Hello everyone and welcome to Power and Consequences. My name is Simon Johnson.
And I'm Gary Gensler. And today's question is: how much trouble is Europe really in?
Well, and I can't wait to hear what trouble that is, Simon, and how you articulate this.
So let's talk about trouble, Gary, of the European variety. Where would you like to start?
Well, I think about its economy, its capital markets. But I suspect that you're going to be challenging me about European institutions and the politics, and they all relate to each other. But let me just say something on the economy.
The European economy. And by Europe, let me say I think what we're talking about really is the 27 nations that are in the European Union. Now I know the United Kingdom moved out of the European Union, and technically it's part of Europe; Switzerland, neutral, out of Europe. But focusing on those 27 countries, or Europe including the United Kingdom, they used to be an economy that was larger than the United States. And not so long ago, just 20 years ago, I'll note about the time you, Simon, were the chief economist at the IMF, you left the IMF. And since then, I'm not saying, you know, correlation is causation, but since then the US economy keeps to grow, and while Europe has grown, it has fallen significantly behind. So I think a lot about that.
Right. So there are some long-term issues about European economic performance at the level of the European Union, and within the European Union about 80% of the economy is in countries which share the euro currency. So it's the European Union and the euro area moving pretty closely together. And you're right, Gary, that if you look back over 25 years, Europe remains prosperous. If you compare European average living standards with the United States, they've not really fallen behind, actually. But if you look at the dynamism, if you look at innovation, if you look at what's happened with information technology in particular, the US, despite some pretty big bumps like a big financial crisis and COVID, the US has forged ahead and made remarkable progress. The Europeans have not. And so there is a general sense among many European economists I talk to of concern and malaise and worry about the future in Europe. And there's really good economic research starting some 20 years ago, even looking at the 1990s and seeing whether this was a pivotal, important time as the internet was coming along, as economies around the globe were more digitizing, but then we were really driving more into this technological age, and that somehow Europe didn't participate fully. And I wonder, a question for you, because you've thought a lot about this: what do you think that was? I'm talking about way back in the 1990s and 2000s, because that may set the stage for the 2020s.
Right. So the key point I would make is that the European economy has been innovative for a long time. If you go back to the origins of the industrial revolution, sure, it's partly in the United Kingdom, not now in the EU, but it spread very quickly to France and Germany. And we often talk about Western Europe, and we often talk about the sort of industrial heartland, and these places were innovative through the 19th century into the 20th century and in the post-war period also. So what happened in the digital era is quite distinctive, and I think a lot of that is about what economists like to call agglomeration effects, meaning that you like to build things where other people are building similar related activities, and there's a lot of backward and forward linkages: people supplying stuff to you, people buying stuff from you. And a great deal of this activity has become concentrated in the United States and in some particular parts of the United States, including on the west coast. So the Europeans sort of missed that first move into the internet by the US. They were very early on some pre-internet technologies. I remember seeing some of those in France, for example, but they didn't ride the big internet wave. They didn't transform their use of information technology in their companies. And this is something that's also not changed over the past 20 years, which is really quite dramatic. And now, of course, there's concern that AI, which is a continuation really of digitization, that AI is leaving them further behind. And let's not forget, I mean, they had Nokia, you know, they were early on certain phone technology. They were early on certain digitization. Even, you know, I like a smallish country to be thrown in there too, but Estonia in terms of digital identity and how they did many things in Estonia, and yet they've fallen behind.
Do you think it's this agglomeration, which is they don't really have a single market? So the Europe we're talking about, this 27 nations, about 450 million people, over here in the United States are about, call it, 350 million or so. And yet their economy is smaller. As we've said, we're about 30 or 31 trillion. They're in the, what, 25, 26 trillion, I think, if I recall. But regardless of the numbers, is it because they don't have a full and open market that amongst those 27 nations there's still a lot of barriers? They say they have free trade, but they really don't have free trade in either goods or services, and there's a lot of barriers in terms of transacting in services cross-border.
