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.
As the Germans, the Greeks and the European Union leadership try to hash out a reasonable plan for Greece to secede from the currency union, the underlying question remains: has Europe managed to deal with the structural problems that brought many of its member states to their fiscal knees?
More specifically: are the problems that have sent Greece into a depression and possibly out of the euro zone unique to Greece – or are they just more concentrated there than elsewhere in Europe?
The answer to this question, presented in my book Industrial Poverty, is that the Greek crisis is merely a concentrate of an endemic European problem: a welfare state that is structurally and permanently too costly for the private sector to pay for. So long as the Europeans keep their welfare state they will continue to dwell in economic stagnation, with chronic problems of growth and budget deficits.
Over the past year countless forecasts of a strong recovery – or even a moderate recovery – in the European economy have been proven wrong. There are two reasons for this: economists normally rely on econometrics when they make their forecasts, a methodology that is not well tuned for large institutional and structural problems in the economy; and the focus on – obsession with – econometrics leads economists to ignore long-term structural trends in the economy.
Europe’s crisis is a structural one, caused by a long trend of weakening growth and increasingly persistent budget deficits. The over-arching problem, again, is the structure of entitlements imposed on the economy by the welfare state, a fact that is visible in the following, rather compelling data.
Figure 1 reports data on GDP growth and government deficits as share of GDP. The data is from 12 European welfare states, selected first and foremost based on data availability. The 12 states are then observed over a period of 48 quarters, fourth quarter of 2002 through third quarter of 2014, for annual, inflation-adjusted GDP growth and the deficit-GDP ratio. The result is a clearly visible correlation between the deficit ratio and GDP growth:
The better the deficit-to-GDP ratio, the stronger is GDP growth.
Now, let’s not rush to conclusions here. The immediate reaction among crude Austrians and crude Keynesians would be, respectively:
- “Yes, this proves that austerity is king!”
- “No, this can’t be – everybody knows that deficit spending is king!”
Truth is, neither side is correct. The reason why budget surpluses, or small deficits, correlate with high growth and deficits with slow or no growth, is as simple as it is independent of political-economic theory. Put simply, modern, mature welfare states are so big and difficult to pay for that a budget deficit is the normal state of affairs. Since the welfare state also depresses growth, by means of high taxes and sloth-inducing entitlements, it creates a combination of deficits and low growth.
Under unusual circumstances, high growth combines with surpluses not because government spending is low, but because GDP growth is high. In other words, observations of surpluses in Figure 1 are due entirely to a fortunate period of strong growth.
To further reinforce the point that growth is the only way to a reduced deficit in modern welfare states, consider Figure 2:
Note how the deficit-to-GDP ratio improves from 2005-2006. The reason is an improvement in GDP growth that started already in 2003. Next, note how GDP growth stagnates and starts declining in 2007 and how the deficit ratio follows downward in 2008. The upturn in the deficit ratio does not come until 2010, a year after GDP started improving.
In a nutshell: it is growth, not austerity, that fixes European budgets. (The same holds true, obviously, for the United States as well.) In absence of growth the budget deficits overwhelm their host economies and pile up more and more unsustainable debt.
It looks like Greek Prime Minister Tsipras is finally getting the country to where he was heading all the time: out of the euro. After winning an extension in February of current bailout conditions, the Syriza-led government has made practically no progress toward accommodating the demands from its creditors. On the contrary, it is increasingly obvious that Tsipras is trying to manipulate the circumstances to where he has no choice but to declare a Greek euro exit.
Yesterday the Greek blog MacroPolis explained:
The Greek government faces a dire financial situation in the coming weeks, especially as lenders are unlikely to relent on the conditions of last month’s loan extension. In fact, Tsipras’ insistence on of pushing for a “political deal” is going nowhere: German Chancellor Angela Merkel, who he will meet in Berlin next Monday, 23 March, is unlikely to deviate from her preference for technical, rule-based solutions. Therefore, the risk of an internal default due to the inability to pay salaries and pensions is not negligible.
Tsipras knows that he has no leverage. If he wanted to keep Greece in the euro zone he would never have run the negotiations to this point. But he has, which strongly suggests that I was correct when I wrote on March 1:
Prime minister Tsipras wants Greece to secede from the euro zone so he can pursue his Chavista socialist agenda on his own. He cannot do that without a national currency, but so long as a large majority of Greeks want to keep the euro he cannot outright declare currency independence. He needs to build momentum and create the right kind of political circumstances. This extension of status quo gives him four more months to do so.
