On this topic the NIESR has no doubt: last week they indicated that on their view house prices needed to fall by about 30 per cent to return to their true value. To bring house prices back to their equilibrium level they advocated one remedy: let the housing market crash.

The FT quotes Ray Barrell, senior research fellow at the institute, as saying “The Bank is worried about putting up interest rates too hastily because of the effect on the housing market and consumer demand. But if you have a boil it’s better to lance it earlier rather than later.”

So the boil may be lanced. But maybe it already has been. This is the difficult question. Rate changes are notoriously ’lagged’ in their impact on real economic activity. So today’s decision will not be an easy one.

But whatever it is, one thing seems clear: one day or another the UK housing market will crash. Even if the NIESR are right about the 30% overvaluation, there is no guarantee that any crash will be limited to a 30% fall in values, there will probably be the problem of ’overshoot’ before the market finds its level.

And what will be the impact of such a crash on the UK economy? Only time will show.

One little commented aspect of this situation is the comparison between the EU’s two ’housing bubble’ economies: the UK and Spain. One is in the eurozone, the other isn’t. One has the ability to set its own rates, the other doesn’t. The UK rate is already 2.25% above the ECB one. Spain still has the 2% eurozone rate set by the ECB (which isn’t expected to change today). Yet Spain has a housing boom every bit as dangerous as the UK one, yet they are virtually powerless to deo anything about it. Which will end better (or worse, if you prefer it that way)?

Will there be lessons here for the single currency question when the cost of the broken plates is counted up. I suspect there will be. But then, as ever, the future is an open question.

In fact the Cologne-based IW economic institute said in a recent survey that German industry’s labor costs are the highest in the world, with 72 percent of 523 companies questioned saying they would hire more staff if the government made headway on lowering the burden. Labor costs -- consisting of net pay, welfare insurance and benefits -- totaled $23 per hour in Germany last year, compared with $22 in Japan, $20 in the U.S., $17 in the U.K. and $16 in France, the IW said.

According to news in this morning, German unemployment rose for a sixth successive month in July. Also all available evidence seems to suggest that the German ’revival’ is export driven with internal consumption remaining largely flat. To this picture must now be added the reality that what expanison there is in Europe’s largest economy has so far failed to prompt executives to hire more staff.

So what’s with the Elga Bartsch thing?

Well first of all, take a look at what she was saying last week on Stephen Roach’s Morgan Stanley Global Forum:

Would you believe it? The deflationists are back! Just a year after the deflation debate in post-bubble America reached a climax, driving global bond yields to historical lows, some economists are warning of a new deflation threat being in the making on the Old Continent. Their concern is that the recent agreements reached in Germany, on extending working hours without compensation for the extra hours put in, would cause downward pressure on consumer prices (see German Economics: Reforms Reach the Grass-Roots, July 7, 2004, for more details on the trend toward company-specific deals on pay and working conditions). Hence, the ECB should consider cutting rates in response to these disinflationary, if not deflationary, work-time deals, to prevent inflation from easing towards the deflation danger-zone. We disagree, on four grounds.

Just one quibble, what gives with the deflationists are back stuff, how can people be back who have never really been away:)? Clearly ’our Elga’ has difficulty getting to grips with the core of the deflation argument, which relates to Germany much more than it does to the US, and to changing global production patterns (the rise of the new Asian ’tigers’) and to changing global demography much more than it does to the (Irving Fisher style) problem of the debt impact of the burst bubble. Still Elga is far from alone here, so perhaps this is unfairly harsh.

However her arguments about why the impact of the changing work contracts in Germany (and later elsewhere) won’t have a disinflationary/deflationary (take your pick) impact are really pretty outrageous. Essentially she argues two things: that the workers affected are too few to have any impact, and secondly, that the workers affected, not having lost any earnings, should not show any changes in their consumption patterns.

