Europe’s Right Makes Left Turn

Europe’s only way out of its crisis is to phase out the welfare state and gradually replace its entitlement systems with private solutions. This is a time-consuming process that requires relentless political commitment over a number of years, but it can be done, in Europe as well as here in the United States. However, the economically necessary is not always the politically realistic. Sometimes the economically necessary is not even politically desirable.

The latter scenario is the most problematic. When ideological preferences pull in an entirely different direction than the economy needs to go, the political rift between “ought to” and “must” happen makes necessary economic reforms close to impossible. The growth of nationalists, socialists and even fascists in today’s European political landscape is a clear sign of how big that political rift has become, but there is more bad news (if you can take it…). Recently I reported that the next head of the EU Commission – de facto the executive branch of the European Union – is going to be a statist, no matter who wins the May European parliamentary elections.

Today, Euractiv.com offers another example on how Europe’s ideological landscape is drifting to the left. They interview a former Belgian union activist and influential politician who is running for the European Parliament on a ticket for the center-right European People’s Party coalition. By their ideological label you would think they would be fighting hard for less government, lower taxes and more economic freedom. Well, sorry to disappoint you:

Mr. Rolin, you’ve decided to leave the trade union and enter into politics and run for MEP at the next European Parliament elections. What will be your priorities?

My first, second and third priorities will be employment, because that is the most important things right now. We see how the current crises affect us, how they deconstruct the European social system. Unemployment is devastating in social and economic terms but also in terms of democracy. We see it with the rise of Eurosceptic, populist and far-right groups.

“Deconstruct the European social system” is a code phrase for cutting entitlements in the welfare state.

We heard from the panelists at the European Trade Union Summit that austerity does not work. Do you share this opinion?

Entirely. Austerity policy does not work. And we see it. If it did work, it would have been verified, you know, like in mathematics. This has been verified by Greece, we’ve just heard it at the panel. It does not work. It creates more inequality, more unemployment, more misery in the population. Therefore it is high time to change our course. Even though we succeeded in saving the European currency, we need to have a policy focused on investments. I think that the ETUC’s programme aimed at boosting investments is very pertinent.

The first problem with austerity that he brings up is “inequality”. The very concept is alien to any concerted effort at promoting economic and individual freedom. By accepting the term “inequality” we immediately accept the false notion that it is somehow wrong that some people work harder than others and thus earn more money.

It is very telling of just how deeply the welfare state has been accepted in Europe that a parliamentary candidate for the large center-right party coalition regards “inequality” as the biggest problem with austerity. Unemployment comes second and general misery third. Never mind that austerity destroyed one quarter of the Greek economy; never mind that it has recalibrated the welfare state and made it an even heavier burden on the private sector. No, the biggest problem with austerity is that it has caused more “inequality”.

But wait – there is more:

Austerity does not work, you say. but you will nonetheless join the European Peoples’ Party (EPP) group in the European Parliament if you win, and the EPP has been the driver of austerity policies. Your party (Belgium’s Christian Democrat’s Centre démocrate humaniste, CDH) is a member of the EPP at the EU level. Isn’t there a contradiction between your trade unionist’s convictions and your political battle?

I see it as a challenge to bring a social dimension to the EPP, which is absolutely necessary. The CDH’s programme is very clear on that matter. We want to turn our back to austerity and put in place social policies, intelligent economic policies which will make it possible to have a real economic recovery through employment oriented investments, and sustainable employment.

Apparently, now it is part of the center-right path through Europe’s political landscape to believe that government can create “sustainable employment”. This is an outright socialist idea, no matter which way you twist and tweak it. If it was just a matter of “employment” you could let the EPP candidate and his party bosses off the hook with the assumption that they want to have fiscal policies that encourage more growth and more jobs. But the adjective “sustainable” gives an entirely new meaning to any policies for employment. It means, in short, either expanding government payrolls or making it even harder for employers to lay off employees. Both strategies are antithetical to economic freedom, growth and prosperity.

But Mr. Rolin is not just convinced that Europe needs more statism – he is also convinced that without it, the entire European Union is in peril. Euractiv again:

The 2009 EU elections had a record low participation from the voters, do you think this will change this time, that people need more Europe this time?

I am convinced that people need a more social Europe, they need to believe again in the European project. … As for the European Commission’s discourse on social affairs, it seems to me that it is not in phase with the reality. The workers are living a particularly difficult reality because of the crisis. It is therefore high time to go beyond the observation that something needs to be done. We have to be more radical in our policies and make them fit to the citizens’ aspirations. What is at stake is crucial. Either Europe succeeds in answering to European citizens’ aspirations and stop the growing social divide, or the European project will fail.

In other words, the only way for the European Union to survive is that it expands the welfare state at its level, in addition to what the member states are doing.

More welfare-state policies is precisely the wrong medicine for Europe. And just to drive home the statist point with particular fervor, Mr. Rolin tells Euractiv how important it is to raise taxes and reduce the scope of free-market policies:

What should be the priorities of the next Commission?

The tax on financial transactions is an indispensable element. It is time to put it in place, because it is economically intelligent; but also because it will bring equity and trust. Then, we need to stop the fiscal, social, environmental competition. We have to realise that we are Europe. Europe cannot be built on intra-European competition policies. We need to put in place cooperation policies. Together we can win. If we fight against each other in Europe, we will all be losers. That is for me the priority of all priorities: fighting against that logic. And the second thing of course is to boost growth throught sustainable investments. And finally, in terms of economic governance: yes, we need to control the state deficits, because the debts will have to be repaid one day but we need to stop confusing consumption debt or investment debt. When I invest in the future, it’s positive.

A tax on financial transactions will move those transactions to Seoul,Sydney or Sao Paulo. And it will happen fast. The financial industry is very fluid compared to other industries. There are other countries and cities in the world that offer likeable climates for the financial industry. If anyone is in doubt, look at what happened when Sweden tried a similar tax on the stock market back in the ’80s. I have lost track of all the people in that trade that I knew who moved to London or Luxembourg with their employers, as a direct result of the tax.

Alas, the tax is not going to produce any noticeable revenue. All it will do is drive high-end jobs out of the EU, and with them a whole lot of upscale spending that in turn will cause job losses in real estate, retail, manufacturing and transportation. Just look at what happened in New York in 2009-2010 (and look what is coming back there now thanks to a slow but sustained economic recovery). If that is the kind of “equality” that this new center-right European politician wants, then by all means, go ahead. We here in America will happily continue to out-compete you with cheap energy, lower taxes and stronger work incentives.

Mr. Rolin’s passage about ending intra-European competition is more frightening than it sounds like. What he is saying is, plainly, that there should not be jurisdictional competition between EU member states for jobs and investments. But that also means an end to policy competition: it means centralized tax and entitlement policies, centralized regulations, etc.

One of the reasons why the U.S. economy is doing comparatively well is that taxes below the federal level have been kept back during the recession. States have made concerted efforts at reining in spending, mostly with positive results. In addition to the Obama administration’s notable fiscal restraint this has eased somewhat the fiscal burden of government on the private sector. (If Obama showed equal restraint on the regulatory side, our economy would be roaring ahead right now.) When states hold back spending they can cancel tax hikes and even cut or eliminate some taxes. Kansas, Oklahoma, North Carolina and Nebraska are four good examples of states pursuing or implementing tax-cutting reforms. States that have pushed taxes higher lose jobs, while states with constant or lower taxes attract employers.

If Europe gives up on jurisdictional competition, it will lose one of its few remaining instruments for growth-and-prosperity promoting policies. Taxes will rise to pay for an expanding EU-level welfare state. Spending will grow in a misguided attempt to eradicate “inequality”.

And the entire continent will travel, Eurostar style, straight into the economic wasteland of perennial stagnation, eradicated opportunities – and industrial poverty.

Government and Poverty

Last week marked the 50th anniversary of President Lyndon Johnson’s declaration of “war on poverty”. The ambitious, bordering on pompous, goal behind this “war” was obviously, and officially, to create a society where nobody would have to live in conditions defined as poverty.

About the same time, the mid-1960s, Western European countries were entering the “full speed” phase of building their welfare states. Health care, income security, education and retirement were all in the hands of, or in the process of being transferred to, government. Across Europe, government spending was closing in on 40 percent of GDP. That level of spending marked a turning point for Europe’s welfare states: from that moment on their economies entered a long stagnation phase that set the stage for the slow decline that began about 15 years ago.

The United States never reached quite the same point of stagnation. While our economy has not exactly had a stellar growth record since the Millennium recession, it has proven more resilient in the current crisis. The reason for this is largely that our government is not quite as big and intrusive as it is in Europe, and that we have not yet created the massive general income-security systems that Europeans are so proud of. Those systems clearly discourage work, but also require destructively high taxes, typically on payroll, making the cost of hiring even low-skilled workers prohibitively high.

