Why Does Europe Struggle with Innovation? With Luis Garicano

- This is the Capitalism and Freedom in the 21st Century Podcast, an official podcast of the Hoover Institution Economic Policy Working group, where we talk about economics, markets, and public policy. I'm Jon Hartley, your host today. My guest is Luis Garicano, who is a Spanish economist, a professor of public policy at the London School of Economics, and a former European member of Parliament from Spain. Thanks for Dr. Thanking you so much, Louis, for joining us and coming on the podcast. It's a real honor to have you on.

- Hi. It's my honor, I'm a big fan of the, of the program and having, having you and treating some episodes, and I, I remember liking a lot, the Levitt, the Levitt interview, which I, I learned a lot from.

- Yeah. Well, well, thank you so much for, for, for commenting on on past, on talking about past episodes really, Aaron, have you on and, and all your experience, you know, both in, in academia and, and in policy. It's very rare to have someone who is both saying these things as an academic economist and also serving in government, working on regulation, particularly a place like Europe where, you know, Europe's I think certainly fallen behind and, and has had to deal with overbearing regulation, certainly in the past couple of decades or so. I think that's shown, shown up a lot in, in Europe's growth. I wanna start with your personal origin. So you grew up in Spain and, and you came to the University of Chicago for graduate school where you say under Sure wind rose and I mean, tell us about your formative years, you know, how you first got interested in economics and how you went from Spain to Chicago.

- So I I I, I was, you know, I grew up in Spain when there was 22% employment was the norm when I was a kid, and that was a big economic crisis. So like many people who, who study economics, I was fascinated by why could this happen? Why couldn't an economy not generate employment and what was going on? We had many years of very, very high employment. Even now we are highest unemployment in Europe. And so I studied economics. The teaching was kind of mediocre at the University of a Elite where I was studying except for one Professor SA Minero, who was, who was great and he inspired me to, to really enjoy it and really like it. He was doing, among others a history of economic thought class, which I think now is missing. He taught from a Mark blog book. I don't know if you know it, John, no. Economic Theory in Retrospect. It's a book that explains it with supply and demand and current economics. It explains you the, the what the fear of Ricardo means. How is the demand curve, how is the supply curve? What, what does Mark's theory and the what assumptions. It was really interesting. And so I learned that and I enjoyed it. I still went the policy side at the time I went to the College of Europe in Bruce, which was the kind of the training school for, for European bureaucrats. I went to the commission to work as a civil servant working on the, on eurostat, on the consumer price index to harmonize all the price indexes for the Euro. I left pretty bored and disappointed after that year in, in the statistical office, I was, I was amused and sudden that that's the, that job is still going on. They haven't still harmonized that bit. So I'm happy I left those 30 years could have been much less productive and, and, and, and I, I had been left with this idea that I wanted to do economics and I applied to Chicago. It was a, an application that, that I I'm not really proud of in the sense that it was just like, it was the year of the Euro and I said I wanted to use monetary policy in Central Bank independence, which, I mean, it's a big topic, but, but it was not a topic that really, I think was, I guess you could have given it the rules for some discretion treatment, but it wasn't really a research from TA topic. And I was accepted. I was, I was a TA of, it was, it was the Great years of Chicago, you, you remember those, those years where Chicago was, was all the eight ideas were coming out of there. Chicago was getting over award prices every year. Lucas Becker, Heckman Hanson, Fogel Miller, all those people. I didn't get classes for me and Fog Fogal, but everybody else was teaching in the core. Our core was, was amazing. I remember was Becker Rosen Shaman for the first, for the micro, for the micro. It was like Coran Luas Hanson for the Econom metrics. Heman, I mean second year

- Royal High at the Chicago school. Really right there in that yeah, that period in the nineties. Yeah. It, it's, it's amazing. I mean, and to have been there, I mean, I, I came only, I mean maybe about 10, 15 years later, and even then it was still, there was quite a bit of that that that left and I mean sure. Warren Rosen's just amazing. Right. And for those I think that aren't familiar with the work of Sherwin Rosen, you know, he's done so, so much in the area of organizational economics firms and the whole concept of spatial equilibrium, you know, the really the, the Rosen robot model is, or the canonical model of spatial equilibrium, you know, we think about, you know, why is it that, you know, certain coastal housing prices are more expensive. You know, the, the Rosero back model can sort of explain why, why housing is so expensive in some places versus others, you know, places that have amenities or, or higher wages.

