Another Attack on Tax Competition

From a macroeconomic viewpoint Illinois is one of the worst-performing U.S. states. A big reason is the high taxes, by U.S. comparison, that drive jobs and businesses to other states. Illinois has raised its taxes more times than I care to count, with a “temporary” income-tax increase in 2011 that (huge surprise) has turned out to be permanent. States neighboring Illinois have been quick to capitalize on The Prairie State’s suicidal tax policy, with some crafty people in Indiana putting up this billboard at the state line:

LB 7 9 14 image

The image is not mine. It was the thumbnail for a policy paper by the Illinois Policy Institute, a hard-working free-market think tank in Chicago. I chose to borrow it because it illustrates the campaign by Indiana to attract tax-weary Illinoisans. In doing so, Indiana participates in one of the most important economic activities of our time: tax competition. Since there is completely free movement of people and capital across state lines in the United States, the decisions by families and businesses where to reside and work is governed to a relatively large degree by factors such as the tax burden. High-tax states (count Illinois among them) lose jobs and investments to low-tax states.

Politicians who want to build big governments can then sell their welfare states to taxpayers as best they can – if taxpayers prefer to keep more of their own money, and pay for more of their own consumption directly out of their own pocket, then they can choose to do so.

Tax competition fulfills two major purposes. (For an excellent introduction to tax competition, please visit this site over at Center for Freedom and Prosperity.) The first purpose is to keep the free-market sector of the economy alive. When people make decisions to move, look for jobs or invest based in part on differences in taxation, it keeps us as economic agents on alert. We do not slouch on the job, we watch for better opportunities and thereby take responsibility for ourselves and those who depend on us.

The second purpose is to put a cap on the growth, and ideally size, of government. If people can vote with their feet – or money – then government will at some point have to reconsider its plans to expand with yet more tax hikes.

Which explains why there is such widespread contempt for tax competition among lawmakers, both in the United States and in Europe. The latest expression of that contempt comes from (another huge surprise) France, where socialist politicians want to do away with tax competition altogether, at least within the EU. Reports Euractiv:

Paris has long backed the idea of an across-the-board harmonisation of EU member states’ tax systems. According to French government advisors, this must begin by a common tax base for the European banking sector, EurActiv France reports. … Those in favour of harmonisation have a mountain to climb, but have not backed away from the challenge.

Fortunately, there is still a shred of common sense to be shared among some in Europe:

Experts across Europe oppose a common tax system on the basis that competition between tax systems is positive and forces governments to be more efficient.

This, however, has not prevented government expansionists from making the most absurd arguments for abolishing tax competition. Euractiv again:

France has one of the highest levels of income tax in Europe and the government argues that low tax rates prevent the smooth working of the European Common Market. Earlier this year French President François Hollande said he wanted “harmonisation with our largest neighbours by 2020.” In a report titled Tax Harmonisation in Europe: Moving Forward, the [French government's economic advisory council] CAE proposed three ways to tackle the negative effects of fiscal competition.

The very idea that low tax rates prevent “the smooth working” of the free market in the EU is patently absurd. The argument is based on the notion that when tax rates are the same everywhere, businesses make decisions based not on taxes but on “real” business matters. But that notion disregards the fact that government is an active player in the economy, and that its services – while provided inefficiently under a coercion-based monopoly – are like most other services in the economy. I can choose to buy tax-paid services from the New York state government, or from the state of Wyoming, just as I can choose to bank with Warren Federal Credit Union or First Interstate Bank, or to buy my insurance products from Farmers, GEICO or any other insurance company.

Since government is an active player in our economy, it must be subjected to the same free-market conditions as the rest of us, as far as that is possible.

However, as we go back to the Euractiv piece we learn that this is not a concept that European statists are willing to entertain:

The first measure is to continue efforts for a common consolidated corporate tax base (CCCTB). Harmonising tax systems would make “fiscal competition more transparent and healthier,” says Agnès Bénassy-Quéré. According to Alain Trannoy, an economist who co-wrote the report, a CCCTB should be based on “reinforced cooperation or with some countries like Germany, France, the Benelux states and Italy, in order to create a snowball effect in different Eurozone countries.” Harmonising tax bases would also reduce the risks of optimisation, when multinationals transfer their revenues from one country to another in order to benefit from lower corporate tax. “Corporate tax is an important element, but there is no point if tax bases are not harmonised,” said Alain Trannoy.

And now for the three-dollar bill question: once these high-tax EU states succeed in creating a high-tax cartel, what is going to happen with the tax rates?

a) They will go up,

b) They will go up, or

c) They will go up.

You may choose whichever answer you want, so long as your choice is harmonized with the answers you do not choose.

Euractiv again:

According to the authors, the Banking Union, which was adopted in April, needs to go further in the area of taxation. This can be done with a Single Financial Activity Tax (FAT) in Europe. They also advocate a minimum corporate income tax for the banking sector, the receipts of which should be reinvested into infrastructure and long term investments and “form the first building block of a euro area budget.”

And there you have it. The real purpose behind this is to build yet another level of government spending. While it sounds noble to invest in “infrastructure” and the like, this is, after all Europe. Therefore, it is a safe bet to foresee that if this new level of government were ever to be created, its spending would go primarily toward yet more entitlement programs in an even more complex welfare state. Let’s keep in mind that there are already politicians on the left flank of European politics who are pushing hard for harmonized entitlement programs across the EU. What better venue for that harmonization than a full-fledged, EU-level welfare state?

And as we all immediately understand, the world’s largest welfare state, which has not solved all the alleged problems of inequality and poverty it was created to solve, must therefore obviously become a lot bigger.

