The Big West Solution

What Arizona can teach Europe about weathering a housing crisis.

For more information about the woes of Club Med, click here. 

Three years after the Great Recession officially ended, the United States is still struggling with high unemployment and a faltering recovery. But for the troubled economies across the Atlantic, where there is now open talk of the potential collapse of Europe's shared currency, the United States looks like a veritable economic success story -- perhaps even a place to look for lessons on how to manage the crisis.

As it turns out, the experiences of a few U.S. states in weathering the housing crisis that precipitated the 2008 global financial crisis can provide insight into the eurozone's struggles. The Sun Belt states of Arizona, Florida, and Nevada saw a big housing bubble and subsequent bust, much like Greece, Ireland, and Spain -- a group we call "Club Med." While both groups continue to suffer from the aftereffects of the crisis, the Sun Belt is recovering more vigorously than Club Med, which appears caught in a vortex of failing banks and deteriorating public finances. Here's what the United States got right -- at least compared with its European cousins -- in its economic recovery.

The Power of Market Adjustment

There are plenty of differences between the United States and the European Union, but they have one important aspect in common: Both are monetary unions. That means neither the Sun Belt nor Club Med can resort to currency devaluation to help weather the shock of an economic downturn by enhancing competitiveness and stimulating exports. Instead, their channels for adjustment are limited to cutting wages, increasing productivity, encouraging some workers to move across borders, and relying on transfers from stronger states within the monetary union. On these counts, as we illustrate here, the United States comes much closer to being an optimal currency zone -- where shocks affect some regions more than others but can be more easily managed. As a result, while the Sun Belt and Club Med both experienced downturns that were severer than those of their broader monetary unions, the Sun Belt has managed a stronger, more rapid recovery.

In the Sun Belt, average annual GDP growth rates from 2000 to 2007 were 1.3 to 2.4 percentage points above the U.S. average. The Sun Belt states' recessions were also steeper: In 2009, their respective GDPs declined between 2.6 and 3.4 percentage points more than the U.S. average. Underscoring the severity of their recessions, the Sun Belt states' GDPs remain between 6.9 and 9.1 percent below their 2007 peaks, even as U.S. GDP has recovered to its pre-crisis level.

Club Med also experienced a sharper boom than the rest of the eurozone. From 2000 to 2007, these economies grew between 1.4 and 3.4 percentage points higher than the European average. Their fall was also steeper than elsewhere in Europe: In 2011, Greece's real GDP was 13.2 percent below its pre-recession peak, Ireland's was down 9.5 percent, and Spain's was down a more modest 3.1 percent. Meanwhile, GDP for the eurozone as a whole was only 0.4 percent below its pre-crisis peak.

Importantly, the Sun Belt states have since returned to growth. In 2010 and 2011, their GDP grew between 0.8 and 1.1 percent, and recent indications suggest that growth is continuing. But the U.S. economic recovery -- modest and hesitant as it is -- is still a distant dream in Europe.

The Sun Belt's quicker housing adjustment has likely played a role in its relative success. Between 2007 and 2011, housing prices fell 43 percent in Florida and Arizona and 53.5 percent in Nevada. In contrast, home prices in Greece, Ireland, and Spain fell 12 percent, 33 percent, and 15 percent, respectively, over the same period. Declining housing prices can be expected to accelerate the recovery of housing demand and, perhaps even more importantly, force banks to recognize and process losses on their mortgage loans more rapidly. This occurred too slowly in Europe -- everybody pretended for too long that housing prices remained stable, nurturing concerns that banks in Club Med carried large, unrecognized real estate losses. This in turn deterred lending to Club Med by other banks and eventually led depositors to withdraw their money, accentuating the credit crunch.

Other economic indicators tell an even more striking story. The increase in Sun Belt unemployment was less than half that in Club Med countries, where it is approaching depression levels, despite both groups experiencing a similar decline in GDP from their peak levels. Moreover, while unemployment in the three U.S. states has declined by 1.2 to 2.8 percentage points since the worst days of the crisis, unemployment in their European counterparts is still on an upward trend.

