The Rise of Populism, Labor Mobility, and the Eurozone

David Beckworth: Our guest today is Jeffry Frieden. Jeff is a professor of government at Harvard University, where he specializes in the politics of international monetary and financial relations. Jeff is the author of many articles and books, including *Currency Politics: The Political Economy of Exchange Rate Policy*, and *Lost Decades: The Making of America's Debt Crisis and the Long Recovery*. Jeff joins us today to talk about some of his work. 

While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

Beckworth: Jeff, welcome to the show. 

Jeffry Frieden: My pleasure. 

Beckworth: It's great to have you on. We previously had one of your former students, and now one of your colleagues and co-authors, Mark Copelovitch. 

Frieden: Right. Mark is great. 

Beckworth: Yeah. I had a fun time with him, chatting about political economy, and obviously you trained him, so we're looking forward to chatting with you. We've seen your work, and looks like you have a very interesting and fun job. 

Frieden: I love it. I've been doing it for over 30 years, and I'm still not bored. 

Beckworth: Very nice. I was going to ask, is this a great time to be doing political economy work? 

Frieden: Oh boy, isn't it? I sometimes say that crises are my business, and business is good, so... But you know, when I first got into political economy really was as an undergraduate at Columbia in the late 70s, early 80s. There really wasn't a lot of political economy out there, and certainly not a lot of international political economy. In fact, the first textbook in international political economy was written by my undergraduate advisor, and I was a research assistant on that textbook. 

Frieden: Now, it's a very popular field. Political economy is hot in both political science and economics, and in other fields, as well, like sociology and history, and I think it makes sense, because it's increasingly obvious that you can't separate politics from the economy, and you can't separate economics from the polity. 

Beckworth: Yes. Kind of takes us back to where we started, right? Historically, it was political economy, then they broke apart. Now it's coming back together. 

Frieden: Absolutely. Well, I think it makes sense in a way, because back in the old days, with the classical political economists like Adam Smith, and David Ricardo, and Karl Marx, and John Stuart Mill, they integrated or tried to integrate politics and economics, and then towards the latter part of the 19th century, with the rise of more professional disciplines, you had the separation into economics and political science, but I think very few political scientists, and very few economists would argue that the other discipline is irrelevant for its own. So, I think it's a natural phenomenon. 

Beckworth: Yeah, it is very interesting, and I was reading your work. I was very impressed. You have a command of both fields. I mean, you're writing about very complicated international monetary issues, looking at both the economics and the politics of it. So, how did you get there? How did you... You got your PhD in political science, but you also had to do a lot of reading and research in economics, right? 

Frieden: Absolutely, absolutely. Well, I got there... In the late 70s and early 80s, when I was an undergraduate and then a graduate student at Columbia, there was... There had been this separation, but the 70s and then into the 80s were a period in which the international economic order seemed to be falling apart. The Bretton Woods system had collapsed. You had the dramatic increase in inflation in the industrial world. You had the debt crisis in Latin America and around the developing world, and it just seemed increasingly obvious that you couldn't separate politics from economics in the international realm. 

Frieden: So, I guess it was a natural outgrowth of what was happening at the time. I think that in many ways, graduate study is... The headlines lag six or eight years, because kids read about this when they're in high school and college, get interested in the topics, and then want to do more work on it, so we had a flurry of interest in things like counter-terrorism, and terrorism, and civil war, and ethnic conflict after 9/11, and now we've got a flurry... You might think a re-flurry of interest in international finance, financial crises, in the aftermath of the crisis of 2008, ‘09, 10, and so on. 

Frieden: So, I got into it, and at the time, as I was starting to say before, there really wasn't a lot of political economy. Political science is in some ways a more multidisciplinary or open discipline than economics, so it was easier to do it in political science, but I would say probably the single biggest impact on my institution... On my intellectual development as a scholar, was at the graduate level, with a wonderful economist named Carlos Diaz-Alejandro, who was visiting at Columbia, and then accepted a position there, and so he was there when I was in graduate school, and he was a spectacular combination of expertise in Latin American economic history, expertise in international macroeconomics, and expertise in political economy, so he was... He unfortunately died very young, in the mid-1980s, but he was a real inspiration. And there have been others since, who have tried to put those together. 

Frieden: I did, of course, take courses both in political science and economics, and I was lucky. At Columbia, there were some wonderful people to take courses from. Robert Mundell was there at the time. 

Beckworth: Oh, wow. 

Frieden: And Jagdish Bhagwati, and Ronald Finley in the economics department, and Bhagwati himself actually had an interest in political economy. He founded the journal, Economics & Politics, which is one of the early journals of political economy, so it was an opportune time to be interested in this area, and I think it's only become more striking that the interaction of economics and politics is where a lot of the action is. So, I guess I was lucky. I got interested in this at a time when it was becoming increasingly important to the world, and increasingly attractive to a lot of scholars. 

