Europe keeps struggling with its impossible balanced-budget endeavor.
In a desperate attempt to save the welfare state while also balancing the government budget they keep destroying economic opportunity for their entrepreneurs and households. This leads to panic-driven spending cuts combined with higher taxes, the worst alternative of all routes available to a balanced budget. The reason – and I keep emphasizing this ad nauseam – is that they desperately do not want to remove the deficit-driving spending programs.
To break out of the shackles of their self-imposed welfare-statist version of austerity, some European politicians have suggested that the EU needs to revise the rules under which member states are brought into compliance with the Union’s balanced-budget amendment. This is not viewed kindly among the Eurocrats in Brussels. From Euractiv:
The European Commission will not let EU budget discipline rules be flouted, incoming economic affairs commissioner Pierre Moscovici said on Monday (29 September), days after his former colleagues in the French government said Paris would again miss EU targets. Last year, European Union finance ministers gave Paris an extra two years to bring its budget deficit below the EU ceiling of 3% of national output after France missed a 2013 deadline in what is called the ‘excessive deficit procedure’. But earlier this month, the French government said it would not meet the new 2015 deadline either and instead would reduce its budget shortfall below 3% only in 2017.
They certainly could meet the deadline, and they could do it even faster than proposed. All they would need to do would be to chainsaw the entire government budget until what is left fits within the three-percent rule. However, they know they cannot do that, for two reasons. The first is simple macroeconomics: so long as you do not cut taxes, any spending cuts will mean government takes more from the private sector and, relatively speaking, gives less back. That reduces private-sector activity and thus exacerbates the recession.
The second reason is that when half or more of the population depend on government for survival, you can only do so many spending cuts before they set the country on fire. The solution is a predictable way out of dependency, one that gives people an opportunity to become self sufficient without suffering undue, immediate financial hardship. That excludes tax hikes and sudden spending cuts – but on the other hand it mandates structural spending cuts that permanently terminate entitlement programs.
However, this solution to their unending economic crisis keeps eluding Europe’s policy makers.
I am a strong supporter of the United States armed forces, which are the world’s most powerful force for liberty. But war and other armed conflicts are costly in more ways than one; there is a much more efficient way to break down tyranny.
The world’s largest authoritarian regime, China, is slowly but steadily reforming in the right direction. The underlying force moving China in the right direction is, plainly, economic freedom. When people are free to own property, be entrepreneurial, build wealth and pursue a lifestyle above what a state-run economy can provide, they will eventually demand political freedom as well. The Chinese leaders know this, but they also know that political freedom can be destructive if introduced before a country is ready for it. They wisely and fearfully look at what happened in Russia after the collapse of the Soviet Union, where political freedom preceded economic freedom – and economic freedom was introduced haphazardly.
But the benefits of economic freedom are not just limited to authoritarian nations. Other countries where government plays a destructively large role can also benefit substantially from a new dose of economic freedom. As I explain in my new book Industrial Poverty, Europe is going backwards as an economy because of persistent efforts by the political leadership to preserve the welfare state and all its big spending programs – not to mention its high taxes.
Economic freedom comes in many forms: deregulation, termination of spending programs, tax cuts… and free trade between sovereign nations. Often, free trade can be an inroad for economic freedom to open up heavily regulated economies. In Europe’s case, free trade with more regions of the world could give some entrepreneurs opportunity to thrive when the domestic economy is holding them back.
Therefore, it would be good if the EU could ratify its pending free trade agreements with the United States and Canada. Unfortunately, it does not look like that is about to happen, at least any time soon. And the reason is a section of the trade agreements that protects private investments under certain conditions. The EU Observer reports:
Provisions allowing companies to sue governments to protect their investments must be taken out of an EU-Canada trade agreement (Ceta), German chancellor Angela Merkel’s coalition partners have said. Speaking in the Bundestag on Thursday (25 September), Sigmar Gabriel, who leads the centre-left SPD, noted that “the chapter regarding investment protection is not approvable,” adding that “the last word hasn’t been spoken yet”.
So what is this investment protection that the European left is so passionately opposed to? Here is how the Office of the United States Trade Representative explains it:
[The U.S. government] seek to ensure that Americans investing abroad are provided the same kinds of basic legal protections that we provide in the United States to both Americans and foreigners doing business within our borders. One element we use to achieve that goal is investor-state dispute settlement (ISDS). ISDS creates a fair and transparent process, grounded in established legal principles, for resolving individual investment disputes between investors and states. … Over the last 50 years, nearly 3,200 trade and investment agreements among 180 countries have included investment provisions, and the vast majority of these agreements have included some form of ISDS. The United States entered its first bilateral investment treaty (BIT) in 1982, and is party to 50 agreements currently in force with ISDS provisions.
Another point made by the U.S. Trade Representative is that the ISDS does not allow any government regulations at all. As anyone even remotely familiar with the United States economy would know, that is absolutely false. We have our own (un-)fair share of regulations. All that the ISDS does is protect private investors from arbitrary, authoritarian government intrusions into the realm of free enterprise.