- And, and the superstar, the superstar are more like, I think, I think a lot about that this 1981 paper for listeners who don't, don't remember, basically argues that there are two key issues in superstar markets like football, like opera, like music, which are, there's joint consumption on the demand side, there's a public good aspect that everybody can listen to. The Taylor Taylor Swift record, nobody needs to listen to the second, and there is imperfect substitution the supply side. You cannot substitute seven musicians for Taylor Swift or seven football players for messy, or 10 or 25, it doesn't matter. There is the, the substitution doesn't exist. None of those conditions. The rewards were very concentrated on the, on the very top. And so when you have elements in markets that give you super, like give you this joint consumption possibility, like now with ai, where a big engineer can, can kind of change the, the AI that we all use, you get these superstar effects. I think it's still very relevant. So Rosen was fantastic, Becker was fantastic. They were teaching me price theory, which I think is still the most important thing I learned in economics. And, and one contrary to what Levi said in that interview, one essential input to to, to, to everything from macro to trade, to, I mean, all this justice restitution, all of these derived demands, all of these things where people actually care about in, in, in, in, in estimating in applied micro, nobody's using maquel kind of discontinuity and, and discontinuity. I, I, I lost, I lost the, I lost the thread. Nobody's using complex real analysis or real analysis for, for, for, for that. So I would say if you, if you want to, to apply to work, Chicago was the right way to do it. The right place to do it. And the, the, the presence of Becker and, and Rosen and Kevin Murphy, who were my, my main supervisors was, was essential to my training. I, I loved learning from them. I loved being the TA of all three of them. I was his, the rt, I was the RA of both Becker and, and Kevin Murphy. And that was the best training one person could dream. I can't just not imagine the better, better team. Also Canice Perga, who was a very good organizational economist, was in my committee.

- That's amazing. And, and you were hired at Chicago Booth as assistant professor. You know, it's really amazing, you know, all the work that you've done on, you know, firm dynamics, organizational economics, you know, really the study of the firm and, and you know, firms are so important for economic growth, you know, innovation and, and you know, obviously, you know, regulation interacts with, with these things as well. I'm curious, a lot of your work has been done in, in on, on certain topics. Some of these topics are, are somewhat theoretical, but you know, this topic, this idea of knowledge, you know, of hierarchies. Can you explain how you know exactly why that's important, why it matters? I understand, you know, ideas are, are central to growth, but explain to me sort of how, how hierarchies and these things work

- Happy. I'll be very happy to. So, so I think the idea, the general idea of organizational economics is that macro has always been kind of, and growth has always been about K and l and a aggregate capital, aggregate labor, aggregate productivity. There is always a, a sense that you add more staff, it's more output end of the story. And you want to, you want to estimate how much organizational economists try to open that black box in order to understand productivity, in order to understand economic growth as, as you were saying. And my work has done that. And my, my main contribution, I think is my knowledge hierarchy's work, which is in, was my dissertation work is in a JP paper in 2000, which is pretty highly cited and has maybe 1800 Google scholar sites by now. And, and a couple of qj pieces with St. Ross Hanberg Po Andrus and, and some other work with Stefan as well. Stephan Ross Hanberg, who is now a Chicago and, and po andrus at Harvard of course. And the basic idea is, is the following. Suppose you have a lot of workers and they have different pieces of knowledge and they have to communicate to each other. So workers can use knowledge in production and in order to produce, you basically have to solve a problem. If you don't know the solution, you have to ask somebody else if you don't know who to ask. So when matching problems and solutions is hard a priority, you only know that you don't know. And I show that the optimal organization of the firm is what I call the knowledge hierarchy. And knowledge hierarchy is basically one where the work, the knowledge is organized, where the routine problems are solved near the production floor and the graph is kind of going up and people ask for help or for directions from specialized problem solvers or managers who specialize in the exceptions. So that way you minimize communication costs by asking about exceptional problems. And the higher up are specialized in, in more exceptional or equivalently more valuable problems. And you are basically organizing the knowledge in, in, in that hierarchical way in order to solve the, the, the optimal utilization of knowledge. Now we, I have done several kind of things to, to consider this idea. Harold Beset used to talk about trading off the hierarchy trades of asking for directions versus training, right? So the knowledge, the, the worker could be superstar and know everything and then doesn't need directions. Or you could have workers, which are not great, but then you have the manager who knows and give them direction, solve the, the harder problems. That's the basic trade off. And we've applied it to thinking about inequality with sorting. So managers and workers sort with each other. You get a convex wage kettle with multiple layers where that was a work with, with Stephan where if you're really smart, you're solving your knowledge is really very, you know, a lot and you, your knowledge has to be protected from dumb problems. So you get a longer hierarchy with more better managers who can solve more things. Think of an RA just to, to, to fix our ideas in the mind of an example. They, our listeners can understand. So think of you have a TA and you have a professor. The professor is very good, the TA should be very good. So that can protect it from the dumb questions. Okay, there is an integral anybody can solve an you shouldn't go to the professor. If the students are not very good and the professor's not very good, then maybe you don't need a TA and you can just directly ask. So, so basically the knowledge organization, the positive sorting that the very good consultant should have good associates and good analysts so that he's specialized, he can really use his knowledge about the unusual problem. So I had work on inequality and on this, this heterogeneity in, in in labor and how communication, the key comparative statics is how communication information technology change this organization information technology allows the, the lower levels to solve more problems. So you get flatter firms eventually, if information technology was such that you could do everything yourself, you would need to ask. So you would like have your your one person unicorn and communication technology, which would be centralizing if you can easily communicate and don't have the workers learn anything, just have them ask all the time. That's cheap. So, so communication and information technology are very distinct. And work with John Van and Nick Bloom also from Stanford, like you and, and Rafael sat from Harvard. We, we showed that indeed information communication technology have different impacts on the organization of firms. I also had worked with Stephen Hanberg on growth showing that firms can kind of deepen the hierarchy and go into, get the knowledge, be go deeper and deeper into the knowledge so that they are kind of getting the more unusual problems about the, the, the, the structure they, they are currently in or explore, kind of go around searching and then throw away their current hierarchy and move to a new knowledge field. Of course, in that case, all the structure they built is, is wasted. So we show under what conditions firms will kind of get stuck in the old technology and not explore because the hierarchy is so powerful and we know so much about the current technology that kind of, it would have to be amazing what we discover elsewhere in order to change. So, so the communication technology here can have the reversal of making you go too deep and not explore enough. So fascinating. Yeah,