Out there, on the outer left rim of unabridged statism, the question “when is government big enough?” simply does not have an answer. With the next EU Commissioner for Economic Affairs likely being a socialist, this unanswered question is going to have serious consequences for Europe. Its current journey into industrial poverty, paved by the world’s most sloth-inducing entitlement systems and fueled by the world’s highest taxes, apparently is not going fast enough.

Spain: A Macroeconomic Assessment

We keep hearing from the soothsayers who suggest Europe is in the recovery phase of a protracted recession. The latest to join the chorus is the British newspaper The Guardian:

Spain’s economic recovery was underlined as its manufacturing sector recorded its greatest activity in seven years, but the financial crisis has left its mark with separate figures showing a sharp rise in people leaving the country. A snapshot of the state of Spanish factories combining output, orders and employment showed activity rose to a seven-year high in June. The Markit PMI increased to 54.6 from 52.9 in July – with a reading above 50 indicating expansion. That puts growth in Spain’s manufacturing sector ahead of Germany, France and Italy and is further evidence that its economy is outperforming the eurozone as whole.

To begin with, it is not very hard to outperform the euro zone, where GDP growth is as close to zero as anything can be. Private consumption is exceptionally weak, and even the OECD has been forced to downgrade its previously optimistic growth forecast for the EU.

But more importantly, a rise in an index is not a rise in actual economic activity. For that to happen, there must be a change for the better in national accounts data. More on that in a moment – first we return to the Guardian story:

The struggling Spanish car industry in particular is showing signs of recovery thanks in part to a government incentive scheme, now in its sixth year, for people to upgrade their vehicles. Christian Schulz, senior economist at Berenberg bank, said Spain was benefiting from the reforms that it put in place in response to the financial crisis. “If we add similarly impressive readings for the Spanish services sector, we can safely conclude that Spain is reaping the rewards of its tough labour market reforms of 2012 and is becoming a mainstay of eurozone growth,” he said.

The program referred to is one where government offers 1,000 euros toward the down payment on a new car that costs no more than 25,000 euros, provided the buyer trades in a 7-10-year-old, less fuel efficient car. According to at least one report this has contributed to the sales of 300,000 cars in Spain in the last couple of years.

There are a couple of problems with programs like these. First of all, they create a sense of entitlement among consumers, who learn to expect their government to chip in. Today it is toward cars, tomorrow – who knows? Homes? Furniture? Haircuts?

Secondly, it skews the car market. People buy smaller cars than they otherwise would, sending signals of demand to car manufacturers that are not based on free-market conditions but government subsidies. When those subsidies end because they are too costly for government, manufacturers will be left there with production capacity designed not based on the free market, but on defaulted government promises.

Third, the rebate increases the purchasing power of consumers who would otherwise not be able to afford a car. As a direct result, consumers can get approved for car loans with weaker ability to repay them than if there had been no tax-paid incentives program. What happens when those consumers default on their loans?

It remains to be seen how important this program is for the weak but nevertheless increase in private consumption that we can see in Spain’s GDP numbers.

LB7714Spain2

Adjusted for inflation, Spanish private consumption fell for 13 quarters in a row, from third quarter 2010 to third quarter 2013. In the fourth quarter of last year and the first this year, households increased their spending by, respectively, one and two percent.

Does this signal a recovery? It is too early to tell, especially since there was a similar spike in early 2010. But it is entirely likely that the car-buyer incentives program has artificially boosted the shift in consumer spending from decline to increase. This means that the reversal from worse to better – at least in consumer spending – is the result of government spending. Since Spanish government finances are in bad shape due to the economic depression, this only means that the macroeconomic problems that the Spanish government is trying to solve are just being shuffled around.

There is more evidence of this. In the figure above, the strongest growth is not in private consumption but in exports. In the past 17 quarters, since the beginning of 2010, Spanish gross exports have increased by an annual rate of 6.7 percent on average. By contrast, private consumption contracted by an annual average of 1.3 percent over the same period. This marks a shift in importance for GDP, with private consumption slightly declining as growth driver, and exports rising in its place.

Arithmetically, this makes a lot of sense. A variable that constitutes a small share of GDP grows rapidly for a long period of time. At some point it ceases to be a small variable and instead becomes important for GDP. When it does, its effect on GDP increases, accelerating GDP growth while exports still grow at the same pace as before.

However, this is a problem from a macroeconomic viewpoint. The Spaniards are not getting wealthier from the exports boom. Private consumption is not moving anywhere, and when it seems to be increasing it is ostensibly because of a government subsidy in one particular area. (There is also a home buyer’s program, but let’s not even get into that today…)

But it is not just private consumption that shows that there is no real domestic recovery in Spain:

LB7714Spain

While, as the green line shows, the exports share of GDP has been growing steadily during the Great Recession, the orange line shows that business investments have been on a steady decline (again as share of GDP). And this decline is all the more dramatic: Spanish businesses have decreased their investments, in fixed prices, for five straight years now.

Yes – five straight years. Since the first quarter of 2009 there is not a single quarter with growth in business investments. Measured in fixed prices, the amount that Spanish businesses spent on investments in the first quarter of 2014 was only two thirds of what they spent in the first quarter of 2009. This has happened while, again, exports have been growing solidly.

So long as businesses do not reverse the downward trend in investments on a sustained basis, there can be no recovery in the Spanish economy. Growing exports will not generate a recovery, especially not when the growth is concentrated to manufacturing. Modern manufacturers in Europe often import parts and assemble them on European soil. This means that growing exports are followed by growing imports of manufacturing inputs – in essence a passing-through of products that does not have any positive repercussions for the rest of the economy.

In January I explained that Germany has precisely this problem. If the exports were a sign of recovery in other EU countries, there would be hope for a recovery across Europe. But that is not the case: everywhere you look in Europe, private consumption and other domestic-spending variables are growing very reluctantly, if at all. The exports that the Euroepans are so happy about are, in other words, bound for other continents, without having any real positive effect on the European economy itself.

