Tagged: EUROPE

An Institutional Analysis of the Crisis

As an institutional economist I focus my research on the role that institutions and policy structures play in our economy. It is a fascinating niche in economics, and when combined with macroeconomics it becomes one of the most powerful analytical tools out there. So far, over the past 2.5 years, everything I have predicted about the European crisis has turned out to be correct; my upcoming book Industrial Poverty makes ample use of institutional economics and macroeconomics to show why Europe’s crisis is far more than just a protracted recession.

In economics, the institutional methodology is often pinned against econometrics, the mainstream methodological favorite. I don’t see it that way – econometrics has its place in economics – but the mainstream of the academic side of economics has given econometrics a far bigger role than it can handle. This has led to over-confidence among econometricians which, in turn, has led to a downplay or, in many cases, complete disregard for the benefits that other methodologies bring. The worst consequence of this over-reliance on econometrics was the multiplier debacle at the IMF, with serious consequences for the Greek economy. (How many young Greeks are unemployed today because their government implemented austerity policies based on IMF miscalculations?) A wider, better understanding for economic institutions and their interaction with the macroeconomy could help mainstream economists a long way toward a deeper, more complete understanding of the economy and, ultimately, toward giving better policy advice.

As an example of how institutional analysis can inform more traditional analysis, consider this interesting article on the European crisis by Economics Nobel Laureate Michael Spence and David Brady, Deputy Director of the Hoover Institution:

Governments’ inability to act decisively to address their economies’ growth, employment, and distributional challenges has emerged as a major source of concern almost everywhere. In the United States, in particular, political polarization, congressional gridlock, and irresponsible grandstanding have garnered much attention, with many worried about the economic consequences. But, as a recent analysis has shown, there is little correlation between a country’s relative economic performance in several dimensions and how “functional” its government is. In fact, in the six years since the global financial crisis erupted, the US has outperformed advanced countries in terms of growth, unemployment, productivity, and unit labor costs, despite a record-high level of political polarization at the national level.

This is true, and as I demonstrate in Industrial Poverty, a major reason for this is that the American economy is not ensnared in a welfare state like the European. We still lack a couple of major institutional components that they have: general income security and a government-run, single-payer health care system. That said, the U.S. economy is not exactly performing outstandingly either:

LB 7 28 14 2

Yes, we are currently in better shape than Europe, but we are also doing worse than ourselves 20, 30 or 40 years ago.

Let’s keep this in mind as we continue to listen to Spence and Brady – their discussion about political dysfunction is actually tied to the role of the welfare state in the economy:

[In] terms of overall relative economic performance, the US clearly is not paying a high price for political dysfunction. Without dismissing the potential value of more decisive policymaking, it seems clear that other factors must be at work. Examining them holds important lessons for a wide range of countries. Our premise is that the global integration and economic growth of a wide range of developing countries has triggered a multi-decade process of profound change. These countries’ presence in the tradable sector of the global economy is affecting relative prices of goods and factors of production, including both labor and capital.

And the government structures that aim to redistribute income and wealth within a country. High-tax economies lose out to low-tax economies. The Asian tigers have generally held tax advantages over their European competitors, but they have also held advantages on the other side of the welfare-state equation as well. By not putting in place indolence-inducing entitlement systems they have kept their work force more shaped toward high-productivity labor than is the case in the old, mature welfare states of Europe.

Why does the welfare state not change, then, in response to increased global competition? After all, Japan, China, South Korea and other Asian countries have been on the global market for decades. Enter the political dysfunction that Spence and Brady talk about. Unlike the United States, there is almost universal agreement among Europe’s legislators that the welfare state should be not only preserved but also vigorously defended in times of economic crisis. This has been the motive behind the European version of austerity, with the result that taxes have gone up, spending has gone down and the price of the welfare state for the private sector has increased, not been reduced as would be the logical response to increased global competition.

It is not entirely clear what kind of American political dysfunction Spence and Brady refer to, but if it has to do with fighting the deficit, they are absolutely on target.

In fact, probably without realizing it, Spence and Brady make an important observation about the long-term role of the welfare state:

Relatively myopic policy frameworks may have worked reasonably well in the early postwar period, when the US was dominant, and when a group of structurally similar advanced countries accounted for the vast majority of global output. But they cease working well when sustaining growth requires behavioral and structural adaptation to rapid changes in comparative advantage and the value of various types of human capital.

