Democrats agreed to a compromise In return for an extension of unemployment aid
Mildner/Prentice, 2009, p 13 James Bullard, Seven Faces of the Peril, Federal Reserve Bank of St Louis Review September-October Issue, July 29, 2010
68 69
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and tax cuts for the lower and middle income class, they agreed on extending President Bushs 2001 and 2003 tax cuts for higher income households Politics also explain why little has been achieved with regard to balancing the budget so far In November 2010, the National Commission on Fiscal Responsibility and Reform issued several recommendations to balance the budget However, the members of the commission could not agree on a common approach Arguing that higher taxes and deficits strangled private business, Republicans believe public spending destroys jobs and hinders economic growth and thus they reject any measures of this kind In their Pledge to America agenda, Republicans call for an end to what they label the Keynesian experiment They want government spending to be reduced to pre-crisis levels and view tax cuts (including tax cuts for wealthy Americans) as the appropriate means to increase domestic demand and stimulate the economy Many of the Congressional freshmen and members of the Tea Party even go one step further In their Contract America, Tea Party representatives argue for making a balanced budget a constitutional requirement Tax increases should only be passed by a two-thirds majority in Congress Democrats, on the other hand, did not rule out tax increases to balance the budget It seems to be increasingly difficult to consolidate these two positions, which also explains the failure of the Super Committee in November 2011 In the EU member states, electoral cycles obviously also influence budgetary policymaking, but the sovereign debt crisis has a strong disciplining effect One example is the new Irish government, which has agreed on a far-reaching austerity program in line with the EU/IMF-conditionality attached to the loans while it also seeks a renegotiation of the interest rates attached to it in order to support consolidation efforts In the U K , the Conservative Party won the 2010 general elections with a very
In the EU member states, electoral cycles obviously influence budgetary policymaking, but the sovereign debt crisis has a strong disciplining effect.
clear message that it would have to implement serious budgetary consolidation efforts because the country had run into a budgetary situation that was on the verge of unsustainability An interesting case to observe will be Greece, where general elections are scheduled to take place in 2013 after the prime minister changed in 2011 Social protests are on the rise and the capacity of the administrative and political system to deliver the required consolidation and reform efforts reach clear limits What can be said, on average, is that the urgency of the sovereign debt crisis and the increasing efforts by the European Commission and some member states to emphasize the need for fiscal consolidation, have led to a situation where politics and electoral cycles are probably less likely to lead to expansive fiscal policies than in normal times Another key factor is that as a result of the sovereign debt crisis, market actors now very closely scrutinize individual country cases, while in the first 12 years of EMU there was too little country-specific risk assessment, as all members of the euro zone were granted a kind of eurobonus Their impact will most likely increase further if the European Stabilisation Mechanism that includes Collective Action Clauses to involve the private sector in future debt restructuring takes over as a permanent debt crisis management mechanism upon ratification in all EMU member states Without wanting to imply that we assume that markets always react rationally (rather, quite the contrary in certain phases of the current debt crisis), it can be said that since 2009, market mechanisms in the EU are the most powerful disciplining device to push member governments toward consolidation
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Case Study II: Global Macroeconomic Imbalances Numerical Targets