Europe will not return to growth, prosperity and full employment until its political leadership realizes what the problem is: the big, burdensome welfare state and its high taxes and anti-productive set of incentives that steer people away from self sufficiency and straight into life long career of sloth, indolence and government dependency.

EU Economy Going Nowhere

There is no better macroeconomic “health indicator” for an economy than private consumption. Not only is it the largest part of GDP, but private consumption also reflects well the overall sentiment of households. Since households are important spenders, taxpayers and workers all baked into one type of economic unit, the growth rate of private consumption is the best quick-check “wellness test” of an economy. (A more detailed understanding of the shape of an economy obviously requires a more detailed macroeconomic and microeconomic analysis.)

Since I have recently reported on how the European economic recovery has not materialized, I figured it would only be fair to perform a quick-check macroeconomic “wellness test”. Alas, I pulled private consumption data from Eurostat, and I made sure to get inflation-adjusted figures based on a price that is relatively distant in time. (If the index year is close in time there can be growth distortions based on the mere proximity to “year zero”.) I also selected quarterly data, which is not commonly used for this purpose. My motivation, though, is that if the quarterly data is not seasonally adjusted it allows for a more frequent communication of household sentiments.

You would expect this type of data to be available from every EU member state for every quarter you might want it. I often encounter that attitude from consumers of public policy research: somehow they assume that every piece of statistical information anyone could ever want is readily available within two clicks into the internet. That is not the case, though, and the reason is simple. Quality statistical material requires careful data collection, according to detailed and very rigid collection methods; it requires methodologically rigorous processing according to standards defined not just for this piece of information, but for every comparable piece of information in the world.

There are other methodological restrictions on statistical information that contribute to the production cost. We should actually take this as a sign of quality for the data we have access to; I always get suspicious when scholars claim to have produced large sets of quantitative information in short periods of time – it often leads to bombastic conclusions that later prove to be little more than a house of cards built on clay feet.

Anyway. Back to the European economy. For reasons of high quality standards and therefore reasonably high production costs for national accounts data, not every EU member state reports the kind of consumption data analyzed here. Figure 1 below reports real private consumption growth in 24 EU member states from 2002 through 2013:

Figure 1

C pr EU 24

The growth rates, again, are inflation-adjusted rates per quarter, over the same quarter the year before. This means that the blue line reports a rolling annual growth rate, updated quarterly. As such it helps us pinpoint business cycle swings with good accuracy. The  most obvious example is that private consumption nosedives in the second quarter of 2008: after having averaged an acceptable two percent per year from 2003 through 2007, private consumption literally came to a standstill over the next five years. From 2008 through 2012 the average growth rate was zero percent.

The difference may not seem like much, but for two reasons it would be wrong to draw that conclusion. First, a one-percent reduction in private consumption equals a decline in spending worth a bit over two million jobs in the EU-28 economy. This does not mean that two million Europeans automatically lose their jobs if households cut spending by one percent – the economy is more dynamic than that. But it does mean that if private businesses lose sales over a sustained period of time they cannot afford to keep all of their employees. At the macroeconomic level this eventually translates into, roughly, two million jobs per one percent private consumption (measured in current prices).

In other words, even seemingly small fluctuations in household spending can have major effects on the economy.

Secondly, sluggish private consumption means that the economy is not evolving. If the growth rate falls below two percent, then at least in theory consumers are no longer improving their standard of living. I explain in detail how this works in my book Industrial Poverty (out August 28); a very brief explanation is that it takes a certain level of sustained spending to maintain one’s standard of living. As products get better and other factors affect the quality of our consumption, we have to grow our outlays by a certain minimum rate just to make sure we keep our standard of living intact.

For the first half of the 12 years reported in Figure 1, households in the 24 selected EU member states managed to maintain their standard of living; on the other hand, for the second half of the period they did not maintain that standard. With an average growth rate of zero (adjusted for inflation) the theoretical loss of standard of living was two percent per year.

In addition to creating unemployment, this protracted sluggishness in household spending is a long-term prosperity downgrade for Europe’s consumers. What is even worse is that there are still no signs of a return to higher growth rates. While 2013 saw an average .8 percent growth in the EU-24 we discuss here, that came on the heels of ytwo years of negative growth (-0.6 percent). There was a similar, and bigger, uptick in 2010 (1.5 percent) that proved to be an anomaly compared to the two years before and after.

Furthermore, data for the first quarter of 2014, which is available for 20 of the 24 EU member states, shows a rise in inflation-adjusted private consumption in three countries only. While it is good to see a rise in Greece and Spain, which have been the hardest hit by the crisis (Austria is the third) this is far too isolated and far too small to be the turnaround many economists have hoped for.

More importantly, this is where the use of quarterly data can spook the careless observer. Spanish private consumption, which is up by 3.1 percent in the first quarter of this year, has a pattern of growing every other quarter. Since it was down 1.3 percent in the last quarter of 2013, this only means that the economy is on track with its historic path (which, sadly, means zero growth over the 16 quarters in 2010-2013). The rise in Greek private spending is part of a similar pattern, coming on the heels of a 2010-2013 average of -1.1 percent.

Bottom line, then, is that European households are unwilling or, more likely, unable to unleash that spending spree the European economy needs so badly. This should not surprise any regular reader of this blog, but it will in all likelihood be a surprise to those who live in the illusion that big government and the welfare state are the blessings that prosperity is built from.