It is very likely that the Germans have called Syriza’s game. As a counter-strategy they refuse to concede anything more, but are instead doubling down on their demands and conditions for a bailout. Reports the Telegraph:
Greece’s hard-Left government has been told to redouble its reform efforts in a bid to begin rebuilding the trust of its eurozone partners after a marathon four-hour meeting of European leaders in the early hours of Friday morning. With the clock ticking on securing the country’s future in the eurozone, Athens was urged to speed up its commitment to raising revenues and overhauling its economy by Germany’s chancellor.
Apparently, Chancellor Merkel has decided to play the chicken race that Alex Tsipras has been begging for ever since he was elected. According to the EU Observer, Merkel’s allies in the EU leadership have de facto made Tsipras an ultimatum:
Give us a list of reforms, and you might get the money you need, Alexis Tsipras was told at a three-hour meeting with select EU leaders on Thursday (19 March). The Greek prime minister met with German chancellor Angela Merkel and French president Francois Hollande. The heads of the EU Council and European Commission, Donald Tusk and Jean-Claude Juncker were also present, as well as European Central Bank chief Mario Draghi and Eurogroup chairman Jeroen Dijsselbloem. Tsipras was reminded that his government must stick to the Eurogroup’s previous, 20 February agreement. He was also told his partners are waiting for precise figures about the state of Greece’s finances and for a set of detailed reform proposals.
Merkel would not push Prime Minister Tsipras for the sake of saving him. She could not care less for a political half-wit from a broke-and-beaten Mediterranean outlier. No, her motives are at a much higher level. She has realized that the days are numbered for the common currency project. Greece is tugging away at its corner of the European currency; a party similar to Syriza is rapidly rising in Spanish politics, opening the possibility for Spain to eventually follow Greece toward currency secession; and then there is the constantly present threat of a President Le Pen in France whose first executive order would be to revive the franc.
On top of this Chancellor Merkel is looking at the exceptional depreciation of the euro over the past year. While this is good for exports, it has had no visible effect on domestic economic activity in the EU, especially not in the euro zone. The ECB has emptied out all its conventional monetary-policy measures and even resorted to unconventional stupidities like negative interest rates on bank overnight deposits. Yet none of this has helped get the European economy out of its state of stagnation.
Whichever way the chancellor looks, the euro is a lost cause. The remaining question then is: who is going to write the script for the end of the common currency? Is it going to be the rogues in Athens (and Madrid) or is it going to be the Germans? By being at least as principled as Tsipras, Angela Merkel is taking charge of the euro dissolution process. Her goal is to guarantee an orderly return to national currencies – and when that return will happen.
Prime Minister Tsipras can look wobbly and indecisive next to Merkel, but nobody should make the mistake of believing that the Syriza-led government eventually wants to stay in the euro. As Euractiv reports, the secessionist attitudes that characterize Syriza are not limited to economic issues:
The Syriza-led government will be against an Energy Union that undermines Greece’s national interests, including in its relations with Russia, said Greek energy minister Panagiotis Lafazanis, who also ruled out any privatisation schemes for the country’s energy sector.
So there you have it. The journey toward “Grexit” continues. The only question is who will blink first – i.e., who is going to be the first to give up on the Greek euro membership? Will Merkel say “I’m firing you” or will Tsipras say “You can’t fire me, I quit”?
Earlier this week I summed up some recent observations of macroeconomic differences between the United States and Europe. Those differences, which explain why the euro has plunged from $1.39 in May last year to its current $1.06, are not going to go away any time soon. I recently did an overview of the fundamentals that constitute the strength of the U.S. economy (see part 1, part 2, part 3 and part 4); today’s article takes a closer look at the European economy.*
As the latest national-accounts data from Eurostat reports, the European economy remains in a state of de facto stagnation. According to inflation-adjusted numbers, GDP growth for 2014 stood at 1.3 percent; while much better than 0.04 percent for 2013, a closer examination shows that it is neither impressive nor sustainable.
Unlike the growth in the U.S. economy, which originates in sustained growth of domestic, private-sector activity, Europe’s increase in growth is driven primarily by exports. In 2013 exports from the European Union grew by 2.16 percent in inflation-adjusted numbers, a number that increased to 3.53 percent in 2014.
There is a sharp contrast between these growth numbers and those for private consumption: -0.1 percent in 2013 turned into growth of 1.29 percent in 2014, hardly an impressive number.
To further emphasize the role of exports for Europe, consider the strong correlation between exports and business investments, vs. the apparent absence of consumption-investment correlation:
Since private consumption barely moves, businesses have no reason to invest for the domestic market. They therefore tailor their business expansions – to the extent such expansions take place – to fluctuations in foreign markets.