- I mean, it, it just, yeah, I mean the knowledge, innovation, ideas, human capital, you know, all these things are, are so, so essential for growth and, you know, allowing them to, to flourish is, I think a keep part of that. And understanding how it's, or how knowledge is organized, I think is also really, really critical for, for understanding that. I, I wanna talk just a little bit about, you know, you, you went back to Europe, you, you know, you became a, a member of European Parliament, you know, I'm curious, you know, what motivated you, you know, as an academic economist to, to run as a member of European Parliament? And I mean, can you explain, you know, what you learned there during that time as an economist inside you, the, the, the belly of the beast of, of the, the, the European Commission, if you will.

- Yeah, the start, the start of the, of the career has to do with the, the, the switch has to be do with after, after finishing at Chicago and being tenure at Booth, I, I stayed there and for, for 10 years I decided to move to the London School of Economics. And, and the crisis came and which,

- Which crisis? This is the SAR

- Crisis 2008 financial crisis. First the queen asked me about it, by the way, the famous queen question that I had to answer. And, and, and I started a block now ti with Tanana Santo birthday,

- The, the, the title, the, the blog is, is, is and nothing is free,

- Right?

- It's sort of a no such thing as free lunch kind of a title.

- Exactly. No, no, free

- Lunch. And this is in a Spanish newspaper?

- Yeah, it was a Spanish blog. We, we, we did it on our own. We, we were, we were on our own. Oh, very good. We, we got a website and we started to put it, it was the time, the golden time of the blocks, and now it's

- This Fernandez Verde at Penn and, and a few other co-authors

- Tan Santos at, at at Columbia. Both co-authors and co and colleagues and close friends. I mean, at the very start there were a few other people, but they all dropped out. And then eventually we, we left it. So other people have continued of course, but that block was very influential because we were able to write about the crisis. I mean, that's something I would tell economists to do, right? I mean, I think there's always this advice people are given like, oh, don't do side projects. I think side projects are useful because they, they, you learn stuff. You, you learn about the world and you have impact and, and, and sometimes, you know, you have more impact writing an interesting blog that gets the IMF to rethink how they're thinking of your country than, than than writing a long paper that gets 35 sites, right? So, which doesn't, is not so unusual papers to have that, that number of sites. So we did that blog, I wrote a book about Spain, which was in the basis of the block, which was El Espan was a bestseller. I got involved in politics through that book. I was asked to write a program of this party, and then I, I, they asked me to run for the European Parliament and I said, yeah, sure. I I, I'll, I'll be, I'll be, I'll be running because the Parliament is a good place for an economist. There's more policy. I thought it was a good fit. And I I I, I was the head of the list. I we got, we got a lot of votes. We did very well. And, and I, I got to be vice president of the, of the group. So it was, it was very interesting. What did I learn?

- Yeah, I I it's like, you know, the, the European Commission, I just think, you know, it's obviously both, you know, they've got this, the European Union, the promise of it, I guess is, it would be a single, single market, I guess, you know, free, free movement of capital, you know, of both capital and, and labor and goods. And so you, you have I guess free trade within, within union. We, we'll talk about the euro in, in a little bit a about the monetary union side of things. But, but I mean, the other side of it too is, you know, the, that, you know, the European Commission acts as a, you know, massive regulatory body as well. So you, Europe also, you know, regulates trade. I mean, outside of, I mean, to some degree they, they act as their own trade block, but, but also, yeah, they're regulating things. They're preventing, you know, tech firms from, you know, think GDPR, you know, the regulating technology, tech firms, all sorts of things. And and what, what did you learn and, and you were there sort of at the, at the, I think the height of a lot of this, and I mean, it still goes on. I'm curious, what, what did you see?

