Lots More With Isabella Weber on Draghi's EU Competitiveness Report

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1:08Bloomberg Audio Studios. Podcasts. Radio. News. Hello, how are you? It's so good to see you. It's nice to be able to do this in person as well. So I saw, I think you tweeted it, but you're here for an event, right? With Adam and Tews? Yes. Yeah, we just had him on. His episode came out today. So this is like a nice segue. You're going to be sat right here. I'm not going to read from the notes. I just took some notes on the report because there's so much in there. I don't know. That's good because it's 400 pages and I didn't read all of it. Yeah, exactly. Joe, is there anything more European than Mario Draghi writing a 400-page report on how to boost European productivity?

1:58No, it's perfect. I did a deadlift. One, two, three. Hegemony. Hegemony. Okay, good. Hegemony. Barges. This is an after-school special, except... I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Where's the best squid ink pasta? These are the important questions. Is it robots taking over the world? No, I think that, like, in a couple of years, the AI will do a really good job of making the Outlots podcast. and people are saying, I don't really need to listen to Joe and Tracy anymore. We do have... Cha-ching. The perfect guest.

2:36You're listening to Lots More, where we catch up with friends about what's going on right now. Because even when the odd lots is over, there's always lots more. And we really do have The Perfect Guest. So that report came out this week and it was sort of long awaited. I think it was delayed in the end, which also seems very European. But it took a year to write, and it's all about how to make Europe more competitive. Right. We talked about this a little bit on a recent episode with Adam Tooze, some of the issues in German. There does seem to be a lot of anxiety about the state of the European economy in general, getting really squeezed on the manufacturing side, the energy side.

3:18Growth has been quite mediocre there, particularly if you compare it to the United States. I think there was a good chart in the Draghi report itself. Talk about at one point, European was like 15 % as big and the gap is widened versus the United States. It's not good. It doesn't seem good. Oh, yeah. Isabella, didn't you tweet that chart? I did. So looking at that chart, I think we can basically see that with every crisis, there's a bit of a divergence between the U.S. and Europe. And it seems that the U.S. is pretty good at bouncing back. Europe, not so much, which has to do with the fiscal rules, I think.

3:50So we are here with Isabella Weber. She is, of course, an economics professor at University of Massachusetts Amherst, and she's been on the podcast a number of times. But it's interesting to see this report come out and actually touch on a number of topics that you have addressed through your work on pricing and shockflation. Yeah, thanks so much for having me on. It's a great opportunity to talk shockflation in the report. Maybe looking at this divergence-convergence thing, 28-2020, I think that the energy crisis actually looms very large here. And the notion that was very prevalent in 2022 in Germany, that basically this is just like a little shock that we can easily absorb, that was very dominant in certain economic circles, I think is now playing out to possibly not be true.

4:41So we kind of start to see the medium-term consequences of the energy shock and just how hard it hit Germany and Europe. The idea of every crisis being a moment where the U.S. and European economies further diverge. And I think, you know, one of the parts of the story is European fiscal constraints. You know, we know about, you know, the recession with government debt and particularly in Germany, but elsewhere in the fact that none of the countries have their own currency, their own central bank. So I guess basically with every shock, productive capacity diminishes. People, you know, lose their jobs, factories close down.

5:16That happens in any economy. And then what happens is basically in Europe, they sort of accept that their potential is just lower than it was before. Is that basically the story? And then they don't really do anything about it? I mean, in a nutshell, I mean, I would say that in the U.S. has also been a steep learning curve from 2008 to the COVID crisis. Right. I mean, the kind of fiscal ambition that we have seen in the response to the COVID crisis, I think is a whole notch above of what we have seen under Obama in response to the global financial crisis. I mean, when it comes to the immediate rescue packages in 2020, there was also quite a bit across Europe, right?

5:52But then very quickly, Europe returned to the idea that they had to go back to regular fiscal rules. And that really is thanks to the German government in large parts. I'm speaking with a German accent here. So when we look at the stance of the German finance minister on the reform of fiscal rules, and he has been a critical player in preventing that reform. If we look at what the German government has been doing, then in 2023, they kind of declared victory too early, on my mind, over the energy crisis, which then also meant that they went back to implementing the debt break, which basically tied up their hands.

6:27And then we got this constitutional ruling saying that they have to stick with the debt break, that all these accounting ways out that they had found were basically not constitutional. And then in 2024, they decided again to stick with the debt rule. While Germany is at this point already like the worst performing major economy in the world, and really any macroeconomist would agree, I think, in their right mind that this is a moment to spend. I was on a panel with Jason Furman. Jason and I are not necessarily known to agree on big questions, but we both strongly agree that this is a moment to increase fiscal spending, right?