Beckworth: Yes, you have done a lot of work in this area, and one of them that you worked on, I want to focus in on that, is populism, the rise of populism, and it's been interesting to follow this, to try to understand it, and you have a recent paper titled *Populism in Place: the Economic Geography of the Globalization Backlash*. And just to remind our listeners, starting in 2016... Before then, in fact, you outline this in your paper, but it was very apparent in 2016 that populism was on the rise, with Brexit, with the presidential election here in the U.S. More recently, we saw the European Union parliament elections. A lot of the centrist parties were kicked out, and more of the anti-EU groups were let in. 

Beckworth: And I recently saw an article in Bloomberg, just to kind of motivate this conversation, and the title is *Wall Street is Desperate for Wonks Who Can Explain the Rise of Populism*. If you're not making... If you want to go to Wall Street and make some extra bucks moonlight, apparently there's opportunity there. 

Frieden: I guess so. 

Beckworth: But let me just read the first few paragraphs from this article. It says, "Better Markets, a left-leaning Washington think tank, describes itself as a watchdog over Wall Street. Nowadays, many of the people seeking its advice are Wall Streeters themselves. There's been a very big uptick in fund managers reaching out to talk to Dennis Kelleher, co-founder and chief executive, which advocates for financial services reforms. He said his unanticipated visitors tend to have one thing in common. They're alarmed very belatedly by the populist turn in U.S. politics, and they're struggling to figure out where they are headed next." 

Beckworth: So, you know, even Wall Street is a little perplexed by all of this. Kind of hit them like a curve ball, and they just weren't ready for it, so talk us through it. What's the story going on, and what did you find in this article, and help us understand the rise of populism. 

Frieden: Well, I think the first thing to say is, and this is not meant to be an apology for academia, but the reality is that academics who have studied the politics of international economics, whether they're economists or political scientists, have for really... For 20 years now, expected, and anticipated, and talked about a backlash against globalization, because everybody who works in this area, we know that globalization, at least in my opinion, is beneficial. Beneficial to national economies. It's been obviously a boon to a lot of developing economies that have grown rapidly, starting with China, clearly. 

Frieden: But even the strongest believers in globalization, understanding globalization in some general sense as the increasing integration of markets for goods, capital, perhaps even people. Even the strongest supporters of globalization recognize that it creates winners and losers, that it's not only... It doesn't only have positive effects. You can't... You start with trade, and for... Almost forever, we've understood that even if you believe that trade liberalization is good, and virtually all economists, and virtually all political economists believe that free trade is good, is the optimal policy. Virtually all of them would also agree that it's going to create losers. 

Frieden: So, I think from the very start, we expected there to be a backlash against globalization. We've been expecting it for a while. This is not just me. People like Dani Rodrik, and Joseph Stiglitz, and others were writing in the year 2000, in the early 2000s, about globalization and its discontents, about the problems of globalization. What we didn't really know is what form it would take. A lot of people expected that it would take the form of, say left wing... The kind of Occupy Wall Street responses that we saw in the aftermath of the crisis of 2008, but the form that it has taken, and I think surprised a lot of us, is this... Typically, this kind of highly nationalistic, usually right wing populism. 

Frieden: Now, populism is a term that... I'm not quite sure that there's any accepted definition of it, except the broad one that we know it when we see it, but... And the populists differ among themselves, but what they have in common, I think, is a rejection, and a real hostility to existing political institutions, existing political parties, existing political leaders, and also in the current era, a real skepticism about and in some cases hostility to various forms of integration. In the U.S., it's tended to take an anti-globalization, anti-globalism... Donald Trump talks about his hostility to globalism, which is really the same thing as globalization. 

Frieden: In the European Union, and Europe, it often takes hostility to European integration, or to the Euro, or to the institutions of the European Union. But what ties them together is this notion that something, whether it's globalization or the European Union, has unfairly and inappropriately taken over and reduced the scope for national policies to have an impact on people's lives. That's the sort of the backdrop. Whether you're thinking about Brexit in the U.K., or Donald Trump in the U.S., or the populists who are currently in power in Poland and Hungary, or the Five Star movement and the League in Italy, or the National Front in France, they differ a lot among themselves, but they all share this hostility to established, mainstream political parties, and hostility to various forms of integration, so that's the sort of backdrop. 

Frieden: How do we understand it? I think looking at the United States and Western Europe in particular, it's important to see that it is the confluence of both a long-term trend, and a set of short-term catalysts. The long-term trend that I think we would identify, and that we do try to identify in this paper that you've referred to, the long-term trend is the gradual loss of manufacturing jobs throughout the advanced industrial world. And I'm going to focus on the U.S., because that's what we know best, and you know, the high point of manufacturing employment as a share of GDP, and... Manufacturing employment as a share of the labor force, rather, and in numbers, was in the late 60s, early 70s, when manufacturing employees were about 26 or 27 percent of the U.S. labor force. 

Frieden: And it has declined continually since then, until it's now around or maybe a little bit below 10 percent, so there's been a dramatic decline in manufacturing employment. Manufacturing jobs, for a variety of reasons, were in many ways the secret to the American dream. They were unskilled and semi-skilled jobs that were very well-paying. They gave the people that held them a path to the middle class, so if you were a steel worker, or an auto worker, or a worker in a machine tool plant, agricultural implements plant in the Midwest, in our Industrial Belt, you could aspire to a middle class life standard, living standard. That's no longer the case. 

