Government debt is a problem. It pushes the cost of today’s government entitlement programs onto the shoulders of tomorrow’s taxpayers. The debt problems are made worse by the fact that the welfare states of Europe and North America all seem to suffer from a structural deficit: over a period of time longer than a business cycle they increase spending faster than their tax base increases. These deficits in turn are caused by entitlement programs that are purposely designed to increase in cost independently of the private sector’s ability to pay for them.
Over time, governments have raised taxes to keep funding their welfare states – and when tax increases have been politically unpalatable they have resorted to spending cuts. The net effect has been a more stingy welfare state at a higher cost to taxpayers.
Herein lies the core of the reason why the Western World has an endemic debt problem. As a share of GDP taxes have increased in every European welfare state over the past half century – in some cases the tax-to-GDP ratio has more than doubled. (See my book Industrial Poverty, pp. 75-77.)
In other words, the welfare state creates a permanent spending problem, the funding of which creates a permanent slow-growth problem which in turn creates a permanent deficit problem.
This is a systemic failure for the Western World of epic proportions. Unfortunately, the “big picture” is still a mystery to many people. Let me offer two examples. The first is from The Telegraph:
The eurozone is “untenable” in its current form and cannot survive unless countries are prepared to cede sovereignty and become a “United States of Europe”, the manager of the world’s biggest bond fund has warned. The Pacific Investment Management Company (PIMCO) said that while the bloc was likely to stay together in the medium term, with Greece remaining in the eurozone, the single currency could not survive if countries did not move closer together.
What this means in a nutshell is that the member states of the EU, or at the very least the euro zone, would have to give up their individual iterations of the welfare state and hand over taxation and spending authority to a union-wide authority. That would be either the EU if it incorporated all 28 states, or some “core” European government if it was confined to the euro zone.
The idea behind this is to bring fiscal and monetary policy into some kind of jurisdictional harmony. But this will not solve anything. It is a change in form, not content. The same welfare state will cause the same problems, and the policies put in place to reduce or eliminate government deficits while preserving the welfare state will have the same negative effects as they now have at the national level.
The Telegraph again, more to the point:
PIMCO used the example of the Latin and Scandinavian unions in the 19th century, which lasted an average of 50 years before breaking up, to illustrate how monetary unions were incompatible with sovereignty. “You need to reach some sort of political agreement about how to share fiscal resources around the zone. We’re a long, long, long way from designing that and getting the political backing for it,” … “So while you’re waiting for that and you’ve got low growth, and high unemployment, you run the risk of letting these anti-euro parties to the forefront.”
Those anti-EU parties would break up the currency union – in fact, that will happen as soon as Marine Le Pen moves into the Elysee Palace in Paris – but they will not alter Europe’s fundamental socio-economic structure. They will try to defend the welfare state, too, and will eventually encounter the exact same problems that have troubled Europe’s welfare states incrementally since the late 1970s.
But let us not forget that the government debt problem is not confined to the “advanced” welfare states shoring the North Atlantic. In fact, as if to underscore the social and economic disease that the welfare state represents, The Guardian reports:
Greek ministers are spending this weekend, almost five grinding years since Athens was first bailed out, wrangling over the details of the spending cuts and economic reforms they have drawn up to appease their creditors. As the recriminations fly between Europe’s capitals, campaigners are warning that the global community has failed to learn the lessons of the Greek debt crisis – or even of Argentina’s default in 2001, the consequences of which are still being contested furiously in courts on both sides of the Atlantic.
Or, for that matter, the Danish and Swedish lessons from, respectively, the 1980s and 1990s. I discuss the Danish crisis and analyze carefully the Swedish case in my book Industrial Poverty; for those proficient in Swedish, see an abbreviated analysis in the next issue of Magasinet Neo, out next week.
Back to The Guardian:
As Janet Yellen’s Federal Reserve prepares to raise interest rates, boosting the value of the dollar, while the plunging price of crude puts intense pressure on the finances of oil-exporting countries, there are growing fears of a new debt crisis in the making.