7:03So this is really a German exception to have this extremely conservative fiscal stance in the middle of this crisis. Wait, can I ask a somewhat personal question? But I think given you're a German economist, and we have German economists on the show, but certainly not every day and not in the week when there is this big competitiveness report. But why is fiscal austerity such a big thing in Germany? Yeah, great question. There was actually an exhibition at the German Historical Museum a little while ago where they were trying to understand why this idea of saving is so deeply rooted in our culture.

7:42Yeah, because it's not like there isn't a social safety net in Germany either. So why? Yeah. Why? And I mean, savings rates are very high, right? So, I mean, their narrative was basically going back to some ideas of Prussian virtue and then Nazi propaganda that very heavily relied on like kind of making it a German virtue to save because it was necessary for the war economy. And then after the war, that like kind of someone who saves is a good person idea was perpetrated. And then I think there's this kind of equation between personal spending and fiscal spending by the state and this narrative of the Swabian housewife, which is very prominently rooted in people's minds.

8:24So if you do polls on whether the debt break is a good thing, most people actually think it is a good thing because it's been preached to them for so long. Where, by the way, I think this idea of the Swabian housewife is the way how to run a national budget also has a good portion of sexism because it, of course, refers to the idea that the housewife doesn't really have authority over the budget, but that it kind of has to ask permission. Ah, right. So passively, except this is the amount of income that you get, but you don't actually control the amount of income. And then you just, but now figure out how to spend it.

8:56Exactly. That's the sort of implication behind that term, which I hadn't, I guess I don't really, I'm not sure if I had heard that term before. I mean, this idea of the Swabian housewife is all over the German discourse. I think it's a very German thing. And I think no one really thinks about the sexist implication of non-sovereignty over your budget. But it's kind of there. And I mean, Merkel really liked to invoke it, which doesn't make it any less sexist. So there's that. But then there's, of course, also the fact that this has been established as a constitutional rule. Right. So now, I mean, beyond all these cultural issues, there's a real issue of politics, where basically the ruling government has a coalition of three parties and one party, the FDP, thinks that the best thing to do is to stick with the fetish of the black zero.

9:37And the other two parties disagree, but they are not in a position to find the majority in parliament. So they're kind of locked into that straitjacket. So you touched on the energy markets earlier, but it's really interesting reading Joggi's report. I mean, energy is a big component of this. And he talks about things like decoupling energy prices and gas derivative markets and things like that. Can you talk a little bit more about how that fits into your research? Because I know you've done a lot of work on things like carbon pricing and obviously shockflation, a lot of which comes through higher energy prices.

10:15Yes. So for the whole question of European gas prices, I'm totally aligned with Draghi. And I that in many ways, actually, his section on prices reads a bit like an implicit commentary on what happened during the gas crisis. So, I mean, he's saying that there are a number of causes for the high gas prices in Europe and the kind of, I mean, gas prices have come down, but there's still a persistent gap between China and the US, right? So, of course, there's a lack of resources, which is obvious, but there's also low grid development, low infrastructure investments, which is kind of these like more long run structural factors.

10:52Oh, yeah. He talked about permitting reform as well. Which is kind of interesting coming from Europe. Yes. But in terms of the like kind of short run dynamics, which I think is where the commentary in 2022 comes in, he's talking about financial markets having driven volatility, having basically increased volatility in these markets, which I think implies that the prices that we have seen in 2022 were not necessarily prices that were reflecting fundamentals. but that some of these price movements were the result of animal spirits on gas markets where no one really knew what Putin was going to do next.

11:26And you basically got a lot of hurt behavior in this situation of extreme uncertainty, which is something that Tom Krebs, a co-author of mine, and I have actually argued in a recent study on the price control question where we say, I mean, if you get these prices overshooting in relationship to the fundamentals in this extreme way, then this actually means that taking some of this overshooting out is optimal even from a general equilibrium, like a very conservative standard economic modeling perspective. And that notion is definitely there in the Draghi report in terms of the volatility. The second point that he makes is that Europe should use its monopsony power in global markets.

12:05So it should team up. Yeah, this is like the collective bargaining argument. Yes. So that basically European countries should team up in buying gas and that way be able to get lower prices on the global market, which again was a very, very hot topic in 2022, where basically the rest of Europe was really trying to do that. And the German government was quite keen to keep procuring by themselves to make sure that Germany is supplied first. So again, this is kind of a commentary on the last crisis, looking ahead at the next crisis that we need more coordinated procurement on the European level.

