With both Europe and America facing serious debt crises, a nightmarish scenario is emerging on the horizon: global austerity.
Europe has already gotten itself very deep into a macroeconomic hole, dug out from underneath the economy by austerity-minded politicians and Eurocrats. The United States has not yet come to that point, in part because we have chosen to try to exhaust the credit worthiness of our currency first. That is of course not a good idea either, but at least we still have a choice which way to go with our fiscal policy. We can still avoid austerity.
Time is running out, though, and fast. There is a considerable risk that the lame-duck session that is coming up after the November election will provide the perfect legislative vacuum for Congress to launch a massive austerity plan against the federal deficit. If so, that would set a bad precedent and bring a lot of macroeconomic trouble to our shores that we don’t need and can’t afford.
To make matters worse, neither can the world. Europe and the United States represent more than 60 percent of the world economy. As buyers of goods from the rest of the world, and as exporters of high-tech products from computers and software to pharmaceutical drugs and patents, over the past 30 years these two economies have helped elevate three billion people from abject poverty to comparatively prosperous lives. Investment capital created in Europe and America helped fund the rise of the Asian Tigers, the surge of China and the elevation of India to a standard of living unimaginable only a quarter of a century ago.
Now that Europe has gotten stuck in its never-ending cycle of rising unemployment, stalled or negative growth, rising dependency on government and endless austerity, that continent can no longer be counted on as an engine for the world economy. If the U.S. Congress decides to adopt Europe’s totally counter-productive approach to fighting debt, the end result will be the same here: economic stagnation and social decline.
Industrial poverty, for short.
This is a state of economic affairs that I am elaborating on in my coming book “The Economic Wasteland”. Briefly, industrial poverty is the ultimate consequence of the welfare state. It amkes itself known in the form of economic stagnation: a long-term trend of growing dependency among the public on tax-funded entitlements, a structural decline in private consumption, an equally structural shift in workforce participation and a long-term slowdown in GDP growth.
Industrial poverty is static. Once we end up there, we make no progress in any direction. The only change we experience is a slow, agonizing decline in our standard of living. The static nature of industrial poverty is similar to agrarian poverty – that which is experienced in static, agrarian-based economies – in that tomorrow offers nothing better for the growing generation than yesterday did for the generation currently working. In fact, our children can be lucky if they grow up to the same level of prosperity that we enjoy. But judging from the long-term trend in Europe, it is more likely that each generation will actually grow up to a slightly poorer life than their parents have had.
The difference between industrial poverty and agrarian poverty is that we will of course have access to the basic conveniences of an industrialized society: we don’t have to chop wood to heat our house; we don’t have to ride horsebacks but can transport ourselves around with the help of cars or mass transit; we have a health care system that can treat all the basic medical conditions without killing most of its patients; we have schools that provide all children with basic life skills.
But nothing ever gets better. If there is any change, it is in the form of a slow but inevitable decline. In some countries that have already entered a state of industrial poverty, health care is declining, with the government-run single-payer systems offering less services to today’s working generation than it did to their parents’ generation. Housing is becoming increasingly unaffordable, jobs pay a bit less, schools are not as excellent as they used to be.
Industrial poverty does not come about suddenly. It sneaks up on us, a little bit at a time, until it has built such a momentum that it dominates our society. The transformation from a prosperous country to one mired in industrial poverty takes place in two steps.
The first step has to do with why we work. In an economy with a small government we work to become more prosperous. We educate themselves, pursue careers or start businesses because we want to grow our personal finances. Our efforts are rewarded: the standard of living grows relatively fast in economies with small governments.
By contrast, in a big-government economy people work to pay taxes. This is not just a rhetorical metaphor: the transition from working for ourselves to working for government is statistically visible. Yet these basic facts are often ignored, especially in the academic economics literature where scholars often seek short-term, single-variable explanations to complex, long-term phenomena such as the stagnation of the standard of living in, primarily, Europe.
When people pay more in taxes they would of course expect to get more back. That is not the case, however, especially not in countries where the prevailing fiscal policy doctrine is austerity. As the welfare state expands, its taxes discourage work and its entitlement programs do the same. As workforce participation declines, the tax base shrinks and becomes considerably smaller than the welfare state needs. People now work less than they did when they wroked predomonantly for themselves. But when the welfare state now responds to its revenue shortfall with higher taxes – again without giving more back for those higher taxes – people have to increase their workforce participation again just to stay afloat with their personal finances.
They have gone from working for themselves to working for the welfare state.
The other step that transforms an economy from prosperity to industrial poverty has to do with private consumption. Data from all over the industrialized world (which I will report in my coming book “The Economic Wasteland”) show that once government grows to a certain size – approximately 40 percent of GDP – the standard of living of private citizens stagnates. This happens primarily in the form of a stagnation in private consumption.
In a low-tax country, private consumption exhibits higher growth rates than in high-tax countries: private consumption is everything households spend their own money on, from housing, food and clothes to health care, education, cars, recreation and computers. In a healthy economy, private consumption exceeds 70 percent of GDP. Logically, therefore, fast-growing private consumption means the rest of the economy will grow fast as well.
By contrast, when private consumption grows at very low rates, people accomplish little more than just maintaining their standard of living. When private consumption grows at less than two percent per year, adjusted for inflation, private citizens experience no noticeable advancement in their standard of living – all they do is essentially reproduce the standard of living they have (with an adjustment for increased quality in the products and services they buy). When they buy a new car they do not trade up, but buy a new model of the same car they have; when they buy a new cell phone they stick to the low-end spectrum of the cell phone market; when they move they do not get a bigger house but one that is similar to the one they had before.
All this is caused, again, by the steady growth in government; by lawmakers putting in place entitlements that force new taxes onto the shoulders of hard-working taxpayers. Europe has already entered a state of industrial poverty, with some countries leading the decline. It is increasingly difficult to see how Europe is going to get out of there: the only way to break the grip of industrial poverty is to do away with the welfare state, and a poor country has much less resources than a prosperous country to make the transition.
America is not insulated against industrial poverty. The same mechanisms that have tranformed Europe are in place in our economy as well. If we choose to try to save our welfare state by means of austerity, we will be forcing ourselves onto the same path as Europe. With the same depressing end station.
That will make us poorer, our children poorer – and our stagnation will inevitably spread to the rest of the world.
We can avoid this. We can still change course and choose to structurally reform away our welfare state. But we have to make that choice now.
Time is running out.