Frieden: Virtually all of the well-paying, low-skill jobs in manufacturing have been eliminated. They've been eliminated either by technological change, or by some combination of imports and offshoring, and as I'm sure you know, David, economists and others have argued long and hard about the relative importance of technological change and international trade or globalization more generally, and we'll probably never solve that dispute, but there's no question that some combination of the rise of microelectronics, and computing, things that essentially meant that to get a good paying job you needed computer literacy on the one hand, and the fact that firms can now move labor intensive activities to Mexico, or Vietnam, or China, means that virtually all of the well-paying, unskilled jobs in manufacturing have disappeared. 

Frieden: That has had a dramatic effect over a 40 year period on the traditional American Industrial Belt. It's affected all of the country, but it has had a concentrated effect on the Industrial Belt, which I... That term, by the way, I prefer to Rust Belt, which sounds a little derogatory. But you know, traditional American manufacturing starts at the crest of the Appalachians and goes through the Great Lake states, up into Iowa and Southern Minnesota. That's where American basic industry was concentrated for 100 years, and that's the area that has been hardest hit by the decline in manufacturing. 

Frieden: So, the first point is that for 40 years, and more, these regions have seen a steady outflow, or steady decline in the availability of good paying, unskilled and semi-skilled jobs. 

Beckworth: Let me ask you a question about that first point. 

Frieden: Sure. 

Beckworth: That's what you're referring to when you said earlier, you guys were expecting something at some point to come about, to emerge, because you've been watching this trend for a long time. Is that right? 

Frieden: Right. 

Beckworth: Okay. One question I have is this trend's been with us. Was it hastened or exacerbated by technology or trade? Was this going to happen no matter what, I guess is my question. And secondly, could it have been done at a more moderate pace? 

Frieden: Right. Well, so I think it was in some ways inevitable, given America's economic endowments. Just as the transition out of agriculture and into industry was inevitable, once agriculture became less labor intensive and more capital intensive, we moved the 50 percent of the population that was in agriculture into the cities. I think manufacturing, the U.S. was a manufacturing superpower. Still is, in many ways in terms of output, but when it rose as a manufacturing superpower, it was doing so with the use of a lot of unskilled and semi-skilled labor, at a time when that labor was relatively cheap in the U.S. It wasn't cheap, but it was relatively cheap. 

Frieden: The U.S., however, is not a low wage economy, and so you would expect two things to happen. First of all, employers would find ways of substituting capital for labor, because capital is cheaper in the U.S. than labor. And they would find ways of taking their production activities that required a lot of labor to places where labor was cheaper, and so whether in turn... So, those are the two components that you've mentioned. Both of them have taken place. Technological change means replacing labor with capital. Replacing unskilled and semi-skilled worker with machines that can do those jobs. Now we're in a period in which when we talk about automation, we're talking about the rise of robots, but in an earlier area, there were other kinds of machinery that replaced labor. 

Frieden: That had a major role in accelerating the process, but I think focusing on globalization, which really in some ways is important from a political standpoint, globalization, unquestionably in my view, sped the process. 

Beckworth: Okay. 

Frieden: Right? And there are two reasons. The first is that it allowed firms to move production facilities offshore, to where they could find cheaper labor. And second, it allowed other countries, that had ample supplies of inexpensive labor, to come into the American market, to export to the American market, goods that were cheaper than could be produced in the U.S. So you know, we lost the garment industry, furniture, toys, textiles. These very labor intensive industries could not compete with producers from Mexico, or China, or Vietnam, or other low... Or Korea and Taiwan earlier. Other low wage economies. So, I think that the transition out of unskilled manufacturing was inevitable, but I also think that it was clearly accelerated by globalization. 

Beckworth: Okay. Fair enough. Let's move on to you or other two points that you make in this paper. Speak to the second one, about how we need to think about this development in terms of communities, versus just an individual. 

Frieden: Right, right, so I think when we think about why it is that this loss of manufacturing jobs has had the broad socioeconomic and political impact that it has, you have to remember that people live in places, and in many... much of the Industrial Belt, and much of the industrial areas throughout the rich world, what we have is small cities and towns that have a few factories, and that are typically economically organized around those factories. If one or more of those factories closes, that'll have a direct impact on the people that used to work there, and so you'll have some unemployment, and wages might go down, but it then has a broad set of effects on the community as whole. 

Frieden: As wages go down, as unemployment increases, typically property values start to drop. As property values drop, property tax revenue drops, and that makes it harder and harder for the local government to provide local public services, and so there's less spending on the schools, less spending on the roads, less spending on law enforcement, less spending on other social services, and these communities find themselves in a downward spiral, and if you're familiar with any of the kind of declining industrial towns and cities, from really the Appalachians west, whether it's Syracuse, New York... I don't want to pick on cities, but Syracuse, New York, or Eerie, Pennsylvania, or Dayton, Ohio, or any of these areas, and we could point to similar communities, similar small cities and towns in the midlands of England, or in Northeastern France, or in Eastern Germany, and the loss of these really almost central manufacturing jobs has a whole series of follow-on effects. 