The combination of us not having a general income security and the fact that our health care system still remains largely market based is enough to set us apart, macroeconomically, from Europe. While those systems were never part of the original intention behind the “war on poverty”, Lyndon Johnson did provide America’s left with a platform from which to strive for a full-fledged American version of the European welfare state. So far they have not succeeded, which today is a blessing for us.

This does not mean that they are not trying. As I reported in my book Remaking America: Welcome to the Dark Side of the Welfare State, high-profile liberal think tanks are pushing hard to bring America even closer to the European welfare state.

Any further addition of tax-funded entitlements would of course be as bad for the U.S. economy as they have been for Europe. The last thing we need right now a combination of work-disincentivizing income security and growth-suppressing taxes. The lesson from Europe is frighteningly clear: once the welfare state passes a certain point – again represented in part by government spending exceeding 40 percent of GDP – the private sector can no longer endure the burden but begins a slow but inevitable process of decline.

In Europe’s case, this decline began around the Millennium recession, though signs were there earlier. It continued during the years up to the beginning of the Great Recession and has since then exploded into a full storm of industrial poverty. This has led to one of history’s big ironies. The goal with the European welfare state was the same as that of the “war on poverty”, namely to elevate everyone to a standard of living beyond what is at any point in time considered “poverty”. Yet, when the welfare state was allowed to grow uninhibited by economic common sense it brought about economic decline of a scale that is now at the very least sentencing an entire generation of Europeans to life-long poverty.

On top of this irony, there is another thoroughly illogical feature common to both the “war on poverty” and the European welfare state. The very definition of poverty actually makes it practically impossible to get rid of poverty: when we define poverty as a fraction of median or average income, we have practically guaranteed that we will have poor people in perpetuity.

It is important to keep in mind that neither the spending programs under the “war on poverty” nor the European welfare-state entitlement programs actually end or reduce poverty. All they do is alleviate poverty by taking money from Jack and giving it to Joe. Once these redistribution programs become woven into the social and economic culture of a country, they tend to perpetuate the need for themselves. When people get money or services – cash or in-kind entitlements – for free over a long period of time they adjust their daily lives as well as their long-term economic planning to what they get without effort. As a result they will not be very interested in replacing entitlement-based goodies with work-based income.

To sum up, the overwhelming experience from the past half-century of trying to use government to eradicate poverty on both sides of the Atlantic is that government is exceptionally inept at helping people to better their lives. Instead of improving the lives of the poor, all that the European welfare state has done is pull more people down into poverty or a near-poverty stagnant life; as for the American “war on poverty”, it redistributes at least $1.2 trillion per year – seven percent of GDP – while doing nothing to reduce the country’s poverty rate (which has remained around 12-14 percent for decades).

Fortunately, there are tangible signs that American big-government liberalism has reached the peak of its political influence. This bodes well for the future of this great nation. Europe, on the other hand, is not only worse off than we are, but still pursuing the same kind of welfare-statist policies that in the first place put them where they are right now. If this difference in policy future defines where the two continents are moving, the differences between America and Europe could, in a decade or so, be as significant as the differences are today between the United States and South America.

That said, there are some global trends and institutional changes taking place that could in fact make it harder for the United States to pursue a free-market based path back to unprecedented prosperity. More on that later. For now, let’s declare the “war on poverty” lost; let’s scrap the European welfare state and let’s make freedom big and government small.

Stiglitz: Europe Needs Bigger State

Joseph Stiglitz is a well-known, respected economist. He has strange views on how to solve the European crisis, but he has been correct in pointing to the destructive forces of austerity as applied in Europe. At the same time, he praised the economic policies of Hugo Chavez, Venezuela’s now-deceased authoritarian socialist president. Those same policies have allowed inflation to run away past 50 percent and caused frequent shortages of power, food products and other consumer goods.

Now Stiglitz is at it again. This time he is back on the European crisis, and he actually sounds like he has read this blog. We welcome him among the readership!

That said, he has not done his Liberty Bullhorn homework all the way. While his crisis analysis is largely on the right side, his proposals for how to address the crisis are off the chart wrong. Defying common sense and thorough scholarship, Stiglitz actually wants more government in Europe, in virtually every corner of the economy.

From British newspaper The Guardian:

It has been three years since the outbreak of the euro crisis, and only an inveterate optimist would say that the worst is definitely over. Some, noting that the eurozone’s double-dip recession has ended, conclude that the austerity medicine has worked. But try telling that to those in countries that are still in depression, with per capita GDP still below pre-2008 levels, unemployment rates above 20% and youth unemployment at more than 50%.

The European Commission has downgraded its growth forecast, though Europe is still very much in a state of wishful recovery thinking. This prevents any rethinking of fiscal policy, making the continuation of the crisis the only reasonable alternative. No wonder the European Central Bank is close to full-scale crisis panic.

Back to Stiglitz:

At the current pace of “recovery” no return to normality can be expected until well into the next decade. A recent study by Federal Reserve economists concluded that America’s protracted high unemployment will have serious adverse effects on GDP growth for years to come. If that is true in the United States, where unemployment is 40% lower than in Europe, the prospects for European growth appear bleak indeed.

Exactly. As I explain in my forthcoming book, “Industrial Poverty”, Europe is in a state of permanent stagnation.

I am glad Stiglitz has come to the right conclusion regarding the nature of the crisis (and he does not have to feel ashamed that he reads this blog…). What troubles me, again, is that he is such a hopeless socialist when it comes to designing crisis solutions:

What is needed, above all, is fundamental reform in the structure of the eurozone. By now, there is a fairly clear understanding of what is required: • A real banking union, with common supervision, common deposit insurance, and common resolution; without this, money will continue to flow from the weakest countries to the strongest. • Some form of debt mutualisation, such as Eurobonds: with Europe’s debt/GDP ratio lower than that of the US, the eurozone could borrow at negative real interest rates, as the US does. The lower interest rates would free money to stimulate the economy, breaking the crisis-hit countries’ vicious circle whereby austerity increases the debt burden, making debt less sustainable, by shrinking GDP.

Please, no. First of all, the banking union would only serve the same purpose as the currency union, namely to extend a shield of artificially high credit worthiness from strong economies within the euro zone to the weak, poorly run countries on the southern rim. That artificial jag-up of credit was what allowed Greece, Portugal, Spain and Italy to borrow boatloads of money despite the fact that their economies and their fiscal policies were basically unchanged from when they had their own currencies. The banking union would do the same for private banks.

Secondly, the “debt mutualization” idea has been floating around for a long time. Superficially it is a good, or logical, idea: now that all these countries have the same currency, why not issue one and the same series of Treasury bonds for every country in the euro zone? However, this would only reinforce the skewed credit evaluation of euro-zone countries that came about as a result of the currency union. Put bluntly: German taxpayers would be responsible for Greek debt, not just de facto as is the case today, but de jure.

The only way that this could work is if all fiscal policy is completely centralized. That, however, would require the creation of a full-blown federal government in Europe. Given the huge democratic deficit that currently exists in the EU – with first and foremost the toothless parliament and the appointed executive office – this would only strengthen the forces that grow government at the expense of taxpayers and private businesses.

Third, Europe does not need more, cheap money. As I explained at length recently, Europe’s businesses and households are not borrowing for lack of money in the banks. They refuse to borrow because they have no good outlook on the future.

Back to Stiglitz:

• Industrial policies to enable the laggard countries to catch up; this implies revising current strictures, which bar such policies as unacceptable interventions in free markets. • A central bank that focuses not only on inflation, but also on growth, employment, and financial stability • Replacing anti-growth austerity policies with pro-growth policies focusing on investments in people, technology, and infrastructure.

His “industrial policy” point suggests that government needs to grow to help the European economy grow. But every time I review data of the size of government and economic growth, the inescapable result is that the smaller government is, the better the economy performs. Perhaps Stiglitz should go back and take another look at the “performance” of the Venezuelan economy?

As for the central bank idea, the European Central Bank is effectively already doing everything that Stiglitz is asking for. This is, in other words, a moot point. So is his third point, despite its note about the negative effects of austerity: unless and until he gets more specific, his criticism does not serve as the platform for an alternative that he sets it up to be.

Then Stiglitz goes on to try to make the case that central banks cannot be left independent, but must somehow be enrolled in the big government conglomerate that is his vision of our future:

Much of the euro’s design reflects the neo-liberal economic doctrines that prevailed when the single currency was conceived. It was thought … that making central banks independent was the only way to ensure confidence in the monetary system; … independent US and European central banks performed much more poorly in the run-up to the crisis than less independent banks in some leading emerging markets, because their focus on inflation distracted attention from the far more important problem of financial fragility.