The European interpretation of ISDS is a bit less forthright. The EU Observer again:
celebrations are likely to be muted now that the [Canada-EU trade] agreement, which is widely seen as a trial run for the ongoing trade talks with the US, faces a number of obstacles before it is ratified. The mechanism, known as investor state dispute settlement (ISDS), allows companies to take legal action against governments if their decisions risk undermining their investments. Critics of ISDS claim that investor claims can prevent governments from passing legislation in fields such as environmental and social protection, enabling corporations to claim potentially unlimited damages in “arbitration panels” if their profits are adversely affected by new regulations.
The part about “unlimited damages” is patently absurd. It would require a forecast for the investment in question that credibly predicts endless profits. But you do not need to study finance or economics to realize that such forecasts simply do not exist. That would require something called “perfect foresight”, an ability of economic agents to predict the world with absolute certainty.
But as the EU Observer reports, reason and good analysis do not prevent leftist hardliners from acting according to their beliefs:
Deputies from the centre-left Socialist and Democrat group and the Liberals have indicated that ISDS would have to be left out in order for them to support Ceta, while the Green and far-left GUE factions have already come out against the treaty. … In a statement on Thursday, the European trades union congress (ETUC) said that it would not support Ceta if ISDS remained part of the agreement. The ETUC also called on officials to include a list of sectors that would not be liberalised by the agreement and for Canada to sign up to the International Labour Organisation Conventions.
The EU Commission appears to be determined to complete the trade agreement with Canada. However, the left-bound winds in the EU Parliament are a guarantee for a protracted battle. This is unfortunate, since the EU is in dire need of strengthening its economy. In lieu of advancements for economic freedom inside the EU, a couple of trans-Altantic free-trade agreements would be of great help.
Remember this name: Julius Malema. He is the power-hungry leader of South Africa’s new Communist party, the “Economic Freedom Front”. I have written about Malema and EFF before, and I am sure we have not heard the last of them. Here is a glimpse of what kind of South Africa that awaits when he gets hold of power:
The ANC has reduced itself to a structure of corruption and incompetence. You would think that once their era is over more sensible people would come to power. Sadly, it looks like the ANC will be followed by the EFF, which is growing steadily, and that is about the worst that could happen to South Africa.
In Europe, frustration is growing almost by the day over the endemic recession. Unemployment is an unending problem, especially among the young, which at least in part explains the rise of the EU skeptics all over the continent. The only solution to the perennial crisis that Europeans seem to be able to come up with is to keep growing government, an idea that would only compound the continent’s structural economic problems and send them further into the territory of industrial poverty and stagnation.
Unsurprisingly, earlier this month the European Central Bank weakened its growth forecast. There is absolutely no doubt that this was an unwelcome piece of news at the time, and frustration among the EU leadership over the stagnant economy has only been growing since then. This is especially true of the central bankers at ECB, an institution that is making increasingly risky policy decisions the longer the crisis persists. The EU Observer explains:
European Central Bank (ECB) chief Mario Draghi has said he is prepared to use more unconventional measures to spur growth in the eurozone. “We stand ready to use additional unconventional instruments within our mandate, and alter the size and/or the composition of our unconventional interventions should it become necessary to further address risks of a too-prolonged period of low inflation,” he told MEPs on Monday … He said loose monetary policy will only be stopped “when we have complied with our mandate” which is to keep inflation at close to 2 percent. Currently inflation is at 0.4 percent.
It is important to remember that the ECB was created in the late 1990s as an institution of monetary conservatism. Its policy goal was limited exclusively to the preservation of price stability. It had no authority to provide funds to governments that ran deficits in excess of the balanced-budget requirement in the EU constitution (a.k.a., the Stability and Growth Pact). It was also beyond the bank’s realm of authority to fight unemployment, which meant a ban on trying to stimulate GDP growth.
Today, the ECB has broken through every boundary on its policy mandate. It has participated in vast funding schemes for deficit-ridden states in the euro zone. It has issued a guarantee to buy an unlimited amount of Treasury bonds issued by any “troubled” euro-zone state, thus de facto making a promise for future monetary expansion way beyond what the Federal Reserve ever did during the height of its QE programs.
The ECB has also cut interest rates on overnight liquidity deposits that banks make with the ECB. These interest rate cuts have gone so deep that they are now negative: banks literally have to pay the ECB to accept deposits.
The last move reeks of desperation. But doing all this has not been enough of a monetary expansion to get the EU economy going, so the bank added a program for favorable lending that was supposed to provide funding for entrepreneurs eager to make massive expansions to their operations – all they lacked was the cash to do it.
Or so the ECB thought. The EU Observer again:
The ECB has taken a series of steps since the summer to try and boost the economy and head off deflation, including interest-rate cuts and cheap loans to banks. In early September the Frankfurt-based bank cut rates further and announced it planned to buy asset backed securities (ABS). However its lending programme was deemed to have faltered when 255 eurozone banks last week only borrowed €82 billion of the €400 billion available.