Frieden: And it has been... We have studies that have shown that regions and towns that have been subjected to these shocks, where they lose well-paying manufacturing jobs, have bigger class size, less law enforcement, they have more opioid addiction, they have more alcoholism. They have a whole series of economic and social problems that follow. It's very hard... I think it's really important to understand that it's hard for a community that has relied on one or a few job producers, factories, or whatever, to get out of the spiral once you get into it. 

Frieden: As I say, the community as a whole is suffering, so we... Sometimes people say, "Well, those who are the losers from globalization are the ones who lose their job when the factories close." That's certainly true, but if you're a dentist, or a schoolteacher, in a town that's declining, that's losing employment, that's been suffering for 25, or 30, or 35 years, you're being hurt, as well. And so, I think we have to think in terms of the places that have been affected by the change in the economic structure of the U.S., and the decline of traditional manufacturing. Not really individuals, but places, communities, people who live in those communities. 

Frieden: It's very striking when you see it politically, because if you looked at a map of the populist vote, say the vote for Donald Trump, the change in the vote for Donald Trump from the 2012 election, or votes for Brexit, or votes for the National Front in France, or any of these other populist movements, you really see a regional concentration of this voting in precisely the areas that have been in industrial decline for so long. And it's not... It cannot be driven only by the relatively small portion of the population there that actually lose their jobs due to globalization. It's driven by the fact that that was simply the tip of the iceberg, or the beachhead of a broader socioeconomic decline, that affects the entire region. 

Beckworth: Yeah. You had some very striking graphs and figures, some maps that highlight this, which is very interesting to see, and we'll put that on the webpage for the podcast. One question I have that's tied to this research, this literature, is this idea that people in these communities often wouldn't move. So, the community gets hit by a China shock, or some other trade shock, and many times they just simply wouldn't pack up and move. So, good econ theory says, "Well, if you don't have opportunities in this town, move to the next town, or move to the city," and what we see is a decline in labor mobility in the U.S. over the same period, here. Any thoughts on that? 

Frieden: Yeah, I think it's certainly true, but I think one has to recognize that there are reasons why people find it difficult to move, and one of the most important reasons is that in the prosperous areas, housing costs have soared. So, it's easy to say, "Well, if you're sitting in Eerie, Pennsylvania, or Syracuse, New York, or Dayton, Ohio, and you can't find a job, and the community's declining, you should move to New York." Well, if you move to New York, you have to be able to pay the rents necessary to live in New York, and there's a great paper by Peter Ganong and Daniel Shoag. Daniel's here at Harvard. Both of them actually at Harvard, one at the Kennedy School, in which they talk about this very explicitly, and what they... 

Frieden: They use sort of a motivating example, saying, "If in 1980 you were an unskilled worker in the Deep South, let's say Alabama, and you move to the Greater New York area... If you were an unskilled worker or a lawyer, you would be better off, because the salary of the lawyer compensated for the higher housing costs, and the wages of the unskilled worker compensated for the higher housing costs. If you did that today, the lawyer would still be better off, because lawyer salaries have kept up with housing costs in New York, but if you're an unskilled worker and you move to New York, you're 20, 30, 40 percent worse off, because the wages of unskilled workers have not kept up with housing costs in New York." 

Frieden: So, it's easy to say, "Yeah, move somewhere else," but there are a whole complex of things, leaving aside the obvious one, that maybe people don't want to move. Maybe they've lived in that community all their lives- 

Beckworth: Fair. 

Frieden: Maybe they have other ties in the community. But from a purely economic standpoint, it may be virtually impossible to move. Maybe you're a renter. Maybe you're a homeowner, and your house, which used to be worth say $200,000, is now only worth $80,000. Not uncommon in these depressed areas. You sell your house for $80,000, that won't even buy you a parking space in New York. I mean, it won't even buy you part of a parking space in New York, so the notion that you could easily pick up and move to a prosperous region is I think good in theory, virtually impossible in practice. 

Frieden: Think of what the country looks like today. We've got a very prosperous Northeast, a very prosperous West Coast, prosperous big cities in between, and then a big swath of areas that really are suffering, and want to focus on the Industrial Belt. Tell someone that they should move from Dayton, Ohio, to the Bay Area, I think is presenting an opportune... an alternative that is really an impossibility with the housing costs... I mean, so this, not to belabor the point, but I think... Let me make a more positive point along these lines, which is that if we wanted to actually do something to encourage people to move, you would almost certainly have to subsidize or provide some kind of mechanism to make it feasible for people who are moving from a depressed area to move to a prosperous area. 

Frieden: It could be a subsidy, it could be subsidized loans, housing loans, or something along those lines, but the market itself, I think does not make it feasible for an unskilled or semi-skilled worker to move from a depressed industrial region to the Bay Area, or New York City, or Boston. 

Beckworth: Yeah, this creates all kinds of interesting questions, diversions we could go down. I don't want to spend too much time- 

Frieden: Go at them. 

Beckworth: Because I want to get some other, but a couple- 

Frieden: I'm all yours. 