No, the reason why the economies of advanced industrial economies have taken such a beating in this crisis is that they have advanced, over-sized welfare states. I have explained this at length on this blog, and – again – more is coming in my book.

And just to get a little taste of his socialist vision:

Finally, the free flow of people, like the free flow of money, seemed to make sense; factors of production would go to where their returns were highest. But migration from crisis-hit countries, partly to avoid repaying legacy debts (some of which were forced on these countries by the European Central Bank, which insisted that private losses be socialised), has been hollowing out the weaker economies. It can also result in a misallocation of labour.

And exactly how does Stiglitz define “misallocation of labor”?? There is no better way to determine where labor is best allocated than the free market. Or would professor Stiglitz suggest that countries with a higher degree of central economic planning somehow allocated their labor better than free-market based economies?

Is professor Stiglitz seriously suggesting that it is better to keep all unemployed Greeks in Greece than to allow them to pursue a better economic future abroad? Evidently, that is his vision.

Europe does not need more government. Anyone who proposes more government for Europe must answer two questions:

a) Why was government not big enough to prevent the crisis? and

b) When is government big enough?

Poverty Returning to Europe

As I have explained on numerous occasions, Europe’s crisis is not a regular recession. It is a structural crisis that will change the European economic landscape for the foreseeable future. The children now growing up in Europe will live a life less prosperous than their parents, who are now in their 30s or even 40s, who in turn find themselves having to work harder than their parents to achieve the same standard of living.

With youth unemployment exceeding 20 percent in most EU member states, and GDP basically having ground to a halt, the young in Europe are fighting an uphill battle to just get a start on some kind of self-determined life. This, together with widespread unemployment among adults and no end in sight to the crisis, opens the door to a grim future for the Old World. The only way to avoid this scenario is for Europe’s political leaders to give up on the welfare state and let loose the private sector. Free-market Capitalism, for short.

Sadly, that is probably not going to happen. Instead, more and more voices are calling for the continent to double down in defense of the welfare state. The EU Observer reports, starting with an essentially valid but not exactly meaningful criticism of current austerity policies:

Up to 25 million more people in Europe are at risk of poverty by 2025 if governments continue with austerity policies, international aid agency Oxfam has said. In a study released Thursday (12 September) ahead of an EU finance ministers’ meeting this weekend, Oxfam said there are lessons to be learnt from deep cuts made to social spending in Latin America, South East Asia and Africa in the 1980s and 90s, where it took 20 years to get back to recover.

So long as austerity is focused on preserving government in a tighter economy, it will have disastrous effects on the economy. If instead austerity was motivated by a genuine ambition to roll back, and eventually eliminate, the welfare state, then the situation would be much better for the private sector. A roll-back strategy combines spending cuts with well-designed, targeted tax cuts to give the private sector room to replace what government is cutting back on.

Unfortunately, rolling back government is the last thing Europe’s politicians want to do. Their sole purpose with austerity is to save as much as they can of the welfare state, even if it means destroying the future for generations of Europeans. What Europe needs is free-market reforms, lower taxes, a gradual privatization of the welfare state and constitutional reforms to guarantee that big government never happens again.

Again the voices in favor of such reforms are few and far between while the voices with the opposite message are loud and high-pitched. Euractiv again:

“These policies were a failure: a medicine that sought to cure the disease by killing the patient. They cannot be allowed to happen again. Oxfam calls on the governments of Europe to turn away from austerity measures and instead choose a path of inclusive growth that delivers better outcomes for people, communities, and the environment.” Greece, Ireland, Italy, Portugal, Spain and the UK – countries that have pursued budget cuts most aggressively – are soon reaching the rank of most unequal countries in the world. “The gap between rich and poor in the UK and Spain could become the same as in South Sudan or Paraguay,” said Natalia Alonso, head of Oxfam’s EU office.

This is precisely the wrong way to go. Income differences are irrelevant, and to see why, let’s ask Natalia Alonso where she would prefer to live the life of a poor citizen, the United Kingdom or South Sudan.

Nevertheless, the consequences of this focus on “inequality” is that strong voices are pushing for a restoration not of the prosperity-producing private sector, but the prosperity-consuming welfare state. By throwing in comparisons to deplorably poor, undeveloped countries with questionable property-rights traditions and economies perforated by corruption, statists turn a blind eye to structural and institutional factors that really matter in building free, prosperous societies. The Euractiv article on the Oxfam report is a case in point. Having mentioned South Sudan and Paraguay in passing it moves focus back to Europe:

As an example, mortgage laws in Spain see banks evict 115 families from their homes every working day. Meanwhile, almost one in ten working households in Europe now live in poverty and the trend is worsening, the report notes. Child poverty is also rising and workers who do get paid often do not have enough to support their families. In the UK and Portugal, real wages have fallen by 3.2 percent over 2010-2012. The real value of wages in the UK is now at 2003 levels. Italy, Spain, and Ireland all recorded decreases in real wages over this period. Greece has recorded a fall in real wages of over 10 percent.

Yes, Europe is turning into an economic wasteland, and poverty is returning. As an example, Greek unemployment is still rising, hitting 27.9 percent in July. But to somehow compare that poverty to what the South Sudanese experience is intellectually disingenuous. Europe’s population is sinking into industrial poverty, a new form of poverty, best compared to what people in Eastern Europe experienced under the Soviet era. They had access to most of the basic products you expect in an industrialized society, but at basic quality and with no prospect of ever being able to improve their lives. This is a bad future for Europe, and a waste of an economic heritage from generations of hard-working Europeans, but it is still a life vastly better than the life the poor endure in South Sudan.

That said, the medicine for eliminating both forms of poverty is largely the same. Industrial poverty is the result of the welfare state, and can only be eliminated through the elimination of the welfare state. That means doing away with the destructive consequences of decades of social democracy, returning instead to free-market Capitalism.

By the same token, the only remedy for poverty in an under-developed country like South Sudan is free-market Capitalism.

Another Attack on Tax Competition

As my good friends at the Center for Freedom and Prosperity have been explaining for many years now, an international campaign is trying to take away a big chunk of our individual and economic freedom. Spearheaded by big governments and statist front groups like the OECD, the campaign aims to make it impossible for you and me to choose where we want to live, work, invest and pay our taxes. Technically, the coalition behind the campaign does not want to stop you from moving across national borders, nor do they want to stop you from moving your money across national borders; their goal is to make sure that you cannot do so and keep more of your own money in the bargain.

In other words, the goal behind the campaign is to end tax competition. This would be a monumental loss to the free world, as Cato Institute senior fellow Dan Mitchell explains very well in these articles:

Tax Havens and Tax Competition Are Crucial If We Want to Restrain Predatory Government

Explaining to the Kleptocrats on Capitol Hill that Tax Havens Should Be Emulated, Not Persecuted

Debating Tax Havens

It is easy to under-estimate the role that tax competition plays in preserving economic freedom. When there are no geographic restrictions of how you dispose of your money, governments are forced to behave just like any sellers of products: they have to give their buyers (taxpayers) a good reason why the buyers (taxpayers) should choose to pay their taxes to one government over another.

Behind the notion of tax competition lies a well-defined, solid natural-rights based principle of property rights. Excellently explained by Robert Nozick in his perennially relevant Anarchy, State and Utopia, this principle says – very briefly – that whatever you earn through work or trade that does not violate the life, liberty and property of another person, is yours and yours only. No one has the right to your property anymore than they have a right to your time, or your body.

Originally a Lockean idea, this property-rights principle has a long history through both the Enlightenment and modern libertarian theory. It has shaped Capitalism and the free market system, thus being an indispensable component in the social and economic success of the Western world.

The activists behind the statist campaign against tax competition do not see things quite the same way. Their view of property rights is a world away from what helped build our modern-day prosperous societies. At best, the statist notion of property is that people have the right to what they earn up until they have satisfied a basic basket of “needs”. This usually means that once you have put food on the table, paid rent for a standard apartment, bought the basic clothes you and your kids need, and paid your monthly mass transit pass to get to work, you have no right to the rest of your income. The fact that governments in today’s Europe do not confiscate everything above that level is a good indication of just how strongly the principles of free-market economics have worked their way into the Western culture.

That does not mean the statists won’t keep trying. I have written repeatedly about the disastrous, purely confiscatory French 75-percent hate tax. Another example of blatant disrespect for property rights is the Cyprus Bank Heist, where the Cypriot government confiscated, Soviet style, large amounts of people’s private bank deposits.

A third example of the ongoing statist attack on private property rights is the campaign against tax competition. That campaign is heating up, as is evident from a recent article in Euractiv.com:

Developing countries will not have access to a new system of automatic exchange of tax information agreed in St Petersburg by the world leaders over the weekend due to their lack of administrative efficiency, a decision that was not welcomed by many development experts. After two days of tense meetings, which focused largely on the Syrian crisis, world leaders agreed that the automatic exchange of fiscal information must become an international standard.