The first of these arguments flies in the face of what Elga herself (and others who advance the same view) have been saying, and the second ignores one key component of economic behaviour: psychology.

In my view, the most promising avenue to improve cost-competitiveness though is through greater flexibility with regard to working hours by either raising the average workweek or cutting holiday allowances. For starters, such flexible arrangements allow companies to react to demand fluctuations without incurring hiring and firing costs. In addition, raising the number of hours worked without fully compensating staff for the additional effort, is a great way to boost cost-competitiveness in the face of a rising euro and EU enlargement. It seems that workers find it easier to put in the extra hours than to accept a pay cut.

I argue that instead of a continuous stream of reform proposals, Germany would need a big bang to restore confidence. In my view, further streamlining of the welfare state is essential to reduce non-wage labour costs. So is further labour market liberalization.

Her colleague at Morgan Stanley Eric Chaney elaborates on this further:

There is already a two-speed Europe. Since the first quarter of 1999, peak of the previous business cycle, final domestic demand has increased by 0.3% in Germany, versus 11.2% in the rest of the euro zone. Zero growth in Germany, 2.2% per year on average in the rest of Europe, these numbers speak for themselves. It is not the place to embark in a detailed analysis of this divergence. My colleague Elga Bartsch has written extensively on this issue and, I believe, spotted the main causes of the German disease: excessive wages and wage costs, a counter-productive “wage cartel”, and a hypertrophied welfare state that is both a burden on companies and workers and a disincentive to work.

One single factor explains this divergence: in the five years that followed the unification, German wages were up 35%, vs. only 15% in France. Since then, German companies have partially restored their competitiveness by substituting massively capital to labor and offshoring production centers to Eastern Europe and now China. However, for the domestic economy, this was done at the expense of capital productivity, which is now so low that the return on capital has become one of the lowest in Europe. Permanent job cuts and, now, capex cuts are just symptoms of the German disease. The root is elsewhere; it is in a wage bargaining system that has fuelled a wage bubble and, then, prevented its correction.

Elga’s suggestion that only relatively few companies are affected is tendentious to say the least: her argument ought rather to be that this is insufficient, and should be spread throughout the German economy. But if the trend is generalised, then the impact surely then will be deflationary. And this for the very good reason that the psychology of the situation will mean that people do feel that their living standard has fallen. They will not feel so affluent, and this feeling is bound to hit consumption negatively. Call it a ’wealth effect’ if you like.

Also to argue that this is not deflationay since the impact of closing the plants altogether and losing all the jobs would have been more so is simply silly.

The German economy is export driven, there is no escaping this fact. The world economy (and in particular the US and China) seems to be slowing down. This will be felt in Europe. So if your external demand is reducing, and your internal demand is about to take another hit, I don’t see how people can fail to draw the conclusions. Just because there are no easy solutions is no reason to fail to face up to reality. Advocating an exit strategy, but then running away from the conclusions doesn’t seem to me to be the best way of doing things. Of course in referring to ’our Elga’ here there is nothing personal, she is simply a representative - possibly a rather overquoted one - of a current of thinking. It is the current of thinking which I think is flawed.

Did Daum get a good deal, or were Terra Lycos laughing all the way to the bank? Hard to say, and that is just the problem. Internet search companies are hard to value, and that is what is making everyone nervous with the forthcoming Google offer, which it has been suggested may raise anything up to 30 billion dollars.

The problem here is twofold: what is the business model, and where is the protection against competition? In the first case the evolution seems to be towards an increasing reliance on advertising revenue. This once worked well for an earlier platform - TV - but now seems to be giving problems even there. Can it really be that the new generation media will always have to fall back on old generation methods to survive?

Secondly, from Google’s point of view, where is the protection? As a non-specialist I have no idea just how difficult it will be for anyone to oust Google from its poll position. Perhaps I should rephrase that: I have no idea how long it will be before someone does. For such is the dynamic behind these new economy information companies that the only thing which is really gauranteed is that someday someone will. And when you come to try to give an estimate of the real value of a company, then one of the things which ought to be important would be how long it might be in business.