An example. The Alaska state government gets more than 90 percent of its General Fund revenue from oil. With the oil price at a third of what it was two years ago the state government is now on the verge of fiscal panic.
Ann Pettifor of Prime Economics, who foreshadowed the credit crunch in her 2003 book The Coming First World Debt Crisis, says: “We’re going to have another financial crisis. Brazil’s already in great trouble with the strength of the dollar; I dread to think what’s happening in South Africa; then there’s Malaysia. We’re back to where we were, and that for me is really frightening.”
I have written several articles about South Africa, where I have pointed to the main problem of the country. It is not debt – that is merely a symptom of what is really wrong. The systemic error in the South African equation is the massive entitlement system that the ANC government has tried to build and fund since taking over power 20 years ago. Trained as they were by Swedish socialists, the ANC leadership that defined the course of South Africa after the fall of Apartheid had only one thing in mind: to build their own version of the Scandinavian welfare state.
The result is high inflation, low growth, very high unemployment, social instability and a tax system that punitively keeps employers from creating jobs.
Without the welfare state there would be no debt problem in South Africa.
The Telegraph again:
Since the aftershocks of the global financial crisis of 2008 died away, … next to nothing has been done about the question of what to do about countries that can’t repay their debts, or how to stop them getting into trouble in the first place.
Don’t build a welfare state. Don’t create spending programs that the private sector cannot afford. This is a particularly bad idea in developing countries where the private sector is in poor shape in the first place.
Unfortunately, this is not the direction that the global debate is moving. It is taking a different route, namely toward welfare states being given a chance to default on their debt with impunity. The Telegraph explains:
Developing countries are using the UN to demand a change in the way sovereign defaults are dealt with. Led by Bolivian ambassador to the UN Sacha Sergio Llorenti, they are calling for a bankruptcy process akin to the Chapter 11 procedure for companies to be applied to governments. Unctad, the UN’s Geneva-based trade and investment arm, has been working for several years to draw up a “roadmap” for sovereign debt resolution. It recommends a series of principles, including a moratorium on repayments while a solution is negotiated; the imposition of currency controls to prevent capital fleeing the troubled country; and continued lending by the IMF to prevent the kind of existential financial threat that roils world markets and causes severe economic hardship. If a new set of rules could be established, Unctad believes, “they should help prevent financial meltdown in countries facing difficulties servicing their external obligations, which often results in a loss of market confidence, currency collapse and drastic interest rates hikes, inflicting serious damage on public and private balance sheets and leading to large losses in output and employment and a sharp increase in poverty”.
Once this measure is in place, what are the chances anyone would buy Treasury bonds from any country that is perceived to have some debt problems? What countries would be allowed this measure? It would have to be all UN member states, or else the rules for the Chapter-11 style mechanism would be ad hoc.
The next question is what would happen if Greece used this way out of its debt problems. All of a sudden we are talking about a euro-zone member state, a European welfare state, a country that is not too different from, say, Spain or Italy. What would happen if Spain or Italy did a “Chapter 11″, countries that are not too different from, say, France?
This is a Pandora’s Box of defaults that would have catastrophic effects on the financial system. It would turn now-safe Treasury bonds – or at least from those countries that still have good credit – into almost toxic assets. Who would want to buy any welfare-state Treasury bonds if that government can choose to file for bankruptcy if they consider the payments too burdensome?
Surely, there would be rules for filing for bankruptcy. But who would be writing those rules? The same welfare states that want to be able to borrow frivolously to keep their entitlement programs going.
The systemic problem with the welfare state still eludes the world’s political leaders. Ann Pettifor may very well be right in that there is another debt crisis coming, but a more accurate way of describing it would be that the same debt crisis – the ongoing, daily borrowing by unsustainable big governments – that has been cooled off for a while will erupt again.
And it will continue to do so until our political leaders get their act together and terminate the welfare state.