sector 71 The United States and the EU also agree that the deficit countries cannot resolve their imbalances acting alone However, the transatlantic partners hold diverging views on how to address macroeconomic imbalances At the G20 meeting in Pittsburgh, after being pushed by the United States, the leaders agreed on a new Framework for Strong, Sustainable and Balanced Growth under which they would review each others national economic policies Supervised by the IMF, the main coordinating instrument was to be a process of mutual assessment and peer pressure (Mutual Assessment Process, MAP) 72 But the United States and export-oriented countries clashed openly again before the G20 summit in Seoul, when the United States proposed numerical targets for current account surpluses and deficits as well as enforcement mechanisms, such as penalties or sanctions The Europeans were initially split on the issue, with Paris first supporting the suggestion to define a limit for trade imbalances to GDP,73 calling on Germany to change its export-driven growth strategy and foster domestic demand Germany, shoulder-to-shoulder with China, on the other hand, strongly opposed the U S position The U K also cautioned that a single number for all countries might not be appropriate In their joint letter to the G20 leaders, Presidents Barroso and Van Rompuy then presented a common EU stance: [] major economies must [to] do their part to achieve rebalancing Current account imbalances should be used as an indicator to
Eric Helleiner, Understanding the 2007-2009 Global Financial Crisis: Lessons for Scholars of International Political Economy, Annual Review of Political Science, 14, 2011, p 67-87 (here: 77) 72 G20 Leaders Statement: The Pittsburgh Summit, September 24-25, 2009, http://www g20 utoronto ca/2009/2009communique0925 html; Claudia Schmucker/ Katharina Gnath, From the G8 to the G20: Reforming the Global Economic Governance System, GARNET Working Paper, Number 73, January 2009 73 G20: EU Split over U.S. Offensive against Global Imbalances European Information Service, October 25, 2010
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ver the past years, countries like China and the oil and gas exporters of the Middle East have accumulated large trade surpluses, while the United States experienced growing deficits Germany is among the states with a large trade surplus, while the EU overall is almost balanced in its trade account At the same time, Chinas foreign-exchange reserves climbed to record heights, reaching $3 2 trillion in September 2011, while the United States faced massive capital inflows from foreign governments, foremost China, Japan, and oil-exporting countries Economist Olivier J Blanchard and Gian Maria Milesi-Ferretti argue that while imbalances had narrowed during the financial and economic crisis, they are still nevertheless a risk They see an urgent need to implement policy changes to address the remaining domestic and international distortions that are a key cause of imbalances 70 The transatlantic partners agree that macroeconomic imbalances pose a problem 1) if they are the consequence of inefficient international capital allocation between countries with different saving, investment, and consumption preferences; 2) if exchange rates are manipulated, automatic adjustment mechanisms of de- and revaluation do not work, or exports are subsidized; or 3) if accumulated obligations cease to be financeable so that confidence in the solvency of deficit countries is undermined Such systemic macroeconomic imbalances are misallocation of capital and financial bubbles Just how dangerous persistent macroeconomic imbalances are was revealed by the recent crisis, when large capital flows into the United States drove down the cost of credit and thus contributed to the bubble in the housing
Olivier J Blanchard/Gian Maria Milesi-Ferretti, Global Imbalances: In Midstream? CEPR Discussion Paper No DP7693, 2010
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trigger an assessment of the possible root causes of impediments to adjustment 74 But the EU did not support concrete numerical targets Furthermore, they stressed that the institutional economic policy set-up of the euro zone as a whole must be fully taken into account, emphasizing that it was putting in place a strong alert mechanism that aims at preventing internal economic imbalances At the G20 summit in Seoul, the leaders agreed to work on indicators to measure the sustainability of imbalances Concrete numerical targets were not included in the agreement At their first meeting under the French G20 presidency in February 2011, the G20 ministers identified a set of indicators to focus on persistently large imbalances that require policy actions: public debt and fiscal deficits; private savings rate and private debt; and the external imbalance composed of the trade balance and net investment income flows and transfers Germany strongly supported the development of these indicators as it could thus ensure that the current account balance was not the only benchmark The United States, in addition to the listed indicators above, strongly supported the inclusion of a currency indicator such as the real exchange rate and foreign-exchange reserves, but failed due to strong opposition by China The G20 finance ministers hence only agreed on taking due consideration of exchange rate, fiscal, monetary, and other policies At their meeting in Washington on April 14-15, 2011, the ministers set forth indicative guidelines against which each of these indicators will be assessed, and launched the second step of this process with an in-depth assessment of
the nature of these imbalances and the root causes of impediments to adjustment 75 The U.S. Case The Obama administration strongly urged the other economic powers to agree to curb persistent trade surpluses and deficits In his letter to the G20 in the run-up of the summit in Seoul in November 2010, Treasury Secretary Geithner demanded that: G20 countries with persistent surpluses should undertake structural, fiscal, and exchange rate policies to boost domestic sources of growth and support global demand 76 Deficit countries should stabilize their public indebtedness over the medium term and raise exports, while surplus countries should undertake structural, fiscal, and exchangerate policies to increase domestic demand Since our current-account balances depend on our own policy choices as well as on the policies pursued by other G20 countries, these commitments require a cooperative effort Geithner also asked the G20 countries to refrain from exchange-rate policies designed to achieve competitive advantage by either weakening their currency or preventing appreciation of an undervalued currency He continued by emphasizing that G20 emerging market countries with significantly undervalued currencies and adequate precautionary reserves needed to allow their exchange rates to adjust fully over time to levels consistent with economic fundamentals 77 While the United States claims it did not officially propose a precise quantitative
Communiqu. Meeting of Finance Ministers and Central Bank Governors, Washington April 14-15, 2011, see in particular G20 Indicative Guidelines for Assessing Persistently Large Imbalances on p 3 http://www g20 org/Documents2011/04/G20%20 Washington%2014-15%20April%202011%20-%20final%20 communique pdf 76 U.S. Treasury Geithners Letter to G20 Colleagues, Full Text, International Business Times, October 22, Sewell Chan, Nations Agree on Need to Shrink Trade Imbalances, The New York Times, October 22, 2010 77 U.S. Treasury Geithners Letter to G20 Colleagues, October 22, 2010
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G20 Summit: Joint Letter of Presidents Barroso and Van Rompuy to G20 Leaders, November 5, 2010, http://europa eu/ rapid/pressReleasesAction do?reference=MEMO/10/546&type =HTML
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Figure 7: U.S. Bilateral Trade Deficits (trade in goods, in billions of dollars and percent of total deficits)
Source: IMF, Direction of Trade Statistics, December 2011
target, G20 finance ministers discussed setting a norm for current account imbalances of less than 4 percent of gross domestic product, with persistent breaches triggering negotiations for its reduction The main culprit in the eyes of the United States is China, with which the United States has experienced persistent trade deficits (see Figure 7) In 2010, the trade deficit stood at approximately $290 billion slightly down but nonetheless the largest that the country has had with any trading partner and largest in the world between any two countries For years, the United States has accused China of currency manipulation as the country has pegged its currency, the renmimbi, to a basket of currencies which includes the dollar, keeping its value too low, thus creating an unlevel playing field for U S exporters and worker In addition, U S debt, largely held by China (see Figure 8), is increasingly perceived not just as an economic but a political risk Although it is not very likely that
China would dump those securities on the market because this would devalue its reserves, Congress is worried that China could use its large holdings of U S government debt to gain political leverage While macroeconomic imbalances are not an election issue in the United States, trade foremost the high deficit with China certainly is For the last decade, support for free trade and trade agreements has dwindled Pro-free-trade sentiment temporarily spiked up in 2009, but the declining trend has returned in 2010 According to a 2010 poll by the Pew Research Center for the People & the Press, only 35 percent of respondents were in support of trade agreements in 2010 With regard to trade in general, public sentiment is much more mixed But while most Americans believe that increasing trade with Canada (76 percent), Japan (60 percent) and European Union countries (58 percent) would be good for the United States, only 45 percent believed this to be the case for trade with
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Figure 8: Major Foreign Holders of Treasury Securities (in billions of dollars and percent)
Source: U S Treasury, Major Foreign Holders of Treasury Securities, December 2011
China 78 In a January 2011 poll, Pew found that by a two-to-one margin (60 percent to 27 percent) Americans see Chinas economic strength as a greater threat than its military strength Fifty-three percent of the respondents want the United States to get tougher with China on trade and economic issues Given this picture, the anti-China rhetoric in Congress is not surprising 79 Several bills were introduced in the 112th Congress to address the macroeconomic imbalance with China The Foreign-Held Debt Transparency and Threat Assessment Act, for example, aims to
Pew Research Center for the People & the Press, Public Support for Increased Trade, Except With South Korea and China, November 9, 2010, http://people-press org/report/673/ 79 Pew Research Center for the People & the Press, Strengthen Ties with China, But Get Tough on Trade, January 12, 2010, http://people-press org/report/692/
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increase the transparency of foreign ownership of U S debt instruments If passed, it would not only require the president to issue a quarterly report on foreign holders of U S debt instruments, but he would need to formulate an action plan if he determined that a foreign countrys holdings of U S debt instruments posed an unacceptable risk 80 The Currency Reform for Fair Trade Act, introduced in the House of Representatives in February 2011, would make currency undervaluation actionable under U S countervailing duty (CVD) law, i e it would allow the United States to impose acrossthe-board tariffs against China if the country was found to manipulate its currency, thus subsidizing its exports and creating an unfair competitive
Wayne M Morrison, China-U.S. Trade Issues, CRS Report for Congress, September 30, 2011, http://www fas org/sgp/crs/row/ RL33536 pdf, p 12
