Europe’s Lehman moment?

Edward Paul Lazear interviewed by Romesh Vaitilingam, 14 Oct 2011

As chief economic adviser to President Bush, Edward Lazear was at the heart of the US policy machine in October 2008. He talks to Romesh Vaitilingam about the Eurozone crisis and whether now might be Europe’s Lehman moment. They also discuss the growing significance of the emerging economies and the US political debate about the debt ceiling. The interview was recorded at the Global Economic Symposium in Kiel, Germany, in early October 2011. [Also read the transcript.]


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Romesh Vaitilingam interviews Ed Lazear for Vox

October 2011

Transcription of a VoxEU audio interview []

Romesh Vaitilingam:  Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam and today's interview is with Professor Ed Lazear from the Hoover Institution at Stanford University. We met at the Global Economic Symposium in Kiel, Germany, in early October 2011, where we spoke about the Eurozone crisis and the debt ceiling debate in the United States.

Ed was chief economic advisor to President George Bush in October 2008. And I began by asking him if, as someone who was at the heart of the US policy machine at that time, he thought that now might be Europe's Lehman moment.

Ed Lazear:  Let me put it this way. I think that Lehman was important, but there's a message I think that we need to take away from that. And that is, Lehman was an exacerbating factor. It certainly was not the cause of the crisis. And I'm worried that the Europeans are making the same mistake with respect to Greece and the importance of contagion. There's no doubt that contagion is an important factor. But simply by stopping contagion, you haven't solved the problem.

So if you look at the situation that we faced, and I don't want to give you too much history, but if you look at the situation that we faced and look what happened during that period, the crisis actually started in August of 2007. Bear Stearns failed in March of 2008. We had a number of markets, auction rate securities markets, student loan markets, monolines all essentially failed during the spring quarter.

The week before Lehman went down, Fannie and Freddie essentially went down. They had to be put into conservatorship. AIG was going that weekend. Merrill Lynch was going that weekend. Wachovia was going. Washington Mutual was going. So even had Lehman been propped up, even had we been successful – and we did try to save Lehman - but even had we been successful at saving Lehman, we still were in a very serious financial crisis.

And I am concerned that Europe, again, is taking the wrong lesson out of that. Because the notion is that if we somehow succeed in saving Greece, and preventing the contagion, the problems that Europe faces will be dealt with in an orderly fashion. I'm not convinced that's the case. If I look at Spain, if I look at Portugal, if I look at Ireland, if I look at Italy, and I say, what are the problems that they face? Very little of it has to do with contagion from Greece. Some of it does, but very little of it does.

And those underlying fundamental problems, some of which are associated with fiscal consolidation, some of which are associated with housing and banking crises, those problems need to be solved by themselves, independent of anything that goes on with Greece. And I just hope that we don't get the wrong lesson from our experience.

Romesh:  What about the immediate focus of Greece, though? We're  at a time where people are talking about certainty of default. The last question at the symposium was, orderly or disorderly? What's your feeling?

Ed:  Well, I mean, look. Greece has already implicitly defaulted in some sense. It's a question of how one deals with that default. There is no doubt that Greece has essentially gone beyond their means. They are not solvent. And the issue is simply, how do we pass those debts around? How do we decide to realise those?

I think that so far Europe has been relatively successful in dealing with that. You want it to be a painful process. The notion that this is all political I think is nonsense. The politics are an important part of the process, because these kinds of problems are ones that you want to avoid in the future. And you want it to be difficult. You want it to be hard. But you want it to be solved.

And I think so far Europe has managed to solve those problems in a relatively effective way. Again, I would argue that what you should do is not take your eye off the ball, not get distracted and say, let's worry about Greece and Greece alone. At the same time that Europe is worrying about Greece, Europe should also be worrying about the other countries, and planning for the relatively near future in terms of their fiscal situations as well.

Romesh:  We've been getting today some perspective from Brazil and from China and India, almost perhaps a feeling of smugness in calling the countries of the West the crisis countries, rather than the industrialized countries. What's your take on their involvement and their role in this crisis?

Ed:  Well, they have a different set of problems. Obviously China's main problem right now is keeping very high growth rates, so that they can create jobs for people who are moving from the rural areas to the cities. And China took a big hit too. They are smug in some sense, but it's because they had 12% growth, and they dropped, depending on the numbers that you believe, somewhere between 6 and 9% growth.

That's still a pretty big hit. It's just that their level of growth, their growth rates, were so high, that they still look pretty good. Same is true in Brazil. But we know Brazil has had its problems in the past as well. I think they're on a great trajectory. I hope they keep it up. I don't think it's a zero sum game. I think the world benefits from having Brazil and China, India, of course, grow very rapidly. And I hope that continues.

So I think they do have something to be proud about. They've got a terrific formula. It's worked very well for them, and they've raised an enormous number of people from poverty into the middle class, and that's a great thing. One of the comments that was made in this last panel that I think is a little bit misplaced is criticism of China for the income distribution difficulties.

It is true that inequality has gone way up in China, but what's also true, and to me the more important statistic is the number of people who have moved from one meal a day or even two meals a day to two to three meals a day. It's just an enormous change in the quality of life – at least in urban China.

Unfortunately the rural areas have not come along. But people are moving to the cities, as they do in most developing economies, and I think that's something that they should be very proud of.

Romesh:  Can these economies support growth in the world economy with the threat of double-dip recession in Europe and the US?

Ed:  Well, no doubt that recession, and by the way, when people talk about double-dip, I always think that this is essentially semantics, because in some sense we are out of the recession, in that we've hit the bottom, and recovery is defined as, are you past the trough? And yes, we are past the trough. But we are so close to the bottom that it almost doesn't matter if we turn down slightly again. I think of this as, things are pretty bad right now, they continue to be bad, and kind of wiggles along the bottom are not that important.

But I think, to get back to your more important question and the fundamental question that you were asking, it is certainly true that the rest of the world has very big effects on China. The United States, obviously, has big effects on China. Europe has big effects on China, and Brazil as well. And until those economies take off, it's going to be difficult for the emerging economies to get the kind of growth that they'd like to see. They've sustained it pretty well, so you have to hand it to them.

Romesh:  Final question. What about your own country? What about the economic policy debate there going forward? That seems to be a very difficult situation politically, which is hampering economic development.

Ed:  I actually have a different take on it. I think it's a very constructive situation. I think it's turned from bad to good. People talk about the discussion over extending the debt ceiling and the budget extensions and so forth. We are in a terrible situation right now. We have gone from a public debt-to-GDP ratio of 38% to almost double that in a period of four years. That's not the kind of thing that we can sustain over a long period of time.

And the fact that that has become the number one issue on the public's mind is a really important change for the United States. And it's good that it's happening. Because I think the lessons that we are learning from where Europe is, and not all of Europe, but Greece and some of the other countries, is one that we should take to heart. And I'm glad that we're talking about this now.

So I'm glad we're having these political arguments. These are important political arguments to have. They are fundamental discussions about the size of government and the direction in which our tax and spending patterns should take. And those are key discussions. So they're painful, but they're necessary.

Romesh:  Ed Lazear, thank you very much.

Ed:  Thank you.

Topics: EU policies, Global crisis
Tags: debt ceiling, Eurozone crisis

Jack Steele Parker Professor of Human Resources, Management and Economics at Stanford University's Graduate School of Business; and Morris Arnold Cox Senior Fellow at the Hoover Institution