In this particular case the attack on tax competition is tied to the notorious inability of developing countries to maintain a stable tax administration. A push to expand the sharing of private citizens’ information across national borders is motivated with an allegedly noble ambition to improve government funding in developing countries. But the two issues have nothing to do with one another. The drainage of money from developing countries is often driven by pure corruption and the theft of public funds by dictators, their cronies and their family members. (Jean-Bedel Bokassa is a notorious example; Yasser Arafat another.) But the fact that corruption is keeping some developing countries in a deplorable state of poverty and tyranny is no reason for governments in Europe and North America to expand general information sharing on individuals and their financial whereabouts.

It is a sad but crucially important fact that if the campaign against tax competition eventually wins, there is little doubt that we would lose our freedom to invest wherever we want. More than that, we may even lose our freedom to move our money with us as we migrate from one country to another. it would become illegal for anyone to invest anywhere except in the country where he or she lives. At that point government has effectively monopolized itself and can set whatever tax rates it desires. French high-income earners can still escape the confiscatory hate tax, but if champions of economic freedom lose to the anti-tax competition crowd, there is a very high probability that governments in Europe – and the U.S. government through elaborations of FATCA – would completely lock in your money under their jurisdiction.

Euractiv again:

The 19 member states of the international organisation and the EU expect the start of automatic exchange of fiscal information to be operational at the end of 2015, according to the summit’s final declaration. The G20 also accepted the Organisation for Economic Co-operation and Development’s proposal against the manipulation of transfer prices of multinational enterprises, a technique that consists in changing the selling or buying prices of the same enterprise in order to transfer the benefits to a tax haven. “Unfortunately this decision doesn’t concern developing countries, who are the first victims of tax evasion,” says Mathilde de Dupré from CCFD-Terre Solidaire, a development campaign group. Global Financial Integrity, another NGO, estimates that developing countries lose around $100 billion a year due to the manipulation of transfer prices of enterprises. “They lose three times more money that they gain with development aid”, wrote Melanie Ward form Action.

This is another twist to blur the line between lawful, entirely moral tax planning and unlawful, entirely corrupt stealing of public funds that is so pervasive in many developing countries. It is exceptionally deceptive to argue that because there is very weak rule of law in some countries in the Third World, we need to make it harder for law-abiding citizens in Europe and North America to invest their money based on centuries-old principles of private property.

As for the criticism of transfer pricing, the hunt for more tax revenues from internationally active corporations is having a depressing effect on international trade. This was well demonstrated by Mansori and Weichenrieder already in 1999. In other words, by trying to squeeze more money out of a given tax base, governments are shrinking that same tax base. The end result may very well be a net loss of tax revenue.

The campaign against tax competition has been going on for well over a decade now. There is a lot more at stake than just the ability of wealthy investors to allocate their capital as they please. A government with full tax monopoly is a government with no restraints on either side of its budget.

Pangaean Government, Part 1

Think about this statement for a moment (emphasis added):

The G20 summit in Washington (2008) aimed to ensure that no institution, product or market was left unregulated at EU and international levels. The EU Regulation on Credit Rating Agencies (Regulation 1060/2009), in force since December 2010, was part of Europe’s response to these commitments. The Regulation was amended in May 2011 to adapt it to the creation of the European Securities and Markets Authority (ESMA) which has been attributed all supervisory powers over credit rating agencies since July 2011.

This is the EU Commission – the executive office of the EU – motivating why it needs to expand its regulatory incursions into the private sector.

No institution, product or market left unregulated.

Welcome to the brave new world of Pangaean government.

One of the new places where the EU government has already gone is with regulations of credit rating agencies. You might think the purpose would be to regulate the way they rate private businesses and individual citizens; if that was what they were doing, it would be bad enough, but it would also be an expansion of government that was in line with other expansions into regulating how private citizens interact with each other in the economy.

But that is not the purpose behind this regulatory expansion. No – the purpose here is instead to regulate how these credit rating agencies rate government. Take some time and read the new EU regulation on credit rating agencies. I have more to say on this, a lot more, so stay tuned for Friday’s article!

In Defense of Tax Avoidance

To begin with, for all you socialists and liberals reading this blog: there is a difference between tax avoidance and tax evasion. Tax evasion is when you do not pay taxes that you are legally mandated to pay. Tax evasion is a crime and should be duly punished (though it is worth pointing out that tax evasion should never be punished on par with any crime against a person).

Tax avoidance is when you take measures within the law to reduce your tax burden. The difference is monumental: it is illegal to drive faster than the speed limit but it is not illegal to take a detour around the city to avoid low downtown speed limits.

In the international debate over low-tax jurisdictions, castigated as “tax havens” by high-tax advocates, tax avoidance and tax evasion are often lumped together. The so called “investigative journalism” project that I mentioned the other day is a case in point. In a global effort to make private bank records public, the “International Center for Investigative Journalism” has shown great disdain for the privacy of their fellow citizens. Here is how one person involved in the project puts it:

“I don’t think we should be worried about the sensitivities of the poor banker and poor criminals whose criminal activities are being exposed,” he said. “If there are people who are doing nothing wrong and their information is being exposed, then it’s collateral. It’s a price to be paid.”

I wonder if this person has the same attitude toward the National Security Agency listening in on all our e-mails and phone calls. After all, if you have nothing to hide, what do you have to worry about…?

The revelation of financial data for law-abiding citizens and the suggestion that such publication is merely “collateral”, is very serious indeed. The people who pry into their fellow citizens’ private affairs with this attitude are dangerous individuals. It is disturbing, to say the least, that they seem to have such deep disrespect for the integrity of other people that they are willing to expose law-abiding citizens – tax avoiders – in the same context as criminals – tax evaders. Again the comparison to government eavesdropping comes to  mind, but there is an even broader issue at work here.

High-tax advocates who criticize tax avoidance as being no different than tax evasion – the aforementioned “investigative journalism” project is a case in point – generally go after so called “tax havens”, more appropriately referred to as low-tax jurisdictions. The purpose is to prevent citizens of country A from choosing to move their money to country B and pay lower taxes.

The premise behind the defense of tax avoidance is that I as an individual citizen have earned that money through my own work or the investment of my own rightfully earned money. High-tax advocates do not see it that way. They do not share the premise that my earnings and my wealth are in fact mine.

This is a fundamental, philosophical difference that extends beyond being mere premises for tax policy. By suggesting that my income is not necessarily mine, and by focusing on the transfers of money around the world for the purposes of tax avoidance (and tax evasion) they imply that there is a legitimate distinction between what is truly mine of my property and what is not mine. The premise is that whatever assets I can move from one country to another for the purposes of lower taxes are assets that I really do not need – with “need” of course defined by the high-tax advocates.

Which brings us to the core of the controversy. High-tax advocates build their reasoning on the false idea that there is a debatable, externally definable and imposable maximum to what a person needs. The roots of this belief is in 19th century Marxism, which claims that a person’s needs are defined by his ability to reproduce his labor. In plain English, your needs are what you need to be able to go back to work tomorrow and do the same job all over again.

To the best of my recollection, Marx never explicitly listed those needs. He came close to defining them by suggesting what part of a work day a person needs to work in order to earn enough to pay for his needs. The rest of the time, Marx said, the person works for the white, evil, heterosexual, baby-eating, Christian Capitalist. (OK, he didn’t say “white”…) This definition of needs is a core principle of Marx’s application of the labor theory of value, and its original purpose was to identify the so called Capitalist surplus. The point was to “return” that surplus to the worker so that the worker could enjoy a higher standard of living.

Even if Marx’s theory was fundamentally flawed already from the outset, his biggest problem was that government got in the way. Fast forward to the mainstream European welfare state, the Marxist concept of “need” has now become public policy in two directions: spending on entitlements to give people their “needs” and taxation in order to take away the excess of “needs” from those who have earned a bit more.

This is where the high-tax pundits go to work on stopping international financial planning. They consider the very existence of money for that purpose a sign that the owners have an excess of what they need. Therefore, if I invest money in a low-tax jurisdiction (Puerto Rico is one, conveniently accessible to Americans) then they see that investment as illegitimate property on my end and a legitimate target of taxation – preferably of the confiscatory kind.

This is the theoretical foundation of the attacks on low-tax jurisdictions. There is obviously one big fault in this foundation: its theory of need, work and the individual. The very idea that someone else can define your needs is an open disrespect for you as a sovereign individual. You and I are free to define what we need without anyone else intervening. As independent persons we are free to pursue the resources for our needs within the framework of respecting other people’s life, liberty and property. I am free to define a brand new Mercedes E-class as part of my needs (though as an automotive purist I might do with my Honda Accord…) while my neighbor can take the completely ascetic route through his life.