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advantage for its goods Whether or not a currency was undervalued would be measured against indicators such as protracted and large-scale intervention in currency markets; a real effective exchange rate estimated to be undervalued by at least 5 percent; and foreign asset reserves held by the government that are greater than the amount needed to repay its debt obligations over the next year, and 20 percent of the nations money supply 81 The House had already voted for a similar bill with a clear majority (the totals were 348 ayes, 79 nays, 6 present/not voting) late September 2010; but as the bill was not voted on by the Senate, it had died with the end of the 111th Congress A similar version to the Currency Reform for Fair Trade Act of 2011 was also introduced in the Senate in February 2011, still awaiting a vote Another Senate bill addressing currency misalignment is the Currency Exchange Rate Oversight Reform Act of 2011 The bill was passed in October 2011 The bill not only requires the Treasury Department to report to Congress semiannually on international monetary policy and currency exchange rates, but it would also be required to designate certain misaligned currencies for priority action If the priority country did not make efforts to correct the currency misalignment, actions would have to be taken For example, the United States Trade Representative (USTR) would be required to initiate a dispute resolution case, and Treasury would be required to consult with the Federal Reserve System to consider undertaking remedial intervention in international currency markets The bill also amends U S countervailing duty law, similar to the Currency Reform for Fair Trade Act Action by the House is still pending Whatever eventually happens in Congress, Capitol Hill demands a tougher stance on China by the Treasury
But China is not the only focus of U S criticism related to global macroeconomic imbalances While Europe as a whole was in external balance before the crisis, U S policymakers repeatedly pointed to the large internal imbalances, which (in their eyes) contributed to the euro crisis: the large trade surpluses of Germany and the large deficits of the euro zone periphery The painful adjustment by the periphery countries will be easier to sustain if it is accompanied by sustained increases in domestic demand in the surplus countries within Europe, Treasury Assistant Secretary Charles Collyns argued in early 2011 82 At the same time, the United States has also recognized and acknowledged the need for adjustment at home (just as China is implementing policies to foster demand at home): less domestic consumption and more exports While President Obama had thoroughly neglected trade policy during the first two years of his administration, he discovered exports as a tool to foster economic growth and employment in 2010 In his 2010 State of the Union speech, President Obama announced his plan to double U S exports within the next five years and thus create 2 million jobs We have to seek new markets aggressively, just as our competitors are, he said If America sits on the sidelines while other nations sign trade deals, we will lose the chance to create jobs on our shores But realizing those benefits also means enforcing those agreements so our trading partners play by the rules 83 To achieve this goal, Obama issued an executive order on a National Export Initiative (NEI) in March 2010 The NEI planned to improve advocacy and trade promotion, increasing export financing, stepping up efforts to remove barriers to
Remarks by Assistant Secretary Charles Collyns on The Transatlantic Relationship and the G20, January 20, 2011, http://www treasury gov/press-center/press-releases/Pages/tg1030 aspx 83 Remarks by the President in State of the Union Address, http:// www whitehouse gov/the-press-office/remarks-president-stateunion-address
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Wayne M Morrison, China-U.S. Trade Issues, CRS Report for Congress, September 30, 2011, http://www fas org/sgp/crs/row/ RL33536 pdf, p 22
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U S exports, getting tougher on the enforcement of trade rules, and forming an Export Promotion Cabinet Since then, the administration stepped up its efforts to push the free trade agreements (FTAs) with South Korea, Panama, and Columbia which were negotiated by President Bush and were since awaiting a vote through Congress On October 12, 2011, Congress passed the pending FTAs with clear majorities in both the House and the Senate The administration intensified its negotiations of a Trans-Pacific Partnership (TPP, including Australia, Brunei, Chile, Malaysia, New Zealand, Peru, Singapore, and Vietnam), with the objective of shaping a high-standard, broad-based regional pact84 and improve market access abroad for U S producers The negotiations gained momentum in 2011 Japan also applied for participation while Canada and Mexico are contemplating joining the initiative The European Case As already mentioned above, while the current account of the European Union is more or less balanced, several European member countries have large surpluses or deficits This has not only led to differences between the EU representatives in the G20 debates, but also impeded the European governments in the running negotiations on setting up a macroeconomic surveillance and coordination procedure in the EU The country with the largest trade surplus is Germany, with 5 7 percent of GDP in 2009, 6 4 percent in 2010, and 5 5 percent in 2011 Fearing interference with domestic economic policy decisions, Germany rebuffed U S demands for trade balance targets The former German economic minister, Rainer Brderle, told reporters that the proposal could be viewed as a reversion
USTR, Free trade Agreements, http://www ustr gov/tradeagreements/free-trade-agreements
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to planned economy thinking 85 While some of its trading partners have repeatedly accused the country of wage dumping, Germany points to its competitive advantage and the many painful reforms it has pushed through in previous years It expects similar reform in the deficit countries One thing is clear, the German Association of Banks argued If the overall competitiveness of the euro zone is not to deteriorate, the less competitive member states must catch up The solution cannot be to tie a deadweight to the German economy86 Not all European countries agree with this interpretation France, for instance, supported the U S proposal 87 There are some parallels between the G20 debates and the European discussions over coping with macroeconomic imbalances in the euro zone In this latter context, Germany takes a very clear position, trying to fend off all coordination proposals that would also oblige the surplus countries to reduce imbalances Since the start of the debate, Germany has argued for an asymmetric approach with the deficit countries bearing the adaptation efforts Meanwhile, French politicians (including then-Finance Minister Christine Lagarde, who now heads the IMF) and commentators have suggested that Germany should do more for domestic demand, e g by raising wages, liberalizing the service sector, or the like Also other European partners have criticized German economic policies, sometimes even blaming Greek problems on German success Repeatedly, European partners have voiced their expectations of Germany, not only to rely on its export success, but to contribute to growth in the euro zone (in particular in the less competitive
Quoted in: Germany Warns against Planned Economy Thinking at G20, Reuters, October 22, 2010, http://www reuters com/article/2010/10/22/us-g20-germany-imbalancesidUSTRE69L1NJ20101022 86 Bundesverband der deutschen Banken, More Stability by Reducing Macroeconomic Imbalances, Berlin, May 2010, p 4 87 G20: EU Split over U.S. Offensive against Global Imbalances, eis, October 25, 2010
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periphery, some critics argue) by fuelling domestic demand The legislation on macroeconomic policy coordination in the EU tabled by the European Commission in September 2010 and agreed upon by the Council and the European Parliament a year later leaves some scope for a symmetric approach, in which both countries with excessive deficits and surpluses would have to accept pressure on their economic policies The member states, which face twin deficits, (high budget deficits and severe current account imbalances), strongly prefer coordination mechanisms, which can also push surplus countries to adjust their economic policies But their negotiation position is rather weak in the current legislative process It was thus rather unlikely that the EU would agree on a framework with numerical targets and sanctions for surplus countries Within the so-called package of six legislative proposals, approved by the Parliament on September 28, 2011, aiming at strengthening economic governance in the EU, the EU Parliamentarians agreed on an alert mechanism for the early detection of imbalances, to be assessed using a scoreboard of economic indicators, as well as on an excessive imbalance procedure, with enforcement for noncompliant member states 88 The scoreboard covers the following indicators for the identification and monitoring of external and internal macroeconomic imbalances: current account balance, net international investment position, export market shares, nominal unit labor costs, real effective exchange rates, evolution of unemployment, private sector debt, private sector, credit flow, house prices, and the general government sector debt However, the Council Conclusions on an Early Warning Scoreboard for
European Parliament, Enforcement Measures to Correct Excessive Macroeconomic Imbalances in Euro Area, September 28, 2011, http://www europarl europa eu/ sides/getDoc do?pubRef=-//EP//TEXT+TA+P7-TA-20110423+0+DOC+XML+V0//EN&language=EN
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the Surveillance of Macroeconomic Imbalances of November 8, 2011 reaffirmed the German position No country will be punished for export surpluses 89 With regard to G20 negotiations, the EU increasingly seeks to defend common positions It is now not only represented by the leaders of the five European G20 members Germany, France, the U K , Italy, and Spain but also by the President of the European Council, Herman Van Rompuy and European Commission President Jos Manuel Barroso The European member states are clearly under pressure to find their space in a potentially emerging G2 world in which key negotiations are happening between those partners who are not only fundamentally dependent on each other, but likewise deeply opposed over key issues: China and the United States Germany is politically in an interesting situation On one hand, there is a rift between Berlin and Washington over different views of coping with imbalances On the other hand, Berlin was rather isolated in the EU negotiations in which some member states, along with the European Commission and the European Parliament, have favored a symmetric approach when coping with internal imbalances in the European Monetary Union But within the G20 format, the EU has recently sided with the United States against China with Germany putting itself into a key moderating role At the Paris finance minister meeting in February 2011, Germanys finance minister, Wolfgang Schuble, is reported to have played the key mediator role between China and its critics, which enabled agreement on at least some indicators and provides the basis for further
The European member states are clearly under pressure to find their space in a potentially emerging G2 world.
European Council, Council Conclusions on an Early Warning Scoreboard for the Surveillance of Macroeconomic Imbalances, 3122nd Economic and Financial Affairs Council meeting Brussels, November 8, 2011, http://www consilium europa eu/ uedocs/cms_data/docs/pressdata/en/ecofin/125974 pdf
