Category: Uncategorized

Nationalism or Economic Freedom

Over the past few years, Hungary has made a name for itself as one of Europe’s most nationalist countries. The nationalism that has been channeled through the Fidesz party has inspired other nationalists in Europe, as well as raised concerns among those who fear the authoritarian flank of the nationalist movement.

I normally do not want to speculate in the relations between economic growth and ideological dynamics – I do, for example, not believe that nationalism can be dismissed as the response of poor, bitter, uneducated rednecks to adverse economic challenges. That narrative is the product of ivory-tower academics suffering from serious real-life comprehension deficiency.

Nationalism is much more complicated than that. It is, on the one hand, a sound patriotic expression of love for your country. I admire American patriotism, which combines a strong belief in the founding values of this great country with a generosity and openness toward everyone willing to respect those values, assimilate and live in peace and harmony with their fellow Americans. British politician Nigel Farage and his UKIP are driven by a similar, British patriotism. Mr. Farage has my full respect and support.

On the other hand, I fear the authoritarian version of nationalism which I see lurking in the shadows behind Marine Le Pen, and which have come out in the open with full force in the Golden Dawn movement in Greece.

I cannot say definitively where Hungary’s Fidesz party stands on the scale between patriotism and authoritarianism, but I think we can get a bit of an idea from looking at what has happened in the Hungarian economy in recent years. But before we get there, let us listen briefly to what the speaker of the Hungarian parliament had to say the other day about his country’s relation to the EU. Euractiv has the story:

If the European Union wants to dictate to Hungary, then the country should consider slowly backing out of the union, Parliamentary Speaker and Fidesz MP László Kövér said on 24 October, as quoted by the Hungarian press. … Kövér said that if Brussels wants to tell a country how it should be governed, then it resembles Moscow before the change of regime in 1989. The speaker reportedly said that if this is the direction the EU takes, then Hungary should consider leaving the union. He added however that this was only “a nightmare” scenario, and that he doubted it would come to that.

There are two, somewhat disparate reasons why Mr. Kövér would say something like this. The first reason is that the EU is indeed a super-state organization that merrily gets involved in every aspect of national politics. Nigel Farage often says that 75 percent of all new laws that apply in Britain are made in Brussels. Regardless of where the exact number is, there is no doubt that the EU continuously expands its powers at the cost of national sovereignty; the EU’s disastrous mishandling of the Great Recession and the debt crises in southern EU states brought out in full force the arrogance, even borderline totalitarian, power grabbing desires that Brussels is home to. From this viewpoint it is entirely understandable that the Hungarians are frustrated with the EU.

The second reason for the speaker’s lashing out is not quite as easily understood. The Hungarian economy has taken a bad beating during the Great Recession and is still struggling to get moving again. Let us take a look at the most critical GDP component, namely private consumption:

LB Hungary

Figure 1 reports two angles of private consumption in the Hungarian economy and the EU. The solid lines, which refer to the left vertical axis, represent the consumption share of GDP in the EU (green) and Hungary (purple). The share has been stable in the EU but declined in Hungary.

If GDP has grown strongly in Hungary, then the decline in the consumption share is not much of a problem. However, from 2007 through 2013 annual inflation-adjusted GDP growth in Hungary was -0.53 percent, on average. That us worse than crisis-ridden Ireland, Spain and Cyprus, and only a hair better than Portugal and Italy. With this in mind, it is hardly a surprise that private consumption in Hungary has exhibited such a deplorable growth record as reported by the purple dashed line (reference the right vertical axis). Average for 2007-2013 is -1.45 percent, worse than all the aforementioned crisis-plagued countries.

Herein lies part of the explanation to why the Hungarian parliamentary speaker is so vocal with his EU criticism. The nationalist government has not been very strong on promoting economic freedom. According to the Heritage Foundation Index of Economic Freedom, Hungary scores poorly in key categories such as government spending, monetary freedom, property rights protection and corruption. Although Fidesz may not be pursuing an open, deliberate statist strategy, the combined effects of their policies is in fact an advancement of government at the expense of the private sector.

It is very likely that statist nationalism is now taking such a toll on the Hungarian economy that voters, taxpayers and even business men are beginning to complain, loudly. In situations like this, it is a well established strategy in politics to turn people’s attention somewhere else. What better object of popular frustration than the EU?

Hungary is a country with a long, rich and fascinating history. Budapest is one of the most beautiful cities in Europe. I wish the Hungarian people all the best, but I do believe it is time for them to take another look at where their nationalist leaders are taking them, politically as well as economically.

Sweden Falls into the Liquidity Trap

Four months ago the European Central Bank officially kicked the euro zone into the liquidity trap with its zero interest rate. Non-euro members of the EU have been resisting – or pretending to resist – the temptation of going all the way out with their central banks. But now Sweden has succumbed to the temptation. The Telegraph reports:

The world’s oldest central bank has slashed interest rates to a record low of 0pc as it battles to ward off deflation. Sweden’s Riksbank decided to cut its benchmark “repo rate” by 25 basis points from 0.25pc at this month’s monetary policy meeting, following three previous rate cuts this year. The decision was not expected by polled analysts who forecast the benchmark rate to be lowered to 0.1pc. The move is designed to increase lending and push up prices and reflects worries about the real threat of deflation which have now gripped the economy.

The Swedish central bank is foolish. The ECB has already proven that you cannot fend off deflation with massive money printing. The ECB has also demonstrated that zero interest rates do not bring about the recovery that almost-zero interest rates did not bring about. In other words, the marginal policy effects of going to a zero interest rate are just that – zero.