And why did they not borrow more? Well, according to Draghi banks are afraid to look less solvent than they must in the upcoming “stress tests”. There is actually a grain of truth in that: banks that borrow but cannot lend won’t make any money on the interest margin. However, what Draghi fails to mention is that banks cannot find people and businesses to lend to simply because Europe’s families and entrepreneurs live in a stagnant economy. So long as stagnation prevails there will be no prospect of profits on new business investments.
In fact, according to Eurostat national accounts data, gross fixed capital formation – the national accounts variable that reports productive business investments – has been falling almost uninterruptedly since 2008. In fixed prices the decline is 16.8 percent from ’08 to 2013.
By contrast, data from the U.S. Bureau of Economic Analysis shows that businesses in the United States increased their investments in 2013 over 2008. The increase was a marginal 1.9 percent, adjusted for inflation, but that is a major sign of health relative European business investments.
To make the difference even more clear: in Europe gross fixed capital formation has decreased in five of the past six years since the Great Depression started; in the United States it has increased in four of the past six years.
No wonder Mario Draghi is getting desperate. But he has now effectively run out of options, proving what I said already in early June: Europe is now officially in the liquidity trap. That means two things: monetary policy is completely impotent and there will be no way out unless and until legislators reform away the enormous and very burdensome welfare state. And those reforms will not happen. So long as the welfare state remains, people are massively disincentivized from working and incentivized to live on welfare. The government budget is structurally in deficit and the massive supply of liquidity in the economy makes it very cheap for government to do nothing about that deficit.
I have said it before, sometimes frustratedly, that Europe is becoming the next Latin America, an economic wasteland filled with the remains of squandered prosperity. But while parts of Latin America are rising again (think Chile and Brazil) Europe continues its slow decline. And the ECB’s desperately-cheap-money policies are not exactly helping.
Scottish voters narrowly said no to independence. This was the better outcome: an independent Scotland governed by the Scottish National Party and Labour would have build a full-fledged Scandinavian welfare state, paid for in good part with revenue from oil taxes. It would have been a bad deal for the Scottish people, especially since they were apparently planning on staying part of the EU.
By remaining part of the United Kingdom the Scotsmen will be better off the day Britain leaves the EU. British taxes are still at the lower end in Europe, its welfare state is not quite as elaborate as in, e.g., Scandinavia and there is still a tradition of individual responsibility and opportunity left there. By seceding from the EU, Britain would have a future at least as bright as that which lies ahead for the United States once we are through this laggard recovery and back in full gear again.
In fact, the list of reasons for member states to leave the EU grows longer almost by the day. The latest addition is the so called “youth guarantee”, a feeble and typically statist idea to reduce youth unemployment. From the EU Observer:
Outgoing EU commissioner for employment Laszlo Andor on Wednesday (17 September) defended EU-wide efforts to tackle youth unemployment amid critical remarks from MEPs. Andor told deputies that the so-called youth guarantee “is well on track and is already bringing results”. He noted many of the programmes in the policy are set for adoption this year. He also said national authorities expected to send the commission “concrete information” by the end of the month on the estimated number of young people who stand to benefit. Submitting and getting the commission to adopt operational programmes is important because it entitles member states access to EU funding.
This is a good summary of what the “youth guarantee” is all about. The EU taxes its citizens (visa member states) then spends the money on putting young men and women on subsidized employment. Employers get cheap labor that they could not afford without the subsidy – and cannot afford when the subsidy ends – while government can formally count the tax-sponsored “employees” as no longer unemployed.
This is a classic example of “active labor market policy”, ALMP. Like most other bad economic ideas it has its roots in Sweden, which by the way at 27.6 percent has the eighth highest rate of youth unemployment in the EU (according to Eurostat, second quarter 2014).
The EU Observer again:
So far only France and Italy fit the description. Launched last year, the guarantee is the EU’s response to persistent record high unemployment rates among the under-25s. It aims to find young people work or training within four months after graduation or after being laid off. “In principle the youth guarantee is a very positive thing for young people, but national leaders lack the political will and ambition to properly implement it,” Allan Pall, secretary general of the Brussels-based European Youth Forum, told this website.
Of course they do. The EU has created this and expects that member states share the cost for it. First Brussels strong-arms member states into jobs-destroying austerity programs – thus saving the welfare state at the expense of full employment – then Brussels comes back and tries to mandate that those same member states spend money on artificial, tax-subsidized employment for the young men and women who could not find jobs because of austerity.
Back to the EU Observer:
Meanwhile, the jobless trend remains stubborn with one in two youths still unable to land a job in either Greece or in Spain. Spain (53.8% in July 2014) now has the highest youth unemployment numbers, overtaking cash-strapped Greece (53.1% in May 2014). Italy, Croatia, Portugal, and Cyprus are not far behind. Overall EU numbers indicate that more than one in five young people still cannot find a job.