A Recipe for Industrial Poverty

I got some really positive feedback on my first austerity video. Thank you! The topic is timely, especially with reference to the crisis in Europe. After the elections in May when statist parties on the left gained seats in the European Parliament, the debate over how to handle the perennial economic slump has intensified. Austerity critics have become more vocal, and the funniest part of that is that they do not even realize that the kind of austerity they criticize is really the kind I define as “Government-First” austerity in my video.

This is telling of what the debate over austerity in Europe is really about, and who the participants are. Proponents of the European version of austerity are not out to reduce the size of government, but to make sure government – the welfare state to be precise – survives the recession as unharmed as possible. As I point out on the video, if they had a “Limited Government” purpose behind their austerity they would use private-sector growth, or lack thereof, as their metrics for whether or not austerity was successful. But since private-sector activity has been plunging in the countries hit worst by the European version of austerity, it is clear that the purpose behind austerity as applied in the EU is of the “Government First” kind.

This puts an absurd light on far-leftist criticism of austerity. Since there are no limited-government proponents on the scene in the European debate, statists are bashing statists over not using the right tools to save the welfare state. With the noise from their fight rising, it is becoming increasingly likely that my predictions for Europe’s future will come true: the continent is bound for a new form of stagnation. So long as Europe does not dispose of the welfare state, they will end up right there, in the economic wasteland of industrial poverty.

The harder the far left works to end government-first austerity, the farther to the left they will pull economic policy in Europe. Instead of trying to balance government budgets as a means toward saving the welfare state, the far left does not even want to have to worry about the budget. Their attacks on the EU’s constitutional stability and growth pact are symptomatic of this.

Austerity criticism is not limited to the EU level. Wherever socialists have made headway in national parliamentary elections they raise their anti-austerity voices. Italy is a case in point, as illustrated by an article in the EU Observer:

The EU is at a “crossroads” between accepting a long period of austerity and high unemployment or taking steps to boost an economic recovery, Italian prime minister Matteo Renzi has warned. Speaking in national parliament on Tuesday (24 June), Renzi told deputies that “high priests and prophets of austerity” were stifling the European economy. Renzi’s government takes control of the EU’s six month rotating presidency next week and has indicated that migration and the bloc’s stability and growth pact will be its main policy priorities. The Italian prime minister has led calls for the pact’s rules on budget deficits to be interpreted in a way that encourages more public investment.

In other words, what they want to be able to do is to spend more on government-run, tax-funded education, on more roads, mass transit and so called research and development programs. They also want to pour more money into non-fossil energy, the kind of complete waste that has been Germany’s failed attempt at replacing nuclear energy with “renewable” energy sources. (Out of utter panic over rising energy prices, Germany is now building coal power plants almost as fast as the Chinese.)

None of that spending would help the economy grow. If you tax the private sector into oblivion, it does not matter if it can ship its products on four-lane highways or six-lane highways. There won’t be anyone there to buy their products in the first place. It matters even less if the energy that manufacturers would use is from sometimes-producing wind turbines or sometimes-producing solar panels. If the energy is too expensive to make manufacturing competitive, nobody is going to want to buy it in the first place.

Europe does not need more government. It does not need more government-first austerity either. It needs limited-government austerity. And soon. Otherwise, it is basically over for Europe as a first-world continent.

Socialists Attack EU Stability Pact

In the May European Parliamentary elections voters expressed strong anti-EU sentiment. This sentiment was split into two main channels, one patriotic-nationalist and one socialist. Europe’s leftist political leaders have aggressively seized the momentum, emboldened in good part by strong showings in national elections in recent years (Greece, France and Italy to mention three). They are now seeking to set a new tone in Europe’s fiscal policy, with the Stability and Growth Pact in their crosshairs.

It is important to understand what this means. The socialist desire to overhaul Europe’s fiscal rules are not driven by a concern for the European economy and its permanent crisis. Instead, their goal is to do away with restrictions on deficit spending so they can get back to their favorite political pastime: growing government. They are, however, cleverly using the lack of economic recovery to their advantage.

Before we get to the details of this, let us first note that – just as I have said over and over again – there is no recovery underway in Europe:

Eurozone business activity slipped for the second month running in June, a closely watched survey showed on Monday, with France leading the fall and possibly heading to recession. Suggesting a modest recovery could be stalling, Markit Economics said its Eurozone Composite Purchasing Managers Index (PMI) for June, a leading indicator of overall economic activity, slipped to 52.8 points from 53.5 in May. The data showed that growth remained robust in Germany, despite weakening slightly, but that the downturn deepened in France, the country generating the most worry in the 18-member currency bloc. “Once again, the bad news in June came largely from France,” said Holger Schmieding, chief economist at Berenberg Bank. Business activity in France slumped to 48.0 points from 49.3 points, pushing even lower below the 50-point line which marks the difference between expansion and shrinkage of the economy.

France is the second largest economy in the euro zone, with 21.5 percent of the zone’s total GDP. It is also the second largest economy in the EU, measured in euros, edging out Britain by eight percent. For this reason alone, a downturn in France is going to affect the entire euro area and, though obviously to a lesser degree, the entire EU economy.

However, as the EU Business story continues, we learn that France is not the only culprit here:

The June PMI rounded off the strongest quarter for three years, but a concern is that a second consecutive monthly fall in the index signals that the eurozone recovery is losing momentum,” Williamson said. The currency bloc excluding heavyweights France and Germany “is seeing the strongest growth momentum at the moment, highlighting how the periphery is recovering,” he added. Germany’s PMI stood well into expansion territory, but at 54.2 points, slightly lower than 56.1 points reached the previous month. “Despite the further drop in the overall Eurozone composite PMI, the index remains comfortably in growth territory,” said Martin van Vliet of ING. But the PMI slip “vindicates the ECB’s recent decision to implement further monetary easing and will keep fears of a Japanification of Europe firmly alive,” he said.