While there are no benefits from the zero rate, there are certainly costs and risks associated with it.

To begin with, the zero rate opens the last floodgates of liquidity supply. Banks can borrow money from the central bank at practically no cost.  This pushes even more money out to the supply side of the credit markets, primarily for mortgages. With an already overheated real estate market, Sweden will now see further injections of virtually cost-free lending to home buyers and speculators.

At the same time, private consumption has been driven in good part by virtually cost-free access to credit. Swedish families are among the most indebted in Europe, with a household debt-to-income ratio far higher than it was here in the United States – even if we go back to right before the recession.

Loans are collateralized against real estate, which essentially means that most of the growth in private consumption in Sweden is directly related to the easy access to mortgages. The situation is increasingly unsustainable, and it is only a matter of time before the national legislature either puts an end to the debt fest by reintroducing amortization requirements for mortgages (yes, interest-only loans are very popular in Sweden) or the market puts an end to the endless upward price trend as banks run their balance sheets to the end.

The former is a distinct possibility – the latter is increasingly plausible as shareholders begin to worry about if mortgage-happy banks will ever get their money back…

The latter could actually happen simply by means of growing loan defaults. Yes, a lot of home owners do not even pay on their loan principals, but a notable tightening of fiscal policy could send many of them out in unemployment. The new green-socialist coalition government has just presented a budget filled to the brim with tax increases. Among them is a restoration of a higher level of payroll taxes for young employees, which will very likely wipe out tens of thousands of jobs for individuals and couples just getting started with their lives. Many of them have bought their first, tiny little apartment and now risk being hurled out in joblessness – and homelessness.

A wave of loan defaults would quickly gain the critical mass needed to send a shockwave through the entire Swedish mortgage industry. That will shut the door for one investment opportunity for the mass of liquidity floating around in the banking system. Banks will have to go find another place to turn their liquidity into revenue.

And here is where the zero-interest central bank policy gets in the way: by dropping their key interest rate to zero, the price of treasury bonds has by definition reached its expectational maximum. The only way for bond prices to go now is down. Therefore, the only place to go is to the stock market.

The problem with the Swedish stock market is that it operates in an economy that is stuck in a long, irritating recession. There are profitable corporations to invest in, but those are of limited supply – especially when the supply of liquidity on the stock market increases rapidly as the real-estate market grinds to a halt. This will push investors out from the low-risk, safe stocks toward stocks that carry increasing rates of risk. As investors go after increasingly risky stocks they will demand speculative returns to match that risk. This exacerbates risk taking, putting the market at risk for self-magnifying destabilization.

It is no longer impossible that Sweden could end up in a situation where both the real estate market and the stock market destabilize at the same time. I would consider this risk theoretical at this point – the stock market is sophisticated and operated with both derivatives and other stabilizing instruments. However, so long as the Riksbank’s monetary policy had some restraints on it, there was not even a theoretical possibility of two-market instability.

Many economists dismiss this scenario by saying that Sweden has performed spectacularly from a macroeconomic viewpoint. However, the seven-year average, inflation-adjusted GDP growth rate covering the entirety of the Great Recession (2007-2013) is a not-so-impressive 1.39 percent. If you deduct the effect from exports and from debt-driven consumption, there is nothing left. In fact, private consumption including that paid for with second and third mortgage loans has averaged 1.1 percent since 2007.

It is therefore irresponsible, not to say reckless, to suggest that Sweden can handle zero interest rates because of some underlying macroeconomic strength. That strength does not exist. The slightest aberration in real estate price trends could eradicate the domestic source of GDP growth.

Sweden has made the same mistake as the rest of Europe: they combined tight fiscal policy with very lax monetary policy. This is a recipe for liquidity-trap stagnation – just as Lord Keynes explained some 80 years ago. Students of Austrian economics have also reached this conclusion, especially through the analysis of the role that lax monetary policy plays in a modern economy.

Sadly, both Keynesian and Austrian economics are left out of the curriculum when modern graduate schools train tomorrow’s generation of economists. Advanced econometrics is passed off as the fix-it-all for our profession. Yet as Paul Ormerod and others have explained so elegantly, econometricians get it right so long as nothing is happening in the economy. Once the economy starts moving like it did in 2008-2009, prediction models based on stability rapidly become useless.

But that is a topic we will have to return to later.

Europe’s Mounting Recession Worries

As awareness rises that Europe’s economy is going nowhere but down again, anxiety among the political leadership is beginning to catch up. The latest addition to the ranks of the worried is the president of the European Central Bank, Mario Draghi. At a summit with all the euro member states on October 24 he gave a speech that echoed of the panic from 2012:

European Central Bank chief Mario Draghi on Friday (24 October) gave a stark warning to eurozone leaders about the risk of a “relapse into recession” unless they agree on a “concrete timetable” of reforms and spur investments. “The eurozone is at a critical stage, the recovery has lost its momentum, confidence is declining, unemployment is high. Commitments were made but often words were not followed by deeds,” Draghi told the 18 leaders of eurozone countries who gathered for a special meeting at the end of a regular EU summit in Brussels.

