The Big West Solution
What Arizona can teach Europe about weathering a housing crisis.
For more information about the woes of Club Med, click here.
Three years after the Great Recession officially ended, the United States is still struggling with high unemployment and a faltering recovery. But for the troubled economies across the Atlantic, where there is now open talk of the potential collapse of Europe’s shared currency, the United States looks like a veritable economic success story — perhaps even a place to look for lessons on how to manage the crisis.
As it turns out, the experiences of a few U.S. states in weathering the housing crisis that precipitated the 2008 global financial crisis can provide insight into the eurozone’s struggles. The Sun Belt states of Arizona, Florida, and Nevada saw a big housing bubble and subsequent bust, much like Greece, Ireland, and Spain — a group we call "Club Med." While both groups continue to suffer from the aftereffects of the crisis, the Sun Belt is recovering more vigorously than Club Med, which appears caught in a vortex of failing banks and deteriorating public finances. Here’s what the United States got right — at least compared with its European cousins — in its economic recovery.
The Power of Market Adjustment
There are plenty of differences between the United States and the European Union, but they have one important aspect in common: Both are monetary unions. That means neither the Sun Belt nor Club Med can resort to currency devaluation to help weather the shock of an economic downturn by enhancing competitiveness and stimulating exports. Instead, their channels for adjustment are limited to cutting wages, increasing productivity, encouraging some workers to move across borders, and relying on transfers from stronger states within the monetary union. On these counts, as we illustrate here, the United States comes much closer to being an optimal currency zone — where shocks affect some regions more than others but can be more easily managed. As a result, while the Sun Belt and Club Med both experienced downturns that were severer than those of their broader monetary unions, the Sun Belt has managed a stronger, more rapid recovery.
In the Sun Belt, average annual GDP growth rates from 2000 to 2007 were 1.3 to 2.4 percentage points above the U.S. average. The Sun Belt states’ recessions were also steeper: In 2009, their respective GDPs declined between 2.6 and 3.4 percentage points more than the U.S. average. Underscoring the severity of their recessions, the Sun Belt states’ GDPs remain between 6.9 and 9.1 percent below their 2007 peaks, even as U.S. GDP has recovered to its pre-crisis level.
Club Med also experienced a sharper boom than the rest of the eurozone. From 2000 to 2007, these economies grew between 1.4 and 3.4 percentage points higher than the European average. Their fall was also steeper than elsewhere in Europe: In 2011, Greece’s real GDP was 13.2 percent below its pre-recession peak, Ireland’s was down 9.5 percent, and Spain’s was down a more modest 3.1 percent. Meanwhile, GDP for the eurozone as a whole was only 0.4 percent below its pre-crisis peak.
Importantly, the Sun Belt states have since returned to growth. In 2010 and 2011, their GDP grew between 0.8 and 1.1 percent, and recent indications suggest that growth is continuing. But the U.S. economic recovery — modest and hesitant as it is — is still a distant dream in Europe.
The Sun Belt’s quicker housing adjustment has likely played a role in its relative success. Between 2007 and 2011, housing prices fell 43 percent in Florida and Arizona and 53.5 percent in Nevada. In contrast, home prices in Greece, Ireland, and Spain fell 12 percent, 33 percent, and 15 percent, respectively, over the same period. Declining housing prices can be expected to accelerate the recovery of housing demand and, perhaps even more importantly, force banks to recognize and process losses on their mortgage loans more rapidly. This occurred too slowly in Europe — everybody pretended for too long that housing prices remained stable, nurturing concerns that banks in Club Med carried large, unrecognized real estate losses. This in turn deterred lending to Club Med by other banks and eventually led depositors to withdraw their money, accentuating the credit crunch.
Other economic indicators tell an even more striking story. The increase in Sun Belt unemployment was less than half that in Club Med countries, where it is approaching depression levels, despite both groups experiencing a similar decline in GDP from their peak levels. Moreover, while unemployment in the three U.S. states has declined by 1.2 to 2.8 percentage points since the worst days of the crisis, unemployment in their European counterparts is still on an upward trend.