- So I I, I learned a lot. I mean, one, one thing, one general thing I learned is an economist is useful during the crisis. I mean, they don't necessarily wanna pay a lot of attention to our ideas politicians, because they, they know they wanna get votes and they wanna not see what they paying the votes. But during the crisis with the Ukraine sanctions and with the COVID, I, I, I felt I had a lot of ability to impact because people needed ideas. So that was, that was a good time for, to be an economist, like my friends who are neurosurgeons and love when somebody has, has a brain tumor and they all talk up to each other and you are like, oh, no guys, this, but they think it's really cool that they're operating these things. So for an economist, the crisis is always interesting and it's an opportunity to contribute. So I-I-I-I-I, I learned that on the, on the question of, of a regulation you pose, I think it's essential to our future. I learned that there was an ideology, ideas mattered, and the ideology in Brussels had two elements that were very harmful, harmful. One is the Brussels effect, the idea that we would be the regulators to the world, that we could just set up a set of rules. And we are such a big market everybody will have to follow. I think that was big mistake. I don't think that's that's correct. I think you set up a lot of rules and then your firms are screwed, and then the rest of the world just looks at you like you are just crazy. And the second was the opposite of my block title. Instead of no free lunch, all lunches are free. So I remember the first speech of the commission president in parliament when we, we had to ratify her. And the first speech she gave was like, well, the green deal for jobs is the future of Europe. We're going to fight the climate change and there's going to be so many more jobs because of this green deal. And it's like, look, you can be against climate change and wanting to do a good climate policy. What you cannot claim is that that's just for free. I mean, that's like, you know, you're going to raise the price of electricity and gasoline and gas, and you're going to make it difficult for people to build and also for the things. And that's gonna cost. And you have to tell people and, and politics everywhere. But in Europe in particular, has become, had become, at the time very much freelance politics. So ideas matter a lot. And this is how, this is how many of these things were discussed. People felt that the digital regulation, oh, that's great because we will be regulators to the world. And that has generated GDPR, which was before me, AI Act, which was happily after I left. So I'm, I'm not responsible any of the two big mistakes of Europe, but a lot of the Green deal legislation, I was there when, when it was proceeding, for example, the parliament voted to stock production of internal combustion engine in 2035 without really a good cost benefit analysis without really any understanding of what that meant. I mean, if you do prices, at least people can adapt and some people can continue. They don't have chargers. This was a crazy volunteeristic policy that has just been reversed last week. And so a lot of kind of regulation that was based on this idea that, oh, we make a move to electrical and then we will be richer and better and cleaner and nothing will cost anything. And it's like, you know, the free lunch is not, is not a smart, it's not smart way to, to, to, to do, to do policy. So on those years, I think there was a lot of voluntaristic policy making I think happened in the US as well, and the Biden administration and a lot of unawareness of how we were really putting Europe in a pretty tricky, tricky situation. I mean, Europe, to be fair, has missed the, we were converging until 1980 to the US in 1980. We stopped converging. You could think it's Ronald Reagan, you could think something else. And since the mid eighties, we have not, we have actually gone back relative to us GDP per capita and basically comes down to we missed the it revolution. Europe was in the frontier of technology in 1980. Nuclear trains, planes, cars, everything, fridges, all the kind of the technologies of the last industrial revolution that were, had been growing during the century. But when it came, when radical change was needed, all our kind of firing calls, which dis discouraged firms from, from, you know, making mistakes from, okay, you start in one direction, you make a mistake, you fire the people, you start in another direction. All that was very difficult to, to, to, to, to do in Europe. And that meant the two radical revolutions innovation revolution have happened. The IT and AI currently basically missed. And I think it has to do a lot with, with with the regulatory luxury regulation to make it equivalent to luxury beliefs. A phrase that we used in our blog. I have a blog with my son Peter that's called Silicon Continent. We have 7,000 subscribers, a substack. Now

- It's a great substack, Silicon Conant, highly recommended. Yeah, I mean, I, I so I,

- And we talked about these luxury rules. Luxury rules are rules that you set up just so rich, you know, everything has to be perfect or, or not exist.

- So, so I, I guess like, you know, the, you know, you, you mentioned, you know, there's this idea, you know, that the process of fact, I mean, it's pretty unbelievable. I mean, the idea that I, I guess maybe the, the lack of humility that certain European regulators have with thinking that they're setting the world standard, you know, with things like GDPR regulating tech. And when I think at, at this point, a lot of this seems to be, you know, I think clearly, you know, backfiring and you know, there, there is no real, you know, I'd say vibrant tech, you know, industry in Europe to, to speak of, at least compared to the us. But I, I guess like one, one re you know, re reaction to that regulatory state is, I mean, you look at like, for example, you know Nigel Farage and you look at, you know, the past 10 years of, you know, Brexit, I mean, part of the complaint that, you know, certain people in the UK like Nigel Farage had, you know, the, the party at that time was that, that there was this regulatory BMF that was, you know, the, the European Union and that they wanted to leave. And, and hence they, you know, they went through with, you know, the Brexit vote and, and you know, by, you know, certain slim majority that the Britain decided to leave. And, you know, part of that means, you know, they obviously have to, you know, they leave the single market and they have to reestablish, you know, the, their trade ties and, and figure out what, what to do in terms of immigration and so forth between, you know, the UK and the eu. And, and then, you know, the, they never joined the Euro to begin with. So they didn't have the monetary union sort of challenge. But, but, but I mean, some people would say that, you know, that the positive part of Brexit was that, you know, now the UK doesn't have to deal with this thing called, you know, the European