Well, sometimes they have had a unified market, Gary. So when a new cell phone technology came along in the 1990s, a standard known as GSM, the Europeans adopted it widely and across, I think, the entire European Union quite quickly. And as a result, you had some very strong telecoms companies emerge and early mobile communications, but they didn't build on that in terms of internet connectivity and services. I remember very clearly in the early 1990s, very beginning of the 1990s, being in Paris and being shown a Minitel, which was a little terminal on which you could basically look up businesses and relevant information, a little bit like a pre-internet, but it was a closed system. It did not interact with the world in the way that the internet did. So I think there's a little bit of, you know, being a bit too parochial, a little bit of not adopting all technology across Europe. And one of your favorite topics, capital markets remain, yeah, a bit too fragmented. Particularly Europe, leading Europeans who look at this flag the lack of scale-up capital. So maybe you can do a startup in Europe, but when you want to grow, you want to reach that first billion dollars valuation, you're better off coming to the United States.
I do think, and I'm about to turn to finance, capital markets, and their experiment on the euro, the currency itself. But I think that in many of the reports that economists look at Europe, including the very self-reflective reports, Mario Draghi, who used to run Italy and then was the head of the European Central Bank, actually, I would say Mario also worked at Goldman Sachs, full disclosure. That report that was published under his name just two years ago now, the Draghi report, does look, and today there's a lot of friction or barriers to the movement of free goods and trade across the continent. And particularly, and I say this because I'm quoting from a self-reflective report, they think that those barriers are significantly higher than, let's say, between the 50 US states. And so I would just say I think that's a part of this, Simon. Now maybe you differ on that. I would say the current administration in Washington sort of also leans in and says there's too much regulation in Europe. I think that sometimes they do that for messaging about the US and say, 'There but for the grace of God go I, don't do all that regulation the Europeans are doing.' I think that's political messaging here. But a lot of businesses I talk to also say there's probably more barriers doing cross-pan-European business.
Well, I think that's not wrong, Gary, but I also think it's incomplete. If you look at the culture of innovation, culture of entrepreneurship, the so-called stigma from failing, I don't think there is a stigma from failing in the US tech sector. Actually, people often see that as a badge of honor and useful experience. But in France, for example, people have for a long time, Augustin Landier, for example, I remember writing his thesis about this about 20 years ago, saying that in France, if you fail, no one will back you again. And that's a problem, and I think a much broader problem. But I'd like to also flag macroeconomics here, Gary, because of course the promise of the euro was exactly that it would create a unified market and that it would lower everyone's interest rates or bring them down to German levels, which it did. Unfortunately, that has not led to convergence in productivity, and now there's a lot of tension within the euro area between countries that regard themselves as being relatively responsible in fiscal terms, that would be Germany, and other countries that, well, the Germans don't think they're equally responsible. So I think that the euro was created on the premise that it would integrate these economies and cause them to converge on economic performance, and that would be helpful to innovation among other things. And I don't think it's delivered on that.