He turned his presentation into a good, old show-and-tell by providing his audience with a slide show. The slides show the following:

  • Quarter-on-quarter GDP growth for the euro zone is in an almost perfect state of stagnation since at least early 2012;
  • Unemployment has fallen slightly in the last year, but that decline is in no way different from the decline in 2012; after that decline unemployment shot up significantly;
  • Per-employee compensation growth is the lowest in ten years;
  • Inflation is trending steadily downward, and will flip into economy-wide deflation within six months;
  • While real GDP has remained stagnant since 2008 – with a growth index a hair below 100 – private investment has dropped to an index of 85 with no signs of growth;
  • Government-sector investment has dropped even further, below growth index 80, and continues to decline.

Toward the end of Draghi’s show-and-tell session he inevitably points to euro-zone government debt and deficit ratios. Then, equally inevitably, he turned to the empty toolbox for macroeconomic solutions to the zone’s macroeconomic problems:

To get the economy growing again, Draghi said leaders should not count only on actions by the ECB, but also do their share: boost investments and implement reforms. He welcomed plans made by the new EU commission chief, Jean-Claude Juncker, to raise private and public money for €300 billion worth of investments for 2015-2017. Draghi alluded to Germany by saying that countries “with fiscal space” should boost internal demand in order to help out the rest of the eurozone.

On the one hand Draghi keeps bashing the member states for not complying with the Stability and Growth Pact debt and deficit rules; on the other hand he demands some sort of help from states in activating the economy again.

Evidently, the knowledge of macroeconomics is rather limited in the higher layers of the European political and economic leadership. That is one of the big reasons why I stand by the same forecast that I have put forward all year long: Europe is in a permanent state of economic stagnation – and there is only one way out of it.

Bad Economic News, Part 2

Yes, there is more bad economic news coming out of Europe. Industrial production fell by 1.9 percent in August compared to the same month last year. Germany, the largest European economy, saw a year-to-year decline of 2.8 percent, but what is even more worrying is that German industrial production fell by 4.3 percent from July 2014 to August, the second highest month-to-month drop in the EU.

Another worrying number comes out of Greece: a decline of six percent year-to-year. While the month-to-month decline is not dramatic i itself at -1.6 percent, the Greek economy has seen industrial production fall month-to-month in five of the past six months. Not a good sign at all.

Furthermore, Sweden, a country filled with large exporting manufacturers, has seen a month-to-month decline in four of the past six months, and five of the past six months on a year-to-year basis.

As far as industrial production goes, Europe is not recovering. At best, stagnation continues. And things don’t look much better on the inflation front, according to Eurostat:

Euro area annual inflation was 0.3% in September 2014, down from 0.4% in August. This is the lowest rate recorded since October 2009. In September 2013 the rate was 1.1%. Monthly inflation was 0.4% in September 2014. European Union annual inflation was 0.4% in September 2014, down from 0.5% in August. This is the lowest rate recorded since September 2009 In September 2013 the rate was 1.3%. Monthly inflation was 0.3% in September 2014.

Despite a frenzy of liquidity expansion, the European Central Bank has not been able to reverse course. Europe as a whole is still heading for deflation. Bulgaria, Greece, Hungary, Spain, Poland, Italy, Slovenia and Slovakia are already in deflation territory. Only five EU member states, Latvia, the U.K., Austria, Finland and Romania have an inflation rate between one and two percent, the highest being 1.8 percent in Romania. The rest of the EU is stuck with zero to 0.8 percent inflation.

No wonder there is a growing conversation about the ailing currency union:

The eurozone appears to have come back onto the markets’ radar amid low inflation, poor economic news from Germany, and Greece’s bailout exit plans. Greece’s long-term borrowing costs went above 8 percent on Thursday (16 October) – their highest for almost a year – as investors took fright at the fragile political situation in the country. The government in Athens has tried to shore up popular support by suggesting it will exit its bailout programme with the International Monetary fund more than a year early. But the recent announcement spooked investors, unconvinced that Greece can stand alone.

The unrelenting stagnation of the European economy is bad news in itself for the sustainability of the currency union. If Greece exits, it will de facto but not de jure abandon the currency union. Moreover, things do not get better when Germans cluster together and sue the ECB for its allegedly illegal expansionary monetary policy:

[Critics] which include Bundesbank president Jens Wiedmann, say that the programme goes beyond the ECB’s mandate of maintaining price stability across the 18-country eurozone. They also say that knowing the ECB will buy their debt could make EU chancelleries less prudent. The plaintiffs had filed their case to the German Constitutional court in Karlsruhe, which in February referred the case to the European Court of Justice. In court, Gauweiler’s lawyer, Dietrich Murswiek, described the ECB scheme as an “egregious extension of [the bank’s] powers” which was designed to “avert the insolvency of member states”.

The ECB is not going to reverse course. They are stalwartly convinced that if money supply just keeps expanding, then eventually they can cause a shift from deflation to inflation. So long as they keep expanding money supply, interest rates will trend to zero. So long as interest rates dwell in that territory, more and more investors will turn to stock markets and real estate for profitable investments. This increases the volatility of those markets, without any gain in the real sector of the economy.

GDP at zero growth, double-digit unemployment, prices deflating, money supply exploding. Yep. This can’t go wrong.

But the budget deficit, folks – the budget deficit is now under control. Aren’t you happy?

When young, third-generation unemployed Europeans are getting tired walking up and down the streets looking for the jobs that aren’t there; when struggling former middle-class families have mopped up the scraps of what used to be a promising future; when the patients in austerity-ravaged hospitals are caught between untreated pain and calling the nurse in vain; when they all want to catch a break in their struggle to make ends meet in their new lives in industrial poverty; all they have to do is look up in the sky and see the shining budget balance spreading its glory over the economic wasteland.