Here are the numbers from Eurostat for the EU states that so far have reported youth unemployment for the second quarter of 2014:
It is worth noting that the Greek unemployment rate has fallen almost ten percentage points in two years. A good part of the reason, though, is that young Greeks emigrate, even to such formerly deplorable economies as Romania.
Overall, the youth unemployment rate in EU-28 is 21.7 percent and 22.9 for the 18-state euro zone. By comparison, America’s youth unemployment rate has fallen to 13.5 percent, down 3.1 percentage points in a year. That is twice the reduction in the EU-28. But more importantly, of the 26 reporting EU states, seven saw youth unemployment rise in the past year, and that includes Germany. The Netherlands reported unchanged unemployment since second quarter 2013 and only eight states reported a decline bigger than that in the United States.
To further highlight the lack of an EU-wide trend of declining youth unemployment, please note that almost one in three young men and women who went from unemployment in Q2 of 2013 to a job in Q2 of 2014 lived in Britain. In Q2 of 2013 Britain was home to only 9.3 percent of all the unemployed youth in the EU, a fact that reinforces the point that Britain, with its strong currency, moderate taxes and Anglo-Saxian economic and social traditions, does not belong in the European Union. It belongs in a trans-Altantic relationship with its culturally proximate friends in North America.
As for the rest of the EU member states, they would be well advised to develop an orderly plan for dissolving the super-state structure before Marine Le Pen becomes the next French president and destroys the euro by reintroducing the franc.
The political momentum has definitely turned against a unified Europe. Exhibit #1 is the referendum in Scotland:
Travelers to Scotland, beware. In buses, pubs and street rallies, people have only one thing on their mind these days: Scottish independence. They wear bumper stickers with “Yes” or “No thanks”, dye their hair white and blue, sing folk songs and hand out leaflets. Posters are everywhere. For the yes camp, it is about a nation going its own way, breaking away from a political elite in Westminister. To “naysayers”, it is a foolish decision instigated by populists, that will ruin two nations for generations to come. Both camps are virtually equal, with pollsters saying the referendum on Thursday (18 September) can go either way. The referendum will also have an impact on other independence-minded regions in the EU, such as Catalonia in Spain and Flanders in Belgium. Scotland will set a precedent for how Brussels deals with territories breaking off from an EU member state.
Alas, Exhibit #2, the independence movement in Catalonia:
Around 1.8 million Catalans took to the streets of Barcelona on Thursday (12 September) calling for the right to vote on independence. The demonstration marks the beginning of a critical period in Barcelona-Madrid relations. Dressed in red and yellow – the national colours – people shouted “in-inde-indepedencia!” and “volem votar!” (we want to vote) while waving the Catalan independence flag. Almost a quarter of the 7.5 million Catalans celebrated Catalan National Day – La Diada – in the streets of Barcelona, according to the local police forces. The day commemorates Catalonia’s loss of independence in the War of the Spanish Succession in 1714, exactly 300 years ago. Earlier this year, the Catalan Parliament voted two-thirds in favour for a consultative referendum to be held on 9 November, asking the Catalans “whether Catalonia is a state” and “if yes, whether that state should be independent”. The central government in Madrid, however, has said that it has ”all the mechanisms in place” to prevent such a vote.
Catalonia is the most prosperous region in Spain, having paid a big price for the country’s ill-designed austerity measures. It would be foolish of the Madrid government to try to suppress the Catalonian independence movement. A much better way forward is to recognize the undercurrent of anti-EU sentiments that also fuel this independence movement. The harsh austerity policies over the past couple of years where imposed on Spain by Brussels; if Spain was independent of the EU or at least had the backbone to stand up to their mad policy ideas the Catalonians would have much less of a reason to want to secede.
Anti-EU sentiments also played a major role in Sweden, our Exhibit #3. Last Sunday’s election sent nationalist Swedish Democrats skyrocketing to a position as the nation’s third largest party. In addition to their criticism of the current immigration policies in Sweden, the SD party is the only outspoken party against Swedish EU membership. They loosely resemble other EU-critical parties, such as Exhibit #4 in Germany:
Germany’s anti-euro party Alternative for Germany (AfD) got a further boost on Sunday (14 September) entering two more state parliaments following regional votes. “We are a party that is renewing the political landscape in Germany where people turn their back to traditional parties that have lost their profile,” said AfD party head Bernd Lucke. “One can’t deny it anymore: the citizens are thirsting for political change,” he added. Preliminary results suggest the right-wing party secured around 10.6 percent of the vote in Thuringia state and 12.2 percent in Brandenburg. The two states are traditionally seen as a power base of support for Chancellor Angela Merkel’s Christian Democrats. Founded 19 months ago, the AfD manifesto calls for a scrapping of the euro in favour of the German Deutsche Mark. The eurosceptic party has strongly criticised the eurozone bailouts and opposes the concentrated power base of the EU institutions in Brussels.