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work on macroeconomic surveillance in the G20 context 90 In addition to the indicators, the European G20 members are keen to push exchange rate issues onto the agenda Before taking over the presidency of the G20 at the end of 2010, Frances President Nicolas Sarkozy had announced that he sought to establish a new global monetary system Although his tone has become much more modest since then, the European governments in particular in times of an appreciating euro have a strong interest in discussing exchange rate regimes While the EU member states agree with Washington on the issue of the renminbi, they are also frustrated whenever the dollar hits new lows, which is interpreted as the consequence of the Feds decision to further ease monetary policies There will be no success in rebalancing growth without addressing currency tension, Commission President Barroso said during a speech to the European Parliament in November 2010, supporting the French attempt to push for a reform of the international monetary systems during its G20 presidency Explaining Convergence and Divergence The most obvious reason for transatlantic divergence on global macroeconomic imbalances is economic parameters The United States has experienced a persistent deficit in its current account balance, peaking at almost six percent in 2006 While it improved during the economic and financial crisis in 2009 (-2 7 percent), it worsened again in 2010 (-3 3 percent) The euro zone and the EU, on the whole, were in external balance with a 0 4 percent surplus for the euro zone in 2006 (2009: 0 1 percent; 2010: 0 3) and -0 4 percent deficit for the EU (2009: -0 1 percent; 2010: -0 1 percent) However, there were large differences between individual EU members Germanys
Die G20-Politik der kleinen Schritte, Handelsblatt, February 21, 2011
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current account surplus amounted to 6 3 percent in 2006 and the United Kingdoms deficit to -3 4 percent (see Figure 9) France slipped from a surplus to a deficit position in 2004 as a result of its deteriorating competitiveness The largest current account deficits were experienced by the periphery of the euro zone, foremost Greece However, economic parameters alone cannot explain the transatlantic differences Again, perceptions and interpretations of the causes of the imbalances also play a large role As Erik Jones pointed out in his 2009 essay, Shifting the Focus: The New Political Economy of Global Macroeconomic Imbalances, the debate on global macroeconomic imbalances has changed Jones argues that in the past, it was easy to criticize net-importing countries for their lack of competitiveness and self-discipline, while at the same time lauding net-exporting countries Today, this is not the case anymore As the criticism towards Germany illustrates, net exporters are not only much more closely scrutinized, they are now also expected to contribute to reducing the imbalances by boosting domestic demand 91 The U S government believes that the causes of the imbalances are not just rooted in competitiveness or a lack thereof According to the United States, Germany ran large current account surpluses as low wage growth held down consumer demand, thereby fuelling the inner-European imbalances Chancellor Merkel, on the other hand, argued that current account balances are also proof of achievements, and they are the result of global market processes, dismissing the U S criticism of the countrys export surplus Our export success shows how competitive German products are 92
Erik Jones, Shifting the Focus: The New Political Economy of Global Macroeconomic Imbalances, Sais Review, Vol XXIX, No 2 (Summer-Fall 2009) 92 Our Export Success Shows How Competitive German Products Are, Spiegel Online, November 10, 2011, http://www spiegel de/international/germany/0,1518,728324,00 html
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Figure 9: Current Accounts (in percent of GDP)
Sources: International Monetary Fund, World Economic Outlook Database, September 2011
Another related factor is the different growth models The German government believed in export-led growth, while criticizing the U S consumption-based growth model (see Figure 10) The American growth model, on the other hand, is in deep crisis The United States lived on borrowed money for too long, inflating its financial sector unnecessarily and neglecting its small and mid-sized industrial companies There are many reasons for Americas problems, but they dont include German export surpluses 93 Last but not least, politics are a decisive factor, at least in the Unites States As argued before, public
Interview with German Finance Minister Schuble, The U S Has Lived on Borrowed Money for Too Long, Spiegel Online, November 8, 2010, http://www spiegel de/international/ world/0,1518,727801,00 html
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support of free trade is lukewarm at best A Pew research poll question on the impact of free trade agreements on the country in 2010 showed that 35 percent believed that free trade agreements were a good thing and 44 percent believed they were, in fact, a bad thing The poll also showed that Republicans and Republican-leaning independents who agree with the Tea Party have a particularly negative view of the impact of free trade agreements 94 It does not come as a surprise that politicians ratcheted up their anti-trade and anti-China rhetoric before the mid-term elections in November 2010 This has not been the case in the European Union at least not yet
Pew Research Center, Americans Are of Two Minds on Trade. More Trade, Mostly Good; Free Trade Pacts, Not So, November 9, 2010, http://pewresearch org/pubs/1795/poll-free-trade-agreements-jobs-wages-economic-growth-china-japan-canada
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Figure 10: Private Consumption Expenditure as Percentage of GDP
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Case Study III: Financial Regulation Too Big to Fail and Bank Levy
of American (90 percent) and EU (72 percent) respondents agreed that people are better off in a free-market economy At the same time, a large majority inside the EU (78 percent) and in the United States (69 percent) agreed that the governments play an essential regulatory role 97 In July 2010, Congress passed the Wall Street Reform and Consumer Protection Act (a k a Dodd-Frank Act), which addresses financial regulation and oversight, closes many regulatory loopholes, reorganizes parts of the oversight system, improves protection of consumers and investors, and deals with the problem of too big to fail The member states of the European Union have also initiated reforms, including an overhaul of the European financial regulatory system 98 But unlike in the United States, there is not one encompassing law, but rather multiple legislative acts both on the EU and the national levels As Mario Draghi, then governor of the Bank of Italy and now ECB president, emphasized in October 2010, addressing the too big to fail problem is perhaps the most challenging remaining legacy of the crisis 99 The problem gained prominence in March 2008 with the controversial rescue of the investment bank Bear Stearns by the Federal Reserve and the subsequent decision to let Lehman Brothers fail in September 2008 Too big to fail (TBTF or too interconnected to fail) describes the assumption that an institution is so large or so inter-connected with counterparties that its creditors (possibly even shareholders) must be protected by the government Otherwise there is
German Marshall Fund, Transatlantic Trends 2010, Washington DC, 2010, p 10 http://www gmfus org; 98 Steffen Kern, U.S. Financial Market Reform. The Economics of the Frank-Dodd Act, EU Monitor 77, Deutsche Bank Research, September 28, 2010 99 Mario Draghi, Key Note at the Peterson Institute for International Economics Bruegel Conference on The Transatlantic Relationship in an Era of Growing Economic Multipolarity, Washington, DC, October 8, 2010
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or more than two decades, the regulation of financial markets was the paramount example for different varieties of capitalisms in the United States and the countries of continental Europe: liberalization and laissez-faire on one side, regulation on the other side of the Atlantic The financial and economic crisis 2008/2009 put an end to this The transatlantic partners agree that while the financial crisis has multiple causes, regulatory failures were a defining characteristic Regulation and supervision fell short on major accounts, to spot systemic risks in the markets and to send out early warnings, as well as to implement effective regulatory safeguards and setting disincentives for excessive risk-taking behavior The United States and the EU also agree that sound, transparent, and predictable rules and oversight are indispensable, because a healthy financial sector is crucial to the entire economy of a country Reform proposals tend to fall into three categories: 1) better oversight to identify and mitigate systemic risks more quickly; 2) clear and predictable rules that reduce excessive risk taking behavior and moral hazard; and 3) increased international coordination and cooperation to reduce regulatory arbitrage Assessments of the need to regulate financial markets converge strikingly When Democratic Senate Finance Chairman Max Baucus opened a Committees hearing on May 4, 2010 by quoting Thomas Jefferson in saying that banking institutions are more dangerous [] than standing armies95 he sounded almost like former German Federal President Horst Khler, who repeatedly called the financial markets a monster96 According to a 2010 German Marshall Fund Transatlantic Trends poll overwhelming majorities
Hearing Statement of Senator Max Baucus (D-MT) Regarding the Proposed Bank Tax, May 4, 2010, http://finance senate gov/ newsroom/chairman/release/?id=f4df2206-043b-47fa-a889a29a59794874 96 Khler bezeichnet Finanzmrkte als Monster, Spiegelonline.de, May 14, 2010, http://www spiegel de/ wirtschaft/0,1518,553143,00 html
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Since the outbreak of the financial crisis, the Fed engaged in unprecedented levels of emergency lending.
a risk of contagion to the whole financial system While TBTF is not a new problem, it was amplified by the extent of governments interventions worldwide to prevent the complete collapse of the financial system In addition, due to consolidation during the crisis, financial institutions have become even larger Goldstein/Vron (2010) highlight three policy challenges presented by TBTF: 1) It removes the incentives to prudently manage risks and creates massive liabilities for governments which can endanger the financial sustainability of states as has been illustrated dramatically by the crises in Iceland (2008-2009) and Ireland (2009); 2) it distorts competition through higher credit ratings for large financial institution through implicit government guarantees; and 3) the treatment of TBTF institutions undermines the publics trust in the fairness of the system The two authors also highlight several policy options in dealing with TBTF: capital and liquidity surcharges, size-related taxes and levies, competition policy, and size caps 100 While the transatlantic partners agree that the TBTF problem needs to be addressed, they differ with regard to the preferred policy option One of these divergences is on a bank levy as an instrument to reduce excessive risk-taking behavior in the financial sector and to recover the costs of the financial crisis At the G20 summit in Pittsburgh, the leaders asked the IMF to: [] prepare a report for our next meeting [June 2010] with regard to the range of options countries have adopted or are considering as to how the financial sector could make a fair and substantial contribution toward paying for any burden associated with government interventions to repair the banking system 101 In response, the IMF
Morris Goldstein/Nicolas Vron, Too Big to Fail: The Transatlantic Debate, Bruegel Working Paper 2011/3, 2011, p 3-4, 21 101 Leaders Statement The Pittsburgh Summit, September 24-25, 2010, http://www g20 org/Documents/pittsburgh_ summit_leaders_statement_250909 pdf