See I told you so. I stand firmly behind my long-term prediction that Europe’s crisis is not a protracted recession but a permanent state of economic affairs. Europe is in a permanent state of stagnation and will remain there for as long as they insist on keeping their welfare states.

This is where the surging socialists come back into the picture. The last thing they would do is admit that government is too big. Instead, they are now hard at work to do away with the restrictions on deficit spending that the EU Constitution has put in place, also known as the Stability and Growth Pact. Or, as explained in a story from the EU Observer:

The European Commission and government ministers will re-assess the bloc’s rules on deficit and debt limits by the end of 2014, the eurozone’s lead official has said. But Dutch finance minister Jeroen Dijsselbloem, who chairs the monthly meeting of the eurozone’s 18 finance ministers, insisted that the terms be kept to for now. “All the ministers stressed the importance to stick to the rules as they are now,” he told a news conference in Luxembourg on Thursday (19 June). “At the end of the year… we will look at whether we can make them less complex.” The EU’s stability and growth pact requires governments to keep budget deficits below 3 percent and debt levels to 60 percent. It has also been stiffened in the wake of the eurozone debt crisis to make it easier for the commission to impose reforms and, ultimately sanctions, on reluctant governments. But the effectiveness of the regime has been called into question this week. Germany’s economy minister Sigmar Gabriel appeared to distance himself from his country’s long-standing commitment to budgetary austerity on Monday, commenting that “no one wants higher debt, but we can only cut the deficit by slowly returning to economic growth.” Critics say that the 3 percent deficit limit enshrines austerity and prevents governments from putting in place stimulus measures to ease the pain of economic recession and boost demand.

It is interesting to compare this to statements from the IMF earlier this month. The IMF does not – at least not explicitly – want to give room for expanded government spending. But government expansionism is the underlying agenda when the EU Commission and other political leaders in Europe start questioning the debt and deficit rules if the Stability and Growth Pact. According to the prevailing wisdom among Europe’s leftists the Pact has driven austerity which in turn has reduced government spending. While they are correct in that regard, they do not mention that the same austerity measures have increased the presence of government in the other end, namely in the form of higher taxes. They obviously do not have a problem with higher taxes, but to them it is politically more advantageous to point solely at the spending side of the equation.

In short, the new leftist attack on the Pact’s debt and deficit rules seeks to cast the rules as not only having damaged the European welfare state but also as preventing future government expansion:

The Italian premier [Democratic Socialist Matteo Renzi] is a key player in delicate negotiations among EU leaders on the next president of the European Commission, who also needs the EP’s endorsement. The assembly’s socialist group, where the PD is the largest delegation, has expressed readiness to support Merkel’s candidate – former Luxembourg premier Jean-Claude Juncker – if he accepts a looser interpretation of EU budget rules. “Whoever is running to lead the EU commission should first tell us what he intends to do for growth and jobs. Rules must be applied with a minimum of common sense,” Renzi said last week, while his point man for the EU presidency, undersecretary Sandro Gozi, suggested that the EU had “worried a lot about the Stability Pact”, forgetting that “its full name is ‘Stability and Growth Pact’, not just ‘Stability Pact’”.

Interestingly, the left has gained such a momentum in their attack on the Stability and Growth Pact that they are beginning to rock support for it even among its core supporters. The EU Observer again:

On Monday, German Vice-Chancellor Sigmar Gabriel echoed Italian arguments by suggesting that countries adopting reforms that are costly in the short term, but beneficial in the long run, could win some form of budget discipline exemption. But his proposal was immediately shot down by Merkel’s right-hand man, Finance Minister Wolfgang Schaeuble. Daniel Gros, the German-born director of the Centre for European Policy Studies (CEPS), a Brussels think-tank, thinks Renzi could get his way as long as he delivers on his domestic reform pledges. “If he manages not just to announce them, but also get them approved by parliament and implemented on the ground, he would have a lot of cards in hands,” Gros says. He agrees it is a question of reinterpreting, rather than changing EU budget rules.

Or, as noted by Euractiv:

Renzi has made it clear that he wants to see increased budget flexibility under EU rules, a condition for him to back Jean-Claude Juncker as the next European Commission president. The Italian PM wants productive investments to be removed from deficit calculations. Padoan said this month that reforms undertaken should be factored in the way budget deficits are calculated.

There is no mistaking the confidence behind the left’s attempts at doing away with the Stability and Growth Pact, or at least disarming it. So far it has been political kätzerei in Germany to even raise questions about the debt and deficit rules. But as another story from Euractiv reports, that is beginning to change:

German Economic Affairs Minister Sigmar Gabriel has advocated giving crisis-ridden countries more time to get their budgets in order, triggering a debate in Germany and rumours of a divide within Germany’s grand coalition over its course for EU stability policy. … “We are in agreement: There is no necessity to change the Stability Pact,” said German Chancellor Angela Merkel in Berlin on Wednesday (18 June). The Chancellor and Economic Affairs Minister Sigmar Gabriel deflected accusations on Wednesday that there is a rift within the German government over changes to Europe’s Stability and Growth Pact. The two were clear that they are in agreement over the fact that the pact does not need to be altered. Rumours of dissent came on Monday (16 June) after Gabriel said countries should be given more time to fix their budgets in exchange for carrying out reforms, while speaking in Toulouse, France. Countries like France and Italy have been struggling with the strict conditions of the Stability Pact for some time now and continue to call for more flexibility and time. Gabriel’s initiative seeks to accommodate these concerns, a proposal that originally came from the family of social democratic parties in Europe. The French and Italian governments are run by parties belonging to this group.