If understood as a general comment on the institutional structure of an economy, this argument makes a lot of sense. So long as the traditional industrialized world only had to compete with itself, it could expand its welfare states without paying a macroeconomic price for it. Gunnar Myrdal, Swedish economist and a main architect of the Scandinavian welfare-state model, confidently declared back in 1960 that the welfare state had no macroeconomic price tag attached to it. Back then, it was easy to let government sprawl in every direction imaginable without any losses in terms of growth, income and employment. That is no longer possible.

Spence and Brady then make this excellent observation of the American economy:

What, then, accounts for the US economy’s relatively good performance in the post-crisis period? The main factor is the American economy’s underlying structural flexibility. Deleveraging has occurred faster than in other countries and, more important, resources and output have quickly shifted to the tradable sector to fill the gap created by persistently weak domestic demand. This suggests that, whatever the merit of government action, what governments do not do is also important. Many countries have policies that protect sectors or jobs, thereby introducing structural rigidities. The cost of such policies rises with the need for structural change to sustain growth and employment (and to recover from unbalanced growth patterns and shocks).

The move of resources from the domestic to the foreign-trade sector is visible in national accounts data as a rise of gross exports as share of current-price GDP from 9.1 percent in 2003 to 13.5 percent in 2013. Furthermore, actual growth numbers for exports relative private consumption reinforce the point made by Spence and Brady: from 20087 to 2013 private consumption has increased by 15 percent in current prices, while gross exports have increased by more than 22 percent. For every new dollar Americans doled out on cars, food, haircuts and motel nights, foreign buyers added $1.50 to what they spend on our products.

However, let us once again remember that the adaptation of the American economy should be viewed against the backdrop of a smaller welfare state. As I have discussed on several occasions, European countries are also making big efforts at increasing exports. They are not as lucky in using foreign sales as a demand-pull mechanism for restarting their economies. One reason, again, is the rigor oeconomicus that the welfare state injects into the economy.

Spence and Brady also compare the United States to a number of other countries, noting that:

Removing structural rigidities is easier said than done. Some stem from social-protection mechanisms, focused on jobs and sectors rather than individuals and families. Others reflect policies that simply protect sectors from competition and generate rents and vested interests. In short, resistance to reform can be substantial precisely because the results have distributional effects. Such reform is not market fundamentalism. The goal is not to privatize everything or to uphold the mistaken belief that unregulated markets are self-regulating. On the contrary, government has a significant role in structural transitions. But it must also get out of the way.

In short – and my words, not theirs: reform away the welfare state. Its detrimental influence actually stretches deeper than perhaps Spence and Brady recognize: it does indeed protect large sectors from competition by simply monopolizing them. Health care is a good example, with a government monopoly spilling over on medical-technology products. Another good example is income security, where many European countries have de facto monopolized every aspect from parental-leave benefits to retirement security. Education is a third example, where the United States, despite its heavily socialized K-12 system has a very strong private sector for academic education. This sector is almost entirely absent in many European countries.

Again, it is good to see a different approach to economic analysis than the traditional one based on econometrics and often irresponsibly simplified quantitative analysis. In a situation like the European crisis, it is very important for economists and other social-science scholars (Brady is a political scientist) to broaden the analysis and focus on such variables that rarely change. Among those are economic institutions such as the welfare state, and the political and economic incentives at work in Europe to preserve it, even in the face of mounting global competition.

The Structural Crisis: More Evidence

The European crisis still seems to confuse the continent’s policy makers. After having believed for several years that austerity would both save the welfare state and increase growth, they have now slowly began walking away from the EU’s constitutionally required government deficit and debt rules. Instead, there is now growing belief in government spending as the remedy for the persistent crisis.

For the most part, the debate now seems to gravitating toward the question of how much government stimulus is needed. If the continent is indeed in a recovery mode, as some suggest it is, then there is not this big need for more government spending.

It is understandable that some believe there is a recovery under way. According to Eurostat, GDP for the EU as a whole grew by an inflation-adjusted 1.5 percent in the first quarter of 2014, over the same quarter of 2013. This is an increase from the last quarter of 2013 (1.0 percent) and in fact the fourth quarter in a row with improving growth numbers.