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proposed two bank taxes in late April 2010 Under the Financial Stability Contribution, all institutions would initially pay a flat-rate bank levy Over time, this backward-looking fee was to become more forward-looking by reflecting riskiness and the systemic nature of their operations, meaning that those who pose a greater danger to the financial system should also pay more The proceeds of this levy could either finance a resolution fund or feed into general revenues The Financial Activities Tax would be levied on the profits of financial institutions 102 However, the G20 countries were not able to find a consensus on whether or not a financial institution tax was an appropriate element of regulatory reform at their meeting on April 23, 2010 The G20 only called upon the IMF to further work on options to ensure domestic financial institutions bear the burden of any extraordinary government interventions where they occur103 The leaders of Canada, Australia, Japan, China, India, and Brazil decidedly opposed a bank fee 104 While the Obama administration and the Merkel government agreed that financial institutions should be held responsible and pay their due share in getting the economy (and public finances) back on its feet, there were considerable differences in their approaches As is so often the case, the devil lay in the details The U.S. Case Since the outbreak of the financial crisis, the Fed engaged in unprecedented levels of emergency
IMF, A Fair and Substantial Contribution by the Financial Sector, Interim Report for the G20, April 16, 2010, http://news bbc co uk/1/shared/bsp/hi/pdfs/2010_04_20_imf_g20_interim_ report pdf 103 Communiqu. Meeting of Finance Ministers and Central Bank Governors, April 23, 2010, http://www g20 org/Documents/201004_communique_WashingtonDC pdf 104 The Presidents Proposed Fee on Financial Institutions Regarding TARP: Part 3, 11 May 2010, http://finance senate gov/ hearings/
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lending For example, in spring 2008, the Fed supported the takeover of Bear Stearns by JPMorgan Chase, putting up emergency funding to prevent a systemic collapse of financial markets According to Fed chairman Ben Bernanke, with financial conditions fragile, the sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets and could have severely shaken confidence 105 Bernanke further argued that moreover, the adverse impact of a default would not have been confined to the financial system but would have been felt broadly in the real economy through its effects on asset values and credit availability106 While the Fed thus prevented a breakdown of the financial system, its actions were highly controversial and concerns arose immediately that other banks might begin to count on the Fed for bailouts Former Treasury Secretary Henry Paulson underlined: Moral hazard is something I dont take lightly, referring to the belief that when the government steps in to rescue a private company, it encourages other companies to engage in risky behavior 107 The Fed and the Treasury therefore took a different course with regard to Lehman Brothers While the government had been able to facilitate the takeover of Bear Stearns, a similar rescue of Lehman proved impossible because a deal to sell the investment bank could not be completed Furthermore, Lehmans collapse was deemed nonthreatening to the integrity of the financial system The consequences of this decision are well known Shortly after Lehmans failure, the government
Quoted in: Bond 37638WAA9 and the Bear Stearns Bailout, Financial Times, April 6, 2010, http://ftalphaville ft com/blog/2010/04/06/195571/bond-37638waa9-and-the-bearstearns-bailout/ 106 Quoted in: Bernanke Defends Bear Stearns Bailout, CBS News, April 3, 2010, http://www cbsnews com/ stories/2008/04/03/business/main3991713 shtml 107 Quoted in: Martin Crutsinger, Paulson Says Lehman Bailout was Never an Option, ChicagoDefender.com, September 15, 2008, http://www chicagodefender com/article-1882-paulsonsays-lehman-bailout-was-never-an-option html
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again stepped in to save the insurance company AIG and the two mortgage lenders Fannie Mae and Freddie Mac It is now commonly agreed that a lack of rules for orderly liquidations of large failing financial institutions contributed to the severity of the financial crisis While there was a special resolution regime (so-called conservatorship) for depository banks that hold Federal Deposit Insurance Corporation (FDIC) insured deposits, this mechanism was not available to investment banks In its White Paper, the Obama administration underlined that the government should be given the tools it needs to manage financial crises [] We propose: A new regime to resolve nonbank financial institutions whose failure could have serious systemic effects 108 To tackle the too big to fail problem, the DoddFrank Act establishes an orderly liquidation process (resolution authority), giving the FDIC the power to dismantle failing institutions in an orderly way If the FDIC and the Fed agree that a company is in financial distress, the Treasury appoints the FDIC as receiver to carry out an orderly liquidation of the financial company If the FDIC is in need of money to carry out its mission under the orderly liquidation authority, these funds can be taken from the Orderly Liquidation Fund, which is to be established within the Treasury and is not required to be pre-funded by the private sector If the FDIC, after dismantling an institution, does not retrieve enough funds to amortize its liabilities to Treasury within 60 months or the negotiated time-frame, it will have to recover the shortfall from assessments on so-called systematically important companies, financial companies with total consolidated assets of $50 billion or more and designated nonbank
Department of the Treasury, Financial Regulatory Reform. A New Foundation: Rebuilding Financial Supervision and Regulation, June 2010, http://www financialstability gov/docs/regs/ FinalReport_web pdf
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financial companies 109 These will automatically become subject to enhanced prudential standards, including risk-based capital, leverage limits, liquidity requirements, risk management requirements, resolution plans, credit exposure report requirements, and concentration limits 110 Also, the Act requires large, complex companies (both bank and nonbank financial companies) to periodically submit plans to the Federal Reserve for their rapid and orderly shutdown should the company go under The Fed and FDIC have to approve of the plans If firms fail to submit acceptable plans, they will have to face higher capital requirements and restrictions on growth and activity, as well as divestment The Obama administration had also planned the establishment of a bank fund On January 14, 2010, the administration proposed a Financial Crisis Responsibility Fee (FCR) to recover intervention costs incurred during the financial crisis under the Troubled Assets Relief Program (TARP) The fee was to be in place for ten years, longer if necessary, until the costs of TARP were fully recovered This fee was thus decidedly backward-looking Only the largest firms (banks, thrifts, insurance companies, and U S holding companies of those entities) with assets of more than $50 billion and that profited from TARP would have been subject to an annual levy U S companies would be taxed based on their worldwide consolidated assets, and foreign entities only on their U S assets Covered liabilities would
Davis Polk: Summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Enacted into Law on July 21, 2010, July 21, 2010, http://www davispolk com/files/ Publication/7084f9fe-6580-413b-b870-b7c025ed2ecf/Presentation/PublicationAttachment/1d4495c7-0be0-4e9a-ba77f786fb90464a/070910_Financial_Reform_Summary pdf 110 Covington & Burley LLp, Advisory Dodd-Frank Act, Systemic Risk Regulation and Orderly Liquidation Authroity of Systemically Important Firms, July 21, 2010, http://www cov com/files/Publication/f3cacf02-b81e-4484-9543-cc561077f388/ Presentation/PublicationAttachment/1053ae45-096f-4d35bae3-d0100fd40789/Dodd-Frank%20Act%20-%20Systemic%20 Risk%20Regulation%20and%20Orderly%20Liquidation%20 of%20Systemically%20Important%20 pdf
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have to be reported by regulators, the fee would be collected by the IRS, and revenues would be used to reduce the federal budget deficit 111 About 60 entities would have qualified for taxation under the FCR according to the Treasury, so 99 percent of the banking sector would have been unaffected Treasury Secretary Geithner wanted to achieve two goals with the fee: putting a premium on risk-taking behavior and reducing the government deficit The FCR fee was estimated to raise $90 billion over a 10- to 12-year period Contrary to the IMFs proposal, the administration did not propose a rainy day fund for future financial crises The administration feared that such a fund could amplify the too big to fail problem and promote rather than prevent taxpayer bailouts of failed financial institutions (moral hazard) The administrations proposal ran into strong opposition from lawmakers, particularly Republicans 112 Backed by the financial industry, their arguments were threefold Their first criticism concerned the timing of the measure The legislation that created TARP, the Emergency Economic Stabilization Act of 2008 (EESA), calls on the president to put forward a plan that recoups from the financial industry an amount equal to the shortfall in order to ensure that the Troubled Asset Relief Program does not add to the deficit or national debt by 2013 Opponents to the tax argued that the full costs of TARP could not yet be measured sufficiently and that the fee would just be a stab in the dark, as Democratic Senator Maria Cantwell put it 113 A second criticism targeted the
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The White House, Financial Crisis Responsibility Fee, May 7, 2010, http://www whitehouse gov/the-press-office/ president-obama-proposes-financial-crisis-responsibility-feerecoup-every-last-penn 112 The Presidents Proposed Fee on Financial Institutions Regarding TARP: Part 2, Senate Finance Hearing, May 4, 2010, http://finance senate gov/hearings/hearing/?id=8e5b624f-5056a032-52e9-12425ef455f8 113 Quoted in: Tom Braithwaite, Geithner Grilled on Proposal for U S Bank Levy, Financial Times, May 4, 2010, http://www ft com/cms/s/0/a653fab6-57bc-11df-855b-00144feab49a html
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fairness of the measure Some institutions that contributed to the financial crisis and benefited considerably from the governments rescues, like the two mortgage companies Fannie Mae and Freddie Mac, were not to be subjected to the levy A third issue that concerned policymakers, Democrats and Republicans alike, was the effect of the fee on small-business lending and the stillfragile economic recovery Financial institutions warned that they might be forced to pass their costs along to the customer In this case, the companies themselves would not have to bear the cost of the tax In addition, credits could become more expensive and less available While the Treasury secretary eloquently lobbied for the administrations proposal, skepticism remained strong Only days before the final vote on the Wall Street Reform and Consumer Protection Act, it became apparent that the bill would not be approved, particularly by the Senate, unless the bank levy was taken out To get the ambitious Dodd-Frank Act passed, the Obama administration needed to reach a compromise with Republicans, who strongly opposed the bill Sixty votes are necessary to make a proposal filibuster proof Not only did the Democrats not have this majority, it was also clear that not all of them would vote for the proposals To win over the necessary Republicans to secure the bills passage, the Obama administration sacrificed the bank levy In mid-February 2011, the Obama administration retabled the Financial Crisis Responsibility Fee, albeit dramatically curtailed in its scope Under the new plan, the bank levy would collect $30 billion over 10 years to recoup the costs of bailing out troubled financial institutions during the financial crisis The fee would be applied to banks and financial firms with consolidated assets over $50 billion and charge fees of 0 075 percent of a large financial firms covered liabilities The proposal was part of Obamas 2012 fiscal budget plan According