In both groups, the bursting of the housing bubble was associated with an abrupt interruption in the growth of the labor force; this was mainly due to the cessation of the big net migration during the pre-crisis years (see Table 2). In addition, many discouraged workers have dropped out of the labor force. The much larger rise in unemployment in Club Med primarily reflects the far-larger decline in employment than that seen in the Sun Belt, rather than differences in the rate at which the labor force grew -- a surprising result given the supposed impediments to firing workers in Spain, for example. The dramatic drop in Club Med employment rates also likely reflects employers' widely held expectations that the crisis will continue for many years, a reluctance or inability to cut wages due to legal constraints, and the fact that Club Med countries have become very uncompetitive -- their labor costs relative to Germany soared 20 to 30 percent during the boom years. In the Sun Belt states, on the other hand, no comparable loss of competitiveness is evident, wages adjust more readily, and workers move much more easily across state borders than in Europe.

The Power of Uncle Sam

The European Union simply can't support its individual member countries in the way that Washington can help faltering state economies. The net fiscal transfer from the U.S. federal government to the Sun Belt during the worst of the recession may have amounted to 5 percent or more of their GDP and still remains substantial today. This includes automatic fiscal stabilizers -- lower tax liabilities to the federal government and increased fiscal transfers, including unemployment insurance, food stamps, Medicaid payments, and welfare -- that played a critical role in cushioning the shock.

The effect of these automatic stabilizers is to offset as much as 40 cents of every $1 decline in state GDP, according to former Council of Economic Advisers chair Martin Feldstein. This amounts to a large fiscal stimulus over and above that provided by the 2009 economic stimulus package, which added up to 2.8 percent of U.S. GDP over the course of 2009 and 2010 and which disproportionately benefited the hardest-hit states.

Nothing of comparable magnitude exists within the eurozone, for the very good reason that the European Union is not a country and it doesn't have a large central government. The widely advertised headline numbers of the support given or planned to stem the crisis in Europe are certainly impressive. However, most of these measures -- such as the European Central Bank's interventions to provide liquidity to banks and purchase government bonds -- have their less-heralded parallel in Federal Reserve operations and the automatic working of the U.S. monetary union. Crucially, intergovernmental transfers in the eurozone take the form of loans to the troubled eurozone countries, adding to their debt and, because those loans come with strings attached and are the result of protracted negotiations, constitute an ongoing source of uncertainty and speculation.

The most striking difference between the Sun Belt and Club Med is the avoidance of a serious crisis in the U.S. state governments' balance sheets. Sun Belt governments' spending represents a small part of state GDP (see Table 3), and they broadly abide by a self-imposed balanced budget rule. Even as Club Med saw its credit ratings collapse, the Sun Belt governments avoided crippling debt problems. Their credit ratings remain solid -- Florida actually retains AAA status. And unlike Club Med, which was forced to cut its deficits while in recession, the Sun Belt governments were able to rely on countercyclical spending, supported directly or indirectly by the federal government.

Importantly, Sun Belt states were not called upon to bail out their failing banks, relying instead on Uncle Sam's FDIC and TARP programs to do so. Meanwhile, Club Med had to deploy massive sums to prevent their banks' collapse -- well over 100 billion euros in Spain alone. The close link between banks and nation-states in Europe has meant that the banking and sovereign debt crises continuously fed on each other.

Meanwhile, as mentioned earlier, the Club Med countries' labor and other costs have massively diverged from Germany -- Europe's economic motor -- further complicating the economic recovery. Even if Club Med had been able to rely on the support of a federal system, such divergence in competitiveness suggests that its adjustment was always fated to be more protracted and painful than that of the Sun Belt.

Club Med cannot just take a page from the U.S. playbook to pull itself quickly out of the economic doldrums. The differences are structural and will take many years to fix, and institutional reform is fraught with political obstacles that could delay the process indefinitely. However, the European project's now obvious weaknesses -- the linking together of very different economies, the slowness of their markets to adjust, and the lack of a strong central government -- at least provide a diagnosis for why the eurocrisis has been so extreme. They also provide some useful pointers for European policymakers on how the eurozone should evolve to prevent a repeat of today's disaster -- assuming, that is, that it survives that long.

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Deadly Aid

How U.S. foreign assistance is helping human rights violators -- and how to stop it.