Bad Economic News, Part 1

Yankees baseball legend Yogi Berra coined the proverbial phrase “It ain’t over ’til it’s over”. That is certainly true about the European economic crisis. This past week saw a crop of bad news from the Old World. Nothing very dramatic – and certainly nothing that should surprise regular readers of this blog – but nevertheless bad news. In this first of two parts, let’s look at a report from the EU Observer:

The eurozone appears to have come back onto the markets’ radar amid low inflation, poor economic news from Germany, and Greece’s bailout exit plans. Greece’s long-term borrowing costs went above 8 percent on Thursday (16 October) – their highest for almost a year – as investors took fright at the fragile political situation in the country. The government in Athens has tried to shore up popular support by suggesting it will exit its bailout programme with the International Monetary fund more than a year early.

There is an important background here. The bailout program had three components:

1. The Greek government will do everything in its power to combine a balanced budget with protecting as much as possible of its welfare state against the economic depression;

2. In return for the Greek government’s tax increases and spending cuts, the International Monetary Fund, the European Union and the European Central Bank provided loans that kept the Greek government afloat cash-wise;

3. The only metric used to measure the success of bailout policies is the stability of a balanced government budget.

If GDP did not grow, if unemployment was at 30 percent, if more than half the young in Greece had no job to go to… none of that mattered. As a result, there has been no structural improvement of the Greek economy; government has not reduced its burden on the private sector – quite the contrary, in fact. Welfare systems have been reduced, but higher taxes have prevented welfare recipients from transitioning into self sufficiency.

As a result, the social situation in Greece is almost unbearable. The political reaction has come in the form of a surge for parties on the extreme flanks of the political spectrum. In my book Industrial Poverty I explain in detail what happened in Greece, what brought the country down from the heights of European prosperity to permanent stagnation. Today, sadly, the country is little more than a macroeconomic wasteland.

It is with this in mind that one should approach the news that Greece is considering leaving the bailout program. The coalition government is under enormous pressure to save the nation itself, to keep parliamentary democracy in place and to inject some sort of life into the economy. If they fail either of two extreme political movements will take over – the Chavista communists in Syriza or the Nazis in Golden Dawn.

International investors know this and are understandably scared. In their mind the bailout is the least of available evils; in reality, as I explain in my book, the attempts at balancing the budget and saving the welfare state in the midst of the crisis are the very policies that keep Greece from recovering; weak signs of a minor recovery earlier this year have yet to materialize into anything other than the “beaten dog” syndrome often following protracted periods of austertiy.

This is the very reason why Greece is now considering leaving the bailout program. They cannot continue forever to try to muddle through with an economy deadlocked in depression and a democracy so fragile that it has brought the first Nazis into a parliament in Europe for the first time since World War II.

However, as the EU Observer explains, the Greek government is caught between a rock and a hard place – as are other hard-hit euro zone economies:

But the recent announcement spooked investors, unconvinced that Greece can stand alone. Long-term borrowing costs also jumped in the weak periphery states, Spain, Italy, and Portugal. The market jitters – while not comparable to the height of the eurozone crisis in 2011 and 2012 – come as the eurozone’s main economies are once again at odds over policy responses.

France also belongs on that list, primarily for its typically European attempt at leaving the bailout program. Its government tried to leave the bailout path for a left turn into the quagmire of government expansionism. Thinking that more government spending, on top of the largest government spending in the world, could in fact bring about a recovery, the French socialists who won the 2012 elections scoffed at the EU balanced-budget rules and went full speed ahead with their government-expansionist agenda.

Two years later that agenda has hit a brick wall. Massive tax increases, supposed to pay for some of the new government spending, have only resulted in an exodus of brain power and entrepreneurship. The French GDP is standing more still than the Eiffel Tower.

In fact, the EU Observer notes,

France and Italy are fighting a rearguard action for more flexibility saying budget slashing will condemn them to further low growth. Paris is on collision course with both Berlin and the European Commission after having indicated that it wants an extra two years to bring its budget deficit to below 3 percent of GDP. Italy, meanwhile, has submitted a national budget for 2015 which brings the country to the edge of breaking the rules.

The French challenge to the budget-balance rules compounds the uncertainty emanating from the talks in Athens about a Greek bailout exit. It is more than a theoretical possibility that at least one of these countries leaves the euro zone in the next two years, and does so for a combination of political and economic reasons. That would be an institutional change to the European economy – and really the global economy – of such proportions that no traditional quantitative analysis can render justice to a forecast of its effects. It is therefore entirely logical that global investors are growing more uncertain and as a result demand higher risk premiums.

As the icing on the uncertainty cake, informed investors know that Marine Le Pen may very well become France’s next president. If she wins in 2017 her first order of business is in all likelihood going to be to exit the euro zone and reintroduce the franc. On the one hand that could be an “orderly” exit; on the other hand it would have ripple effects throughout the southern rim of the euro zone to the point where the very future of the common currency is in grave danger.

In summary: mounting uncertainty about the future of the euro is being mixed with growing uncertainty about the macroeconomic performance of the member states of the currency union.

Stay tuned for the second part about the bad news out of Europe.

Spanish Growth An Exports Bubble?

At the beginning of this year there were lots of forecasts that the European economy was going to recover. I never believed them, primarily because government was a bigger burden on the economy than ever. So far I have been proven right, which is not something I would want to celebrate. But I also want to make clear that once government pulls back from its efforts at balancing its budget with higher taxes and spending cuts, the private sector will eventually start to recover.