- Yeah, I mean it's, it's, it's, let me make a a broad intellectual point first and then, and then address the, the Brexit and, and the overall regulation. The broad intellectual point, which is a very Stanford Chicago point is, is, is from so well about the constraint of cons. Yeah. The constraint versus the unconstrained were to think, and, and, and how you have to think of incentives and, and, and, and constraints when you are thinking about, about policy and, and, and, and the de sets point at UCLA, but, but also Chicago in some sense point about the nirvana fallacy. The nirvana fallacy is like, oh, well, you know, we have this problem, this other world is solved, like the state will solve it. It's like, okay, you wanna think about constraints and incentives in state A and you want to think of incentives and constraints in state b in the market and state. In both of those cases. And in in this excessive regulation, there is this sense like, oh, we have a market failure less intervene. And there is very little thinking about what will this intervention lead to as to the Brexit specifically. And, and, and the, and the as asset cause of, of, of due to the overregulation, I'm in the UK right now. I'm in the London School of Economics and it's very depressing. I mean, look, Europe has two problems, has a problem overregulation, it has a problem of a single market, which is far for complete. And the UK gave up the single market, which is big thing to weave up in order to eliminate the over regulation. They didn't, they've given up the single market and you will just not believe. I mean there is this story everywhere in the press about a hundred million dollars pounds spent in a bad tunnel. The HS two, the high speed lane that was going to be trend that I was going between non Edinburg was budgeted for like 24 billion is gone up to 110 billion. And it's basically 'cause it has become a tube because it goes under everything because there is some biodiversity, this or some biodiversity data, or there is some rule that the UK is hobbled by rules more than ever, it's unable to build electricity, nuclear plant, I don't know how many hundreds of millions they, they spent billions, if I don't remember wrong. I, we wrote a block about my, my son wrote a block about how the salmon in the, in silicon continent, that, that there was like an enormous number of millions un seing number of pounds, millions of pounds to save each sum in the ley pint in the nuclear plant that was built in the UK with the enormous delay. So the UK has been really wasting the chance they've incurred the cost, which is given out the single market in order to obtain that benefit potential, which is to become Singapore on tha to be, to be a, a power in, in, in, in, in doing all this technology innovation Europe cannot do. And instead they've just done nothing with it. I mean, they can't build a tunnel, they cannot build a terminal in Heathrow, they can't allow housing to be built in London. It's very depressing. And I don't think Nigeria Farage will be any better because he's basically not interested in policy and because the voters he has are not interested in, you know, the problem of Europe largely is the problem of an aging electorate. The aging electorate doesn't really care that the young people don't have housing. They don't care that we're not building stock, we're not investing in the future. They want their pensions. They, when the healthcare and the politicians say whatever they wanna say, but at the end of the day, look at France, they increase pensions and they increase health spending and they cut everything else and increase taxes to pay for those pension, the health spending. So at the end of the day, there's a political economy problem that is affecting the UK as well.

- Yeah, absolutely. So, you know, i i I guess I, I just wanna a little bit about, you know, the the monetary union side of things because you, you, you also recently wrote a book titled Crisis Cycle Challenges, evolution in the Future of the Euro with John Cochran. And, and Klaus message in, I'm just curious, you know, obviously the, the euro, you know, it is had a a very interesting, you know, trajectory where you, one, we had sort of the ascent of the euro in the, the, the, the late nineties in, in the formation. You had the first Europe, the European exchange mechanism and exchange rate mechanism. Then you had the formation of the euro at the, at the dawn of the millennium. And then, and then, you know, we had this, you know, in the early 2010s you had the European reign debt crisis. There were questions about whether or not Greece would exit the Euro or maybe other countries, other indebted countries like Portugal, Italy, you know, I mentioned Greece, but also Spain, that that, you know, potentially could, could exit or, or that there would need to be some, some rethinking to deal with the fact that you had this sort of like fiscal free riding thing that that was sort of contingent, you know, on, on this big monetary union that this, the rest of the monetary union had to subsidize in some way. And then you had the, the sort of draggy whatever it takes moment. And, and that seemed to, to make things sort of go away, at least the volatility in the markets disappear. And then, you know, sort of 10, 10 years following that you end, I mean you also, you've got countries that are joining wanting to join the Euro again. I mean you had the Baltics in the, in the mid 2010s that joined or followed through with joining the, the Euro. And, and even more recently you've had, you know, countries like Croatia and others that, that are, that, that are joining it. I, I'm just curious, I mean, what are the challenges with the euro that the remain, as you see? I mean there is this, I guess, concept that, you know, you can, you can't have a a a a, a monetary union without having a fiscal union. There's pushes to have more euro wide debt and it's, I something that I think some European countries might not like. And I'm just curious what, what your thoughts are.