No, I do not think it's delivered. But I think it's, I personally think it's more than a coincidence that the euro came about. It went live in January of 1999, for our listeners. But the euro came about with all of that hope, but it's also coincident with the period of time that Europe has fallen behind. So I think a lot about has the euro contributed to some of these challenges, and I think it's a mixed record. One of your forebears, I can call it, in the Nobel club, the Nobel laureate club, from the 1960s, his research, Mundell, talked a lot about what's an optimal currency area, so-called, economists called OCAs. But what's an optimal currency area? And some people say that Mundell is somewhat sort of the father of the euro. I don't know if he would have agreed with that, but nonetheless, I don't think that Europe has an important component of it: the free mobility of labor, truly free mobility of labor. You can debate this and so forth, how they have that, but a unified fiscal picture that they've come together and they can deal with the shocks of one part of their currency area as we do in the United States. If we have shocks and we need to deal with those shocks in the South or the West or the Midwest, we can use fiscal adjustments and so forth. And so I think part of what happened in Europe, Simon, is on the backs of that really dominant economy, Germany, which I think is somewhere in the order of a quarter of the European Union's economy, and France and Italy, but particularly on Germany and France, the northern sort of countries, the southern countries, the Spains, Italies, Greeces and so forth, got much lower borrowing rates once you had a unified currency. And so what did they do with that? Did they use that to boost productivity, boost investment in capital, boost investment in stronger working conditions, or did they use it for consumption? And by 2010, when I was serving in the Obama administration and we, the US, were exporting our financial crisis out of housing, Europe was also in real financial stress, distress if you wish, with those southern countries having consumed so much on low borrowing rates, and there wasn't the fiscal discipline in the south. So what do you say back to me? You say, 'No, the euro didn't contribute to this, or it's somehow fraught with some contributory problems to the slow growth.'
Well, I would emphasize also the importance of that so-called euro area crisis, which was an aftermath and partial consequence of the global financial crisis. So that was very intense, 2010 to 2012. Now there are differing views about how irresponsible fiscal affairs were in various countries. For example, Greek economists with whom I work feel that they were treated rather badly and would have done much better with a more generous level of support from the European level, from the big countries. But what I would emphasize, Gary, now, and I think this is really important, is the politics around European integration have changed, particularly in Germany. And what we're seeing actually exactly in these days is the rise of an extreme right-wing group, Alternative for Germany, that has done very well in regional elections, and the national government under the Christian Democrats is extremely unpopular. And part of this is long-standing resentment, part of it is disappointment. Germany has not suffered an economic collapse. This is not the Great Depression or anything like it. But there is disappointment. There's a lot of friction about immigration levels. And I would note that the AfD has recently picked up again an anti-euro card, saying that Germany should consider leaving the euro area. Now that's a very big deal, and that speaks to or channels the frustrations. And in addition, Gary, I think we need to talk about what happened when Germany unified, because I think a lot of what's feeding the AfD is 30-year-old resentment, more than 30 years now, 35 years of resentment about how East Germany and East Germans were treated when the country unified.
As you suggested this episode to me earlier this week, I asked you, well, why now? Why were we doing this now? And though there's this economic story which is really relevant, I sense it was really about Germany and for you about the declining popularity of the current government in Germany, coupled with a whole host of elections that are coming up in Europe. But I was wondering if you wanted to say more about that.
Well, absolutely, Gary. My concerns are the long-term malaise or disappointment, the lack of innovation, and concerns about what will happen as Europe ages. So that demographics are changing as they're changing in many places. The population is becoming older, and having missed out on the IT transformation, what's next in terms of innovation, and how hard are they going to be pressed, for example, by China on electric vehicles and other kinds of manufacturing which Europe has traditionally been very strong on. So that the Chinese imports are threatening clean tech, for example, renewable energy. These are things the Europeans are good at, should be good at, but they've lost their edge. At the same time as the level of frustration is boiling over in Germany. And I think that that combination is pretty dangerous. It also feeds into elections in other countries, including an important presidential election in France next year, and other elections where similar sentiments might or might not be expressed.