In both groups, the bursting of the housing bubble was associated with an abrupt interruption in the growth of the labor force; this was mainly due to the cessation of the big net migration during the pre-crisis years (see Table 2). In addition, many discouraged workers have dropped out of the labor force. The much larger rise in unemployment in Club Med primarily reflects the far-larger decline in employment than that seen in the Sun Belt, rather than differences in the rate at which the labor force grew — a surprising result given the supposed impediments to firing workers in Spain, for example. The dramatic drop in Club Med employment rates also likely reflects employers’ widely held expectations that the crisis will continue for many years, a reluctance or inability to cut wages due to legal constraints, and the fact that Club Med countries have become very uncompetitive — their labor costs relative to Germany soared 20 to 30 percent during the boom years. In the Sun Belt states, on the other hand, no comparable loss of competitiveness is evident, wages adjust more readily, and workers move much more easily across state borders than in Europe.
The Power of Uncle Sam
The European Union simply can’t support its individual member countries in the way that Washington can help faltering state economies. The net fiscal transfer from the U.S. federal government to the Sun Belt during the worst of the recession may have amounted to 5 percent or more of their GDP and still remains substantial today. This includes automatic fiscal stabilizers — lower tax liabilities to the federal government and increased fiscal transfers, including unemployment insurance, food stamps, Medicaid payments, and welfare — that played a critical role in cushioning the shock.
The effect of these automatic stabilizers is to offset as much as 40 cents of every $1 decline in state GDP, according to former Council of Economic Advisers chair Martin Feldstein. This amounts to a large fiscal stimulus over and above that provided by the 2009 economic stimulus package, which added up to 2.8 percent of U.S. GDP over the course of 2009 and 2010 and which disproportionately benefited the hardest-hit states.
Nothing of comparable magnitude exists within the eurozone, for the very good reason that the European Union is not a country and it doesn’t have a large central government. The widely advertised headline numbers of the support given or planned to stem the crisis in Europe are certainly impressive. However, most of these measures — such as the European Central Bank’s interventions to provide liquidity to banks and purchase government bonds — have their less-heralded parallel in Federal Reserve operations and the automatic working of the U.S. monetary union. Crucially, intergovernmental transfers in the eurozone take the form of loans to the troubled eurozone countries, adding to their debt and, because those loans come with strings attached and are the result of protracted negotiations, constitute an ongoing source of uncertainty and speculation.
The most striking difference between the Sun Belt and Club Med is the avoidance of a serious crisis in the U.S. state governments’ balance sheets. Sun Belt governments’ spending represents a small part of state GDP (see Table 3), and they broadly abide by a self-imposed balanced budget rule. Even as Club Med saw its credit ratings collapse, the Sun Belt governments avoided crippling debt problems. Their credit ratings remain solid — Florida actually retains AAA status. And unlike Club Med, which was forced to cut its deficits while in recession, the Sun Belt governments were able to rely on countercyclical spending, supported directly or indirectly by the federal government.
Importantly, Sun Belt states were not called upon to bail out their failing banks, relying instead on Uncle Sam’s FDIC and TARP programs to do so. Meanwhile, Club Med had to deploy massive sums to prevent their banks’ collapse — well over 100 billion euros in Spain alone. The close link between banks and nation-states in Europe has meant that the banking and sovereign debt crises continuously fed on each other.
Meanwhile, as mentioned earlier, the Club Med countries’ labor and other costs have massively diverged from Germany — Europe’s economic motor — further complicating the economic recovery. Even if Club Med had been able to rely on the support of a federal system, such divergence in competitiveness suggests that its adjustment was always fated to be more protracted and painful than that of the Sun Belt.
Club Med cannot just take a page from the U.S. playbook to pull itself quickly out of the economic doldrums. The differences are structural and will take many years to fix, and institutional reform is fraught with political obstacles that could delay the process indefinitely. However, the European project’s now obvious weaknesses — the linking together of very different economies, the slowness of their markets to adjust, and the lack of a strong central government — at least provide a diagnosis for why the eurocrisis has been so extreme. They also provide some useful pointers for European policymakers on how the eurozone should evolve to prevent a repeat of today’s disaster — assuming, that is, that it survives that long.