Some commentators are drawing attention to the fact that Microsoft are preparing an entry into the search business. How successful this will be only time will show. But clearly anyone with a brand, and a related business which offers the necessary technical expertise and resources might well consider themselves candidates to join the race.

And what about the next generation engines? Who is to say that the first move won’t come from another couple of college kids just playing around.

All of this would give me plenty of food for thought if I were contemplating (which I’m not) buying shares in Google. Doubtless Telefonica’s Spanish fixed line clients (who will probably be paying off the bill for the last broken dream for some years to come) will have their minds on other matters.

Of particular interest is a new paper from American economist Robert Gordon, reviewed by Sam Brittan in the FT (subscribers only, I’m afraid), that examines the growth experience of the US and Europe, in particular North-West Europe, over the last 200 or so years.

America has been ahead since the 1870s, an advance Gordon attributes to political unity which fostered large-scale manufacturing and marketing, plus various other factors (such as immigration) that would have meant Europe would have been at a disadvantage even if it had achieved political union. This lead expanded in the first half of the 20th century as the crucial inventions of electricity and the internal combustion engine were deployed widely in the US, while Europe tore itself apart in wars. Only in the Golden Age of 1950-1975 did Europe implement these technologies, the period in which it enjoyed its greatest ‘catch-up’.

The 1990s saw the US surge ahead again, partly again due to earlier technological adoption (namely IT) but also due to productive advances in retailing, which Europe due to its constrained space and thus tight planning laws was unable to follow.

Thus today European GDP per capita is only 77% of US GDP per capita.

But to what extent does this matter in terms of living standards?

European output per capita is partly lower because Europeans work less hard. When Europeans do work they are nearly as productive as Americans’ with output per hour worked a much higher 93% of the US level.

Insofar as Europeans choose to work less hard then, as Brittan says ‘there is nothing to complain about’. You can’t take both leisure and work (at the same time) thus, assuming rationality, if one trades off work for leisure it is welfare-enhancing. But to the extent European’s shorter hours are due to restrictive labour markets it is not welfare enhancing. Gordon estimates that one-third of the difference is due to voluntary decisions, and two-thirds due to bad labour market laws.

Thus advantage still with the US. But Gordon believes other factors may be in Europe’s favour. Brittan notes:

“When Prof Gordon turns from crude GDP to welfare, he is not so sure. He suggests that not all the higher US GDP is welfare-enhancing. Some of it involves fighting the environment: for instance, heating and air conditioning to combat a more extreme climate. Some of it, too, goes on a higher level of home and business security to protect against crime or to maintain 2m people in prison. He speculates that the Europe/US economic gap might well be reversed by a broader welfare measure”

Brittan concludes, interestingly, that:

“My own assessment is that the US and at least north-west Europe have now reached a stage of development where there is little to choose between them in economic performance and where growth is no longer the most sensible policy objective. If the “European social model” is to be criticised, it is because it restricts freedom of choice.”

The one that got away

A Complicated Kindness is the story of Nomi, a brilliantly acute, confused, generous-spirited 16-year-old growing up in a Mennonite community some miles from Winnipeg. Its author, Miriam Toews, was raised in just such a place, and got out as fast as she humanly could (the day after graduating from high school). The narrative voice is so strong, it could carry the least eventful, least weird adolescence in the world and still be as transfixing, but the fact is, this community is compellingly strange. The shorthand for Mennonite is “like Amish, only in Canada” (there’s a large Mennonite community in the US, too, but that rather spoils the analogy) […]

Mennonite diktats express a deeply-held horror of almost all aspects of modern life. Emphasis on “plain” dress means that, in some households, even buttons and zips are a sign of inadequate faith. Ownership of a Janis Joplin record is the most direct known route to hell, apart from all those millions of other routes. Literature is an irreligious diversion; indeed, the life of the mind outside worship is utterly abrogated. Toews’s experience was by no means the full Mennonite monty. “My parents both had masters degrees, they were educated, so it was a very tolerant, liberal family within the grander scheme of things. We were allowed to read.” Yet she recalls, in all the time she grew up, going to see only one film (Tom Sawyer): “I remember us all sitting there, sitting up really straight. And nearly fainting when the lights went down.”