So long as the economic crisis continues it will be close to impossible for pro-EU politicians to gain back the momentum. And, as I have repeated ad nauseam, the crisis will not end until they structurally reform away the welfare state. Which, again, won’t happen.
The sad part of this is that the movements trying to roll back the EU for the most part want to do it to protect their national welfare states from EU-imposed austerity. The only real exception is UKIP which fundamentally is a libertarian party. But everywhere else the goal is to localize control over fiscal policy so that they can perpetuate their own version of the standard, redistributive welfare state.
In short: the way things are going now it is a safe bet that the EU will be history long before the European welfare state.
In the last quarter of the 20th century large parts of the world lifted themselves out of poverty. China and India are the best known but far from the only examples. Countries like Malaysia, Indonesia, Vietnam and Korea elevated themselves to a standard of living that for most of the population meant life in the global middle class. The Soviet sphere collapsed and allowed hundreds of millions of people from Saxony to Sakhalin to pursue happiness unhindered by government.
Now the prosperity train is slowly making its way through the African continent. Its effect is still marginal, but global corporations have discovered pockets of economic environments in Africa where they can actually set up operations with reasonable prospects of stability and profit.
While this is happening, the old industrialized parts of the world have mismanaged their prosperity. Latin America offers a split image with Argentina and Venezuela sinking into the holes of socialism while Chile and Brazil are examples of economic progress. The United States is still an economic superpower but has over the past 25 years allowed its government to grow irresponsibly large. It is still manageable and we are moving forward economically, but not at the pace we could.
Europe is the black sheep of the industrialized family, having squandered its prosperity for the sake of income redistribution. While Europe has not yet sunk into abject poverty, and probably never will, the continent has entered a stage of economic stagnation that it will take a very long time to get out of. In fact, the European economy is beginning to resemble some of the less oppressive countries in the Soviet sphere – not in terms of political oppression, but in terms of the destructive presence of government in the economy. Europe has, partially and unintentionally but nevertheless destructively, adopted the static statism that characterized countries like Poland, Czechoslovakia and Hungary before the Iron Curtain came down.
The stagnant nature of the European economy and the slower-than-capacity growth rates in the United States and Canada are all self inflicted. The fatally erroneous belief that government has a productive role to play in the economy inhibits the creation of prosperity in parts of the world where, fundamentally, the conditions for creating prosperity are better than anywhere else. This structural mismanagement of some of the world’s wealthiest economies have ramifications far beyond their own jurisdictions. By keeping their economies from growing, Europe’s political leaders hold back demand for products from countries on the verge of climbing out of poverty. By holding back the forces of prosperity, America’s political leaders prevent the creation of a surplus that otherwise could provide funds for development and investment projects in developing countries.
Instead of unleashing the prosperity machine we know as capitalism and economic freedom, governments in Europe and North America spend far too much time trying to preserve their welfare states. When their government-run entitlement programs promise more than taxpayers can pay for, they resort to growth-hampering austerity measures, aimed not at reducing the presence of government in the economy but at saving the very structure and philosophy of the welfare state. The result, again, is stagnation and industrial poverty.
The First World’s obsession with the welfare state thus prevents the proliferation of prosperity to parts of the world still struggling in poverty. By means of economic freedom, nationally and globally, the relatively wealthy can help the poor toward a better life. This cannot be stressed strongly enough; if accounts of the demerits of the welfare state are not enough to turn our political leaders in favor of economic freedom, then perhaps a new report on global poverty can help. Published by an organization called ATD Fourth World, Challenge 2015: Towards Sustainable Development that Leaves No One Behind provides a painfully direct account of abject poverty around the globe. The authors do not exhibit any deeper understanding of what causes poverty, but the parts of the report that tell the story of poverty from the “ground level” are definitely worth reading.
More than that, they provide a stark contrast to the destructive policies used in Europe and North America to preserve the welfare state. Instead of raising taxes and putting more of our own people on welfare, we owe it to the rest of the world to maximize our creation of prosperity. We can only do that by relieving our own population of the shackles of artificial redistribution. With more wealth, higher incomes and a growing standard of living we will have more money to trade with developing countries, as well as more surplus to donate to and invest in productive development projects in the poorest parts of the world.
Economic freedom has elevated billions of people from abject poverty to a respectable standard of living. It has elevated millions into true prosperity, and thousands upon thousands to almost unlimited wealth. It can do the same for those still in poverty. All it takes is that we in the most prosperous nations of the world sort out our priorities and responsibilities.
Sweden holds a national election on Sunday, September 14. The current parliamentary majority, a center-right coalition called The Alliance, is set to lose its majority. A three-party group of red-and-green socialists is expected to come in a few parliamentary seats short of majority, leaving the next prime minister and his cabinet dependent on nationalist, self-proclaimed “socially conservative” Swedish Democrats.
Not a lot has been said about the election outside of Sweden. This is unfortunate, because the country that American liberals used to tout as their role-model society is on the brink of a social and economic disaster up and above what any European country has experienced since the military coups in Greece and Portugal in 1967 (not counting the Balkan War).