The problem with the left’s aggressive assault on the Pact is not that the Pact itself is good. It is not. It is constructed by artificially defined debt and deficit limits with no real macroeconomic merit to them. No, the problem is that the left wants to be able to grow government even more, in an economy that already has the largest government sector in the world. Doing so would only reinforce Europe’s stagnation, its transformation into an economic wasteland – and its future as the world’s most notorious example of industrial poverty.

An Economic Gateway Drug

The United States of America is a wonderful country to live in. Contrary to the laments of most of my conservative and libertarian friends, this country is still among the most free and opportunity-friendly places on Earth. Americans are strong individuals, they are friendly yet have a lot of integrity, they celebrate winners and have compassion for losers. There is less racism here than in Europe, and we are more prosperous than they are, and deep down in the fertile soil of Middle America, the roots of freedom and democracy stand firm even when the political storms rage viciously through the legislative hallways of our country. Our constitution, while twisted and tweaked and bent and stretched, is still working.

Our deeply rooted sense of individuality – as opposed to individualism – and freedom is currently helping America through one of the toughest periods in her almost 250-year long history. This country is the last place on Earth where totalitarianism would take over. But our freedom, prosperity and peace are at least to some degree dependent on what is going on in the rest of the world.

This is why in the 20th century the United States established itself as a global power. Throughout most of that time, Europe has been a major scene for our foreign policy and military engagements. A big reason is that Europe has long been, and still is, a central stage for the fight against totalitarianism.

With the rise of totalitarian nationalism in primarily Germany, Italy and Spain in the 1920s and ’30s, Europe became the world’s most important battle ground between freedom and tyranny. Freedom won the war, but once the bullets had stopped flying a more polished version of the values that drove Hitler, Mussolini and Franco to power began setting roots in Western Europe. The idea of collectivism, which is in the DNA of Naziism and fascism, is also prevalent deep into the segments of European politics that are generally considered democratic. The notion that government can and should shape a nation, socially, culturally and economically, has taken seemingly more palatable forms than the swastika.

Today, nationalists no longer use the sense of patriotism as their first and foremost voter recruitment tool. The new gateway to nationalism is the welfare state.

More on that in a moment. First, a quick look back at how nationalism – and totalitarianism – is once again able to rise to political prominence in Europe.

In 1960, in one of the most revealing books on the subject, titled Beyond the Welfare State, Swedish economist Gunnar Myrdal explains how the idea of central economic planning without political dictatorship has conquered Western Europe and is slowly but relentlessly replacing Capitalism as the prevailing economic model. The welfare state, for short, would soon spread its intellectual tentacles across the Atlantic and peacefully defeat the American free-enterprise system. Myrdal was partly right: with considerable help from John Kenneth Galbraith’s Economics and the Public Purpose and The New Industrial State the American left made a major effort during the 1960s and ’70s to establish the European notion of collectivism and indicative economic planning as the new normal for the New World.

They never quite succeeded. The Obama administration represents the last effort of the collectivist left to “fundamentally remake” America (as Obama put it during his campaign). But while the welfare state is finally reaching its peak as a socio-economic model here in the United States, the Europeans are holding on to it for dear life. The entire fiscal struggle during the Great Recession has been about saving Europe’s ailing welfare states with every means possible – even at the expense of years of declining GDP, at the cost of 30, 40, 50 and even 60 percent youth unemployment. Ill-designed austerity, motivated not by a desire to shrink big government but to save it, has taken more from people in the form of higher taxes and given less back.

Instead of conceding that the welfare state is a lost cause; instead of repealing the welfare state and giving economic freedom a chance; the political leadership in Europe has doubled – no, tripled – down in their defense of collectivism, high taxes, income redistribution, entitlements, socialized health care and deep, stifling regulations of the labor market.

In countries with the biggest, most intrusive governments this has resulted in a dangerous political backlash. When voters feel betrayed by the government that promised to take care of them cradle to grave, and there is no alternative there presenting a case for economic freedom, voters turn their back on the established political institutions that gave them the welfare state. Those institutions also happen to be parliamentary democracy. Feeling that parliamentary democracy has let them down and left them out to dry, both financially and politically, large groups of voters are now turning to another form of collectivist parties.

The modern totalitarians.

When the European welfare state swept through Western Europe in the ’50s and ’60s its collectivist principles appealed to people whose cultural background was a straight line from late Medieval collectivism through undemocratic monarchies to the nationalist movements of the early 20th century. Europe may have been the birthplace of the concept of the individual, but the continent never quite unleashed what they had discovered. Unlike America, the roots of Europe’s political culture are still firmly in the notions of nationalism, collectivism and – almost for a century now – the welfare state. It was a smooth transition for Europe to go from nationalism to the welfare state: instead of being part of an ethnically, racially or culturally defined group along nation-state lines, the Europeans became part of a mildly Marxist dichotomy between taxpayers and entitlement recipients.

While the technical difference is considerable, the cultural difference is minor. The individual shrinks and crawls in under the group banner, hoping that the group will care for him. By giving legislative power to political parties that promise more entitlements, Europe’s voters have reaffirmed and reinforced the collectivist principles that guide the welfare state.

Those collectivist principles, however, are easily transferrable, from the welfare state onto another collectivist vehicle. Now that the welfare state has proven, beyond a shred of a doubt, that it can no longer keep its entitlement promises, Europe’s voters have begun listening to the old nationalist tunes again.

The difference between today’s nationalists and those that ultimately paved the way for Naziism and fascism after World War I, is that today they know how to use the welfare state to appeal to people. Every nationalist party in Europe, from the Danish People’s Party and the Swedish Democrats to the far uglier Front National in France, Fidesz and Jobbik in Hungary and Golden Dawn in Greece, promises to preserve the welfare state in one form or another. They have learned to capitalize on people’s frustration with the failing welfare state. But instead of rightly pointing out that the statist economic model is flawed, the modern nationalists – and especially the totalitarians among them – have projected the blame onto centrist, social-democrat and liberal political parties. Ultimately, this blame falls on parliamentary democracy itself.