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13:32Support for the show comes from public.com. You're thoughtful about where your money goes. You've got your core holdings, some recurring crypto buys, maybe even a few strategic option plays on the side. The point is you're engaged with your investments and public gets that. That's why they built an investing platform for those who take it seriously. On public, you can put together a multi-asset portfolio for the long haul. Stocks, bonds, options, crypto, it's all there. Plus an industry leading 3.6 % APY, high yield cash account. Switch to the platform built for those who take investing seriously.

14:05Go to public.com slash market and earn an uncapped 1 % bonus when you transfer your portfolio. That's public.com slash market. Paid for by Public Investing. All investing involves the risk of loss, including loss of principal. Brokerage services for U.S.-listed registered securities, options, and bonds in a self-directed account are offered by Public Investing, Inc., member FINRA, and SIPC. Crypto trading provided by ZeroHash. Complete disclosures available at public.com slash disclosures. Many people seem to agree that the Eurozone is sort of a half-baked project. There is the common currency, but then there's like fragmented capital markets and fragmented regulatory schemes, arrangements, et cetera.

14:46Setting aside, okay, we talked about energy, which is very important for industry. We talked about the fiscal straitjacket and the constraints that Europe imposes on itself for investment and how that makes it harder. Do you, as an economist, accept the premise that Europe has a competitiveness problem? And one of the other areas that Draghi talks about is like the regulatory environment. And you hear it from tech people, it's really hard to start a business or do a startup in Europe because of various rules. Do you accept that component of the premise that there is other aspects of the regulatory environment that make it harder for companies is to be at the global cutting edge against competitors in the US and China, and that Europe needs to rethink some things.

15:34I do agree with that basic premise. Basically, there is a challenge how to rethink the European model to make it competitive moving ahead. And I think that Draghi is also right in emphasizing that in good parts, this should build on existing strengths. So Europe is still pretty competitive in the whole clean tech sector. I mean, of course, China has become a very major player there. the most important player, but still there are many technologies where Europe actually is in a good position and where basically the pipeline from innovation to employment and then actually like turning this into successful businesses is where the project fails.

16:10And I think trying to tackle this is spot on and it's exactly right. I would also say that the whole discussion around energy prices is of course related to competitiveness. And this is where I would actually add the CO2 price question, which is something that he kind of touches on, but doesn't really go into where I think in the US, I don't know how you see it, but my impression is that the idea of carbon pricing in the US is basically off the table. I mean, the Democrats are not going to do it and Trump is definitely not going to do it. In China, there's some scope for carbon pricing, but it's really secondary to the kind of investment led big green state transition strategy.

16:47So this leaves Europe alone as a country that is trying to rely on making emission incentive stuff more expensive. And that, I think, is actually a huge competitive disadvantage in the approach to the green transition. And as we have been arguing in a recent study where we have simulated the inflation impact from carbon pricing could also actually trigger inflation, which then given European inflation governance, which basically relies on interest rate hikes, could create another competitiveness constraint. Because if you get what we call carbon inflation, inflation triggered by carbon price increases, and you then respond by hiking interest rates, then of course, you make the cost of capital even higher, which is one of the points that Draghi points out is a disadvantage for Europe.

17:35The model that's being pursued in the green transition also really matters for competitiveness. And basically, what Draghi is saying is that we need more of what the US is doing, right? But he doesn't quite say we need to maybe rethink some of the stuff that we are doing right now. Yeah, I think the cost of capital point is so important. And like the green transition, the way Europe is pursuing it only really works if other countries are kind of doing something similar. And I remember there was this mind blowing stat, I think it's like five years old now. So it's probably not true. But I think it's very indicative of the tension that we're talking about.

18:10It's not true, but it sounds good. Well, it was true. It was true in 2019. It's probably not true now. But I remember, I think it was Citigroup, they put out this report saying that because of the different ways US and European investors were treating and approaching energy companies, it meant that European energy companies had borrowing costs that were 200 basis points more expensive than their American counterparts. And what that meant is like, maybe it would make sense for like Exxon to buy Shell or something. I think they said that somewhat facetiously. But that's the issue here. If Europeans care more about the environment and carbon pricing, and that results in a comparative disadvantage, as Isabella pointed out, then that's not helpful to the green transition or the European economy.