Miriam Toews is from Steinbach - a small, overwhelmingly Mennonite city not far from Winnipeg. Since my great-grandfather was one of the town founders, the odds that we’re related is not bad. However, I can’t claim to know her. My mother grew up in the next villiage over - a wee speedbump of a place called Blumenort, and my father spent his youth one town over from that. From the stories they told me growing up, I suspect they would probably identify with Ms Toews’ story.

You can read a longer extract from her novel over at the Globe and Mail website. The best bit is this:

We’re Mennonites. As far as I know, we are the most embarrassing sub-sect of people to belong to if you’re a teenager. Five hundred years ago in Europe a man named Menno Simons set off to do his own peculiar religious thing and he and his followers were beaten up and killed or forced to conform all over Holland, Poland and Russia until they, at least some of them, finally landed right here where I sit. Ironically, they named this place East Village, which, I have learned, is the name of the area in New York City that I would most love to inhabit. Others ran away to a giant dust bowl called the Chaco, in Paraguay, the hottest place in the world. My friend Lydia moved here from Paraguay and has told me stories about heat-induced madness. She had an uncle who regularly sat on an overturned feed bucket in the village square and screamed for his brain to be returned to him. At night it was easier to have a conversation with him. We are supposed to be cheerfully yearning for death and in the meantime, until that blessed day, our lives are meant to be facsimiles of death or at least the dying process.

The teenaged embarassment of coming from as explicitly anti-social a movement as the traditional Mennonites is, however, something I can identify with. I didn’t grow up in Manitoba, I spent my teens in the States, first in Colorado, then in New Jersey, and then in a Mennonite college in Indiana after I turned 16. My parents watched TV, read trashy novels and watched movies. We were not plain. However, just having a no-drinking, no-smoking, no-sex background is hard when you’re a teenager.

Some Mennonites take 1st Corinthians 11:5-10 literally, and require women to wear a hat in church, or even at all times. They aren’t the kinds of Mennonites who always send their daughters to college - in fact they usually don’t. There was one in my college, however. She wore her little bonnet for a couple semesters, then lost it. The next year, she stopped wearing “plain” clothes. The year after that, she hit me up for a cigarette.

What makes isolationist faiths so appealing is how self-justifying they are. People who’ve never been involved with those kinds of societies don’t realise how tempting the world can seem when you are cut off from it. The very features people most deplore about the modern world - its impersonality, anonymity, and laxity - are the very virtues people who actually live in pre-modern societies see in it. Small, closed communities are places where your life is laid open like a book to everyone around you, where you police your own life, afraid of doing anything out of the ordinary because everyone would immediately know. Somewhere where your neighbours don’t know you and don’t care if you smoke and drink and aren’t interested in who you have sex with can quickly start to sound like paradise.

The stronger the temptation to leave, the easier it gets to justify excessive pressure and even threats to prevent people from “falling into temptation.” The more people feel drawn to leave, the more certain you become that everyone else is out to get you, and the easier it is to justify the sort of inflexibilty and outright oppression that makes the alternatives so tempting. This is quite common human behaviour. I could tell the same story about Israel or the Republican Party. Once upon a time, it applied to a lot of the left too, but not so much nowadays.