Technically, this represents a recovery. However, in no way does this mean that Europe is out of the crisis. To see why, let us compare GDP growth rates for EU-28 during the 2009-10 spurt to the one that started in 2013:

Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010
Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014
2009-10 -5.9 -4.4 -2.1 1.1 2.5
2013-14 -1.3 0.1 0.5 1.0 1.5

Early on in the Great Recession, the European economy made a rapid recovery and kept growing at more than two percent per year for four quarters straight. The rate slowly fell, though, and by the second quarter of 2011 growth was once again below two percent. By the end of that year it was below one percent, and down into negative territory in Q2 of 2012.

But should not a growth spurt count as a definitive recovery? Are not four quarters of improvement enough, especially if followed by a year of growth above two percent?

There is some merit to that argument. The problem is that the growth rates discussed here are not the kind of rates that normally would constitute a recovery, let alone a growth phase of a business cycle. Europe is in a structural crisis, which means that its growth rate is permanently lower than it was before. This is now becoming painfully evident in Eurostat’s national accounts data.

It has now been six years since the Great Recession began. For the entirety of the crisis that we have seen so far, namely 2008-2013, the average inflation-adjusted annual GDP growth rate for the European Union is a depressing -0.1 percent.

This is despite the aforementioned growth spurt.

Compare that to the six preceding years, 2002-2007: 2.4 percent. And that covers the back end of the Millennium Recession. Going back yet another six-year period to 1996-2001, we include the opening and trough of that recession, and still come out with 2.8 percent per year!

To further emphasize the structural nature of the European crisis, let us look at a long-term trend in growth. The following figure illustrates GDP growth in the EU as a six-year moving average. Starting in the fourth quarter of 2001 the average begins by covering the 1996-2001 period. The average is quarter-based to give as detailed an image as possible:

LB GDP EU28 6YR MAVG

The red trend line conveys a chilling message of structurally driven decline. In order to get Europe out of this decline and persistent crisis, economists must re-write their own books on macroeconomics. Surely, the conventional relative-price based advice from accomplished economists such as Michael Spence is still valid: a reduction in the cost of production in Spain vs. other exporting countries will eventually bring about a boost in exports. But as I have pointed out on several occasions, when that boost happens, such as in Germany or Sweden, it has very little influence on GDP growth as a whole. Modern foreign trade in industrialized economies is an isolated activity as many inputs are imported from elsewhere.

But more importantly, the presence of the welfare state throws a heavy, wet blanket over the economy. Austerity, as practiced in Europe in recent years, has added insult to injury by means of even higher taxes and even more perverted economic incentives.

As Michael Spence points out in the aforementioned article, it does not help Europe’s most troubled economies to share currency with Germany. This prevents the exchange rate adjustment needed to reflect global relative production costs. But the conventional macroeconomic wisdom also tends to downplay the growth-hampering effect that welfare states, and welfare-state saving austerity policies, have on GDP.

Spence actually opens for a recognition of this problem in another article together with political scientist David Brady. They acknowledge that modern Western governments have difficulties unifying all their policy goals, including income redistribution. However, Spencer and Brady do not go into more depth on the role that income-redistributing policies may play in causing the downward growth trend illustrated above. Their choice not to do so is understandable – their focus is elsewhere – but it also reflects somewhat of a conventional wisdom among economists: income redistribution and its institutional form, the welfare state, is just another sector of the economy.

It is not. It is the overweight on the private sector that is slowly but inevitably destroying the prosperity of the West. For more on that, stay tuned for my book Industrial Poverty. Out soon!

The Future of the Euro

The economic problems in Europe make themselves known in many different ways. Among them, a weakening of the euro. TorFX reports, via EUBusiness.com:

While the Euro recovered losses sustained in the wake of Portugal’s mini-banking crisis earlier in the month, the common currency put on a fairly lacklustre performance last week. The Euro dropped to a fresh 22-month low against the Pound and struggled against the US Dollar as investors speculated on the prospect of the European Central Bank bringing in additional stimulus measures.

It is important to keep in mind that exchange rates swing very frequently and sometimes violently, only to return to long-term stability. However, there is more than a short-term message in a 22-month low for the euro. Four variables are aligning to make the euro’s future difficult:

1. The negative interest rate. The ECB is penalizing banks for depositing excess liquidity with the bank’s overnight accounts. Even the moderately skilled speculator knows that a negative interest rate means he will have less money on Friday than he had on Monday, which of course drives investors to other currencies. The British pound comes to mind, as does the U.S. dollar. The problem for Europe is that once it has dug itself into a hole with the negative interest rate, it is mighty hard for the ECB to get out of there without any macroeconomic gains to show for it. The argument for the negative interest rate is that it will “encourage” more lending to non-financial corporations – business investments, for short. But businesses do not want to invest unless they have credible reasons to believe they will be able to pay back the loans. That really does not change because interest rates drop from almost zero to zero.