There is a lot of research to show this. I review the public policy part of that research in chapter 5 in my new book Industrial Poverty. My conclusion is that this kind of austerity can work – the private sector emerges growing from even the most protracted periods of austerity. However, this is not a reason to use austerity as it has been applied through most of recent history, namely as a means to save government. Instead, austerity must be redesigned to reform away government. Otherwise the private-sector recovery that follows will suffer from two ailments:

1. It will look fast in the beginning, as consumers catch up with the standard of living they lost during the austerity period; and

2. Because of the recalibration of the welfare state – permanently higher taxes and permanently lower spending – the economy will hit its full employment level at a higher rate of unemployment than before the austerity episode.

It is also important to keep a watchful eye on whether or not a recovery is external or internal. In too many European countries over the past quarter century, a recovery has come from a rise in exports, i.e., been external. The consequence of this is that the domestic economy lags behind.

To make matters worse, much of modern manufacturing in Europe consists of bringing in parts produced in low-cost countries, assembling them at a highly efficient plant in a European country and then shipping them on to their final destination. This new kind of industrial production is increasingly isolated from the rest of the economy, which means that its multiplier effects on private consumption and business investments is relatively weak. It is, in other words, no longer possible for a small, exports-oriented European country to enter a lasting growth period merely on a rise in exports.

Earlier this year I pointed to Germany as an example of the feeble macroeconomic role of exports. You can get a temporary boost in GDP growth from a rise in exports, but once that boom goes away, it will have left very few lasting “growth footprints” in the economy. It looks like the same thing is now happening in Spain, which is in a recovery, according to the ECB:

The economic recovery has gathered momentum during 2014, with GDP growing at a faster pace than the euro area average.

Going by the latest national accounts numbers from Eurostat, which for obvious reasons covers only the first two quarters of 2014, it was not until Q2 this year that Spanish GDP outpaced the euro zone: 1.1 percent real growth over the same quarter previous year, compared to 0.5 percent for the euro zone.

Before that, Spain was doing worse than the euro zone by a handsome margin.

The ECB again:

Growth has been supported by a rise in domestic demand, while the external balance has weakened substantially as a result of a slowdown in export market growth and higher imports. Domestic consumption and investment in equipment are benefitting from growing confidence, employment creation, easier financing conditions and low inflation.

Over the past year there has been a slow but steady decline in Spanish unemployment, from 26.1 percent in August 2013 to 24.4 percent in August 2014. That is very good for a people hit very hard by disastrously ill designed fiscal policies over the past three years.

At the same time, there are clear signs that this is an “export bubble”. Consider these growth numbers for the country’s GDP (quarterly over same quarter previous year):

SPAIN 2013Q3 2013Q4 2014Q1 2014Q2
Real GDP -0.6 -0.1 0.7 1.1
Private cons. -1.2 1.1 2.1 2.2
Exports 3.7 3.2 6.4 1.5
Investments -5.4 -2.4 -0.7 0.6
Government 0.5 -3.7 0.5 1.0

There is no doubt that GDP growth is improving. While 1.1 percent is absolutely nothing to write home about, as mentioned earlier it exceeds the euro-zone average. The big question is whether or not this improvement will last. The biggest concern is the exports numbers: good growth for two quarters, then a major leap up to 6.4 percent, only to fall back to 1.5 percent. (While these are not seasonally adjusted numbers, they are quarterly growth on an annual basis which neutralizes seasonal effects.) If exports fall back to tepid growth numbers below two percent, GDP growth will most likely slide back into zero territory.

However, there are a couple of other mildly encouraging factoids in these numbers. To begin with, government spending, while on the growth side, is expanding slowly at no more than one percent per year. This number does not account for financial payments, such as unemployment benefits and other income security entitlements, but they do account for government activities that involve government employees. Alas, restraint in government spending means very little effort from government to expand its payrolls to do away with unemployment.

The apparently stable growth in private consumption is in all likelihood attributable to the post-austerity effect I pointed to above. This means that we will not see 2+ percent growth for much longer; for that to happen there has to be a sustained and substantial addition of consumers to the economy who are capable of spending more than what is required for pure subsistence. This, in turn, will not happen until unemployment comes down more than marginally.

Another mildly encouraging sign is that business investments have stopped declining. The turnaround over the past four quarters is in all likelihood an attempt by exporters to expand their capacity. If the exports boom is coming to an end, so will probably investments.

To turn this fledgling recovery into a lasting trend, the Spanish government needs to address the underlying problem in its economy: the welfare state. Otherwise it will just experience spurts of growth here and there as anomalies to a permanent state of stagnation – and industrial poverty.

Will Tax Greed Force Up Irish Taxes?

Europe is known for its high taxes, but there is one exception: corporate income taxes. Compared to American corporate income taxes – federal and state – the EU has relatively mild tax rates. While punitive personal income taxes, very high payroll taxes, confiscatory value-added taxes and other taxes contribute to holding Europe back economically, the comparative advantage of moderately reasonable corporate income taxes has helped, on the margin, to prevent the economic crisis from getting even deeper.

Now there is a push in the EU to squander this one little competitive advantage that they have on the global economic arena. The EU Observer reports:

Ireland will scrap a controversial tax instrument which allows companies to legally shift huge profits from Ireland to countries with low taxes, the country’s budget minister has announced. Speaking in the Irish parliament on Tuesday (14 October), Michael Noonan told deputies that the scheme, known as “double Irish” would be closed to new entrants in 2015 and gradually phased out between now and 2020. He added that in the future all companies registered in Ireland would have to pay tax there. The double Irish enables companies to make royalty payments to separate Irish-registered subsidiaries whose parent company is based in another country, allowing them to avoid paying corporate tax. Taken together with Ireland’s corporation tax rate of 12.5 percent, far lower than the EU average, it has prompted plenty of criticism from other EU countries in recent years.