One of the things I’m going to get to, when I get back to Grandpa’s autobiography, is how things were changing in the Mennonite world. Already before he went to Africa, you could see the tension between the kinds of Mennonites for whom their culture and faith form a wall to separate them from the heathen outside, and the Mennonites who have decided that they have to live in the world, and try to bring their church into the world with them. This tension dates back to the “revival” era in the US, in the period just after the Civil War. Even here in the 21st century, this foundational conflict over who owns “Mennonite” has not been fully resolved.

It is the flip side of what happened to Judaism over the last two centuries. As long as the Mennonites and Jews lived segregated lives - usually by some form of legal prohibition or social contract enforcing segregation - their ethnic, cultural and religious identies always correlated. A Jew was always born a Jew, believed in Judaism and adhered to Jewish culture. The same was true of Mennonites. Once the prohibitions were lifted, this identity became more problematic. Judaism has, in some sense, decided that the ethnic and cultural elements of Judaism are essential to being a Jew. Mennonites have done the opposite. And in both cases, there are dissidents from this new consensus.

I suspect being an ultra-orthodox Jew has to be just as embarassing to a teenager as being an old fashioned Mennonite.

The thing is, these kinds of isolationist sects - Protestant, Jewish, Muslim and no doubt others - have remarkable staying potential. They persist. They survive massacres, deportations and even genocides. Abolishing them because they are oppressive is just another version of destroying the villiage in order to save it. The only just, decent, dignified way to deal with these sorts of communities is to hold the door open for people who want to leave and to make sure that their lives once they’re out are more like their fondest hopes than like their worst nightmares. Walking away from everything you know is more than hard, it’s terrifying. Having someone else take it away is not easier or less terrifying.

This is why I’m still so angry about the French government’s anti-headscarf law. I imagine conservative Muslim communities are not terribly different from conservative Mennonite ones. Most of the Mennonite population of Canada nowadays is urban and integrated. The public school law that ended German education had little to do with it. Manitoba’s rural public schools can easily be more religious than American religious schools. The girl who wore a bonnet in my college gave it up quite quickly, even though she was attending a Mennonite college. Young Amish are given a couple of years to do what they want and see the outside world. Most of them come back, but far from all of them do. There is a tourist trap in Indiana, near my college, Amish Acres, that used to specialise in hiring young Amish who were either experiementing with life outside the community, or had already left it. I suspect it’s not too different for conservative French Muslim girls. Given an open door and a real prospect for a better life on the other side of it, many will walk away from intolerant cultures. Close the door and offer no real alternative to poverty in the cités, and you shouldn’t be surprised to see oppressive communities spread.

Of course, this kind of approach never provides a final solution. Just as some will leave, some will stay. But somehow, history’s many final solutions never really are that final. Eradicating one intolerable social division always seems to lead to another one.

Part of the reason is that the one group you’d expect to make an issue of it--the right-wing CDU and, especially, their very right-wing Bavarian sister-party the CSU--have in recent years been close partners of the FDP. They’re unlikely to mount a gaybashing campaign against the man who leads a party with which they hope to be in coalition after the next national elections.

But politics isn’t all, not even for the Union. This simply isn’t the issue it would be in the United States, or even in Britain (think of poor Michael Portillo, done out of the Tory leadership because he’d batted for the other team a few times as a student). I’m certain Germany has its share of homophobes, and doubtless the Roman Catholic hierarchy is not amused. Still, most Germans seem to view a politician’s sexual orientation much as they’d view his or her extramarital affairs, if any: if it doesn’t interfere in the doing of one’s job, then it’s not anybody else’s business. And that holds true even in the ’family-values’ conservative ranks of the Union: it’s pretty widely understood that Ole von Beust, Hamburg’s CDU mayor (and thus head of government of a Land, with a voice in the upper house of the federal legislature), is gay. His career has hardly suffered as a result--on the contrary, he is one of the Union’s rising stars.

It’s good that Westerwelle is confident enough to come out. And it’s good that Germans aren’t going to judge him on his sexuality. But really, this is essentially a non-story; and that’s the best thing of all.

* Article in German.