to the Treasury Department, the financial crisis responsibility fee is intended to recoup the costs of the TARP program as well as discourage excessive risk-taking, as the combination of high levels of risky assets and less stable sources of funding were key contributors to the financial crisis 114 However, the proposal failed, as had previous attempts to introduce such a fee The European Case In general, European views on the TBTF problem differ from those in the United States One reason is that the EU member states continue to foster their national financial sectors in the integrated European financial markets Moreover, bank failures are not regarded as a normal occurrence, but seen as potentially disastrous given the historical experience of the 1930s When the financial crisis reached the EU, its political leaders agreed at a European Council meeting in October 2008 to take the necessary measures to stabilize the financial system and to support major financial institutions, while emphasizing that these measures should go hand in hand with measures to protect tax payers Accordingly, the EU member governments also discussed a bank levy to recoup the costs of the financial crisis and to curb excessive risk-taking behavior But while Single Market Commissioner Michel Barnier was calling for a European bank levy, the European Commissions powers are actually quite limited Competencies on financial regulation are shared between the national and the EU level; the power over tax legislation is almost entirely national
The EU member states continue to foster their national financial sectors in the integrated European financial markets.
Quoted in: Obama Floats $30 Billion Bank Tax as TARP Costs Shrink, Reuters, February 14, 2011, http:// uk reuters com/article/2011/02/14/us-usa-budget-tarp-idUKTRE71D3YA20110214
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Banks should be resolved in ways which minimize the risks of contagion and ensure continuity of essential financial services, in order to prevent expensive bank bailouts in the future.
What the Commission did propose in May 2010 was a European Bank Resolution Fund 115 The proposed fee, which would be shouldered largely by the 15 largest listed banks in the EU, is forwardoriented rather than making ex-post payments But the Commission also concedes the risk of moral hazard if a rainy-day-fund for future bank collapses was introduced It therefore emphasized that resolution funds must not be used as an insurance against failure or to bail out failing banks, but rather to facilitate an orderly failure 116 In October 2010, it set out further plans for crisis management in the financial sector117 with a triple objective: 1) to equip authorities with common and effective tools and powers to tackle bank crises as early as possible; 2) to ensure that banks can fail without jeopardizing wider financial stability; and 3) to avoid costs for taxpayers Banks should be resolved in ways which minimize the risks of contagion and ensure continuity of essential financial services, in order to prevent expensive bank bail-outs in the future A particular challenge continues to be that no system exists to deal with the cross-border implications of a Europe-wide bank failing, which ensures that authorities coordinate and cooperate as fully as possible in order to minimize any harmful effects The proposed measures include preparatory and preventative measures such as obligatory resolution plans to ensure adequate planning for financial stress or failure and stronger powers for
Communication from the Commission to the European Parliament, the Council, the European Social and Economic Committee and the European Central Bank, Bank Resolution Fund, Brussels, 26 5 2010 COM(2010) 254 final, May 26, 2010, http://ec europa eu/internal_market/bank/docs/crisis-management/funds/ com2010_254_en pdf 116 Quoted in: EU Proposes Preventive Bank Levy, Euractiv, May 26, 2010, http://www euractiv com/en/financial-services/ eu-proposes-preventive-bank-levy-news-494501
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supervisors For instance, these powers would include requiring the replacement of management, or requiring an institution to implement a recovery plan or to divest itself of activities or business lines that pose an excessive risk to its financial soundness It would also include resolution tools, such as powers to affect the takeover of a failing bank or firm by a sound institution, or to transfer all or part of its business to a temporary bridge bank, which would enable authorities to ensure the continuity of essential services and to manage the failure in an orderly way From January 6 to March 3, 2011, the European Commission ran a public consultation on the banking crisis management framework, the results of which were published on 5 May 2011 The legislative proposals are likely to be tabled in the course of 2012 A relevant number of member states are supportive of a European solution for bank rescues But although the European summit of June 17, 2010 reached a general agreement to push ahead with a system of national bank levies, one week before the topic was up for debate at a G20 leaders meeting in Toronto, several governments either announced an opt-out or pursued plans that risked distorting competition in the EU single market For instance, France pushed for a European Bank rescue fund during its European Council Presidency as early as 2008 But it is unlikely that the Commission proposals on the bank resolution fund and the overarching framework for banking crises resolution will be adopted easily Differing roles of the banking sectors in the national economies and the diverging financing needs of the banks make it difficult to find a common stance even for the euro zone members Those governments, whose banking sectors do not face important recapitalization or restructuring needs, refuse to share in the risks and costs of other member states by creating a pan-European solution The feasible option is hence the introduction of
Communication from the Commission to the European Parliament, the Council, the European Social and Economic Committee and the European Central Bank, An EU framework for Crisis Management in the Financial Sector, COM(2010) 579 final, October 2010 http://ec europa eu/internal_market/bank/ docs/crisis-management/framework/com2010_579_en pdf
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national bank levies albeit with a certain degree of coordination, not only on taxation levels and the actual tax base, but most importantly to avoid double taxation German Finance Minister Wolfgang Schuble announced a legislative proposal to improve the countrys ability to deal with failing financial institutions as early as March 2010 Unlike in the United States, the systemic risk adjustment levy was forward oriented, just like the Commission proposal tabled only two months later Schuble suggested that while all banks would be subject to the fee, its amount would vary according to the systemic risk an individual bank posed to the financial system Systemic risk would be determined on the basis of the size of the banks liabilities (excluding capital and deposits) and its interconnectedness with other financial market participants, among other factors Thus, banks with a higher systemic risk would have to pay more than, for example, credit unions and savings banks 118 The levy, which was finally adopted in 2011, is designed to be a corrective measure on financial institutions behavior The receipts feed into a stability fund to finance the restructuring and resolution of systemically relevant banks in the future Financial supervisors hence obtain expanded powers to intervene in banks The fund and the resolution mechanism are supervised and managed by the Federal Agency for Financial-Market Stabilization (Bundesanstalt fr Finanzmarktstabilisierung, FMSA), created in
2008 119 The government also continues to discuss a tax on international financial transactions and has pushed for the introduction of such a tax together with France As in the United States, the bank fee was not met with sympathy everywhere, but in part for different reasons In Germany, the Social Democratic Party (SPD) called for a more radical approach, such as a financial transaction tax and stricter regulation Sigmar Gabriel, leader of the SPD, warned about the effects on small- and medium-sized business lending The Left Party criticized the tax as window dressing and political bait for the then upcoming state elections in North Rhine-Westphalia Also members of the Sachverstndigenrat, a council similar to the U S Council of Economic Advisors, were skeptical about the tax 120 Former Bundesbank President Axel Weber conceded the levy could be used to make banks contribute to cost sharing However, in comparison to capital requirements, it was less well equipped to reduce risk taking behavior 121 Unlike in the United States, however, opposition from the financial sector was not quite as strong The Association of German Banks, which represents private sector banks including Deutsche Bank AG and Commerzbank AG, supported a privately financed, state-controlled stabilization fund that could intervene to rescue
Bundesregierung, Banks to Make Provisions for Future Crises, http://www bundesregierung de (accessed May 8, 2010); Bundesregierung, Bank Levy Making Provision for Risis at International Level, http://www bundesregierung de (accessed May 8, 2010); Freshfields, Bruckhaus, Deringer, The German Bank Levy, Briefing July 2010, http://www freshfields com/publications/pdfs/2010/july10/28427 pdf
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Bundesministerium der Finanzen, Eckpunktepapier: Krisen vermeiden, Banken beteiligen, March 31, 2010, http://www bundesfinanzministerium de/DE/Wirtschaft__und__Verwaltung/Geld__und__Kredit/20100331-Eckpunkte-Finanzmarktregulierung html; IMF, A Fair and Substantial Contribution by the Financial Sector, Interim Report for the G20, April 16, 2010, http://news bbc co uk/1/shared/bsp/hi/pdfs/2010_04_20_imf_ g20_interim_report pdf 120 Sparkassen und SPD kritisieren Bankenabgabe, Weltonline March 22, 2010, http://www welt de/politik/deutschland/ article6884935/Sparkassen-und-SPD-kritisieren-Bankenabgabe html 121 Bundesbank/Weber sieht geplante Bankenabgabe mit Skepsis, May 5, 2010, http://www dowjones de/site/2010/05/bundesbankweber-sieht-geplante-bankenabgabe-mit-skepsis html
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or wind up troubled lenders 122 The Federation of German Industries (BDI) also agreed that it was legitimate for the government to seek to involve banks in the costs of saving and stabilizing financial institutions if questions concerning the extent of the fee, its base, and its target were addressed and the design ensured that it would not worsen credit conditions for the real economy 123 In the end, the Reconstruction Fund Act (Restrukturierungsgesetz) was passed in fall 2010; the Act came into force on January 1, 2011 It sets up a new restructuring fund (Restrukturierungsfonds) with a target size of 70 billion, financed by a bank levy Banks are expected to pay a minimum of 5 percent and a maximum of 15 percent of their profits into the fund Several other EU member states, such as France, Great Britain, Sweden, Austria, and Hungary, to name just a few, have individually introduced national bank levies Unlike Germany, France, Sweden, and Hungary opted for models in which bank levy revenue is not put into a restructuring fund, but flows directly into the state budget The choice may reflect differing perceptions of actual support the banking sector may need, and different degrees of political willingness to intervene in banking institutions In France, which has a rather strong tradition of state interventionism, it is less problematic to intervene in the financial sectors with big sums of public money straight from the budget if a national emergency case can be argued politically Meanwhile, in Germany, the need to show that the tax payer it not always the cash cow seems to be comparatively higher and a restructuring fund which is financed by the banks themselves provides transparency