Beckworth: A couple observations. So one, this speaks to the importance of all the work that's being done on reforming zoning laws, land use regulations in those cities. San Francisco, notorious for NIMBYism, not building enough supply, so we have a national housing shortage, which is a whole other discussion, but this speaks to the importance of that conversation, I think. 

Frieden: Oh, I agree completely. I think we have... I mean, the unavailability or the restricted supply of housing in the prosperous areas, is obviously, or obviously to me, contributing to the problems of the declining areas, of the troubled areas, and I... Unfortunately, it's difficult to convince policymakers in the prosperous areas that what they're doing is exacerbating problems that I think are going to come back to bite them, but that's the reality. 

Frieden: In a sense, that's what national governments are for. You know, it's the national governments that internalize the externalities. You can't expect the policymakers in San Francisco, or New York, to worry about what's happening in Syracuse or Dayton, but the national policymakers I think have to think about internalizing those externalities, and they're pretty substantial. 

Beckworth: Yeah, which leads me to a second observation related to this, and that is the whole notion of the U.S. as an optimal currency area, so kind of taking it as given, and probably we still are the best example, that if the Fed is raising interest rates, and Michigan's in a recession, and Texas is in a boom, we're like, "Oh, no big deal." There's all these shock absorbers built in place. One, maybe there's fiscal transfers, unemployment insurance, maybe prices are flexible, but one of the big shock absorbers is labor mobility, at least in theory, right? 

Beckworth: People in Michigan can pack up and move to Texas, but they're not, as we've suggested, and this suggests to me, and I've discussed this with some other folks on this show before, is that on the margin, we're incrementally moving away from being an optimal currency area. The more we let this set in, the more that it kind of becomes a permanent feature of our economy, the tougher it's going to be for the Federal Reserve to do an adequate job. 

Frieden: Right. Well, that's certainly one way of putting it. The broader picture, which I think is closely related to whether we're an optimal currency area, is the increasing inter-regional divergence that we observe. And I think it's a problem. It's a problem economically, because it suggests that there are opportunities that could be taken, that increase the productivity of the country, that are not being taken because of this inter-regional divergence. Example, the general opinion here, and it's appeared in some of the local papers, is that there are 300,000 unfilled jobs in Massachusetts, because of the skill mismatch. 

Frieden: Now, there have to be at least 300,000 people who could fill those jobs elsewhere in the country, who are underemployed, because we know that labor force participation has gone down in the Industrial Belt and some of these other troubled areas in the Midwest. So, from benevolent social planner's perspective, the right thing to do is to move the people from where they can't find employment, to where there are job shortages, which is the Northeast and the far West. We don't work that way, but it is an effect of this increasing divergence among the regions. 

Frieden: Whether it affects the... I'm not convinced the U.S. was ever an optimal currency area, to be honest, because the demands for actually satisfying optimality in that literature are pretty severe. The kind of labor mobility that would be necessary to make the U.S. an optimal currency area is pretty extreme, and these fiscal or automatic stabilizers and other transfer mechanisms really only pick up some of the slack. I think one of the reasons we work as a currency area is that we have a general agreement that if there's a crisis in Florida, or Texas, or Arizona, that is regionally specific, there is some willingness on the part of the Federal Government to intervene, not only with the automatic stabilizers, but with transfers that are perhaps targeted in those areas. 

Frieden: That's one of the reasons the U.S. works along those lines, and was able to address the crisis more effectively than the Europeans, because in Europe, of course, there's no agreement among Europeans that Germans should sacrifice to help the Spaniards out if they're in crisis. So, there's a political angle to this currency area focus, which is not purely economic. 

Frieden: I should point out, going back... I've gone very far afield, but the evidence that I've seen indicates that inter-regional mobility in the U.S. has declined continually over the last 40 years, and I've seen a couple of papers that suggest that it may be lower in the U.S. today than it is in Europe. 

Beckworth: Wow. Okay. 

Frieden: We know... Yeah. 

Beckworth: I was going to say, well, maybe relative to Europe, we're more of an optimal currency area, but that would say no, that evidence you just suggested. 

Frieden: Yeah. It's not clear. We know that social mobility, sadly... One of our great calling cards was the great social mobility of the U.S., but Raj Chetty's work has shown that the U.S. has the lowest level of social mobility of all the advanced industrial countries today, and that's a sad fact. I think it is related to these inter-regional differences, frankly. And he shows, if you know Raj Chetty's work, you know... He shows which regions have the most social mobility. That from one quintile to the next, in the income distribution, and again, it's the prosperous regions where there's a lot of social mobility, and then the struggling regions where social mobility is at its minimum. 

Beckworth: So, if you're born in Appalachia to a low income family, chances are you're going to stay there and be stuck in that- 

Frieden: Absolutely. That's right. Appalachia, Southern Ohio, Western Pennsylvania, all of the areas that we would associate with the declining Industrial Belt. And then parts of the South, as well. Yeah, so those are the areas where social mobility is not only low, but as far as we can tell, declining. And then places like the Northeast and the far West are areas where social mobility remains relatively high by American and global standards, and has not declined. That's what Chetty's data show quite clearly. 

Beckworth: Yeah. 

Frieden: My interpretation. 