Bottom line: the ECB has entered the liquidity trap and will be stuck there for a long time to come, negative interest rate and all. This weakens the currency, especially over the short term.

2.  Deflation. Part of the reason for the ECB’s move into negative interest territory is the spreading fear of deflation. The past few years have shown that a rapid expansion of the money supply has no effect on inflation, either in Europe or in the United States. Therefore, the ECB cannot reasonably be hoping to cause monetary inflation with a desperate move like negative interest rates. Its hope is instead hitched to a rise in business investments which would cause inflation through traditional, Phillips-curve style excess-demand effects.

Bottom line: not gonna happen. As mentioned earlier, businesses are not borrowing at almost-zero interest rates – why would they borrow at zero rates? There is no profit-promising activity in other parts of the economy, and there won’t be, as our next point explains.

3. Austerity and government debt. Ever since the Great Recession began, Europe has used austerity not to reduce the size of government, but to preserve the welfare state. This has led to perennially slow or non-existent GDP growth and high, perennial unemployment. This has two consequences that spell trouble for the euro over the longer term. The first is that persistent lack of economic activity discourages business investments per se. Austerity, European style, includes tax hikes which constitute further government incursions into the private sector. The perpetuation of European austerity therefore means the perpetuation of low levels of business activity. The second consequence is that even if economic activity picks up, because, e.g., a long-term rise in exports (unlikely to happen) there is so much excess capacity in the economy that there will be no excess-demand driven inflation for a year, maybe even two. The excess supply, of course, consists of massive amounts of un-demanded liquidity slushing around in the European economy, and perennially high unemployment, including 20+ percent youth unemployment in a majority of EU member states.

Bottom line: political preferences to preserve the welfare state will keep macroeconomic activity low. Long-term outlook is continued stagnation. No support for a return to interest rates above liquidity-trap levels.

4. Continued recovery in the United States. Despite dismal growth numbers for the first quarter, the long-term outlook for the U.S. economy is moderately positive. We have not applied the destructive European version of austerity, even though its tax-hiking component makes it a wet dream for many statists. Furthermore, Obama has been surprisingly restrained on the spending side of the federal budget, being far more fiscally conservative than, e.g., Ronald Reagan. This has created reasonably good space for U.S. businesses to grow. There are caveats, though, such as the implementation of Obamacare, which in all likelihood contributed to  the negative GDP number in the first quarter of this year. There has also been a regulatory barrage from the Obama administration that has stifled a lot of business activity, although it has subsided somewhat in the last year and a half. But even a moderately positive business climate makes the U.S. economy notably stronger than its European competitor.

Bottom line: a slowly strengthening dollar will attract investments that otherwise would have gone to the euro zone, putting further downward pressure on the euro.

There is actually a fifth variable, which is entirely political. If Marine Le Pen gets elected president in France in 2017 she will pull her country out of the euro. That means goodnight and farewell for the common currency. Long-term minded investors would be wise to keep this in mind.

All in all, the case for the euro is not good. Stagnation at best, weakening more likely, with the probability of its demise slowly gaining strength.

More Tensions over Stability Pact

The European Parliament elections in May conveyed a somewhat schizophrenic voter message. At the end of the day, though, the inevitable outcome is a strong gain for the left. Socialists were emboldened, as were their fellow statist nationalists. Both flanks are pushing for a number of policy reforms that, taken together, could very well mark the beginning of the end of the European Union as we know it. On the left, more and more voices demand a restoration of Europe’s austerity-tarnished welfare state. Some of those demands come in the form of attacks on the Stability and Growth Pact, which dictates budget deficit caps for all EU member states, attacks that are motivated by the desire to rebuild the welfare state.

Europe’s left turn seems to continue at the state level, and with it the criticism of the prevailing austerity doctrine. The most recent example is from Slovenia. Euractiv reports:

Center-left political novice Miro Cerar led his party to victory in Slovenia’s election … (13 July), indicating he would rewrite a reform package agreed upon with the European Union to fix the euro zone member’s depleted finances. The result will test investor nerves, given Cerar’s hostility to some of the big-ticket privatization programmes that the EU says are key to a long-term fix for Slovenia, which narrowly avoided having to seek an international bailout for its banks last year.

