Spain, Unemployment, and Recession

One of the great weaknesses of Keynesian analysis is its lack of any coherent theory of causality. John Maynard Keynes laid the "problem" of volatile investment spending (which he claimed was the cause of sudden downward shifts in "aggregate demand") to the "animal spirits" of investors.

Now, I hate to break it to people, but the manifestation of "animal spirits" within the investment community does not count as a causal mechanism in the turn of the business cycle. It is mere gibberish.

In his recent blog post on the rising unemployment and recession in Spain, while Krugman does not resort to "animal spirits," nonetheless he gives no sense of causality as to why there is high unemployment in that country. He writes:

...Spain’s troubles are not, despite what you may have read, the result of fiscal irresponsibility. Instead, they reflect “asymmetric shocks” within the eurozone, which were always known to be a problem, but have turned out to be an even worse problem than the euroskeptics feared.

After explaining how the real estate bubble also hit Spain (not surprisingly, contributing to the boom there), he then says:

But then the bubble burst, leaving Spain with much reduced domestic demand — and highly uncompetitive within the euro area thanks to the rise in its prices and labor costs. If Spain had had its own currency, that currency might have appreciated during the real estate boom, then depreciated when the boom was over. Since it didn’t and doesn’t, however, Spain now seems doomed to suffer years of grinding deflation and high unemployment.

Here is the problem: Spain's troubles ultimately are not due to the Euro or its lack of a currency it can manipulate (as though currency manipulation is an economic solution at all). The troubles are due to the fact that the government there is hostile to productive people. Spain's policies of forcing up wages and having draconian anti-employer labor laws are the major reason that Spain is not well-positioned for a recovery.

While I don't think that so-called economic freedom indices are perfect, nonetheless I think this recent rating by the Heritage Foundation has some merit. Notice, especially, the very low rating on "labor freedom" in which Spain falls into the "repressed" category. Guess what? In a downturn, strict and inflexible labor policies are going to translate into mass unemployment. Look for Spain to have numbers well above 20 percent in the coming months and years.

Unfortunately, you will not see Krugman deal with that central issue. Instead, he will call for general debasement of the Euro as a "solution" when inflation is no solution at all.