I have covered Sweden in scattered articles, and my new book Industrial Poverty has an entire chapter on the crisis of the Swedish welfare state. However, time constraints have precluded me from analyzing the situation there in more detail on this blog. Therefore, I am grateful that the Economist reports on the pending election and its consequences. Unfortunately, the reporting is not entirely accurate:
For a decade Sweden could plausibly claim to be Europe’s most successful economy. Anders Borg, the (formerly pony-tailed) centre-right finance minister since 2006, likes to trot out numbers for his time in office: GDP growth of 12.6%, a rise in gross disposable incomes of almost 20%, a budget moving into surplus and a public debt barely above 40% of GDP.
I have no idea where they get these numbers from. But I also do not see what is so impressive with them. A GDP growth of 12.6 percent in eight years is less than 1.5 percent per year if you factor in the compounded growth effect. According to Eurostat National Accounts data, GDP growth has averaged just over 1.3 percent per year since the center-right government won the 2006 election. Private consumption has increased a bit faster, but only at the expense of a doubled debt-to-income ratio for Swedish families. In 2000 the debt-to-income ratio was approximately 90 percent; ten years later it had doubled. (By comparison, the U.S. debt-to-income ratio topped out at 140 percent before the Great Recession began.) In my new book Industrial Poverty, which has an entire chapter on Sweden, I adjust consumption growth for a constant debt ratio. The result is a staggering loss of spending (you will have to buy the book to get the details…) which shows that the only reason why the Swedish economy has grown a bit faster than the EU average over the past decade is that Swedish families have accumulated a lot more debt.
In fact, from 2006 to 2012 household debt as share of GDP grew by 22 percent, faster than in two thirds of EU countries. By 2012 Swedish households are the seventh most indebted in the EU; an extrapolation of the 2006-2012 trend would place Sweden among the top five in 2013 (for which no complete data has been reported yet).
Debt-driven growth is not the way forward, especially since the debt drive is based on an out-of-control real estate market. Swedes have access to mortgage loans that only cost them interest payments, and the Swedish central bank has the most aggressive in the EU – after the ECB – in pushing more cash out into the economy. Long story short: there is nothing to brag about in the Swedish economy.
The only sector that is thriving in Sweden is the exports industry. They, on the other hand, are increasingly operating as an isolated sector from which little more than tax revenue trickle down.
The Economist again:
[The center-right government] has overturned Sweden’s old image as a high-tax, high-spending Socialist nirvana. Twenty years ago public spending took an eye-watering 68% of GDP; today the figure is heading to 50%. Although the tax burden remains high by international standards, top rates have been cut, as have corporate taxes. Taxes on gifts, inheritance, wealth and most property have been scrapped.
This is a bad case of statistical trickery. The reason why government spending reached two thirds of GDP in 1994 is that the country’s GDP had been contracting for three years at that time, that unemployment exceeded 15 percent and that there had been no major cuts in income security programs. During the three years that followed that 1994 figure government spending was cut by an equivalent of five percent of GDP. That would be $850 billion here in the United States. Later, the Swedish government laid off one fifth of the employees in its socialized health care system. Replacement ratios in income security systems were pushed down from 90 percent of your current income to 50 percent in the worst case and nowhere more than 80 percent. Student-to-teacher ratios grew in public schools and the number of hospital beds per 100,000 citizens was reduced to the lowest level in the European Union.
If you make such heavy spending cuts you will no doubt see a decline in the ratio of government spending to GDP.
On the tax side, the Economist perpetuates the mythology that Sweden has cut its top income tax rates. In 2013 the top rate was still 60 percent, a figure that anyone can find who is willing to examine Swedish tax tables. What has been cut is the tax burden at the lower end: Sweden now has its own version of the American Earned Income Tax Credit. However, its effect has been the same as the EITC, namely to increase the discouraging marginal effect in the income tax system. While it is cheaper to live on a low income, the price tag on a promotion or an education has risen significantly.
Ignoring reality on the ground in Sweden, the Economist is surprised that Swedish voters seem ready to hand government over to the green-socialist left. Needless to say, the magazine struggles to explain the predicted election outcome:
Although the polls have narrowed sharply in the closing days before the September 14th election, all the signs are that Swedes will toss out the centre-right alliance in favour of a centre-left government led by the Social Democrats. … Inequality has risen fast, as almost everywhere—but Swedes care about this more than most. Mr Reinfeldt boasts of the creation of 300,000 private-sector jobs, yet unemployment is stubbornly high at almost 8%, and far worse among immigrants and the young.
The number for job creation is flat wrong. According to Statistics Sweden, quarterly workforce data, a total of 227,000 jobs have been added to the Swedish economy from first quarter of 2007 to first quarter of 2014. Of those jobs, only 47 percent are full-time permanent positions. The rest are temporary, primarily low-wage service jobs. Furthermore, youth unemployment – which government has tried to manipulate down – persists around 25 percent, which is close to the EU average.