Beckworth: Well, let's go back to your paper. You had a third point that you and your co-authors bring out, and I really like it, because this is... This is the point that I've been framing my thinking around, but clearly it's incomplete. Your whole article shows this is a long-term development, but your third point about how the Great Recession, the financial crisis was a catalyst in bringing these simmering pressures to the surface, and kind of exposing the problems we have. 

Frieden: I think... Yeah, it's absolutely right. I think it is... The Great Recession could not have had the powerful impact that it had, were it not for having taken place against the backdrop of this long-term trend, but I also think that without that catalyst, without that shock, we would not be seeing the rise of these kinds of populist movements that we've seen today. So, I think many people underestimate, and I think we can't overestimate the broad economic and socioeconomic importance of the crisis that began in 2008, 2009. 

Frieden: It's very clear in Europe, so let's not even talk about that, because it's just so obvious. I mean, Europe really hasn't even recovered from the crisis, and there are countries that will take another 10 years to recover from the crisis, so that's I think very obvious, but in the U.S., I think a lot of people are not quite clear on how severe the crisis was, especially for some parts of the country, and for some of the income groups in the country, so the crisis had very disproportionate effects on the bottom 30 to 50 percent of the income distribution, and very disproportionate negative effects on these distressed areas, like in the Industrial Belt and parts of the industrial areas of the South. 

Frieden: So, I'll give you just a few examples of, from a data standpoint, of what this has implied. So, median household income, which is by definition the middle class, the American middle class, median household income at the country level as a whole, has just about recovered, a little bit more than recovered from where it was before the crisis. Which, okay, so we've gotten back to 2007, but that means that essentially median household income has been roughly stagnant for 13 years. 12, 13 years. That's not a good thing. 

Frieden: The economy has grown pretty substantially, but the median household has not benefited from that, and then if we think about it again in regional terms, if you look at the prosperous areas, states like Massachusetts, or New York, and others, median household income has risen pretty substantially in those states. But then there are regions in the Midwest where median household income is still below where it was in 2007, so the middle class as a whole is really not doing that well, despite the recovery of the economy, and the middle class residents of the distressed areas are actually doing more poorly than they were before the crisis, so there has been in some sense no recovery for large portions of the American population. 

Frieden: A second summary statistic that I think illustrates this is wealth. In some sense, household wealth is perhaps more important than income, because wealth is the cushion that you can rely on in bad times. It's what you're saving up for, for your children, or for your retirement, so in some sense, wealth is perhaps a more important indicator of how well a family is doing than income. Ed Wolff's work shows that as of 2017, median household wealth is one third lower than it was in 2007, before the crisis. That is the median household, that is middle class households in America are one third poorer today than they were in 2007, before the crisis. 

Frieden: That's a staggering statistic, and when you deconstruct it and look at where it comes from, it comes from first of all, the fact that a lot of middle class households have experienced long spells of unemployment, that they experienced either during that period of afterwards declining real wages, real income. That because of that, they typically had to dip into savings, sometimes retirement savings. That their assets, typically their housing price, the value of their home went down, and in many parts of the country has not recovered. That because of the difficulties they faced, they had to take out substantial loans, like second mortgages, student loans, consumer debt, credit card debt, things like that. All of which obviously is a negative impact on net worth. 

Frieden: So, if you take into account the hit that people's assets took, especially in housing prices with the crisis, and the hit that their earnings took, which required them to take out more debt, you understand why today the median American household is one third poorer than it was before the crisis. And that, I think gives us some purchase on why people are so angry. Right? 

Frieden: The economy's recovered. Wall Street's booming. Who knows... Today, maybe not, but it's... Wall Street is booming. The Northeast is booming. The West Coast, I keep talking about these regions, and I'm a New Yorker, so it's not like I resent the fact that New York is... I think it's wonderful that New York is booming, but the news, the politicians, the government focuses on the fact that the economy has recovered, and New York, and Boston, and biotech, and entertainment, and high tech, and Google, and Facebook, and the economy seems to be incredibly prosperous, and all these great, high paying jobs are coming forth, and the middle class household, on average, is one third poorer than it was in 2007. 

Frieden: So, you take the image that's projected by the media, by policymakers, the picture you get of rampant prosperity in the big cities, and the reality that median American households face, and you can understand why people are a little frustrated with what you might think of as the elite. 

Beckworth: Yeah, that is a very staggering statistic. One third less wealthy. I mean, wow. It's hard to wrap your mind around that. 

Frieden: It is. It is. 

Beckworth: Now, this last point, though, it really resonates with me for several reasons. One, it's just kind of anecdotal, but I observed, growing up and starting to follow this stuff, that whenever there was a recession, you tended to get more anti-trade populists. I remember Ross Perot, for example. 

Frieden: Of course, yeah. 

Beckworth: But then there was a study that I've mentioned on this show several times. I'm sure you're familiar with it, but it's called *Going to Extremes: Politics after Financial Crisis, 1870-2014*, Manuel Funke and several other co-authors. 

Frieden: Right. 