So far, only the outer rim of the modern nationalist surge has pointed finger squarely at parliamentary democracy. However, as Golden Dawn, Jobbik and similar parties gain ground, antipathy toward the parliamentary system will grow. France will be one of the key battle grounds between nationalism and parliamentarism: if Le Pen follows in the early footsteps of her father it is entirely possible that her rise to the presidency in 2017 could mark the beginning of the end of De Gaulle’s Fifth Republic. If the radicals in her movement set the tone, the new France that would emerge – the Sixth Republic – could become a catalyst for a new, broad nationalist surge across Europe.

There are already movements around the continent hard at work to create a fascist “Gross-Europa”. They are probably not going to gain more than marginal political influence, at least not in the near future. But it is important to remember that a decade ago, the idea of a President Le Pen in France was laughable. Furthermore, the idea of a resurrection of European communism was ridiculed. I know, because I warned about it in an article in Front Page Magazine back in 2006 and got more than a few sarcastic comments from more established “thinkers”. Even a cursory look at the results in the EU Parliament election in late May shows how frighteningly right I was back then.

And I did not even consider that nationalism would be a competing force. But with two competing, and growing, totalitarian movements now procreating in Europe’s political landscape, the continent is facing a dark future. Independently, these movements will reinforce Europe’s collectivist culture and cling to its dying welfare state for as long as they can, and then some. Most of all, they are going to use it to entice people into crossing the line, from parliamentary democracy into a totalitarian political system Europe has supposedly left behind it.

Using the welfare state as an economic gateway drug, the modern totalitarians are going to try to reshape the continent that, for a century, has been America’s most costly foreign-policy problem.  Given that both the nationalists and the communists now rising to political prominence are negative, in some cases outright hostile, toward America, that foreign-policy problem may soon come back knocking on the doors of the U.S. State Department – and the Pentagon.

In a great article in the Wall Street Journal, former vice president Dick Cheney and his daughter, former senatorial candidate Liz Cheney, explain how Obama’s failures on the foreign-policy front are transforming the Middle East into a new major headache for America. They are correct, but it is crucial for America’s future that our foreign policy does not overlook the radical transformation taking place in Europe right now.

More Gasoline on EU’s Fiscal Fire

Europe’s political leaders are showing more and more signs of discomfort – not to say emerging panic – over an economic crisis that just won’t go away. My diagnosis is that this is a permanent crisis, brought upon Europe by its fiscally obese and unsustainable welfare state. (Make sure to get my book Industrial Poverty when it comes out August 28!) By consequence, it is therefore not possible for Europe to get out of the crisis unless they first roll back and eventually fully dismantle their welfare state.

Not everyone agrees. As the EU Observer reports, the social affairs commissioner of the EU – compare him to the U.S. Secretary of Health and Human Services – is getting mighty frustrated with the crisis and calls for a restoration of the welfare state:

The EU’s social affairs commissioner on Friday (13 June) lashed out at the EU’s response to the economic crisis. Lazlo Andor, in a speech delivered in Berlin, said debt-curbing policies designed to resolve the sovereign debt crisis have wrecked Europe’s social welfare model. “Austerity policies in many cases actually aggravated the economic crisis,” he said.

Has he been sneak-peeking on this blog? Apparently, because he cannot have read my articles in full. If he had, he would know that there are two answers to his frustration over austerity and the crisis. On the one hand, yes, the spending cuts have slashed entitlement programs and made it tougher to get by on government handouts. On the other hand, though, the current European austerity model has raised taxes on businesses and households. This has stifled economic growth and thus made it harder for people to get out of their government dependency.

The reason for this is that austerity, as designed and carried out during the crisis in Europe, has had the purpose of balancing the government budget – even at the cost of depressed private-sector activity. Other forms of austerity, applied back in the late 20th century, had other goals, among them to inspire growth in the private sector. The difference is monumental for the outcome of an austerity strategy.

Europe has been under the statist version of austerity, the purpose of which is to balance the government budget and therefore restore fiscal sustainability in government. The reason for this, in turn, is that as Europe’s political leaders designed a response to the crisis, it never occurred to them that the very existence of a welfare state could have something to do with the crisis.

Back to the EU Observer:

He described the EU’s economic and monetary union (EMU) as flawed from the start, forcing troubled member states to make deep cuts in the private and public sectors via internal devaluation. “Internal devaluation has resulted in high unemployment, falling household incomes and rising poverty – literally misery for tens of millions of people,” he said.

This is a technical level of macroeconomics. What Commissioner Andor is saying is actually that Greece would have been better off when the crisis began if they had been able to devalue their own currency – the drachma – vs the Deutsch mark. However, that is a way to grossly simplify the problem: the argument rests on the assumption that Greece fell into a depression because of bad terms of trade vs. Germany. But the fact of the matter is that Greece was in trouble for years before the outbreak of the Great Recession, with deficit and debt problems resulting not from insufficient exports capacity (which is what Commissioner Andor alludes to) but from a vast system of entitlement programs that promised a lot more to their recipients than taxpayers could afford.

The EU Observer again:

[The] EMU is gripped by a social and economic paradox. “On the one hand, we introduce social legislation to improve labour standards and create fair competition in the EU. On the other hand, we settle with a monetary union which, in the long run, deepens asymmetries in the community and erodes the fiscal base for national welfare states,” he said.