The dependency on exports is even more apparent at the member-state level. Over the past two years, exports has been the leading absorption variable in 17 of the 26 countries included here (Ireland and Luxembourg have not yet reported fourth-quarter data). In five of the countries exports was the only absorption category that shows any growth; in Spain private consumption barely squeezed into positive territory:
|Consumption||Investm.||Govt cons.||Exports||GDP avg|
The long-term trend of growing dependency on exports is visible across the board in the EU. From 2011 to 2014 (4th quarters), exports share of GDP increased in 23 of the 26 member states included here.
While there is nothing wrong inherently with growing exports, there is a problem when an economy almost entirely depends on exports. Contrary to prevailing wisdom among, primarily, European economists there is no lasting positive “multiplier” effect from exports to the rest of the economy – except, as mentioned, the business investments that relate specifically to exports.
The lack of positive multiplier effects from exports to, e.g., private consumption is reinforced by the fact that government spending is the strongest or second-strongest growth variable in 15 of the 26 countries. This is remarkable: for all of EU-28 government absorption grew at an annual rate of 0.6 percent per year over the 2013-2014 eight quarters. The fact that this was enough to finish second speaks volumes to the overall weakness of the European economy.
So long as this weakness remains, there will be no reversal of the long-term decline of EU economy.
*) Eurostat, 2005 chain-linked national accounts data.
I normally do not write about momentary events, such as the daily fluctuations on the international currency market. But today’s exchange rate between the dollar and the euro, which according to Bloomberg happens to be $1.06 per euro right now, is worth a broader analysis. The trend toward euro-dollar parity has gained a fair amount of attention in the media, and rightly so: when the euro was launched a decade and a half ago it was sold as a stellar currency, backed by some kind of European integrity, and certainty way above that flimsy greenback.
Reality turned out different. The euro and the dollar would have reached parity many years ago had it not been for the excessive money printing during Bernanke’s QE programs. But now that the Federal Reserve has cooled down its printing presses and the European Central Bank, on their end, have cranked up theirs, it is only logical that the two currencies are re-evaluated on the global currency market.
Immediately, one could question the case for parity based on the fact that the Federal Reserve Board of Governors meet tomorrow, Wednesday and likely will throw some cold water on the surge of the dollar. However, a postponed interest-rate hike will not make much of a difference over time: while only about three percent of all short-term rate changes are related to real-sector events, long-term trends are determined by the macroeconomic performance of the two economies. From this perspective, euro-dollar parity is a historic event. Its underlying cause is a long-term, widening gap between GDP growth, consumer spending, business investments and job creation in the United States and in Europe.
I have on several occasions analyzed the differences between the European and American economies. This is a good time for a quick recap. To begin with, the American economy is a much stronger job-producing machine than the European economy:
Our job creation record in this recovery is not exactly stellar, but our unemployment is nevertheless almost half of what it is in the euro zone. The EU as a whole is doing microscopically better than the euro zone, but that is almost entirely thanks to the comparatively positive trend in the British economy.
The American advantage in terms of job creation originates in a still-overall business friendly institutional framework. On the one hand, the Obama administration has a penchant for regulations; on the other hand this president has a comparatively modest spending record – far better than his predecessor – which has allowed Congress to combine largely unchanged taxes with an expansion of private-sector business opportunities. As a result, GDP growth is comparatively strong here:
It is important to understand the driving forces behind growth. If it is private consumption and business investments, it means that the private sector is doing well. In my recent blog series “State of the U.S. Economy” I pointed to these variables as being essential to the growth of our economy. What is particularly interesting is the visibly stronger confidence in business investments.
Therefore, we can safely conclude that we have a growth period in the U.S. economy that is well grounded and could last for a couple of more years.
The European economy, on the other hand, is not as lucky. Whatever growth they have appears to be driven by exports more than anything else. Private consumption is not playing a key role here:
The differences are striking in terms of private-consumption growth. Americans are now back at a level of consumption where they can maintain their standard of living and even start getting ahead a little bit. In Europe, by contrast, the standard of living has been declining consistently for over a decade: consumption growth has been below the Industrial Poverty threshold since the Millennium Recession.*
This points to a fundamental weakness in the European economy. While government has assumed more responsibilities for people’s lives in Europe than here – and as a result has a higher level of spending – it is important to understand that this does not compensate for lack of private-consumption growth. Government spending in Europe has been held back by welfare-statist austerity policies for a good six years now, which only pours more salt in the growth-stopping wounds on the European economy.