Beckworth: But to me, it's a very persuasive, thorough study. It looks at 800 general election, 20 countries since 1870, and it finds... This is what's fascinating to me. It finds that after not just any kind of recession, but a financial crisis... Has to be a hardcore financial crisis, that you get this more populist, nationalistic reaction. For all the reasons you probably listed already. And this... The Great Recession's just another data point that kind of confirms this story. 

Frieden: Right, right. Yeah, I think that's right. Well, I think it's part of a more general observation, that we're, as a profession I think, only starting to come to grips with, which is... Some of us have been working in this area for a while, and understood it, and I think it's... But it's been more broadly understood, I think, among economists and political scientists that debt crises, financial crises, are different than normal recessions, and we were lucky in some way that in 2009, in the midst of the Great Recession, Carmen Reinhart and Ken Rogoff came out with their wonderful book, This Time Is Different, which as you know David, sort of a sarcastic title, because the subtitle is Eight Centuries of Financial Folly, in which they show that the recovery from the typical debt crisis takes five to seven years, as opposed to the nine to 12 months in a typical recession. 

Frieden: And there are both economic and political reasons why financial crises are different. The economic reasons, which we're discovering, and the Europeans are discovering in the aftermath of the Great Recession, are that a debt crisis leaves the society in question with a debt overhang, with in this case trillions of dollars of bad debts. So, if you look at it from the standpoint of creditors, in the aftermath of a debt crisis, all the financial institutions are worried about is they know that they've made trillions of dollars of bad loans, that they want to get off their books, and they're worried that there are trillions more that are going to come forward, so they're primarily concerned about getting a healthier balance sheet. 

Frieden: They're not interested in making new loans. They're not interested in finding new opportunities. They're just trying to clean up their balance sheets, and their portfolios, and that means that the banks aren't lending. From the standpoint of debtors after a financial crisis, the debtors' incomes usually have gone down, because there's been a crisis, but their debts haven't gone down in nominal terms, so what do they have to do? They have to save more, in order to be able to service their debts, which means that they have to consume less, so just as banks aren't lending, consumers aren't spending. 

Frieden: And the debt overhang has exercised this drag on recovery, which is why the typical recovery from a debt and financial crisis is five to seven years, Reinhart and Rogoff estimate it as, which sounds about right if we think about Europe today, or even the U.S. Much longer recovery, much more difficult recovery than any of the typical recessions in the Post-War Period, whether in Europe or in the U.S. 

Frieden: But then there's also the politics, and that's what I think is very important about the article that you cite, and about the experience that we're having today, because debt crises, financial crises, almost always lead to lots of political conflict. Which recessions... You know, recessions often lead to an upsurge in protectionist sentiment, and some discontent, but financial and debt crises, as the paper you cite and many others have shown, often lead to much more extreme divisions within society. And I think you can understand that by saying that essentially any debt... By seeing that virtually any debt crisis is going to, of necessity, raise the question of who's going to pay, who's going to make the sacrifices to deal with the aftermath of the crisis? The technical term that we might use is, "How is the burden of adjustment going to be distributed? Who's going to pay for everything that's going to have to be done to get the economy healthy again?" 

Frieden: Is it going to be the creditors, by forgiving debts? Restructuring debts? Trying to forgive or restructure debts that are outstanding? Is it going to be debtors, who are going to have to pull in on their consumption? Is it going to be... If it's government debt, as in many European countries, is it going to be government employees? Is it going to be taxpayers? Virtually every financial crisis I can think of breaks down almost immediately into conflicts between creditors and debtors, and various groups of society, over who's going to pay for dealing with the cleaning up of the aftermath of the crisis. 

Frieden: Now, that's especially obvious if the crisis in question involves international debts, because then you've got countries against countries. Like in Europe, you have the creditor countries versus the debtor countries. It's the Germans against the Greeks, the Dutch against the Spaniards, but it's also true within countries, because in Spain, or in Greece, the conflict is over, "Well, who's going to make the sacrifices for us to deal with our massive debts? Is it going to be government employees? Is it going to be taxpayers? Is it going to be the private sector? Is it going to be the public sector?" So, I think the... It's not a secret, but the answer to your question, or the... We can shed on the issue that we've raised about why financial and debt crises are different, is that they create a whole complex of economic problems, which are much more serious than normal recessions. And they set the stage for a whole complex of political conflicts that don't typically arise in a normal recession. 

Beckworth: Yeah. Very interesting. Which also speaks to the need to make sure we don't get into that mess in the first place, but- 

Frieden: Exactly. Exactly. 

Beckworth: Whole other show. But you've spoken to the Eurozone crisis, and we don't have a lot of time left, and I want to move to that more closely, and I want to ask this question, since we've been talking about this long perspective. You've been in this field for a while. You've been following this debate. Were you around when they were discussing the Eurozone? 

Frieden: Oh, yeah. 

Beckworth: Okay, so were you one of the American economists who said, "Hey, hey, hey, you better slow down. This is not the best idea." 

Frieden: I can't say that I was one of the Americans who said that the single currency was not a good idea, first of all, because I don't typically take positions on things like that, but also because I think a lot of the American economists who said that were justified. I mean, that is they had good reasons, and everybody who's looked at it understands that there were problems with the construction of the Euro, but I think a lot of people, it's easy in hindsight to say they should never have done this, but if you go back as I do... I was involved in a lot of studies and discussions of this in the early... in the late 80s and early 90s. 