There you go. No blame on the welfare state, all blame on admittedly dysfunctional EU institutions. But the role of the EU did not become acute until the economic crisis had escalated to depression-level conditions in some southern EU states. It was not until the Troika (EU-ECB-IMF) went to work in 2010-11 that the venom of ill-designed austerity went to work deep inside the economies of Greece, Spain, Portugal and Italy. By then, the crisis had already started, it had escalated and caused runaway unemployment and rampant deficits.

So long as Commissioner Andor persists in believing that the welfare state is the victim, not the culprit, in this crisis, the crisis will prevail.

Commissioner Andor’s complete ignorance on this item is revealed as the EU Observer story reaches its crescendo:

A possible way out, he says, is to disperse some money from national coffers through so-called “fiscal transfers” between member states using the euro. Some of the pooled money would be used, in part, to fund a European Unemployment scheme to better prop up domestic demand, says Andor.

How many entitlement programs, and how many levels of government, do you have to involve before government expansionists understand that pouring more gasoline on the fire is not going to put out the flames?

Exports Drive Weak EU Recovery

In an article commenting on the latest Eurostat GDP numbers, Euractiv,com proclaims:

Eurozone employment rose for the second consecutive quarter in the first three months of the year in a sign the recovery was finally helping the labour market. A widening trade surplus signalled a further positive contribution to growth in April.

The article goes on to report an upward trend in economic activity for the European Union. As readers of this blog know, however, such optimism should always be consumed in moderate portions. Far too many commentators, political analysts and policy leaders have far too often declared the European crisis over, and far too many of them – all, in fact – have been wrong. Therefore, let us dive into the most recent national accounts numbers from Eurostat and see what they can tell us.

In the first quarter of 2014, the total EU economy grew at an inflation-adjusted 1.4 percent over the same quarter 2013. This is the strongest growth number since the third quarter of 2011. For the 18-state euro zone, growth was not as good: a meager 0.9 percent, which again is the best number since the third quarter of 2011.

These are not growth numbers to write home about, but the fact that they are the best in 2.5 years is at least worth a note. But what is perhaps the most remarkable news in this is that the EU and the euro zone have gone two and a half years with growth below, respectively, 1.4 and 0.9 percent. In fact, the average annual growth rate for 2012 and 2013 was -0.16 percent for the EU and -0.54 percent for the euro zone.

So does this mean that Europe is now finally seeing the light in the tunnel? Not so fast. First of all, the big problem for the European economy, the welfare state, remains in place, not unscathed by the economic crisis but vigorous enough to continue to weigh down the private sector, and in fact make life even worse for taxpayers in the future. Austerity has changed the presence of government in the economy by raising taxes and cutting spending, to a point where it will start net-taxing the economy through budget surpluses far earlier in the economic recovery phase than previously. This will stifle growth and contribute to long-term economic stagnation.

There is another, even more important reason to believe that this is not the beginning of a sustained recovery. The largest component of the European economy, namely private consumption, grew more slowly than GDP did: 0.7 percent in the EU and 0.3 percent in the euro zone. This means that households remain either heavily economically depressed by the lingering effects of austerity, or that austerity has scarred their outlooks on the future (or both). They are therefore holding back consumption as best they can. Until households recover and restore their faith in the future, there will not be any sustained economic recovery.

Business investments grow faster than private consumption: up 3.5 percent in the EU and 2.3 percent in the euro zone. With private consumption growing as weakly as it does, this investment boom must have an external reason.

And it does: exports are up 4.1 and 4.0 percent, respectively in the EU and the euro zone. This may look like a jackpot for the European economy, as sharp increases in exports should lead to significant multiplier effects out to the rest of the economy. So far, it looks like that is true to some degree, as gross fixed capital formation (investments) is rising as fast as it is. However, even if these are the largest investment growth numbers since the start of the Great Recession, it is crucial to keep in mind that investments have declined, in inflation-adjusted terms, in four out of the last five years. At some point businesses simply have to replace aging equipment.

With the European Central Bank trapping the euro zone in an abundance of liquidity, this is indeed a good time to do it. But even when you pay almost no interest on your loans, you still have to make loan payments. If it was not for the rise in exports, Europe’s businesses would have relatively weak reasons to invest. But combined with the weak numbers for private consumption this means that the exports-investment “boom” may very well be isolated from the rest of the economy.

A further indication of this is that imports have grown basically on par with exports: in the EU with its 28 member states imports and exports grew at exactly the same rate, namely 4.1 percent. In the euro zone imports grew at 3.9 percent, a tenth of a percent behind exports. Since private consumption is growing slowly – much more slowly than imports – it is very likely that the increase in imports is directly related to the growth in exports. Manufacturers in Europe buy raw materials and intermediate products from low-cost suppliers outside the EU (with north and east Africa becoming increasingly important here), bring them in, assemble more advanced products and ship them off to a slowly recovering U.S. market, but also to still-growing Pacific Asia.

Due to the direct dependency on foreign trade, this is a dicey way for an economy to recover. The Chinese economy is increasingly troubled, especially by a looming real-estate crisis. Japan is on the rebound – their annual GDP growth rate has been accelerating for five quarters in a row now – and their appetite for imports is growing even faster. However, that is not enough to sustain an exports boom in Europe, especially not since Europe is increasingly burdened by high energy prices compared to competitors in North America.

Add to that the high taxes that keep household consumption down, and the case for a sustained recovery remains as weak as I have explained before.

One last point that adds to my forecast of continued stagnation in Europe: consolidated government consumption grew by 1.3 percent in the EU and 1.0 percent in the euro zone. Compare these numbers to the 0.7 and 0.3 percent, respectively, by which private consumption increased, and we have a case of continued government dominance over the domestic economy.

With government spending growing 1.8 to 3.3 times faster than private consumption (EU and euro zone respectively) Europe is simply cementing its place in history as the birthplace of the welfare state, and the economic wasteland created by it.