For all the macroeconomic reasons reported above, Europe will not return to growth any time soon. The American economy will continue to grow at moderate rates for another couple of years, during which we will see a reversal of the exchange rate between the euro and the dollar.
*) For an explanation of the two-percent growth threshold in private consumption, see my book Industrial Poverty, specifically the section about applying Okun’s Law to private consumption.
Yesterday I asked if libertarianism has failed as a political theory. The question is merited: in a world where government is involved in everything from health care and education to “saving” for your retirement, and where government involvement is increasing, one has to wonder why the libertarian movement has not been able to move the needle in the right direction.
Despite this pessimistic review of the lack of libertarian accomplishments, the answer to yesterday’s question is actually: No.
The libertarian movement has not failed. But its list of accomplishments is way too short. If all libertarians share the common goal of saving – and restoring – individual and economic freedom, then our combined efforts thus far have missed the target by a big margin. If we are going to reach the ultimate goal of a minimal state with a maximum of freedom, we need to reboot our operations and get back to work, but do so under two very important conditions.
Before we get to the two conditions, though, let us acknowledge what is actually on the list of libertarian accomplishments. Globally, the movement helped bring down the Soviet empire. It provided moral inspiration to liberty-minded people from Greifswald to the Black Sea. Economic literature on free-market Capitalism were studied behind the Iron Curtain long before the Wall fell in Berlin. Even Robert Nozick, who himself had Polish ancestry, influenced thinkers and inspired people to challenge the prevailing communist order.
Domestically, though, the accomplishments in Thatcher’s Britain and Reagan’s America were more of a temporary nature. They are in fact difficult to see today. The United States reaped the harvests of the Reagan tax cuts all the way through the 1990s, but unrelenting growth in government spending eventually neutralized and overwhelmed the positive effects of the tax cuts.
In retrospect, the Reagan era and its surge in the intellectual, political and economic pursuit of liberty looks less and less like a corner turned in modern American history. In the context of the decades before and after his presidency, Reagan appears to have inspired a temporary halt to, but not a termination of, a very long trend of welfare statism.
The first condition for future success is that libertarians revise their political methodology. the need for revision is well explained by the Niskanen Center, a newly founded libertarian think tank in Washington, DC. In their conspectus, declaring their raison d’etre, the Center explains:
Despite having invested tremendous time, energy, and resources in achieving political change, libertarians have produced little policy change. Of the 509 significant domestic legislative policy changes since World War II, more than half (265) expanded government while only four percent (20) contracted government. When policymakers act, they have, on balance, acted to expand state power.
They also analyze the “mechanics” of policy change in Washington, DC and how libertarians, despite major investments, thus far have failed to correctly identify and successfully use those mechanics to turn libertarian ideas into legislative practice.
In addition to misunderstanding the legislative mechanics, libertarians have also failed to fully comprehend the nature of government spending. This brings us to the second condition for future success. The Reagan-era tax cuts were accompanied by 7+ percent annual federal spending increases; the George W Bush administration repeated the pattern, combining tax cuts with 6.7-percent annual spending increases. The libertarian movement has failed to fully comprehend the reasons behind, and the complexity of, those spending increases. Therefore, they have lost the debate over government spending to the welfare statists.
This is a general observation; there are bright exceptions to it who pursue actionable reforms to welfare-state entitlement programs. But they are just that – exceptions. Their voices are simply not strong enough to set the tone for the libertarian movement in general. Instead, libertarians tend to fragment their analysis and policy approach, and in too many cases they leave the entitlement sector of our society altogether. Those who do tend to end up fighting the battle of eclectic flea killing, a.k.a., legalization of recreational drugs.
While some libertarians turn on, tune in a and drop out of the fight for economic freedom, the welfare state eats its way deeper into the flesh of the free market. The time to change course is now – and it begins with:
a) following the advice of aforementioned Niskanen Center, i.e., revising the political methodology and learning to master legislative mechanics; and
b) studying and intellectually conquering the welfare state.
I cannot stress enough how important the second condition is. Libertarians in general – again, there are exceptions – dismiss the welfare state by saying either that “just cut spending darn it” and the welfare state will go away; or by refocusing on issues that are not as intellectually intimidating or hard to navigate in terms of policy and actionable reform legislation.