My neighbor and I are then free to work as much or as little as we want, entirely in accordance with our own definition of what we need.

As for the concept of “work”, we once again clash with the high-pitched proponents of high taxes. When I work for my employer, I put in all of my time into that work. It is my effort, my skills and my talents that produce the product that my employer has contracted me to deliver. That contract, in turn, is a deal between me and my employer and absolutely nobody else. Therefore, the proceeds – the salary – are mine and mine alone.

This may seem trivial to us with common sense, and it is. However, high-tax pundits do not share our view of this contract between an employer and an employee. Their view of work is based on the same Marxist theory from which they derive their ideas regarding needs. In their view, the work day is split up between the work that I need to put in to reproduce myself for tomorrow, and the work that – in statist theory – is my boss’s profit. (Since I work for a non-profit, that concept is rather ironic…)

Since my boss will not give up that “profit” voluntarily, high-tax activists turn to government for help. They use taxation as a means to confiscate as much as they dare to confiscate of the alleged profit. The confiscation takes place on several levels: in a regular, for-profit business both the employer and the employee pay a slew of taxes that are all aimed at raking in the “Capitalist surplus” to government.

The problem for the statist comes when the individual entrepreneur decides that he wants a cut of the money that his business is generating. Tired of paying high taxes he moves his business or just his own money to a low-tax jurisdiction, out of reach for the tax-greedy statist. This angers the tax-to-the-max crowd because by their playbook, for reasons just outlined, the Capitalist has no moral right to that money.

In other words, the witch hunt against low-tax jurisdictions and people who use them is founded in a radical, Marxist philosophy that is not just detached from reality but directly dangerous as a means for public policy. The danger lies primarily, but far from solely, in that this Marxism-in-disguise constitutes a platform for a political assault on individual and economic freedom. By splitting the work day of the individual employee into two parts – one where he works for himself according to what other people define and one where he works for others – the statist effectively splits the individual’s life into two parts. The first part is private and recognized as such, namely the time he works for his own needs as the statist has defined them, and where he gets to satisfy those needs (eating, sleeping, doing maintenance work on his dwelling, washing his clothes and teaching his children the virtues of Marxism). The second part is public and subjects the individual to the state. This is the part where he works to pay taxes so government, not his employer, can enjoy the surplus of his work.

By dividing the individual’s existence into these two parts, the Marxist/statist reduces him to a subject under the authority of government. This subjection – or subjugation – characterizes everything the government does at the hands of the statist. Furthermore, depending on the needs of government, the statist can move the dividing line between “needs” and “evil profits” as he pleases. In a situation such as the one currently holding Europe’s welfare states in a tight grip the line tends to move rather sternly in the direction that favors government.

This means tax hikes.

It also means an increased aggressiveness against those who plan their finances based on a desire to pay less taxes. It is with this in mind that we should resist the urges of the statists to eradicate low-tax jurisdictions and the freedom of individual citizens (as well as corporations) to choose where to invest their money, for what purpose and why.

If the high-tax advocates succeed in eliminating low-tax jurisdictions – either explicitly or implicitly by preventing people from investing abroad – then they have won a big moral victory on behalf of big government over the individual. Their underlying philosophical agenda, a revived Marxist notion of the individual as being a subject of government, will set deeper roots in our public policy arena. It will open for more restrictions and confinements on individual freedom.

How do we know this? When was the last time you heard a coherent answer from a statist to the question: when is government big enough for you?

We also know it because both European and American history  over the past 75 years show us that once government starts growing, it will continue to grow uninterruptedly – until its sheer size and burden on the private sector destroy government’s host organism.

For all these reasons together it is very important that we, friends of freedom, do not let the statists get away with their assault on tax avoidance and low-tax jurisdictions.

Can Lower Wages Save Europe?

Economic despair is widespread in Europe today. But there are also signs of emerging economic desperation. That is, desperation among politicians that their prescribed medicine – austerity – is not doing the trick. Unemployment keeps rising while budgets do not balance despite years of spending cuts and tax hikes.

No wonder some politicians put their faith in even more desperate measures, such as widespread pay cuts for private-sector workers. From The Guardian:

Wages have fallen across Spain in the past year as the government tries to cheapen labour for employers just as austerity measures cut back the welfare state. Salaries fell by an average of 0.6% in the year to the first quarter, with inflation pushing the real loss in the purchasing power of those Spaniards in work to 2%. Private sector salaries were harder hit than those of public employees.

The Spanish unemployment rate is still rising and is now 27 percent. This puts a massive downward pressure on wages, but also rapidly extends jobless lines.

There is nothing inherently wrong with wages taking a nosedive in a recession: the wage is the price of labor and if labor is in excess supply the price needs to fall as part of the free-market adjustment process to restore full employment. But when wages are pushed down as part of a policy package to save big government, then there is no free market at work here, only cynical politicians:

Falling wages are seen as good news by prime minister Mariano Rajoy’s conservative People’s party government, which believes wage devaluation is one of the few options left to Spain now it is part of the euro and can no longer devalue its own currency. “This will help us become more competitive,” the country’s employer’s federation said.

Spain is in the middle of a multi-year process of trying to close its budget deficit by means of austerity. The national government is putting its faith in tax hikes and cuts in government spending, hoping they will close the deficit, thereby push interest rates down and as a result increase private-sector investment.

The theory behind austerity is flawed, and that is clearly visible in the Spanish, Greek, Italian, Irish, French and Portuguese economies. In 2012 alone these countries lost a total of 49.4 billion euros worth of GDP as a result of austerity. This is money that is not spent in the private sector – sales lost by European businesses – roughly equivalent to 700,000 private-sector jobs. And that is before we even consider the multiplier effects.

So if the purpose of austerity was to balance the government budget and thus push interest rates down, what is so wrong with this leading to wage drops?

Here is the problem. There is a goal embedded in the budget balancing itself. It is not explicit, but implicit and visible only in the fact that the budget balance, not the size of government, is the target of austerity policies. If austerity was all about shrinking government the policies would be designed to achieve that goal, but they are not. There are no terminations of spending programs in austerity, and the quantitative goals in each austerity package, from Greece to Italy to Spain and on, are set in terms of reduction of the deficit, not reduction of the size of government.

This means that austerity is an instrument to preserve the welfare state. The premise behind austerity is that the welfare state intrudes on private-sector activity with its budget deficit. Therefore, the goal with austerity is to make sure the welfare state can continue to exist without imposing an extra burden on the private sector through higher interest rates.

Since austerity has dramatically increased Spanish unemployment, and since unemployment is driving wages down, the real reason for the wage drop is that the government wants to preserve its welfare state – not that it wants an economy where free-market principles rule. It has already increased taxes and cut government spending, thus imposing massive explicit and implicit tax hikes on Spanish families; the wage drop, forced upon workers by austerity, is the redeeming instrument, so to speak, that government employs in order to help the economy recover some of the jobs it has lost.

Needless to say, for this to work the Spanish economy has to turn to the world beyond its borders. The combination of higher taxes and lower wages is a strong guarantee that domestic demand, especially consumer spending, will remain depressed for years to come. The Spanish government is aware of this and therefore chooses to rely on export demand to pull the economy out of its perennial crisis.

All this while the government manages to preserve the welfare state and shield government workers from some of the tougher pay cuts that private-sector employees have to take.

It is difficult to say how far the European crisis can continue in its current state. When an economic crisis reaches a boiling point it usually spills over into massive social unrest and leads to radical political changes. Those changes are usually not for the better and would certainly do a lot of harm to Europe, but with the economy inching further down into the abyss one has to ask how much worse things could actually get.

The broader scope of that question is for another day, another article. Today, though we have noted yet another absurd twist to the crisis, namely the Spanish wage cuts that aim to preserve big government and make workers in the private sector pay yet another bill for an over-bloated welfare state.

Perhaps it is not surprising that the debate over austerity in Europe is intensifying. From the Economics Blog at the leading British newspaper The Guardian:

Another month, another dismal set of jobless figures from the eurozone. Unemployment was up by 95,000 in April and if the trend of the past three months continues, an unenviable milestone will be reached by Christmas. At that point, there will be 20 million on the dole in the 17 nations that use the single currency. Europe now faces a triple crunch: an interlocking human, economic and political crisis that will have devastating consequences if left unattended.

Absolutely. The destruction now being done to Europe is unprecedented because it is coordinated, deliberate and rationally (as in “planned” and “legislatively driven” – not “reasonable” or “smart”) enforced by governments across the continent.