With all this in mind, there is no doubt that Sweden is better off today than it would have been under a left-wing government over the past eight years. The social democrats and their prospective coalition partners – the greens and an unapologetic communist party – have promised to raise a slew of taxes as soon as they get into office. Among the more controversial proposals is to return the payroll tax for young workers from its current rate of ten percent to the normal rate three times higher. It is difficult to estimate what the actual effect of this would be on the Swedish labor market, but the attempts made thus far point to 10-20,000 lost jobs for people between high-school age and 25.
Again, Sweden would be better off under the current Alliance government, but it is, frankly, not very difficult to provide better policy than socialists whose idea of growth and prosperity is a higher tax bill. What Sweden truly needs is a turn in the libertarian direction, with major reforms to dismantle the welfare state. Such reforms would start with privatization of the country’s anorectic health care system, proceed with a strengthened – and truly private – school choice system, then privatize the country’s costly and inefficient income security system, and top it all off with a major tax reform that would cut the current world’s-highest tax burden in half.
Such reforms, however, will have to wait until there are true libertarians in Sweden’s parliament. And that won’t happen over night.
Today my book Industrial Poverty: Yesterday Sweden, Today Europe, Tomorrow America is officially available. You can order it directly from the publisher or through Amazon. An ebook version is on its way out, too, but why wait when you can get the real thing now?
In his foreword, Cato Institute senior fellow Michael Tanner writes:
Larson provides convincing evidence that the welfare state, and misguided policy choices by Europe’s governments, turned a regular recession into a systemic economic crisis. During the seemingly prosperous first years of the European Union, few people could foresee the problems ahead, and even fewer viewed these developed countries as struggling with a form of poverty. However, during this stubborn economic recession, GDP growth in many European countries slowed (or even stopped), private consumption stalled, government spending surged, and unemployment rates among the young increased. This book helps us to better understand the current situation facing Europe today, one far more complicated than the austerity versus stimulus dichotomy that is so often imposed.
And that is the most important point I hope readers will take away from this book. Europe’s crisis is not just a recession – it is the result of decades of bad policy compounded slowly into an ultimately unbearable burden for the private sector. There is plenty of evidence for this. Europe’s decline during the Great Recession is not new, but the logical continuation of four decades of slow but inevitable stagnation. The U.S. economy is on a similar, but more recent trajectory and still has the dynamics to recovery (albeit modestly) from the recession.
With slower growth it becomes more difficult for Europeans (and Americans) to increase, and eventually maintain their high standard of living. Stagnant economies also produce less surplus that can be used for aid to poor nations, either through government or through charitable donations. Trade also suffers negatively, hitting primarily low-income nations first.
Another side of economic stagnation with global repercussions is high, persistent unemployment. More than one in five young men or women in the European Union is unemployed. Overall unemployment remains stubbornly above ten percent. While the United States is experiencing declining unemployment rates, job growth is still far from as strong as it normally would in a recovery. With unemployment remaining high, it becomes increasingly difficult for Europe to provide opportunities for immigrants from poorer parts of the world.
With the two largest economies in the world tentatively on a path to long-term stagnation, the consequences for the rest of the world could be serious, especially in terms of the ability to provide disaster relief, aid and development funds. This paper suggests that the long-term stagnation is the fault of the industrialized countries. Given that the people of the prosperous nations of the world have a moral obligation to help those in abject poverty, it is immoral to fail to address the cause of long-term stagnation.
In other words, what is happening in Europe is not just a matter for the poor 500 million souls who live there, but for the rest of the world. It is of vital importance to all of us that Europe today, and the United States very soon, get their macroeconomic act together and remove the hurdles to growth and prosperity that the welfare state has created.
Yes, the welfare state. It is the root cause of Europe’s many problems. Their crisis is, to put it plainly, self inflicted. Over its more than half-century long life, the welfare state has fundamentally transformed large parts of the economic landscape. It has changed work incentives by means of both taxes and entitlements. Income-security programs, much larger in Europe than in the United States, have weakened people’s motives for participating in the workforce. The redistributive nature of the income-tax system discourages entrepreneurship and the pursuit of high-end professional careers.
Self determination and innovation are replaced by sloth and indolence.
This is a new perspective on the European crisis, a perspective that I spend my entire book explaining. The usual question “why isn’t anyone else saying this?” is easily answered: it is only recently that we have access to enough information, enough economic data, to piece together a hypothesis about the welfare state’s long-term effects on its host economy. Especially in view of the Great Recession it is now possible to study broader economic trends and the long-term macroeconomic effects of the institutions that constitute the welfare state. In this new wealth of information, a pattern is emerging, suggesting that while the welfare state can have short-term positive effects on economic growth, its long-term effects are undeniably negative.
In particular, it now appears to be possible to identify a “point of no return” beyond which the welfare state pushes an economy over the line, from the realm of GDP growth into perennial stagnation.
For more on that, and for more on what life looks like under Industrial Poverty, buy my book today!