In other words, there is an enormous amount of work to be done. But all is not lost. On the contrary, looking at the young generation in this great country, there are glimmers of hope. A fledgling libertarian grassroots movement has risen as a result of the Tea Party reaction. It consists for the most part of regular Americans whose interest in politics and willingness to become activists are fueled by clearly visible government over-reach.
More specifically, the Obama presidency is actually a gift to the libertarian movement. After having promised “hope” and “change” and rallied millions of young voters and activists, the 44th president burdened job creators with massive regulations that made it very difficult for young workers and professionals to find jobs; he put health insurance out of reach for many of those who got jobs; and he vigorously defended government surveillance programs, invading the electronic integrity of a young generation who takes the privacy of their cell phones as seriously as the privacy of their own pockets.
Young voters turned away from Obama in his re-election bid. Thanks only to an unbelievably out-of-touch Romney campaign, Obama managed to prevail. But this has not made disappointment among the young go away – on the contrary. When today’s 20-somethings look at the career opportunities their parents had, and when they know that the government is intercepting and storing their text messages, their minds are open to arguments on government over-reach, individual freedom – and libertarianism.
The growing interest in individual liberty is a promising platform for a renewed effort to end America’s slow but steady transformation into a European welfare state. High school and college students are flocking in growing numbers to internships and educational offerings by liberty-promoting organizations. Dedicated donors provide financial support, and sharp minds at think tanks and advocacy groups can turn that money into intellectual firepower.
Only two pieces are missing. One of them is the right use of the legislative mechanics. Explains Niskanen Center president Jerry Taylor, whose operational credo “terrain dictates tactics” sets the prelude for his verdict:
The political terrain could not be clearer. Despite our best efforts, America is a center-left nation. Libertarians constitute no more than 5 percent of the public. And if a Republican manages to win the White House in 2016, the recent erosion in the public support for more government will almost certainly reverse.
Europe’s record is even more disappointing. Anyway, Taylor continues:
Until some political tectonic plate shift occurs, radical libertarian policy change is not in the cards. Repealing the Great Society, much less the New Deal, is unlikely. Business regulation of some sort is not going away. The EPA, FCC, SEC, etc. will not be abolished. Less radical improvements in public policy are possible. But to do that, we need to stop making “the better” the enemy of “the best” and cease complaining that the former commits the unpardonable sin of “compromising on principle.” By definition, advocating anything short of the night watchman state “compromises on principle,” and the night watchman state—for now anyway—is a fantasy.
While Taylor unintentionally overlooks the rekindled interest in libertarian ideas during the Obama years, he is correct in that the road from today’s welfare state to the night watchman state is long and littered with road bumps and uphill battles. But if libertarians can intellectually conquer the welfare state, and if they can learn to master the legislative mechanics that Taylor points to, then no road bump or uphill will stand in their way.
In a four-part series I presented the current state of the U.S. economy. Overall, things look relatively good here: growth is moderately good, private consumption is moderately healthy, business investments are stabilizing at a good rate and government consumption and investment spending is under control.
Generally, the private sector of the U.S. economy is in fairly good shape. So what is there to complain about?
First of all, the growth rates that I refer to as “moderately good” are at least a full percentage point below what we should have at this stage of a recovery, even from a deep recession. There are reasons why we are not at higher growth, one of them being the kind of government spending that does not show up in GDP: entitlements. Another reason is the Obama administration’s affinity for regulations. Without big entitlements and invasive regulations we could easily be growing at 3.5-4 percent per year.
Secondly, the biggest strength of the U.S. economy is relative, not absolute. As I continuously report on this blog, Europe is in a perennial state of stagnation and industrial poverty. The Chinese economy is in what looks like a relatively serious recession; add to that a real estate bubble that they still don’t know how to handle and the growing trend of job migration from China to lower-cost countries like Vietnam. Japan is fledgling but not much more than that.
And third – well, there is always Obamacare… Fortunately it looks like that reform, well-intended as it was, is being reshaped into something more palatable and manageable. It takes time, though, and while the president understandably holds on to his trademark legislative achievement he, too, must come to the conclusion that not all is good in America’s most complicated piece of legislation ever. When that happens, another ball and chain around the ankle of the American economy will fall off and allow free-market Capitalism to grow even bigger.
Bottom line: the U.S. economy is not very impressive when compared to itself a couple of decades ago, but at least from an international perspective it is the best place to be for job seekers, families and businesses.
The big question is why we can’t do better. What is holding us back? As a libertarian my conclusion is “big government”. As an economist my conclusion is “it depends, but big government is a strong candidate”. But that does only begs another question: how is it that the United States, a constitutional republic born from the yearnings of freedom, has fallen for the temptation of the big welfare state?