One reason why Ireland was able to elevate itself from the bottom of the economic ranks in the 1980s to one of the wealthiest nations in the world in the early 2000s was that it promoted entrepreneurship, business investments and free markets. A package of reforms, including a drastic cut in the corporate income tax and rules such as the one mentioned here, attracted many multi-national corporations who decided to use Ireland as their springboard toward the European market.

Now Ireland is under pressure from the European Union, and the reason is deeper than just the “double Irish”. The EU Observer again:

The European Commission is currently investigating whether the tax deal between software giant Apple and the Irish government breaks the bloc’s rules on state aid, as well as similar cases in the Netherlands and Luxembourg.

Reuters elaborates:

The European Union has accused Ireland of swerving international tax rules by letting Apple shelter profits worth tens of billions of dollars from revenue collectors in return for maintaining jobs. European Competition Commissioner Joaquin Almunia told the Dublin government in a letter published on Tuesday that tax deals agreed in 1991 and 2007 amounted to state aid and may have broken EU laws. … The Commission said the tax rulings were “reverse engineered” to ensure that Apple had a minimal Irish bill, adding that minutes from meetings involving Irish officials showed that the Irish tax authority did not even attempt to apply international tax rules in its deals with Apple. Instead, the company’s tax treatment had been “motivated by employment considerations”, the Commission said, citing the minutes of meetings between Apple representatives and Irish tax officials.

I am not a legal expert, but I know enough about how taxes work to be certain about one thing: tax laws are very complicated and almost always written to benefit either the lawyers – who get more jobs by interpreting the laws for us plebeians – or to generate as much short-term government revenue as possible in a static economy. This fact alone is a reason for a conflict between the EU and the Irish government: one of them is obviously not happy with how the laws are interpreted.

However, there is another aspect on this. The commonly shared wisdom among government expansionists is that all private income belongs to government by default, and that government does the private sector a favor by not raising tax rates to 100 percent. This is why a tax cut is viewed as a “gift” to taxpayers and a “cost” to government. Therefore, when Ireland allows businesses to make money at a lower tax rate than the rest of the EU, other European government see this as Ireland is giving corporations government money – a corporate subsidy. But not only that: they see that gift as being not just from the Irish government, but from all European governments. The reason is simple: by having a low corporate tax rate Ireland puts competitive pressure on other EU governments who then have to lower, or at least refrain from raising, their corporate tax rates. By being forced to hold back taxation, Ireland’s competitors think that they are being forced to give up their own money.

As weird as it sounds, this is the reasoning underlying the debate over Ireland’s tax policy and its corporate tax rates.

More French Flee Punitive Taxes

I recently noted that the French government has resorted to desperate tax cuts. These cuts reflect a major change in economic thinking in Paris, but the decisiveness of this turnaround struck me as a bit odd. After all, there was no unpredictable economic news out there to explain why it happened now.

Or was there?

British newspaper Independent has the story:

The land of 400 cheeses, the birthplace of Molière and Coco Chanel, is facing an unprecedented exodus. Up to 2.5 million French people now live abroad, and more are bidding “au revoir” each year. A French parliamentary commission of inquiry is due to publish its report on emigration on Tuesday, but Le Figaro reported yesterday that because of a political dispute among its members over the reasons for the exodus, a “counter-report” by the opposition right-wing is to be released as an annex.

And why is this such a controversial topic? The Independent explains:

Centre-right deputies are convinced that the people who are the “lifeblood” of France are leaving because of “the impression that it’s impossible to succeed”, said Luc Chatel, secretary general of the UMP, who chaired the commission. There is “an anti-work mentality, absurd fiscal pressure, a lack of promotion prospects, and the burden of debt hanging over future generations,” he told Le Figaro.

That is France in a nutshell. No other country in Europe, not even Sweden, has been able to combine welfare-state entitlements with ideologically driven labor market regulations to the extent that the French have. (In Sweden, labor market law delegates the right to regulate the labor market to the unions instead, effectively elevating them to government power without government accountability.) But this is not the work of two years of socialism under President Hollande – it has been very long in the making. Alas, the Independent continues:

However, the report’s author Yann Galut, a Socialist deputy, said the UMP was unhappy because it had been unable to prove that a “massive exile” had taken place since the election of President François Hollande in 2012. What is certain is the steady rise in the number of emigrants across all sections of society, from young people looking for jobs to entrepreneurs to pensioners. According to a French Foreign Ministry report published at the end of last month, the top five destinations are the UK, Switzerland, the US, Belgium and Germany.

So here we have the explanation of why the French government is now scrambling to cut taxes. Their tax increases were the straw that broke the camel’s back. By raising the top income tax bracket to a confiscatory 75 percent they gave tens of thousands of entrepreneurs, medical doctors, computer engineers, finance experts, investors and business executives the final reason they needed to leave the country. As a result, tax revenue from the punitive taxes introduced under Hollande are nowhere near what the socialist government had planned for. As a result there is less money in government coffers to pay for the same socialist government’s entitlements.