- It was just agreed last Friday. Last Friday was a, there was a meeting where more European debt for, for Ukraine was, was decided to issue. So the book comes from a lot of the work and the policy work I did over those years from Klaus experience on the, on the, on the European Central Bank. He was one of the earliest employees. And from John Coran, who is a Hoover fellow, as Australia listeners well know, who is a fantastic micro economist and a wonderful writer. And what we argued is that the European Central Bank, the institution of the Monte Union without fiscal union is perfectly feasible. We think that it was established with clear rules and with clear eye view of what the, what the risks were. But as the crisis, the different crisis came, we had four, one in a hundred years crisis, one after the other, the French crisis, the Euro crisis, the pandemic and the war. In initial of this crisis, they, they should be jumped or destroyed some of the, some of the rules that were established there, probably with good reason, probably it was necessary at the time, but at the same time, not coming back to VR rules afterwards. It's true, after the first travel, the 2012, Mario demanded conditionality in order to, to do this whatever it takes. And there was a, a clear conditionality for his outright monetary transactions. If he was going to rescue a country, that country had to be on a program like think of an IMF program. But, and there was a, a banking union effort at that time. So some of the problems that were left un un unthought during the, the big thing, sorry, lemme just go back to one important thing. The big thing that was left unsolved in the design was, okay, we have fiscal rules in order to have this common credit card, but people have their own income and their own expenses. How are we going to do it? We're going to put fiscal rules. Okay, good. The problem is what happens if people don't follow the fiscal rules? Exactly. Oh, okay. And what happens if they're bankrupt? They won't be, we didn't have any European IMF didn't have a banking rules that would allow banks and states to be separated and banks not to drag states or vice versa. We didn't have a sovereign bankruptcy procedure. So when all these things started, it was all improvised a solution. And so during 12, with druggie and with the conditionality in the rescues, 13, 14 with the banking union, we were putting in place those institutions, but eventually QE came, the states discovered that, you know, money was cheap, debt was cheap, there was not much reason to put their house in order, neither fiscally nor in terms of growth, nor in terms very importantly of finishing these institutions. And they abandoned all these efforts to strengthen the union because you had the European Central Bank behind why would you need a fiscal authority if the monetary authority can give you the money for free? Right. Much better, much better. So they were, they were kind of abandoning all these reform efforts. And our book is basically a plea to say, look, the fiscal monetary union with a fiscal union can work, but you need to accept those constraints. And countries like France have basically jumped over those constraints every time since the start of the Euro. And as Ker said in a phrase that we have at the start of a book, he said, because it's France, I mean, why do you sanction France? The president of the commission said, because it's France. So France basically hasn't had to fulfill these rules and they don't have the fiscal discipline from the union, which is fine, then they should have the market discipline. But the market discipline disappears because the European Central Bank says, we will intervene and has a program which is called TPI, the transmission protection Instrument, which is there to do that. So in a way, you have neither one or the other. And the result is that you have a situation where the welfare states that keep growing the pension define demands, which are politically imminent, are more powerful than the efforts to establish growth enhancing reforms. I mean, Germany has decided we don't want debt break because we're in, in a defense trouble. And in fact they take out the debt break and what do they spend the money on welfare, because that's at the end what the politics is pushing. So basically what we say in the book is, look, we understand dear ECB, why you did these things. We don't think these are good presence to keep in place. These were exceptional moves. We need to go back to a system like the initial one where those boundaries between monetary and fiscal policy are very clear and where the institutions that require are required for a banking union including a bankruptcy sovereign procedure. If Illinois, you know, goes down or Chicago goes down, then the US government is not in the Federal Reserve. Nobody thinks the Federal Reserve will rescue Chicago or Illinois. And the example certainly are not totally unrealistic.

- Well, I guess part of it, you know, I think a lot of these states are supposed to have balanced budget amendments, and that's kind of, I guess how, how a lot of that, you know, it's supposed to work, but I mean, of course there's, you know, there's exceptions to that and it's a very similar thing, I suppose in the US to, to Europe, as you know, there's fiscal rules that that that aren't being followed by, by member states. Yeah, I mean it's fascinating. I, me, yeah, you know, I, I forget exactly what the fiscal rules were, you know, something about 60% of GDPI dunno if there's the mash

- That is 60% deficit is 3%. That's correct.

- Wow. And, and then, you know, obviously many countries just totally blew, blew

- Path. Yeah, France basically, my memory is that I just from memory, but I think only two times, only by mistake fulfilled the deficit. Of course, that rule, France has been increasing the debt as a share of GDP every year since the start of the euro until today, every year.

- Wow. - Maybe not in 2018, maybe that, that year not, but

- I mean, do you, do you see Europe as maybe being in a place where it's sort of entering this period of fiscal dominance, where now obviously you do have many very indebted countries, Germany's starting to take on more debt. I mean there's, you know, a big shift in, in sort of developing their own, you know, defense now and, and funding that Germany is playing a role in funding that, you know, amidst the Russia invasion of Ukraine. Yeah, but you, you see what happened in Japan, you know, Japan's trying to raise interest rates. Now their, their currency's actually falling, and there's some suggestion, I mean, Japan has even more debt, you know, compared to, to Europe as a fraction of GDP. But now, now they're running into these issues where they're, you know, by even raising interest rates that there's expectations that there'll be, you know, for further problems, more, you know, higher interest costs on the debt and potentially future inflation problems. And that'll just make that, that makes the currency sell off. I, I don't think Europe's quite reached that, but there are some concerns that there are these sort of issues that there's now such a big fiscal debt load that that that,