This is a big question to answer. A good way to start is to ask what has happened to the most freedom-loving movement in recent American history – the libertarian movement – and why it has failed to turn the tide on big government. After all, modern libertarianism is now almost half-a-century old. The intellectual groundwork was laid in part by economists like Milton Friedman and Friedrich von Hayek (who, by the way, allegedly did not get along with one another…) and partly by the great moral philosopher Robert Nozick. In his Anarchy, State and Utopia, originally published in 1971, Nozick challenged the prevailing wisdom of redistributive justice and – by implication – the theoretical foundations of the welfare state. His vision of the minimal state was close in theory to the small government that would be necessary for Hayek’s and Friedman’s free-market Capitalism to work.
The Reagan presidency marked a surge for libertarianism in America. Similarly, the Thatcher era unleashed libertarian thinking and activism in Britain. While its success on continental Europe was more limited, the libertarian movement made its footprints, especially in Scandinavia and eastern Europe, where it helped inspire the liberation from the Soviet empire.
But what looked like a success story back then never translated into policy success. Why?
The question is highly relevant. In a world where government consumes 40 percent or more of GDP; when taxes can take away more than half of a man’s earnings; when government controls or wants to control the education of all children and the health care of all citizens; in that world, libertarianism seems to be little more than a topic for esoteric dinner conversations.
Where are the libertarian victories? Can libertarianism even be saved?
Yes, it can. But only under some very important conditions. For more on this, check in tomorrow.
In the first three installments of this series we looked at the aggregate-demand side of the U.S. economy. The overall message is that the economy is in pretty good shape, given the circumstances: the private-sector share of the economy has grown over the past 15 years, consumers buy more durables (such as cars) while maintaing a steady overall level of indebtedness; business investments are increasingly stable at a high rate – and government consumption and investment spending has been declining for a couple of years.
There is no doubt that the economy could do better. In the past three years GDP has been growing at 2.1-2.4 percent per year, adjusted for inflation; a good growth rate this far out of a recession would be 3-3.5 percent. There are two reasons why we are not seeing more growth than we do:
- In the short run, the federal debt and the Obama administration’s affinity for regulations have put a damper on private-sector activity;
- In the long run, the U.S. economy is in the same early stages of industrial poverty that Europe experienced some 20-25 years ago.
Nevertheless, the economy is growing and so is the private sector. This fourth and last installment takes a closer look at the production side of the economy, asking the question: what industries produce the value that adds up to our Gross Domestic Product?
The first thing we note about the value-added analysis of GDP is that the American economy is remarkably stable from a structural viewpoint. The industries that were the backbone of the economy ten years ago remain its backbone today. In 2005,
- The financial industry produced 23.2 percent of the value added in the economy;
- Manufacturing came in second at 15.1 percent;
- Professional and business services contributed 12.7 percent.
Together, these three industries added $5.67 trillion to the economy (in current prices), or 44.2 percent of the entire GDP.
In 2014, the same three sectors, again topping the ranking in the same order, produced a total value of $7.83 trillion, representing almost exactly the same share of GDP.
This is a sign of structural stability, and it is worth noting that manufacturing – the death of which is so often declared – continues to grow. From 2005 (the earliest year with consistent value-added GDP data) through the third quarter of 2014, American manufacturing grew by an average of 2.4 percent per year (again in current prices). Admittedly, this is not exceptional; most other industries have seen stronger growth. But it is a higher growth rate than, e.g., manufacturing in Europe.
If we look at value-added per employee, manufacturing looks even better. For the same 2005-2014 period, per-employee value added grew by 4.2 percent per year:
- In 2005 the average manufacturing worker produced a total value of $119,800;
- In 2009, right in the middle of the Great Recession, he produced a total value of $145,900; and
- In 2014 (annual value based on the first three quarters) the value added per employee was $171,200.
The number of employees in manufacturing has gone down over the past ten years, from 14.2 million in 2005 to 12.2 million last year. On the upside, there are 700,000 more manufacturing workers in America today than there was in 2009 and 2010, the bottom of the Great Recession.
In other words, manufacturing is on the rebound in America.
The leading industry of our economy, the financial sector, is even healthier – at least judging from the value it produces. (Let us keep in mind that this is the market value of their services, not the investments they make.) Per employee, the financial sector produced a value of…
- $322,200 in 2005;
- $366,700 in 2009; and
- $440,200 in 2014.
During the same period of time, the financial industry has increased its value added to GDP by $1 trillion in current prices, from $2.5 trillion in 2005 to $3.5 trillion in 2014.