The smaller-than-planned revenue stream in combination with larger-than-affordable entitlement spending opens up a budget deficit. The French government is already in breach of the EU balanced-budget law, often referred to as the Stability and Growth Pact. A self-inflicted escalation of the deficit puts Hollande in direct confrontation with the EU Commission, which is already loudly complaining that France seems perennially unable to bring its deficit down under the ceiling of three percent of GDP mandated by the aforementioned Pact.

Back now to the Independent for some more details on the French exodus:

Hélène Charveriat, the delegate-general of the Union of French Citizens Abroad … told The Independent that while the figure of 2.5 million expatriates is “not enormous”, what is more troubling is the increase of about 2 per cent each year. “Young people feel stuck, and they want interesting jobs. Businessmen say the labour code is complex and they’re taxed even before they start working. Pensioners can also pay less tax abroad,” she says.

Wait… what was that?

Businessmen say the labour code is complex and they’re taxed even before they start working.

Those evil capitalists. Two 20-year-old guys from working class homes have a passion for fixing people’s cars. They decide to open their own shop and start by working their way through the onerous French bureaucratic grinds to get their business permit. (I know someone who tried that. A story in and of itself. I’ll see if he wants to tell it in his own words.) Once they have the permit they scrape together whatever cash they can, buy some used tools and put down two months rent on a garage at a closed-down gas station. While they get the tools together, find the garage and get everything set up they obviously have no revenue. But that does not stop The People’s Friendly Government from showing up at their doorsteps to collect taxes on money they have not yet made.

These two young Frenchmen do not exist. And if they did, they would move to England and open their shop there instead, thus joining the growing outflow of driven, productive Frenchmen from all walks of life. But it is actually good that the Independent is less interested in reporting on the young French expatriates and instead puts focus on the country’s hate-the-rich taxes:

As for high-earners, almost 600 people subject to a wealth tax on assets of more than €800,000 (£630,000) left France in 2012, 20 per cent more than the previous year.

Governments in high-tax countries rarely pay any attention to the outflow of their young, productive and aspiring citizens. The argument is that those young people don’t pay much taxes anyway. Right now. Of course, if they are allowed to work and build careers and businesses instead of emigrating, they will become wealthy and create lots of jobs in the future. That, however, is a perspective that big-government proponents notoriously overlook. Therefore, there is really just one way to explain to them what harm their punitive tax policies do, and that is to shed light on the exodus of wealthy, productive people happening right now. Such news can actually work.

As indicated by my earlier article on the desperate French tax cuts, it may already be working. The French government cannot ignore forever how its combination of a wealth tax and a 75-percent tax on top incomes destroy existing jobs and, more importantly, solidly and decisively prevents the creation of new ones. They cannot forever dwell in the delusion that government somehow can raise GDP growth above the current level of zero percent, and they certainly cannot use government to create jobs for the more than ten percent of the work force that are currently unemployed.

It remains to be seen how sincere the French socialist government is about reversing course. It is by no means certain that the newly announced tax cuts mark a turning point. It could just as well be that they are mere token gestures, aimed at giving false hope of a better future to new prospective emigrants.

In Search of Economic Leadership

The global economy is gradually becoming more disparate. The United States and Japan are pulling ahead while Europe is in a permanent state of stagnation and China is likely going to experience its first, real industrialized recession ever.

In this structurally changing world there is a need for thought leadership, both nationally and globally. We have institutions that, at least to some degree, where created for that purpose. The International Monetary Fund is a good example. Unfortunately, the IMF is not taking a lead, echoing instead much of the same analysis and arguments heard from the national governments whose macroeconomic ineptitude created this long crisis in the first place.

A good example of the Fund’s attitude is put on display in a new report where the managing director of the IMF notes that:

the IMF’s World Economic Outlook had trimmed its growth forecasts for the global economy. “In the face of what we have called the risk of a new mediocre, where growth is low and uneven, we believe that there has to be a new momentum and that is what we will be discussing with the membership in the coming days. “This new momentum—with, hopefully more growth, more jobs, better growth, better jobs—is certainly something we would call on the membership to produce,” Lagarde declared.

So what is the IMF’s idea on how to get the world economy growing again? Well, Lagarde said…

the IMF has noted growing country specificity in its analysis, where within each group of economies some countries are progressing and others are lagging behind. She said the IMF recommends action in three particular areas. Monetary policy where, particularly in the euro zone and Japan, more accommodative monetary policy is needed going forward to support the economy.

This is actually the wrong recipe. Europe is already profusely accommodating with a stretched-to-the-limit monetary expansion totally unbecoming of what the founders of the ECB had in mind. Accommodation policies are in fact so bad that the euro zone is now over-saturated with liquidity and interest rates on bank overnight lending have gone negative.

None of this has helped. There is no sign on the European horizon that real-sector activity has picked up. Instead, it looks very much as though Europe has now entered its own version of the Japanese decade. After almost 15 years of a combination of stagnation, deflation and liquidity saturation, the economy has now finally entered a recovery phase. But there is no doubt whatsoever that the very protracted monetary expansion period put a lid on real-sector activity, precisely the opposite of what was intended.

The mechanisms that brought about the Japanese decade were those that Keynes specified when he defined the liquidity trap. The mechanics of the trap are important, but a topic for a separate article. What is important here is that IMF managing director Lagarde no doubt disagrees with the Keynesian analysis and, despite lack of evidence in her favor, suggests that yet more liquidity supply would get the European economy going again. That does not bode well for the Europeans.

But what about fiscal policy? Well, says the report,

more growth-friendly measures can be put in place as outlined in the IMF’s latest Fiscal Monitor that called attention to fiscal policies adjusted to support job market reforms.