The phrase “lost generation” can be over-used: on this occasion it is entirely appropriate to describe what is happening in Greece, where the youth jobless rate is approaching two-thirds of the young population.

And not just there. As I reported yesterday, in both Greece and Spain youth unemployment is above 50 percent. Four other European countries, Croatia, Portugal, Italy and Slovakia, record youth unemployment above one third. A total of 19 European states have unemployment rates above 20 percent for the young.

Back to The Guardian’s Economics Blog, which makes an astute observation:

The eurozone’s prolonged slump has forced some modest changes to deficit reduction plans, giving some member states longer to hit their targets. But Europe still appears a long way from embracing the sort of strategy that would start to bring the jobless total down. In part, that’s because there is still a belief that the impediments to growth are all structural and have nothing to do with a deficiency of demand.

Indeed. Higher taxes, increased net drainage of money from the private sector to government, and falling wages all conspire to reduce total demand in the economy. Thereby the continuation of the recession, even its deepending, is essentially written in stone.

The pressing question now is: when higher taxes and lower wages don’t do the trick, what will the desperate governments of Europe’s ailing welfare states do next?

Structural Reform Euro-Speak for Austerity

On April 24 I reported that the chairman of the European Commission, Jose Manuel Barroso, was going out and about telling Europe and the world that years of crippling austerity policies were coming to an end. I warned against believing him, especially because the EU was unrelenting in its demands on member states with budget problems to stick to austerity programs.

My warning still stands, for a number of reasons I will outline below. There is growing evidence, though, that the Commission is trying to divest itself of austerity, and the reason is ostensibly that they have come to realize that austerity has become politically toxic. But this does not mean they have abandoned the economic thinking behind austerity, only that they have decided to dress it in new political attire.

A report from Euractiv explains what the Commission now wants for Europe:

The European Commission will further shift the EU’s policy focus from austerity to structural reforms to revive growth when it presents economic recommendations for each member state tomorrow (29 May), officials said. In its annual assessment as guardian of the EU’s budget rules, the Commission will say that while fiscal consolidation should continue, its pace can be slower now that a degree of investor confidence in the euro has been restored.

First of all, investors are more pessimistic about Europe now than they were before the austerity campaign began. This means, among other things, that they believe that either will austerity continue or its effects will linger on in the European economy for a long time to come.

Secondly, the only reason why there seems to be restored confidence in the euro is that the ECB has artificially propped up the value of the treasury bonds of troubled states. The ECB has de facto pledged to buy up every single treasury bond from Greece, Spain, Italy and Portugal. In other words, the confidence is not in the currency but in the short-term soundness of owning Greek, Spanish and Portuguese treasury bonds.

It is really very simple. Normally, investors who lose confidence in, e.g., a treasury bond would demand a very high interest rate to even consider buying it. This drove the interest rate on Spanish treasury bonds up north of seven percent, a rate that means the bond is teetering on the edge of the financial junk yard. At that point, only the boldest investors put any substantial money into it.

Then came the ECB and its guarantee to buy back bonds – in theory an unlimited amount – from anyone who owns Spanish, Italian, Portuguese or Greek bonds. (Technically the guarantee was more limited than that, but the expectation quickly spread that it would apply to all troubled euro countries.) Needless to say, investors suddenly saw a practically unprecedented opportunity to make some really big money: seven percent return on treasury bonds with a 100-percent buyback guarantee.

In order to avail themselves of this unique opportunity, investors had to buy euros. The rise in demand for the money give-away party hosted by governments in southern Europe meant that more people needed more euros. The decline in the euro’s exchange rate stopped and the currency suddenly looked stable.

That is, in a nutshell, what happened in 2012 and early 2013. It is a sordid story, and the political cynicism in it is only reinforced by the fact that the European Commission is using it as an excuse to try to get out of its commitment to austerity. But as we shall see, it is wise not to believe them.

Euractiv again:

Because highly indebted governments cannot afford to kickstart growth through public spending, they must reform the way their economies are run – by making labour markets more flexible or by opening up product and services markets. “The main message will be that the emphasis is shifting to structural reforms from austerity,” one senior EU official said. The recommendations, once approved by EU leaders at a summit in late June, will become binding and are expected to influence how national budgets are drafted for 2014 and onwards.

Let us put aside for a moment the ridiculous notion that government spending is a good kick-starter of economic growth. When the EU Commission talks about structural reforms it means deregulation of markets. This may sound like a big leap in the direction of economic freedom, but it really isn’t. Deregulation is always good, but it cannot do the trick on its own. Deregulation of the labor market is Euro-speak for loosening up hire-and-fire laws, thus making it easier for employers to take on workers without a life-long commitment.

This would make a difference for the better, if employers were screaming for more workers. But the reason why there is not more job creation in Europe is not that hire-and-fire laws are in the way of job creation – the reason is that private employers do not see their sales go up. On the contrary, in many countries the private sector is stagnant; the entire economy for the euro area is expected to grow by a microscopic 0.1 percent this year. This translates directly into stand-still sales for millions of businesses, large and small, across Europe.

Why take on more employers when there is no new business for them to take care of?

The other deregulation effort mentioned above is to increase competition on regular consumer-product markets. The idea is to drive prices down, thus give people’s real wages a boost and thereby encourage more consumer spending.

This structural reform could have substantial effects. I remember reading a study back in graduate school (about 1998 or ’99) that showed that disposable income of Danish households was 20 percent higher than otherwise thanks to deregulation efforts a decade earlier. I am not going to vouch for the results of this study as I don’t have it available, but economic theory rather clearly supports the notion that a high degree of competition on consumer markets is good for the economy.

However, once again we run into the problem of a stagnant economy. The Danish economy was thriving back in the ’90s, which made it easy to reap the harvests of deregulation. This does not mean you should not deregulate in a deep recession, but I would caution against believing in this as the sword that will solve the Gordian knot. It takes longer for competition to affect prices in a stagnant market than in a growing market: a stagnant market does not invite nearly as many new sellers as a market characterized by growing sales. It takes longer to recover the costs of investing in sales infrastructure and in establishing a market brand on a stagnant market, compared to one that is booming.

It is therefore safe to conclude that deregulation, while welcome, will have little positive effect on the European economy.

Which brings us back to the austerity issue. I suspect that the EU Commission is basing its deregulation proposals on some glossy forecast of growth. That growth in turn will, they think, grow the tax base and boost government revenues, which in turn will eliminate budget deficits and make austerity redundant.

The ten-thousand euro question, then, is: what will the EU Commission do when they discover that their deregulation efforts have not had nearly the effect they were hoping for? Let us not forget that they are still very much committed to balanced budgets in all euro-area member states (and theoretically in all other EU states as well, though not as adamantly since they have their own currencies). If tax revenues fall short of what the EU Commission needs to declare austerity cease-fire, it is as certain as Amen in church on Sunday that they will return to austerity.

Another piece of evidence to the same conclusion is the fact that they have not even abandoned austerity, just slowed down the pace at which it is being implemented. Euractiv again:

The 17 countries that share the euro will have halved the pace of budget consolidation in 2013 compared to 2012, as the overall budget deficit of the eurozone fell by 1.5% of GDP in 2012 but will only shrink a further 0.75% this year, the European Commission forecast this month. … Unless policies change the overall eurozone consolidation will be only 0.1% of GDP in 2014, the Commission said … The Commission has already indicated that it will give France, the eurozone’s second biggest economy, and Spain, the fourth largest, two extra years to bring their budget deficits below the EU ceiling of 3% of GDP, and other countries are also expected to get a year’s extension.

The flattening-out effect is probably under-estimated. The reduction in deficit-to-GDP in 2012 is the accounting-style effect of a slew of austerity programs in Spain, Greece, Italy, Portugal, the Netherlands and France. Once these programs have gone into effect – which they now have – they will start spreading their venom into the economy. Governments take more money from the private sector and give less back. Private sector activity is depressed, resulting in lower GDP growth. The tax base shrinks compared to the forecast that the EU Commission had in mind, and the deficit-to-GDP ratio starts rising again no later than 2014.

Bottom line is that the EU Commission has not given any country a pass on austerity, only some leeway to take a couple of extra years to shove the bitter pill down the throats of their voters. Austerity remains the top item on their agenda.

And just to reinforce this point, Euractiv explains that in exchange for more leeway on austerity…

both France and Spain will have to commit to broad structural and labour-market reforms intended to make their economies more competitive and help create jobs.

In other words: austerity first, then maybe some reforms to boost the tax base. If the reforms don’t work, the governments of both France and Spain will be forced back into the fiscal torture chambers again.

One final note. Nowhere in this does the EU Commission speak of structural reforms that actually reduce government spending on a permanent basis. Which makes the welfare state the elephant in the room that no one is talking about.