- I mean, the aggregate, the aggregate fiscal position is not, is not terrible the problem of distribution, right? You, you have, I mean, the problem of fiscal dominance doesn't necessarily come from the, from defense side, I don't think that's going to be our problem. I think it comes from the, again, from the pensioners, from the welfare states. I mean, I think we had very, very, very powerful welfare states, very aging electorates with very low fertility. For the politicians, it's always going to be preferred to satisfy this constituency. And the France, you know, both bar and the, the, the, the, the, the popular, the the front national, the, the right wing populist and the left wing populist national have noticed that the European Central bank is there. And they both proposed that it should be, you know, France should be basically bailed out by Europe and by the European Central Bank, and that it should cancel the debt or well by the has said we should talk to the A CB and they should do things differently. Even McComb has recently said it. So the risk is more that people play the Samsung game. Like, if you don't save me, I'm going to just take the temple down with me. And that it's going to be hard for the a CB in front of countries like France or potentially Italy. Although Italy is, is behaving well now, it's going to be difficult to resist. So it's more the welfare states, their growth. We ta France doesn't have scope for more taxing and, and they're just lowering the, the pension age from 64 to 62. Imagine after having done the effort from to raise it, I don't think, let's imagine the alternative, France has the French Franc. Can anybody imagine that they will be lowering the retirement to 62? I mean, there would be a big crisis, a frank would be falling people, the markets would be scared, but they are in the Euro and, and they're protected by the whole, by the Europeans in Japan and by the whole. And so they can kind of hide their trouble. And of course, if it starts to get bad, like in 2000 10, 11, 12, for, for some Australian proliferate countries at the time, if it starts getting bad France, what is this going to do? Is it going to let you know France fall? Are we going to go see a bankruptcy? Are we going to see the politicians really be serious and, and, and, and do a pension reform? I mean, all those things are very, very uncertain. So in what sense? You're protected against fiscal dominance because you have a board that has to vote and the majority of the states are not prote and the average state is not bad. But on the other hand, you have this risk of gaming of some member states kind of trying to figure out how committed is really the a ccb to price stability and price stability. And ACB might have to choose to price stability and then in some country fall and have some default or fiscal governance and letting the price, the price objective inflation objective called, called called out of control. So I, I think that, that the design still needs the elements that John and Klaus and me are arguing. And you need to make sure that countries know that they play games, they're going to go on bankruptcy and nobody's going to worry the, the banks are not going to fall when the country falls and the country's gonna have to restructure the debt. And that's not a big deal, like a big corporation or like, you know, at least they need to know it and then they will do these things. Right now we're in bit of a situation where we don't have the commission enforcing the rules, the fiscal rules you were talking about, and we don't have the market enforcing the rules, and that's a bit scary.

- Absolutely. I wanna talk a little bit more about innovation and I guess, you know, the lack thereof in Europe. Getting back to a little bit more about regulation, you know, you recently were a document, you know, it's titled The Constitution of Innovation with Benton Hol from Nobel Prize winner and, and Nicholas Petit. Can you tell us a little bit more about what you think the key ingredients for innovation are and what's holding it back, particularly in places like Europe?

- Yes. So it's, the title of our, of our document is, is after the, the Constitution of freedom of Hyatt Liberty in the Constitution of Liberty. And we are kind of echoing this, this, this is his way of thinking about, about, about that. We are looking into why is Europe kind of since 1980 behind. We think that the single market and the lack of innovation are sense are are the, the single market and the regular excessive regulation are, are essential that Europe is doing luxury rules, is setting up all sorts of rules that the Brussels affect. This idea that Europe is de regulated to the world is insane. That that costs and there's no free lunch that we have to understand cost and that Europe should put prosperity as their main and only guide the European Union. We should drop all the other things that Europe has been trying to do, focus on the single market, focus on letting firms scale up, eliminating regulations. And unfortunately, the single market, we inspire ourselves a lot from the US interstate commerce clause. We say like you shouldn't, I mean basically mutual recognition in every case. So if you can sell in one country, you should be able to sell in all the others. There shouldn't need be a need. In other words, for harmonization, the legislation, which is always a mess and always kind of at the end of the day, harmonizes nothing, because then each country implements the rules in different ways. Instead, we just let the countries have their rules compete and everybody can sell products everywhere else. We talk about a federal commercial court where firms that are not allowed to sell from one country into the next should be able to get a ruling in English in 180 days and not have to go to the commission, which never enforces or to a local court which don't know European rules. So it's really about getting a true single market and eliminating regulation. And instead of like other reports that have been talking about this, but having talked about what are the constitutional aspects of this, we propose this set of reforms along the lines of what I was telling you that actually will result in Europe working in a different way and pro producing a completely different regulatory outcome. So we, we believe that Europe is a good idea. We also, like Klaus and John, me, believe that the euro is a good idea, but we believe that we are kind of badly abandoning our initial purpose, which is in the case of the Euro low inflation full stop. And in the case of the stable currency and in the case of of, of this, of the European Union, it's a single market that allows firms to compete and to scale everywhere Europe.