On the job-creation side, though, the financial industry seems to suffer from the same reluctance that is holding back manufacturing. In 2005 there were almost 8.2 million people working in the financial industry; in 2014 that same number was 147,000 people lower. That said, since its recession bottom of 7,678,000 employees the industry has regained 318,000 jobs.
There is one more sector that deserves a note. Of all the major industries, mining produces the highest per-employee value: $528,000 in 2014. Furthermore, with a value-added increase of more than ten percent per year and a job growth of 4.2 percent annually, mining strongly contributes to our economic recovery.
To sum up, there is growth almost in every corner of our economy. It is a ho-hum recovery, but it remains relatively steady and it has no doubt replaced the recession as the “norm” of the economy. This is good, but things can get better. While it is unrealistic to expect stellar growth rates for the United States when both China, Europe and Japan are in recession mode, at the very least we can squeeze another percent in annual growth out of the economy.
How could we that happen? Well, that is the question for another day. For now, relax and enjoy the ride.
This the third installment about the current state of the U.S. economy analyzes consumer spending and consumer credit. Since private consumption constitutes almost 70 percent of GDP, it is of fundamental importance to have an essential understanding of how households spend money – and how they finance that spending.
As I noted in the first part of this article series, consumption as a share of the U.S. GDP has risen in recent years, claiming an almost four percentage points larger share of the economy today than it did 15 years ago. In the second part I explained that…
as the sole engine pulling the industrialized world forward, the United States is doing a reasonably good job. More details from the GDP growth numbers reinforce this conclusion. There is, e.g., private consumption which over the past three years has averaged 2.1 percent in annual growth. For 2014, though, the preliminary growth rate was 2.5 percent, a good but not excellent number. Underneath it, though, is some good news: spending on durable goods – household appliances, automobiles etc – has averaged 6.5 percent per year since 2012. This means two things: American families are improving their credit scores again after taking a beating in the trough of the Great Recession; and they are more optimistic about the future.
One of the concerns with strong growth in durable-goods spending is that it will come at the price of rising household indebtedness. Fortunately, American families in general are not going down the debt lane; perhaps having learned from the mortgage circus before the Great Recession, they seem to be holding back on overall borrowing:
- In 2008 American households had a gross debt of $14.2 trillion, equal to 133.1 percent of their disposable income;
- In 2010 their debt was down to $13.9 trillion, pushing the debt-to-income ratio down to 124.3 percent;
- In 2012 those numbers were down to $13.6 trillion and 110.6 percent, respectively.
In 2013 household debt started increasing again, exceeding $14 trillion (by $61bn) in Q3 of 2014, the first time in almost five years. The debt-to-income ratio continued to slide, flattening out at 107.7 percent inQ2 and Q3 of 2014.
However, a more detailed look at household debt shows a relationship between debt and spending on durable goods. The small rise in household debt since 2013 is due to a rise in consumer credit, i.e., the kind of borrowing that is, e.g., often used to buy cars.
After the deep dip during the opening of the recession, U.S. consumers soon regained confidence and began spending on long-term items. Almost immediately the ratio of consumer credit to disposable income started rising again. After it bottomed out at 21.4 percent in 2010 the ratio has increased steadily since then. The latest numbers reported by the Federal Reserve is 24.8 percent for Q3 2014.
Since 2010 durable-goods spending has grown by, on average, 4.9 percent annually in current prices. The growth rate for disposable income is almost exactly the same. Theoretically, this means that consumers should not have to increase their indebtedness as they spend more on durables, but the explanation for that increase is not by any means illogical. While the consumer credit ratio has increased, the ratio of mortgages to disposable income has declined steadily:
- In 2008 the ratio was 97.3 percent;
- In 2010 it had fallen to 90.7 percent;
- In 2012 it was down to 77.6 percent.
By Q3 2014 it had declined yet more, to 71.8 percent. Compared to the mortgage-to-income ratio of 2008, U.S. households have $4.7 trillion less in mortgage loans today. This opens up for the opportunity to borrow for other purposes, such as car loans.
It is encouraging to see that American households are better off and feel more confident about their future. All is not well, of course, but the slowly improving debt situation combined with the confidence in spending on durables is yet another encouraging sign that our economy is slowly moving down the right track.