Except, of course, The Liberty Bullhorn. Here, on the other hand, we already have a plan for doing away with the welfare state.

Austrian Theory vs. Economic Freedom

My apologies for a long article, but this is a very important topic.

When someone titles his article “The Bankruptcy of Governments” it attracts interest from every friend of economic freedom. If the piece is well-written, it makes a valuable contribution to the intellectual battle over the future of Western Civilization. We need more of intellectually sharp contributions and less of ill-founded demagoguery. Our followers on the political side of the arena are inspired by us, bring our arguments and our analysis to the legislative hallways and try to get laws and budgets passed that will change economic policy and the role of government in the better direction.

If we get it right, all the way from good analysis to good policy decisions, we win – and more importantly: everyone else wins when we all benefit from more economic freedom. The wealthy can invest and improve businesses under more liberty; the poor and needy get more opportunities to improve their lives; creative, entrepreneurial people get more opportunities to build new businesses.

However, if we get our analysis wrong our cause is badly hurt. In theory, it does not matter where the mistake is made in the chain from analysis to legislation, but the closer the error is to the analytical starting point, the more serious the mistake is. Policies that are built on flawed legislative work will have repercussions that are limited to the legislative process; analysts and policy advocates can still do their work without having put their future credibility in jeopardy.

When the error is in the analytical foundation, the entire chain unravels. Bad analysis contaminates analysts, policy advocates, grassroots and activists, as well as elected officials. We who create the analytical foundation therefore have to hold ourselves to the standard that we can’t miss once.

In fact, as I explain in my book Ending the Welfare State, with the big welfare state we have today we will in reality only get one chance to restore economic freedom. If we stumble on the reforms or execute them in such a way that it causes a lot of hardship for many people, we will lose the battle for at least a generation. By that time there won’t be much of a prosperous, industrialized world to save.

For precisely this reason it is crucial that we freedom scholars and analysts do not waste our time – and other people’s time – on analytical constructs that lead to pain, suffering and a certain death for the cause of freedom. This is also why I engage other scholars and analysis whose ambition it is to promote economic freedom, but whose analysis I disagree with.

In the field of economics there is one school that meets all the criteria of purportedly supporting freedom but in reality doing a lot of harm to the cause. That school is, hardly surprisingly, Carl Menger’s Austrian tradition of economics. I have already on a few occasions written about the flaws in Austrian economics and I will continue to do so until its role in the freedom movement has been marginalized to the point of no influence.

This side of Marxism, Austrian economics is the most ill-conceived theory currently at use in the public policy arena. When it was put to work in Russia after the collapse of the Soviet Union, the result was a decade of economic waste, deprivation, abject poverty and collapse of almost every social institution except the Orthodox Church. The demise of a bankrupt government did not automatically, through some spontaneous order, give rise to a well-ordered society with a minimal government. When big government disappeared chaos, anarchy and mob rule took over.

With this experience in mind we have to know exactly what we are doing when we lay out a path to limited government. The article mentioned earlier, “The Bankruptcy of Governments”, has a promising title but unfortunately turns out to be yet another example of flawed Austrian thinking. It is an important example to discuss, though, precisely because it so well illustrates the fine line between good and bad analysis.

The author, Alasdair Macleod with the British think tank The Cobden Centre, starts off well:

For a long time governments have been redistributing peoples’ income and wealth in the name of fairness. They provide for the unemployed, the sick, and the elderly. The state provides. You can depend on the state. The result is nearly everyone in all advanced countries now depends on the state. Unfortunately citizens are running out of accessible wealth. Having run out of our money, Governments are now themselves insolvent. They started printing money in a misguided attempt to manage our affairs for us and now have to print it just to survive.

That is not entirely true. The excessive money printing did not start until the Great Recession broke out in 2009. Up until that point EU governments in particular were very good at maxing out taxes on their citizens. But Mr. Macleod’s point about governments printing money just to survive financially is a good one, and falls well in line with my analysis.

However, this statement…

The final and inevitable outcome will be all major paper currencies will become worthless.

…is a bit on the excessive side, to say the least. Austrians have been crying about American monetary inflation for years, yet it has not happened. The reason is that their analysis does not recognize the existence of transmission mechanisms between the monetary and the real sectors of the economy. In order for newly printed money to drive up prices in the real sector there has to be some movement of activity in the real sector to motivate price setters to mark up their prices at hyper-inflation rates. In a recession like the current one those transmission mechanisms are weak – consumer credit demand is weak and it is tough for small businesses to get bank loans for investments. As a result, the newly printed money stays in the monetary sector of the economy, where it has no contact with prices.

This does not mean that a modern economy in a recession cannot succumb to high inflation pressure. We know numerous examples from Latin America where government has used its own spending to push newly printed money out in the economy. This is in part how Venezuela under Hugo Chavez got stuck with 30 percent inflation. So far this has not happened in the United States, but that is no guarantee it won’t happen. While the simplistic Austrian prediction is wrong, the facts on the ground are not sufficient to completely dismiss their argument. More evidence is needed, especially on the nature of the transmission mechanisms.

Alasdair Macleod disagrees. True to the Austrian school he dismisses the use of empirical evidence and quantitative reasoning in economics:

Modern economists retreat into two comfort zones: empirical evidence and mathematics. They claim that because something has happened before, it will happen again. The weakness in this approach is to substitute precedence for the vagaries of human nature. We can never be sure of cause and effect. Human action is after all subjective and therefore inherently unpredictable.

Does this mean that Macleod never drives? After all, he apparently cannot be sure that his fellow Brits will drive on the left side of the street tomorrow just as they did today.

Macleod’s statement about the “inherently unpredictable” nature of human action is of course rather silly. It is, however, typical for the Austrian school. One of its key tenets is the denial of empirical analysis, which of course begs the question why they even bother with economics. But by taking the attitude that human action is inherently unpredictable they also suggest that we as humans are not rational. Rationality means, among other things, repeating successful behavior in order to assure your own survival. In terms of economics this means repeating successful trade and other exchange relations with other rational individuals.

I should not have to explain this to someone who is in the game to change public policy. But Alasdair Macleod appears to be one of those activists/analysts who have been seduced by the supposedly refined nature of Austrian theory without seeing its public-policy consequences. If he did he would realize that a theory that starts out with suggesting that human action is inherently unpredictable will have a hard time convincing legislators that they can trust people to make the right decisions on their own. Quite the contrary, in fact: if we all behave unpredictably there is no chance for a society with a minimal government to survive, let alone thrive; the only way to create a stable, predictable society would be to have government organize and regulate it.

Macleod is of course wrong on the fundamental nature of human action. So is the Austrian theory. May I recommend some reading on the role of uncertainty in economic analysis. Austrian theorists might also want to disseminate Armen Alchian’s classic but very dense essay on uncertainty, evolution and economic theory.

Because of their disdain for empirical evidence and quantitative reasoning, Austrians have a hard time constructing workable analytical arguments on their own. Instead they often spend their time producing pure rhetoric, often directed at competing theories. Mcleod is no exception, going after the man Austrian theorists dislike almost as much as Karl Marx:

Keynes was strongly socialistic. In the concluding remarks to his General Theory, Keynes looks forward to the euthanasia of the rentier (or saver) and that the State will eventually supply the resources for capital investment.

This statement is not only false, but also very telling of the difference between Austrian theory and Keynesianism. Austrians prefer the armchair as the foundation of their analysis, while Keynesians work inductively to constantly evolve and enhance the proficiency of their theory and their ability to interact with the public policy arena. The statements by Keynes that Macleod has cherry-picked are from chapter 24 of the General Theory, where Keynes has left his theoretical work and is speculating about what role economic policy could play, and how government would fit in to that role.

It is important to note that in the preceding 23 chapters of his General Theory Keynes barely even touches upon government, even as a subject of conversation. Already for this reason, Macleod’s statement about Keynes being a socialist is false. But there is also a deeper and from a policy viewpoint more important reason. When Keynes got to the end of his book he had examined the “mechanics” of a modern industrialized economy – he had in effect laid the groundwork for what we now know as macroeconomics. With this pioneer work Keynes challenged a great many prejudices held by Classical economists, but he also opened for the potential of an entirely new era of economic policy.

First and foremost, Keynes’s work allowed for a new understanding of what brings about recessions – and, even more importantly, depressions. Never before had anyone systematically proven that when you try to starve an economy out of a recession, you make matters worse. But to produce and explain this proof, Keynes had to spend almost the entire volume we know as his General Theory; as he was finishing it, he only had time for brief, speculative thoughts about what role government could play in defending or restoring full employment.

This is what Austrians do not get. Keynes’s analysis was systematic. He built a macroeconomic theory, induced from evidence, that allowed him and anyone else who takes it seriously to do an open-ended analysis of what role government might play. Unlike closed systems like Marxism or Austrian theory, the Keynesian analysis is open in that its conclusions are not deductively produced – or, to be blunt, dictated – by the theory.