- Well, I I wanna just, I guess my last question here, I, I'm curious about your thoughts on, on the current state of Spain, you, you know, the Spanish Prime minister, you know, Sanchez, you know, socialist prime minister's been in, you know, since 2018, you know, certainly been, I'd say one of the most both, you know, pivotal and controversial politicians in Spain, you know, probably since, you know, since Franco. And, and I'm just curious in terms of a lot of his, the changes that he's tried to put in place. I'm just curious, what do you think about the, the trajectory of Spain in the past 10 years, 10, 15 years? Obviously there's a lot of dynamics between, you know, Catalonia and, you know, certain regions and, and my understanding is that, you know, the essentially to continue and to stay in Power Sanchez and the socialists have in, in part allied themselves with the catalonians, you know, which, which obviously, you know, independence has been something that certain sections of catalonians of, of, of soft war obviously, or either independence or autonomy. Yeah. I'm just curious, what, what's your take on on all of this and all these changes?

- Yeah, no, I, I think, I think the trajectory of Spain's extremely worrying. The markets look at our growth and they say it's great, but the reason it's great is we're getting 500,000 immigrants per year. That's like, if the US was getting over 3 million, that would be, that would be a problem for the US It was a big crisis with i in the US with 1 million. So we're getting extensive growth. We are not getting any increase in per capita income since basically 2008. All the GDP per capita that increased has gone to higher pensions. So the pension is, have increased their average earnings, but the people between 18 and 65 have not. So it's been a, a since 2008, Spain was converging to Europe and 2008, but since 2008 we basically stagnating over and the government of Sanchez has been extremely negative for Spain. Yes. And he allied with the separatists in the bus country and in Catalonia. And, and in, in, in both places he even allied with, with the supporters of the terrorist groups who never repented hei with the people who did a esta the tag against, against Spain try to over overthrow the constitution. So, but, but most importantly, and also of course he allied with the Communist party and extreme left, he has basically now discovering under a huge set of corruption scandals, two number twos, his personal choices to run the party while he was in government are in jail or have been in jail and are probably going to spend a huge amount of time in jail because they've been basically scandals related to Venezuela and to construction. There, there's been a big set of connections with Venezuela that we will find out if Maduro goes, a lot of people in Spain are going to be panicking because the paperwork, the paper that will come out will, will be, will be very incriminating. So there's a big set of corruption scandals he's destroyed the institution's taken over the public, the telephone company, which was privatized in the nineties, he's put on the state control the main defense company that was in telecom and, and and intelligence, no, the, sorry, the first the main, main defense and technology company, which is, has been put under his direct control. He put socialist ICS everywhere. He's destroyed basically the, the independence of all the regulators. So basically he's trying of the Denmark versus Venezuela dilemma that I had in my dilemma, the Spain in the book I, I wrote in, in 2014. And that served as the inspiration for the program of the, of the party that, that I was with he anos that I ran for, he basically has chosen the road of Venezuela. He wants to turn Spain into some sort of banana republic. Happily. I think his time is over part thanks to his corruption scandals. So I, I've been very sad with Spain. I thought I, the socialist part in Spain traditionally has been pretty market oriented and pretty sensible. During the eighties they had a, a set of pretty good. I mean, there were socialists, but they were social democratic and non-European way and they, they were not necessarily, they were not many of them Muslim, were not corrupt and so on. But these new socialist party has proven like to be another thing. He was basically voted out by the party, he came back with support from the grassroots and basically eliminated everybody on the party who was sensible in any way and has govern with, with a very extremist and not clean clique of, of people.

- Wow. Wow. Well, hope, hope, hoping that, you know, Spain turns, turns the corner and, and is able to recover from, from all this. And, and it's now near near decade of, of, of socialist rule and really want to thank you for coming on those, this is amazing hearing your perspective and your experiences, you know, working not only as an academic economist, but also your time in, in Brussels. It's a member of European parliament. It's really,

- I'd like academia do tell your, your business that I'm back to academia. I mean LSC I'm working a lot on doing research and present work

- And I'm sure your students, you know, really benefit from, you know, hearing from someone who's, you know, not just, not just someone who's doing research, but someone who's actually, but worked in palsy, you know, actually, you know, ran and, and and, and seen a lot and and done a lot. And it's so important. I think understanding how Brussels works. I mean, I think and understanding that the European regulatory state is so critical. If, if it's going to be the case that innovation and and growth are gonna be revived in, in Europe in, in some way. So really thank you so much Lewis for, for all you're doing and thank you so much for coming on. This has been a real honor to talk to you.

- Thank you. My pleasure.

- This is the Capitalism and Freedom in the 21st Century podcast, an official podcast of the Hoover Institution Economic Policy working group where we talk about economics, markets, and public policy. I'm Jon Hartley, your host. Thanks so much for joining us.