18:59Yeah. And I think there's kind of a more general gap or unrealized potential in the Draghi report here, because a lot of the things that he is talking about could actually also be used for price stability, right? I mean, he is talking, for example, about buffer stocks. He is actually talking about strategic reserves. He's pretty vague on what exactly he wants them for, but he's putting this on the table as one possibility. He is talking about lower energy prices. He is talking about a more coordinated industrial approach. And what we have been arguing is that basically, in terms of the inflation governance, there's a huge gap in Europe because if you get shockflation, if you get inflation that is actually triggered by major supply shocks to systemically significant sectors, and then you respond, the only way to respond is by hiking interest rates.

19:48You kind of have a gap. You could have a much more sophisticated toolbox to deal with these shocks. And I mean, a lot of the things that Draghi is talking about in terms of investments, in terms of strategic reorientation of sectors in terms of resilience could also be used to make these sectors more resilient to price shocks, right? And I think this is kind of a bit of a missing piece in the puzzle. This reminds me, Joe, do you remember the first time we ever had Isabella on the podcast? Oh, I think we talked about China. Yeah, we were talking about China. And since then, you've done so much work on things like pricing and shockflation.

20:24And it feels like there's been a lot more acceptance, certainly in Europe, of things like even price controls. The transition has been very remarkable to watch. And it's only been a few years. Absolutely. And I think it's actually quite remarkable how there is some sort of a pretext, both in the US and in Europe, that basically they now need industrial policy because China is doing it. So we can no longer not do it. What is missing from my point of view is that actually China has not just been doing industrial policy as a kind of sector level one of policies, but has actually been thinking about re-industrialization from the perspective of system reform.

21:10So it's always been like kind of from this perspective, how do you change the system as a whole, where the price question, inflation question, and macro stability questions are integrated with the question of changing specific industries. And that is actually, I think, something that hasn't quite taken on yet in Europe and the US. Reina Faruha at the FT recently had this op-ed where she was saying that basically, we need much more systems thinking in all these initiatives that currently run under the label industrial policy, which makes it sound as if it's about specific industries, it's about innovation policy, but really what we need is more of a systemic approach, right?

21:45I think the same, I would say about the Draghi report, where we have several elements of systems thinking, like when he talks about more coordination and so on, he's kind of walking in that direction. But then he's talking about prices without talking about interest rates and inflation. So kind of this like major link with the macroeconomy is missing, which I think comes from a lack of this kind of like system thinking. And that is quite interesting to me. And it seems like, I mean, if I look back at the last couple of years and how quickly the discourse has changed, my sense is that this is the next like kind of cutting edge in terms of how the economic policy debate might actually shift in the West.

22:21It's interesting thinking about this sort of the US, Europe and China all have similarities with respect to sort of the challenges or the opportunities of the sort of internal cohesion. Right. Because even, you know, China, for all the sort of talk about centrally planned and plan out of Beijing, there's quite a bit of competition, is my understanding, between the provinces and their desire to compete against each other for investment and jobs and things like that. I mean, competition in China is absolutely cutthroat in many areas, right? I mean, if you take the EV sector, like many people are talking now mainly about subsidies, which, of course, in the early phase, when basically the Chinese state decided to create an EV industry, there was a lot of subsidies flowing.

23:12But right now, we are in a situation where we have a larger number of car companies than we have had like since the 1910s or something, because there are so many new EV companies that came on the market in China, and they are engaged in the most brutal kind of competition that you can imagine. It's basically a competition for survival, where it's clear to everybody that at the end of this competition process, there might be, I don't know, three, four, five companies left. So this is just one example where everybody points to subsidies, but I think it's really also about competition between Chinese players.

23:44Another example is if you look at the meat industry, which is something that we have talked about before, then this is an extremely highly concentrated sector in the US and Europe, right? In China, I mean, concentration has started to pick up, but it's still extremely, extremely competitive with many small meat processors producing still pretty large shares of what comes to the market. And to me, when I first went to Beijing, like as an undergraded student, actually, just walking around the city, you sometimes come to these streets where the whole street just sells one product. There's a guitar shop street, okay?

24:18So there's one shop next to another that sells basically the same product portfolio, which is the most extreme kind of competition that you can imagine. Like none of them has any scope to move out of this. And this same model we see in a lot of the production towns in China, right, where, I don't know, one town that only does bottoms for shirts and is the most important supplier for shirt buttons in the whole world. There's that famous Christmas decoration town where they just make Christmas decorations. Exactly. And each of these companies has like zero leave. This is actually kind of your ideal of perfect competition as you see it in the textbooks.

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