Herein lies the problem with Austrian theory. Because it refuses to recognize the role of evidence, it refuses to open itself to the probable – as opposed to uncertain – nature of human action. Because there is no room for probability, there is no open end to the analysis an Austrian produces. His conclusions are dictated beforehand.

This leads to major problems when theory is brought in to the public policy arena. More on that in a moment. First, let me wrap up Macleod’s point about Keynes being a “socialist”. In chapter 24 of the General Theory Keynes suggests a death tax as one possible policy measure to help build economic policy in favor of full employment. The tax would be used to fund investment activity when private-sector activity is unable to reach full employment. Keynes speculates on the possibility of having government be a permanent agent in this way, which he suggests would mean that the economy would be operating at or very close to the point of full employment.

Keynes’s theory of investment equates full employment to a point where the so called marginal efficiency of capital is virtually zero. The practical meaning of this is that there is no more profit opportunity left in expanding the economy’s capital stock – it is operating at its economically viable maximum. This is accomplished, Keynes suggests (but does not firmly conclude), when private-sector investment is supplemented by government investment, funded by a death tax

Obviously, a death tax, even at 100 percent, would never lead to government replacing private investment funding. Yet Macleod makes the critical mistake of thinking that the point where the marginal efficiency of capital is zero is also the point where private credit is eliminated. He misreads Keynes’s idea about “euthanising the rentier” as the elimination of privately funded investment. In reality, this statement means that funding for investment is so abundantly available that it ceases to be scarce. Thereby no one can make money on credit in response to systemic uncertainty. Individual risk factors still remain, though, as Keynes makes clear in his elaboration of his theory of investment and the concept of the marginal efficiency of capital.

In short: government eliminates systemic uncertainty while the private sector handles uncertainty and risk at the market level.

I disagree with Keynes’s speculation about the death tax. But I do agree with him that the free market is unable to incorporate and manage systemic uncertainty. How that is best done is a matter for further scholarly work; my own doctoral dissertation was devoted entirely to finding the demarcation line between the roles of government and the private sector in managing uncertainty. What I learned from Keynes is that there is indeed a role for government to play there; the exact nature of that role is still an open question, especially because the attempts made thus far at organizing government to eliminate systemic uncertainty have had a lot of side effects.

I apologize for the wordiness of this article, but it is important to understand the depth of the problem with Austrian theory. One good way to do that is to contrast it toward its arch enemy, Keynesianism.

Speaking of which, it is almost amusing to witness the obsession that many Austrian theorists have with Keynes. As Alasdair Macleod demonstrates, this obsession sometimes gets so bad that they throw out the only analytical tool they themselves cherish, namely logic, just to get another chance to go after Keynes:

The misconceptions of Keynesianism are so many that the great Austrian economist von Mises said that the only true statement to come out of the neo-British Cambridge school was “in the long run we are all dead”.

Let’s put this in its proper Austrian context. In December last year one of the Cobden Centre’s academic advisors, Phillip Bagus, applauded the shrinking GDP that some European countries were experiencing. Bagus was jumping up and down with joy over the fact that Greece had lost a quarter of its GDP and suggested merrily that this elimination of economic activity would free up resources that would create new investments and new jobs. He suggested that it was a home run for the economy that people were laid off from jobs right and left and forced to scavenge for food because an austere government was not providing the poverty relief people had been promised.

Bagus is a prime example of what Austrians do when they enter the public policy arena. They are completely locked in to their theory, without a single open window to the outside world and its empirical evidence that when they are confronted with the worst economic crisis since the Great Depression they suggest that the world needs more of the same. To them there is no such thing as hesitation and caution among private entrepreneurs and consumers. Their static and rigid theory says that consumers and entrepreneurs fail to produce full employment for the economy because government takes away resources from them. There is a great deal of truth in this part, but what the Austrians forget is that there is a second leg to this analysis: they conclude that all you need to do is fire government bureaucrats and  they will all get jobs in the private sector. All you need to do is shut down a government agency and someone else will take over their office.

The problem is, as we witnessed in Russia during the 1990s, the private sector may hesitate to step in and absorb idle resources formerly employed by government. The one tiny detail that Austrians forget is that an entrepreneur will not make an investment unless he has reasons to believe that he will be able to pay off the loan he funded the investment with. Furthermore, the banks won’t lend him money toward the investment unless he can make a good case for the profitability of that investment.

Keynes knew of this problem very well. That is why he speculated that government should supplement private investment in times of uncertainty, in order to eliminate systemic risk factors. While I disagree with Keynes’s particular suggestion, I am wholeheartedly with him on the nature of the problem. Individuals can be held back by uncertainty and thereby, in the aggregate, hold back the entire economy.

Austrians do not believe in uncertainty. They recognize its existence but they do not incorporate it into their analysis. Instead, they assume that all that needs to happen for the economy to be perpetually in full employment is that the so called “natural” rate of interest can prevail. They assume the existence of this “natural” interest rate without ever providing proof of its existence. This assumption, again entirely theoretical, allows them to create a perfect intertemporal allocation of resources – in other words, to eliminate uncertainty.

When you ask an Austrian theorist when this natural interest rate will come about, he will give you an answer that resembles something like “in the long run”. In other words, in the long run the economy will always be in a perfect state of equilibrium and full employment.

Keynes always criticized Classical economists for relying on the long run to fix all sorts of problems. When Austrian theorists take the same view on the long run as Keynes did, they jeopardize the very foundation – flawed as it is – of their own theory. Either they have to resort to illogical reasoning or they have to make up their mind: do they agree or disagree with Keynes on the role of uncertainty in the economy?

Alasdair Macleod, needless to say, does not see this lack of logic in Austrian theory. He marches on like nothing happened. The rest of his analysis is unfortunately as simplistic as the Austrian theory he relies on. He echoes a commonly held belief among Austrians that there have never been economic crises before big government:

The misallocation of economic resources which is the result of decades of increasing government intervention cannot go on indefinitely. Businesses have stopped investing, which is why big business’s cash reserves are so high. Money is no longer being invested in production; it is going into asset bubbles. Dot-coms, residential property, and now on the back of zero interest rates government bonds and equities. These booms have hidden the underlying malaise.

Although I disagree with John Kenneth Galbraith on virtually everything under the sun, I have to give Galbraith credit for his book A Short History of Financial Euphoria. There, Galbraith takes the reader on a journey through speculative bubbles that have occurred throughout history – the ones we know of – and done so at times when there was no big government.

I have discussed the nature of today’s crisis at length in other articles. Very briefly, I do agree with Macleod that government has played a bad role in exacerbating this crisis – my conclusion is that our banking system would have absorbed the shock from the real estate crisis were it not for the fact that those same banks had also invested heavily in government bonds. During 2011 and 2012 more and more of those bonds turned into bad assets, effectively destroying an otherwise sound balance on banks’ balance sheets.

The implication of a sound analysis of today’s crisis is that we need to get government out of the economy, but that we need to do it in a structurally sound way and by showing great respect for two groups of citizens:

  • Those who already live on the dole because they have lost their jobs and been let down by government;
  • Those who still work but have become dependent on government to make ends meet.

The true challenge for freedom-minded public policy scholars is to design a path for our economy out of the welfare state without causing undue hardship for either of these two groups. It can be done. The problem is that we are not getting much help from Austrian theorists here: all they suggest is the destruction of the welfare state so that Phoenix may rise from the ruins.

Macleod is no exception. He makes a good observation about the role of government…

Take France. Government is 57% of GDP. The population is 66m, of which the employed working population is about 25m, 17m in the productive private sector. The taxes collected on 17m pay for the welfare of 66m. The taxes on 17m pay all government’s finances. The private sector is simply over-burdened and is being strangled.

But then, instead of helping pull the economy out of this entitlement quagmire, Macleod resorts to the favorite Austrian pastime, namely to bash the printing of money:

The progressive replacement of sound money by fiat currency has destroyed economic calculation, and has destroyed private sector wealth. These policies were deliberate. We have now run out of accessible wealth to transfer from private individuals to governments. That is our true condition. Governments will still seek to save themselves at the continuing expense of their citizens, and in the process destroy what wealth is left.

He never gets to the usual advocacy for a gold standard, but he comes pretty darn close. However, as a brief look at Galbraith’s book will show, we have had crises even during the heydays of the gold standard.

The problem is not big money. The problem is big entitlement. It would be nice if Austrians could put down their Scriptures and help us get rid of the welfare state in a sound, stable way that encourages people to be optimistic about the future. If they are not interested in that, may I suggest they withdraw to their academic chat rooms and stop pretending to be concerned.