No word about the need for lower taxes, more reforms promoting private deliveries on government promises. No word on how structurally over-bloated welfare states have put an unbearable burden on the welfare state in the vast majority of the world’s industrialized nations.

The IMF should be a thought leader on these issues. Instead, it has become a service organization for countries that have become stuck in a permanent state of anemic growth, recommending 20th century solutions to 21st century problems.

Ebola and Socialized Health Care

When government creates a spending program, it also makes a promise to taxpayers. So long as the sum total of those promises is small and government limited to protecting life, liberty and property, we have good reasons to believe that government can deliver on its promises. However, the more promises government makes, the fewer of those promises it will be able to keep. As government promises reach into income redistribution and services like health care, the distance between promise and provision grows into a chasm.

That chasm has opened up across Europe. As millions upon millions of Europeans have discovered, a broken government promise is not just a theoretical construct. It is harsh reality. First they were lured into dependency on government by lavish promises of being taken care of, then government walked away from its promises  – and did so without offering people a route to an alternative.

The price is paid by the people. As government fails to deliver as promised, and taxes and regulations supporting the government monopoly all remain in place, people have nowhere else to go but down. A permanent blanket of stagnation slowly descends upon the economy and a new form of industrial poverty replaces prosperity and a bright future.

This is, again, not just theory. It is harsh reality. When government asks people to trust it, and then fails to provide that trust, even ebola can slip through the cracks of the crumbling tax-funded promises. A story from the New York Times offers a chilling example:

The case is particularly worrisome to health experts because Spain is a developed country that is considered to possess the kind of rigorous infection control measures that should prevent disease transmission in the hospital. Although the Ebola epidemic has killed hundreds of doctors and nurses in West Africa, health officials in Europe and the United States have reassured the public repeatedly that if the disease reached their shores, their health care systems would be able to treat patients safely, without endangering health workers or the public.

The story also suggests:

While the risk to hospital workers is thought to be far lower in developed countries, the infection of the Spanish nurse, along with the missteps in dealing with Ebola in Dallas, exposes weak spots in highly praised defense systems.

There is a major difference between the American and Spanish cases. In Dallas, health care workers approached the patient under the assumption that the U.S. government was right when, back in July, it assured Americans that there was no real risk that ebola would ever spread to the United States. Trusting their government, the health care professionals in Dallas used their professional skills as they have been trained, assuming that the people in charge of keeping our country safe were doing their job as promised.

Once the ebola case had been confirmed, however, our health care system, which still to a large degree is private and therefore has plenty of resources, went to work and contained what could have become a very serious outbreak.

Spain is a different case altogether. To begin with, the country has a virtually open border to northern Africa, with migrants coming daily across the narrowest stretch the Mediterranean. It is comparatively easy to travel from the epicenter of the ebola outbreak to the southern coast of Spain. But more importantly, the Spanish health care system, unlike the American, has suffered major spending cuts in the last few years. In December last year The Economist observed similarities between cuts in government health monopolies in Greece and Spain, with the Greek cuts leading to…

dramatic increases in HIV, mental illness, TB and the return of malaria. Greece made its cuts two years earlier than Spain did, so their impact became evident sooner. But the situation in Spain is just as worrying, warns Helena Legido-Quigley of the [London School of Hygiene and Tropical Medicine], who fears that if the government doesn’t change course soon, similar outbreaks could very well happen in Spain.

Specifically, The Economist notices, Spanish health care spending…

was reduced by 13.7% in 2012 and by 16.2% in 2013 (including social services). Some regions imposed additional cuts as high as 10%. As a result a significant part of the Spanish population is excluded from basic health care, which could in turn lead to public-health problems for the entire population.

As part of the 2012 cuts, the Spanish government reduced tax subsidies for medicine, a measure that was also used in Greece. The effect of these cuts is that many people simply do not get the medicine they have been prescribed – since there are no private alternatives, people are locked in to a defaulting government monopoly. Because of the high taxes needed to fund the welfare state, few Spanish families have enough money to pay privately for what they have already paid for through taxes.

With resources at hospitals being tightened, access to health care rationed and a culture of austerity spreading through the entire health care system, it is not out of the realm to ask to what extent Spain is at risk of an ebola outbreak because its government made a promise to its people that it cannot afford to keep. As an example, the New York Times story cited earlier reports that in order to treat one single ebola patient, a hospital in Madrid turned an entire floor into a sealed-off isolation unit. In a health care system with tight resources, that means the hospital has to move numerous other patients to other units or even other hospitals. This in turn means increasing the number of patients per room, or (as in Sweden) putting patients in storage rooms, lunch rooms, corridors or even patient lunch cafeterias.

In a private health care system, the supply of resources is dynamic. It depends on the public need for health care and is funded through a multiple of sources, such as insurance plans, out-of-pocket payments and charitable donations. Competition and patient choice guarantee that, over time, there is always provision of health care for all patients.

By contrast, in a government health monopoly resources are static and rigidly dependent on how much taxes the legislature can squeeze out of the private sector. If, in theory, health care were the only thing government provided, it may not be an unbearable burden to taxpayers. However, a single-payer government health monopoly is the crown jewel of the welfare state, and therefore adds up to an excessive tax bill for the private sector.

The effect is inevitably a long-time economic decline and the kind of welfare-state crisis that Spain is now experiencing. The pressing question now is: can a rationed government health monopoly protect a modern, industrialized nation from a deadly disease?