Selling off government-owned businesses is a way to temporarily reduce the budget deficit:

Cerar’s government will now oversee a raft of crisis measures agreed upon with the EU, in order to reduce Slovenia’s budget deficit and remake an economy heavily controlled by the state. Cerar, however, opposes the sale of telecoms provider Telekom Slovenia and the international airport, Aerodrom Ljubljana, fuelling investor fears of backsliding. … He said his cabinet would immediately consider which companies would remain in state hands and what to do with the rest. … The outgoing government suspended the privatization process this month pending the formation of a new government, which is not expected before mid-September. Cerar will have to find other ways to raise cash if he is to meet to targets agreed to with the EU, in order to slash Slovenia’s budget deficit to 3% of output by 2015, from a forecast 4.2% this year.

The Slovenians better make up their minds on this issue. According to the EU Observer, the EU and the ECB are not budging on the Stability and Growth Pact:

ECB boss Mario Draghi urged EU leaders not to meddle with the bloc’s rules on debt and deficits on Monday, warning that it could turn the tide on much needed economic reforms.

It remains to be seen to what extent the emboldened left in the European Parliament can influence the way the EU Commission interprets the Stability and Growth Pact. So far, though, the Draghi view is also that of the Commission.

And just to add to the schizophrenia of current European politics, Draghi added a curious remark:

Addressing MEPs on the Parliament’s economic affairs committee in Strasbourg (14 July), Draghi said structural reforms combined with government spending cuts and lower taxes were the only route to restoring economic stability. “There should be a profound structural reform process,” he said, adding that “there is no other way”. “We should take great care not to roll back this important achievement, or to water down its implementation to an extent that it would no longer be seen as a credible framework,” he said.

The combination of less government spending and lower taxes is almost the antithesis of what the EU and the ECB have been preaching to euro-zone member states in the past few years. The austerity packages they have forced on member states have been of the government-first kind, aimed at balancing budgets to make welfare states more fiscally sustainable.

This type of austerity relies at least partly on tax increases. A combination of less taxes and less spending is in fact not austerity at all – it is a policy for government roll-back. If Draghi really means this, he is the first major EU figure to step forward and promote such a structural change to the Euoropean economy.

It is unlikely, though, that Draghi will get much support for any kind of permanent reduction of government. There is far too much power to be had in making the Stability and Growth Pact more flexible. Not only does it allow statist politicians to save their welfare states, but it also opens for a classic form of “Italian governance”. The EU Observer again:

Italian prime minister Matteo Renzi, whose government holds the EU’s six month presidency, has led calls for the pact’s rules to be applied with more flexibility to allow governments to increase public investment programmes. The demand was rejected by Draghi who stated that “the present rules already contain enough flexibility”. “If a rule is a rule then it has to be complied with,” he said, commenting that “I’m not sure I get – perhaps because I lack political skills – the chemistry of flexibility being essential to make a rule credible”.

It’s simple. The flexibility that Renzi wants is simply a way to apply a general law selectively. That, in turn, gives elected officials more power, as they can oversee the “flexible” application and choose who will get and exception and who will not. Inevitably, the choice will be made based at least in part on the size of the brown envelopes that exchange hands under the negotiation tables in Brussels.

Between corruption and the welfare state, big government has enough supporters to stay right where it is in Europe. Furthermore, regardless of what kind of interpretation of the Stability and Growth Pact that will set the tone in the next few years, it is going to be there as a power tool for the EU over the member states. The left’s desire for more flexibility is just a desire to put more direct power in the hands of bureaucrats and legislatures.

Another Attack on Tax Competition

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

LB 7 9 14 image

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

a) They will go up,

b) They will go up, or

c) They will go up.

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

Euractiv again:

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

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

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

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

A Recipe for Industrial Poverty

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

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

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

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

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

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

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

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

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

Socialists Attack EU Stability Pact

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Or, as noted by Euractiv:

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

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

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

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

An Economic Gateway Drug

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

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

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

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

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

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

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

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

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

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

The modern totalitarians.

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

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

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

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

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

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

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

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

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

More Gasoline on EU’s Fiscal Fire

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

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

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

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

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

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

Back to the EU Observer:

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

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

The EU Observer again:

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

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

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

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

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

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