Frieden: So, if you go back to that period, you perhaps get a better understanding of why it was that the Europeans went to this direction, and let me, if I may, develop this a little bit further. So, you have, after 1991, you have a single market, so there are no barriers to trade among the member states of the European Union. They have a single market as much as we do in the United States. In 1992-93, you have a serious currency crisis, and at that point, keep in mind, there was the European monetary system, in which many of the countries that eventually created the Euro had a fixed exchange rate against each other, so that... fixed to the Deutschmark, the Deutschmark, the franc, the lira, all these... All former currencies were fixed to one another. 

Frieden: In 92-93, you have a currency crisis, and a bunch of the currencies are substantially devalued, 20, 30 percent, and there's a flood of imports from Italy and Spain, which devalued substantially, into France and Germany. So much so, that there was a massive outcry from producers in France and Germany against these imports, and the French actually threatened to impose emergency tariffs on Spanish and Italian goods. That highlights the conundrum that you find yourself in if you're a single market with different currencies, because the idea behind a single market is that no one country is going to be able to use trade policy to gain unfair advantage, whether by subsidizing, or by taxing imports, over its counterparties. 

Frieden: But if you can devalue your currency at will, we know that a 10 percent devaluation is equivalent to a 10 percent tariff and a 10 percent export subsidy, so if, for example, North Carolina could devalue its dollar at will, and flood the rest of the country with its goods, we might have some questions about whether we wanted to be in a single market. So there was... By the mid-90s, there was a real question about whether the single market was consistent with separate national currencies, and the broad view was that it was not. That as long as the major countries had different currencies, and could devalue them at will, that that was a real challenge to the single market. 

Frieden: So, I think you have to go back to that period to understand why it was that the Europeans felt that they really didn't have much choice but developing a single currency. That said, I think the Europeans made a whole series of... I don't want to call them mistakes, because they were constrained by the politics of the day, but the way in which the Eurozone was devised left lots of gaps in the design, and created the conditions for the crisis that eventually ensued. You know, you had the development of a Europe-wide, or Euro-wide financial market, with different national financial regulators, so allowing for banks to operate in different national systems, even though there was a single financial market. 

Frieden: You had the fact that there was a single monetary policy for highly disparate countries within the European monetary system, within the European Monetary Union, the economic and monetary union, so highly disparate macroeconomic conditions, and no way of trying to coordinate fiscal policies, so that they could deal with their differential national macroeconomic conditions. You have the European Central Bank trying to set a common monetary policy for countries at very different levels of development, and facing very different macroeconomic conditions. And you have, as you referred to before, a monetary union, a currency union, where there was relatively limited mobility of labor, and very few, if any, transfers among the major units. 

Frieden: All of those things contributed to the crisis. I would say, and this is probably more than we can get into, that if I were to highlight the single biggest problem, it was that they went into a currency union of national governments, without having a credible commitment not to bail out a country in trouble. And the fact, for example, that you could say after 2000, that if Spain got into trouble, it would be bailed out by the Germans, meant that the Spaniards could borrow at the same interest rates as the Germans. That, of course, gives Spain a massive incentive to borrow, or Greece, or Portugal, or Italy, or other countries, and led to the accumulation of what turned out to be... What can we say? Risky loans, and risky bets that didn't pay out. 

Frieden: You know, they were... There was irresponsible lending by the Northern European financial institutions, and irresponsible borrowing by the Southern European, both private and public sector, all of which was made possible, and even attractive, by the incomplete architecture of the Eurozone, and that really is part of the story. I do think it's important to keep in mind that there were reasons why the Europeans went in this direction. They weren't just being misled by a bunch of foolish bureaucrats. 

Beckworth: Well, let me ask one last question, because I know our time is almost up. Are you hopeful for the future of the Eurozone? 

Frieden: I'm guardedly optimistic. I think that they've made some steps forward. There have been some proposals made, and some even accepted. Things like banking union and other areas, where they are addressing some of the flaws in the structure of the Eurozone. I think that the... A lot of it has to do with the politics. If the kinds of nationalistic populists that have come to the fore in some countries in Europe, Hungary and Poland, for example, which are not members of the Eurozone, but if those kinds of populist nationalist movements get more powerful, it'll be very hard to hold the Eurozone together. 

Frieden: If, on the other hand, Europe starts growing again, if unemployment comes down, if some of the structural difficulties of the Eurozone are addressed, like banking union and some fiscal coordination, then I think it can move forward. It will be difficult, and I don't underestimate I think the difficulty, but I think it's possible that the Europeans will be able to move forward with a more or less feasible monetary union among the current members of the Eurozone. 

Beckworth: Okay. Well, our time is up. Our guest today has been Jeff Frieden. Jeff, thank you for coming on the show. 

Frieden: Thank you. 

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes, or your favorite podcast app, and while you're there, please consider rating us and leaving a review. This helps other thoughtful people like you find the podcast. Thanks for listening.