I just want to mention a couple of other things in the financial side and then turn back to the current events and the politics. Just to scale something: the US economy has led to deep, liquid capital markets. I'd like to say the really solid institutions have done that as well. Our stock market is about $80 trillion of value. Now you can debate the valuations and so forth, but to scale it, the European Union, again, we're leaving out the United Kingdom, your home country, Simon, is about a $16 trillion stock market, 20% the size. So their economy, the European economy, 450 million people, we have about 350 million. Their economy is maybe give or take 80% of our size, 85% of our size, but their stock market's only 20% of our size. So another thing is going on. They are very focused on banks doing the lending rather than the capital markets. I think this is a feature of the United States that has driven innovation. I think our very dynamic venture capital ecosystem and private investing in venture technology has been a real benefit as well in the United States. Now you see a lot of recommendations in Europe out of the Draghi report, out of more recent IMF reports with very colorful presentations saying they need to unify their financial sector and not have all these different stock exchanges, have all these different clearing houses. These are technical features that go to the fragmentation of the economy. I think it's more than just their capital markets, though. I think that they're still, they don't have a unified market, my earlier point, as much as they could. But in the capital market side, I think that we have a comparative advantage, a big comparative advantage, and it's playing out to help and support this innovation economy. Now you might say, should Nvidia, Amazon, Microsoft, Alphabet added together, just four US companies, have an aggregate market valuation more than all of the European equity market? That any one of these companies have a market valuation more than France's or Germany's. So I just layer that in and I say there's some real challenges there. I think.
I agree. I think the contrast with the United States is quite powerful and compelling. We may be overvalued, but where's the value in Europe? And also, who owns stocks? So, by some estimates, 60% of American households have some exposure, some ownership of stocks, for example, through their pensions or their savings for retirement. In some of the European economies, for historical reasons, very few households own stocks. So the US market may go up, it may go down. Let's be clear about that. I think we should be sharing more of the wealth from innovation and from the information technology economy more broadly in the US, but the same thing is true in Europe, and they need a more dynamic economy and a more future-looking valuations and expectations and hopes for raising capital. And on top of this, I have to add Russia, the threat from Russia, the Russian invasion of Ukraine, which to many Americans seems important but far away. This is right on Europe's doorstep. And the Russians, I'm afraid, are not necessarily going to stop at the current European border. They'll find ways to be difficult. They'll find ways to disrupt. They may threaten to take some European territory. I think this is something Europe has to stand up against, and probably without as much American support as in the past.
So you raise an important contextual point, though. Europe was already in relative decline versus the United States economically over 20-odd years before Russia invaded Ukraine. We've had a number of real shocks. You've named one of those big shocks. But when I talk to Europeans, when I travel there, and you and I collaborated with the Center for Economic Policy Research on a book, two volumes last year on the economic consequences of the second Trump administration, many Europeans would say that was another shock. It was also a change of US policy, somewhat withdrawing from the broad military and national security support that Europe now needs to invest a lot more in its defense. Not just because Russia invaded Ukraine, but also because the US is saying, 'Look, we might not be as there for you.' And the president's been pretty specific about that. There's been policy shocks in terms of tariffs and trade and where the US is as a reliable ally on that. How do you think that fits in, both economically and politically, on what's going on in Europe, Simon?
Oh, I think the shocks are really important, Gary, including the war with Iran, what's happened to oil prices. So, as you know, the US is a net energy exporter. Rising oil prices do hit American consumers. Rising diesel prices are a big pain point right now, for example. But Europe is a net energy importer, and part of the European strategy pre-2022 was to import gas, relatively cheap gas from Russia, use that to fire up factories in Germany and other places, and be competitive on that basis. Well, that cheap gas has gone away. I don't think it's going to come back anytime soon, and I don't think you'd want Russia to have that kind of noose around the neck of Europe ever. So Europe already has higher electricity prices than the US, electricity being a key input, of course, into all information technology production. They're more exposed to the risks, and what's happening in Iran is out of their control, that they don't really have a seat at that table, and that's a great concern, I think, in geopolitical terms. And Russia is on the move, and Russia and Iran are aligned on many issues, including development of drone technology. Ukraine has stood up to Russia, of course, better than some people expected, and Ukraine is very innovative, but they have a hard time manufacturing at sufficient scale because the Russians blow up their factories. So I think there is a future for Europe integrating with Ukraine, building stronger defense, standing up for itself around the world, but I'm not seeing that as a proactive policy that's really at the forefront of European initiatives right now. They seem to be pretty passive and in the back seat.