A Stability and Resolution Fund for a Robust Financial Market, Bundesverband Deutscher Banken, DeFacto, April 2010, https://shop bankenverband de/shop/ods/a-stabilityand-resolution-fund-for-a-robust-financial-market/br1005_ defacto9_en pdf/download 123 Quoted in: Germanys New Bank Fee Will Pay for Future Bailouts, Huffington Post, March 22, 2010
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One of the remaining political challenges for the EU member states is the need to improve crossborder agreements on the implementation of national bank levies From the point of view of the banking sector, the key task is to avoid double taxation, as some of the tax is applied to total assets This means that activities of a bank in other states are also subject to the levy Explaining Convergence and Divergence The financial sectors of both the United States and EU member countries have been severely hit by the financial crisis 2007-2009 The differences in the severity of the problems alone, however, cannot fully explain why some countries have implemented a levy and others have not Given the impact on the U S financial sector and the high costs of bank rescues, greater support for implementing a bank fee could be expected One explanation for the divergence in policy preferences lies in the importance of the financial sector for the respective economy and for growth Over several decades leading up to the financial crisis, the size of the financial sector has grown strongly in the United States and in some EU member states such as the United Kingdom Financial services (e g banking, insurance, investment) have become a sizeable share of the GDP and an important source of employment In the United States in particular, the financial industry has been perceived as a growth industry, contributing to the economic well being of the country But since this is also the case in the U K , this factor again does not sufficiently explain why the U S government has not implemented a bank levy A more compelling explanation is offered by Goldstein/Vron (2010) They argue that European countries are more inclined to rescue failing banks than the United States In many European countries, foremost Germany, bank failures are perceived not only as an economic challenge
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Figure 11: Finance and Insurance as Percentage of GDP
Source: Eurostat; U S Bureau of Economic Analysis, March 2011
but as a political disaster The memory of the last significant wave of bank failures in 1931 still weights heavily on policymakers minds, as it enabled the rise of the National Socialists in Germany There is another reason why European governments have a preference for bank rescues Historically, governments have encouraged the development of a strong financial sector to be competitive vis--vis their neighbors In the United States, the experience is a different one Historically, the United States is much more critical of the power of large banks, and many laws have curtailed the ability of banks to grow too large, in particular the Glass Steagall Act of 1930 The United States is also much more comfortable with letting large banks fail The reason for this also lies in the structure of the financial market Banks in the United States play less of an intermediary financial function than their European competitors So what has this to do with the bank levy? Accepting the necessity of bank rescues during
crises to ensure not only economic but also political stability, the question of who eventually bears the costs becomes paramount in countries like Germany Not to unfairly burden the taxpayer, the financial sector needs to be bailed-in In the United States, where there is greater acceptance of letting banks fail, rules and regulations on how to facilitate an orderly unwinding of failing financial institution becomes important Last but not least, politics and special interests played a large role In the United States, the bank levy proposal ran into stiff opposition by a powerful financial sector Campaign contributions are a good indicator for the role special interest groups played during the financial reform efforts The Center for Public Integrity showed how financial sector political action committees (PACs) switched from largely supporting the Democrats during the 2008 election cycle to the Republicans in the 2010 election cycle The Center examined 1,300 political action committees that gave at least $300,000 over the 2008 and 2010 election cycles They identified 50 committees whose
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bipartisan contributions shifted dramatically from Democratic candidates to Republicans And 13 of these political action committees represented financial sector interests While this sector gave only 44 percent to Republicans during the 2008 election cycle, contributions to Republicans went up considerably after the House passed the DoddFrank Act in December 2009 The Center found that contributions went up a second time after the Senate passed the bill in July 2010 By the end of the election cycle 2010, 65 percent of the contributions from these PACs went to Republicans The National Association of Mortgage Brokers (NAMB) is a good illustration of this While they gave 57 percent of their contributions to Republicans in 2008, this figure jumped to more than 88 percent in 2010 124 In the EU, politics also explain part of the dynamics that have led to the introduction of bank levies in some member states In Germany, for instance, there has been a clear link to the sovereign debt crisis It is widely acknowledged that this crisis is not only a product of unsound budgetary policies, but also (as seen in the Irish case) a demonstration of problems within the banking sector This raises the question: for what purposes are taxpayers money actually used? This is a particularly delicate question if rescue mechanisms such as the EUIMF aid package for Greece or the stabilization mechanisms are constructed to stabilize other member states while the public perception is that rescue mechanisms (and hence taxpayers money) are actually being used to save their own or another member states banks
Josh Israel/Aaron Mehta/Elizabeth Lucas, Scared Red: The PACs that Followed the Nation Rightward in 2010, March 1, 2011, http://www publicintegrity org/articles/entry/2947/
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T
Conclusion
ransatlantic convergence and divergence in financial crisis management are driven by a potpourri of factors: economic and financial realities, perceptions and historical experiences, ideas, institutional and structural constraints, and politics in particular election cycles The analysis of immediate crisis management and fiscal policies, as well as of macroeconomic rebalancing in particular, underlines the importance of different economic starting points: differences in growth projections, saving rates, and unemployment to name just a few indicators Certainly, the reality of heavily export-dependent economies such as Germany on one hand and an equally heavily domestic consumption-dependent economy like the United States on the other, along with the influence of its various stakeholders and interest groups, has guided policymakers thinking and decisions These variables also explain differences that exist between member states in the EU But ideas drawn from the countries historical experiences about the proper role of the government in the market and fiscal experiences (for example, low inflation and stable prices) have also been important factors guiding policy responses Institutional and structural factors, like the power-sharing agreement within Germanys Grand Coalition, and the reality of the national elections in September 2009 have also been decisive, as have the change of government in the United States in 2008 and the 2010 mid-term elections In both the United States and the EU, the distribution of power and authority on different levels of decision-making within the realm of financial regulation has placed conflicting demands and limits on policymakers in the formulation of their policy responses The dividing line does not in all cases run through the Atlantic, but also right through the EU This can be explained by different growth models
prevailing in the EU, but is also due to diverging traditions in economic thinking and other factors European governments meanwhile face a particular challenge at the moment, as they are in the midst of negotiating substantial reforms to the European economic governance framework Furthermore, 5 of the 27 member governments, plus the council and the commission president, are involved in the G20 negotiations The negotiations on these two levels sometimes complicate matters: for instance, Germany could not agree to more scrutiny of external surplus countries in the G20 context since it has a clear preference to prevent a symmetric approach to macro-economic policy coordination in the EU If the European negotiations succeed and the EU does indeed grow closer together economically and politically, over time some of the current divergences in positions of the EU member states that emerge in external relations will be leveled out at least to a certain degree This could then make the EU a more homogeneous actor in international fora such as the G20 and in relationships with its major partners, including the United States The analysis of these three policy fields shows a snapshot of transatlantic relations and highlights relevant points of divergence in policy responses We cannot rule out that with changing economic conditions and public pressure, it will again come to more convergence For instance, the sheer size of the budget deficit in the United States makes fiscal consolidation inevitable In the case of Germany, pressure by fellow EU members and some political parties, and a growing insight that it may be in Germanys self interest to find a reasonable growth perspective without assuming it will run high external surpluses in the long-run, might induce a subtle readjustment of its growth strategy The period investigated is arguably short But it is a key period for all actors involved, as it combines elements of crisis management and governance
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reforms, with the latter drawing conclusions from the crisis for the future Hence, while budgetary and economic policies may be adjusted within a rather short time horizon, the governance framework that is currently being amended or set in the United States, in the EU member states, on the EU level, and within the G20, is here to stay for some time Governance in the EU and, to a stronger degree on the G20 level, crucially depends on cooperative behavior of the member states Domestic politics and policies will determine the beneficial impact of the new and adjusted mechanisms The United States, the EU, and its member states will remain key partners in tackling the current and future transatlantic and global policy challenges We can safely predict that the transatlantic policy agenda will remain full of important issues But only thorough knowledge of the partners domestic constraints, a far-sighted assessment of the benefits of cooperative behavior, and a joint strategy in the global fora will allow for substantial progress
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Narcissism of Minor Differences or Major Economic Rifts? The Political Economy of (Post) Financial Crisis Management in The United States and The European Union