When Colombian paramilitary leader Carlos Mario Jimenez, known as "Macaco," tried to reduce his expected prison time in 2008 by turning over his ill-gotten gains to prosecutors, he included on his property list the assets of a major palm oil cooperative. The revelation came as little surprise: The drug-running militias had famously displaced thousands of small farmers across the country through years of massacres, killings, torture and threats, and there had long been rumors that their proxies were developing palm oil projects on the stolen land. Now it was clear that the suspicions were correct.

What came as a shock, though, was that the specific palm oil projects Macaco was delivering had received funds from the U.S. Agency for International Development (USAID) as part of an "alternative livelihoods" strategy meant to wean farmers off growing coca leaf. The U.S. agency, however, had neglected to look beyond the formal list of members of the cooperative to see the violence and human rights violations associated with the projects. USAID had halted similar projects with another company around the same time after U.S.-based groups raised concerns over its alleged paramilitary ties, and claimed to have instituted better procedures to screen land projects. But its failure to adequately implement them in the Macaco case reinforced concerns that the United States seemed willing to turn a blind eye to rights abuses.

This damaging episode is not merely an isolated example, but the result of U.S. aid agencies' weak human rights safeguards. President Barack Obama, who laid out "a new comprehensive strategy to prevent and respond to mass atrocities" in a speech at the Holocaust Museum in April, is well aware of the need for the United States to respond to the worst crimes on the planet. But the White House risks missing the bigger picture if it does not address human rights abuses and repression more broadly.

For decades, the human rights community has raised concerns about military support directed at abusive security forces, but it has paid relatively little attention to softer forms of assistance. This aid, however -- which is provided largely through USAID and the State Department, adding up to approximately $47 billion in 2011 -- can also play a significant role in either abetting or addressing human rights violations.

Fortunately, USAID is starting to recognize the importance of integrating human rights more thoroughly into its work, and has begun to revamp its procedures to achieve this goal. It has strengthened human rights programming and begun to integrate concerns about rights into areas like health and gender rights. But success will require the agency to address a number of areas where its work has failed to meet basic human rights standards, or even worse, supported repression.

Aiding Repression and Abuse

Providing U.S. assistance to countries where booming economic growth is coupled with severe repression -- for instance, Ethiopia, Rwanda, and Uganda -- presents a particularly difficult challenge. In Ethiopia, human rights groups have reported in great detail how the leadership in Addis Ababa has become increasingly authoritarian over the past few years. Since 2003, Human Rights Watch (HRW) has documented crimes against humanity and war crimes by Ethiopia's security forces in response to armed insurgencies, both within its own territory and in neighboring Somalia. And following the introduction of two repressive pieces of legislation in 2009, the vast majority of Ethiopia's independent voices -- including journalists, human rights activists, and opposition party supporters -- have either fled the country or been jailed on trumped-up charges.

In 2010, the ruling party won 99.6 percent of parliamentary seats after a national campaign of threats and coercion. During the campaign, HRW found that the government was using development and food aid, partially funded by the United States, as a tool for repression -- conditioning access to essential government programs, funded through foreign assistance, on support for the ruling party.

Yet even as repression has worsened, development aid has increasingly flowed to Ethiopia. USAID spent almost $740 million on aid to Ethiopia in 2010, the latest year for which solid numbers are publicly available, compared with $588 million in 2005.

This is not a simple issue. Ethiopia is one of Africa's largest and poorest countries, and donors understandably want to help provide a safety net for its most vulnerable citizens. Unlike in countries where donors can support non-governmental activity in lieu of funding a repressive state, in Ethiopia the government has constricted that opportunity through a repressive law that limits the ability of civil society groups working on any human rights or advocacy issues to receive foreign funds. But ignoring the reality that aid to a closed regime means bolstering the power of the ruling party -- and failing to monitor the social effects of U.S. aid programs appropriately -- is no solution.

In other cases, USAID has supported abusive government programs out of lack of concern for human rights standards or simply lack of vigilance. For example, in Vietnam, HRW recently documented how people detained by the police for using drugs are held without due process for four to five years. They are subject to a government policy of "therapeutic labor" for up to 12 hours a day, six days a week. Those who refuse to work, or who infringe on the institution's rules, are tortured and subjected to other forms of ill treatment. These centers "are little more than forced labor camps where tens of thousands of people work against their will six days a week processing cashews, sewing garments, or manufacturing other items," HRW wrote upon the publication of its investigation.