On Friday I reported that the European Central Bank has downgraded its growth forecast for the euro zone. This wraps up a summer of bad economic news from Europe, all together showing that there is no recovery under way. At the same time, as I have explained in a series of blogs elsewhere (Ode to the American Economy, parts one, two and three), the United States continues its sleepwalk out of the Great Recession.
The differences between the U.S. and EU economies are striking. A review of the most recent Eurostat quarterly national accounts data shows that the American economy is not only outgrowing its European counterpart, but it is also in the healthier position of being dominated by consumer spending.
Let us begin with GDP growth (using the single-currency euro zone as the proxy for Europe):
Over the past 20 years for which Eurostat provides quarterly, inflation-adjusted data, there are three episodes where the United States outgrows Europe. The first episode was the heydays of the ’90s, when our unemployment was trending below four percent. Europe was struggling with twice as high unemployment rates and, in fairness, the remaining issues with Europe’s reunification. That said, with the right fiscal policies the 18 current euro-zone countries could easily have enjoyed the same forceful growth as the U.S. economy was producing.
The second episode of faster U.S. growth comes between the Millennium and Great Recessions. Many would attribute this to the housing bubble, and I am inclined to agree to some extent. However, it is important not to forget the Bush tax cuts, which in two phases – 2001 and 2003 – created a one-two punch of multiplier and accelerator effects on economic activity.
Unfortunately, this was also a period of excessive federal spending. The U.S. government grew its budget by 6.7 percent per year, on average, from 2001 to 2009, with the heaviest spending growth allocated to the latter half of that period. Indirectly, this drew resources away from private-sector growth, which partly explains the weakening of GDP growth from the top in early 2004.
As for Europe, the bump in growth right before the Great Recession is not easily explained. As shown in the two charts below, neither consumption nor exports were strong enough to produce that bump.
The third episode of American dominance is the one we are in right now. Amazingly, at a GDP growth rate mostly below 2.5 percent per year, we are leaving Europe in the dust. The difference is easily explained: after the serious dip early in the recession, U.S. fiscal policy has basically been neutral, with only marginal movements in taxes and spending. In fact, after the American Recovery and Reinvestment Act, President Obama has been the fiscally most frugal president since before Reagan. The states have also held back their spending, and even though most states still struggle with budget problems the overall trend in taxation is weakly in favor of lower taxes.
From this viewpoint the American economy has actually for the most part benefited from the Congressional deadlock and President Obama’s passion for playing golf. Our federal government is doing the American economy a favor by doing nothing. It would of course, be better if they cut taxes, reformed away entitlement programs and deregulated, but in lieu of that it is better that they continue to do nothing while we go about our business and slowly bring this economy back to something that resembles full employment.
Europe, on the other hand, is continuing to suffer from years of government-saving austerity. Their tax hikes and spending cuts have been motivated by a desire to keep as much as possible of the welfare state through the Great Recession, with little or no regard for what happens to the private sector. The European people and their businesses are now paying the price in the form of almost zero growth, eleven percent unemployment and a grim outlook on the future.
Adding insult to this national-accounts injury, the next chart shows the role of private consumption in each of the two economies:
There is a simple way to show the importance of private consumption in an economy. Subtract GDP growth from the growth rate of private consumption per period observed, in this case quarters. Sum up the difference per period and divide by the number of periods. If the resulting number is negative, it means that GDP grows faster on average than private consumption; if it is positive the opposite is true. An economy where consumption grows at least as fast as GDP is an economy where the consumer is the key economic agent, where he enjoys a high degree of economic freedom and where, therefore, the free market is a major player in the rest of the economy. In a consumption-drivene economy, the dominating end purpose of productive economic activity is to win over consumer spending on a free market, hence private businesses have to operate as free-market entities as well.
The U.S. consumption growth ratio is 1.3, meaning that for the period observed here, private consumption growth exceeds GDP growth by 1.3 percent per quarter, on average. By contrast, the euro-zone economy has a ratio of -0.7, showing that growth is driven by other variables than private consumption.
Is that “other variable” exports? Let’s take a look:
Interestingly, since the Millennium Recession there has been no major difference in the growth rate of U.S. exports and exports from euro-zone countries. The growth rates are high, especially compared to GDP growth, which means that for the slow-growing euro-zone economy the exports sector has helped keep growth up. This explains why GDP in the euro-zone countries outgrow their own private consumption, but since strong exports growth does not translate into household spending (if it did, private consumption would grow on par with exports) this means that the euro-zone economies are increasingly dependent on foreign markets to grow at all.
With its strong private-consumption growth, the U.S. economy has a big leg up on the European economy. We are, simply, a domestically dominated economy and are much less vulnerable to ups and downs of the international business cycle. Europe’s GDP, on the other hand, basically stands and falls with spending on other continents.
Furthermore, with as big a government sector as the Europeans have, their austerity policies which raise taxes – thus diminish the private sector – and cut government spending actually depress GDP in two ends.
The compounded effect on GDP is, as shown here, rather depressing. Pun intended.