The fiscal stress on the euro-zone continues. Last week the EU non-solved the Greek problem:
Eurozone finance ministers on Tuesday (24 February) approved a list of reforms submitted by Athens and cleared the path for national parliaments to endorse a four-month extension of the Greek bailout, which otherwise would have run out on 28 February. “We call on the Greek authorities to further develop and broaden the list of reform measures, based on the current arrangement, in close coordination with the institutions,” the Eurogroup of finance ministers said in a press statement.
Don’t expect that to happen. Prime minister Tsipras wants Greece to secede from the euro zone so he can pursue his Chavista socialist agenda on his own. He cannot do that without a national currency, but so long as a large majority of Greeks want to keep the euro he cannot outright declare currency independence. He needs to build momentum and create the right kind of political circumstances. This extension of status quo gives him four more months to do so.
The question is what those circumstances will look like. The EU Observer article provides a hint:
[The] IMF, while saying it can support the conclusion that the reforms plan is “sufficiently comprehensive”, criticised the plan for lacking details particularly in key areas. “We note in particular that there are neither clear commitments to design and implement the envisaged comprehensive pension and VAT policy reforms, nor unequivocal undertakings to continue already-agreed policies for opening up closed sectors, for administrative reforms, for privatisation, and for labour market reforms,” IMF chief Christine Lagarde wrote in a letter to Eurogroup chief Jeroen Dijsselbloem.
These are reforms that the new socialist government in Athens would not want to carry out. It is a good guess that they will be punting on the reforms to provoke the IMF into making an ultimatum. At that point Tsipras can tell the Greek people that he will not subject them to any more IMF-imposed austerity, and the only way he can protect them is to re-introduce the drakhma.
Will this happen in four months? It remains to be seen. But there is no way that Tsipras is going to tow the line dictated by the IMF, the ECB and the EU. His very rise to political stardom is driven by unrelenting opposition to such fiscal subordination.
In other words, the Greek crisis is far from over and will continue to be a sore spot on the euro-zone map. If it were the only one, the euro zone and the entire EU political project might still have a future. That is not the case, however:
The European Commission on Wednesday (25 February) gave France another two years to bring its budget within EU rules – the third extension in a row – saying that sanctions represent a “failure”. France has until 2017, having already missed a 2015 deadline, to reduce its budget from the projected 4.1 percent of GDP this year to below 3 percent. “Sanctions are always a failure,” said economic affairs commissioner Pierre Moscovici adding that “if we can convince and encourage, it is better”.
This is a non-solution similar to the Greek one, though for somewhat different reasons. In the Greek case the EU does not want to provoke an imminent Greek currency secession; in France they do not want to give anti-EU politicians more gasoline to pour on the European crisis fire.
What the European leadership does not seem to realize, or at least will not admit, is that the euro will lose either way. By pushing Greece too hard the EU Commission will give Tsipras his excuse to reintroduce the drakhma; by treating France with silk gloves the Commission hollows out the enforcement backbone of the currency union. Known as the Stability and Growth Pact – the balanced-budget requirement built into the EU constitution – it was supposed to hold sanctions as a sword over member states to minimize budget deficits. Now the EU Commission has effectively neutered the Pact and created an ad-hoc environment where austerity is forced upon some countries but not others.
With no sanctions there are no incentives for the states to comply. On the contrary: compliance means austerity, which comes with a big political price tag for the member states; non-compliance, on the other hand, comes with no price tag whatsoever.
To be blunt, the silk-glove treatment of France has put the final nail in the coffin of the Stability and Growth Pact. Aside from its consequences for the inherent strength of the euro, this silk glove stands in sharp contrast to the iron fist that the Commission presented Greece with already in 2010. The EU Observer again:
Valdis Dombrovskis, a commission vice-president dealing with euro issues, admitted that France is the “most complicated” case discussed on Wednesday. Paris is in theory in line for a fine for persistent breaching of the euro rules. However the politics of outright punishing a founding member of the EU, a large member state, and a country where the economically populist far-right is riding high in the polls, has always made it unlikely that the commission would go down this route.
This is of course a major mistake. The only mitigating circumstance is that France is not yet in a situation where it requires loans from the EU-ECB-IMF troika to pay its bills. But if the socialist government generally continues with its current entitlement-friendly, tax-to-the-max policies it will not see its budget problems go away.
Down the road there is at least a theoretical possibility that France could be sucked into the bailout hole. More likely, though, is that Marine Le Pen will be elected president in 2017 and pull France out of the euro. That will, so to speak, solve the problem for both parties.
I have said this before and I will maintain it ad nauseam: so long as Europe’s political leaders persist in their fervent defense of the welfare state, they will continue to drive their continent deeper and deeper into the macroeconomic quagmire called industrial poverty.