The United States has funded a number of programs in these centers -- including workshops and training for government "addiction counselors," who are often Ministry of Labor staff that operate as little more than guards. USAID, on its own and as an implementer for the U.S. health aid program PEPFAR, has provided much of this support through its partners -- mostly American NGOs, but also Vietnamese government authorities. In one case, PEPFAR actually listed a drug detention center as its implementing partner. While funding activities in the centers, USAID and PEPFAR have had limited access to the centers or ability to speak privately to detainees. Consequently, they and their partners have reported back only on indicators related to their narrow programming goals, while stating that they have seen no evidence of abuse.

Another problem arises when U.S. assistance becomes too closely aligned with a repressive government's priorities and is interpreted as political support for the regime. This is particularly difficult when dealing with countries that restrict the types of support foreign donors can provide. In Egypt, for example, USAID's willingness to comply with President Hosni Mubarak's funding restrictions while he was in power led to criticism from many civil society organizations at the time. What's more, this compliance harmed the credibility of USAID's protests after Egypt's military-led government harassed and intimidated American NGOs last year -- the Cairo authorities could simply say they were merely enforcing their own laws, by which the United States had previously abided.

Although the United States may not wish to violate local law, it can use its own leverage, and work with other donors, to insist that minimal standards are met so that civil society groups can function freely, or at least spend political capital to publicly oppose the restrictions. For example, a more public, unified, and insistent diplomatic response to Ethiopia's current draconian restrictions on civil society and the media might have more impact than quiet diplomacy, which is getting nowhere. For the United States to use its leverage though, human rights concerns have to be bumped up the list of diplomatic priorities. USAID also has to be willing to drop or find alternatives to non-essential programs in countries where programming is more likely to further repression than provide any real support to vulnerable populations.

A Solution: Screens and Safeguards

Despite an extensive process for planning, monitoring, and evaluating projects, USAID has no systematic way of considering unanticipated or undesirable human rights-related side effects of its programming. Essentially, it sets goals and then establishes indicators for meeting them -- but it does not monitor for unintended consequences of its actions. That should be fixed: USAID should consistently screen potential projects to reduce the likelihood that they will contribute to political repression, discrimination, dispossession, or widespread arbitrary deprivations of economic and social rights.

The agency should also put procedures in place to help it understand the underlying risks of its projects. This would include taking into account reliable information on human rights conditions, such as State Department human rights reports and reporting by local and international human rights organizations. Should USAID find that a project might have negative human rights implications, the project should be modified or, if need be, abandoned. This will require its staff to be trained in rights-based approaches and analysis, not just technical fixes -- and to be rewarded for applying the training.

USAID already has safeguards in place. For example, all projects are supposed to account for their impacts on gender dynamics and women's empowerment. Under U.S. law, all projects must also consider environmental impacts and, if necessary, show that any negative impacts will be mitigated.

But that's where the safeguards end. A formerly mandatory policy requiring USAID to analyze a project's social impact during the planning phase was made optional and effectively discontinued in the early 2000s; it was dismissed as time-consuming and unwieldy, and nothing has replaced it. A position for an indigenous peoples' coordinator at USAID was also scrapped. Today, no specific mechanisms exist to prevent harm to indigenous people or forcible displacement of local groups in conjunction with economic, agricultural, mining, or infrastructure programs.

Experience shows that skimping on time and effort up front results in failed projects, political controversy, and a loss of trust from local communities and groups. Obama's renewed commitment to preventing and responding to atrocities -- and the steps toward reform at USAID -- are welcome moves. But to have a real impact, the Obama administration must reexamine deeply entrenched policies surrounding how the United States distributes foreign assistance. Congress could assist by changing funding patterns that encourage separate "silos," where agricultural or health specialists are on different budget cycles, rather than rights-integrated programming. It could also lengthen short funding cycles for USAID, which make due diligence and public participation more difficult.

USAID has taken the first steps toward implementing the president's initiative. But if it fails to go far enough -- if it continues to provide support to repressive regimes, ignores human rights issues in favor of other policy priorities, and fails to seriously incorporate human rights concerns in its work -- the administration's strong words about supporting rights and preventing atrocities will be just that: words. It's time for USAID to take bold steps, and make sure its aid programs are used to prevent atrocities, not to promote them.