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Economic Policy PaPEr SEriES 2012

narciSSiSm of minor DiffErEncES or major Economic riftS?

Narcissism of Minor Differences or Major Economic Rifts?

Economic Policy Paper Series March 2012

By Stormy-Annika Mildner and Daniela Schwarzer2

Narcissism of Minor Differences or Major Economic Rifts?

Introduction: Explaining Convergence and Divergence

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

Case Study I: Stabilizing the Economy Fiscal Expansion versus Austerity

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Figure 1: Unemployment Rates (in percent)

Source: European Commission, Ameco Database, October 2011

Narcissism of Minor Differences or Major Economic Rifts?

The White House, State of the Union 2011, http://www. whitehouse.gov/state-of-the-union-2011.

The German Marshall Fund of the United States

Figure 2: General Government Gross Debt (percent of GDP)

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

Figure 3: Gross Domestic Product (constant prices percent change)

The German Marshall Fund of the United States

Figure 4: Household Dept to Disposable Income Ratio (in percent)

Sources: Eurostat; EconStats, Balance Sheet of Households and Nonprofit Organizations

Narcissism of Minor Differences or Major Economic Rifts?

Figure 5: Exports of Goods as Percent of GDP

The German Marshall Fund of the United States

Figure 6: Net Saving Rate (in percent)

Source: European Commission, Ameco Database, October 2011

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Case Study II: Global Macroeconomic Imbalances Numerical Targets

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Source: IMF, Direction of Trade Statistics, December 2011

Narcissism of Minor Differences or Major Economic Rifts?

Source: U S Treasury, Major Foreign Holders of Treasury Securities, December 2011

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Figure 9: Current Accounts (in percent of GDP)

Narcissism of Minor Differences or Major Economic Rifts?

Figure 10: Private Consumption Expenditure as Percentage of GDP

Source: European Commission, Ameco Database, October 2011

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States

Narcissism of Minor Differences or Major Economic Rifts?

The German Marshall Fund of the United States