A Glimmer of Hope in Greece

Greece just made its IMF payment due last week, indicating that the socialist government still does not think it has strong enough support among the Greek general public to secede from the euro zone. It is unlikely that any other arguments will keep them from reintroducing the drachma; high inflation – an inevitable consequence of a drachma resurrection – does not discourage socialists in other countries, such as Venezuela, from pursuing reckless domestic policies. Syriza, whose leader Tsipras is a dyed-in-the-wool Chavista socialist, wants to be the first to bring the warped ideology of Hugo Chavez to Europe, and he is not going to let his plans be spoiled by petty things like currency turbulence or 50-percent inflation like they have in Venezuela.

However, if the population generally is against a currency secession, he runs the risk of a parliamentary challenge long before the next election. His majority is very slim, and depends critically on the participation of a small nationalist party that could be peeled away by a determined opposition. In other words, Tsipras is walking a thin line to get Greece to where he wants her to be.

One of the problems with this thin line is that it does not allow for any sound economic policies. Nothing that could actually revive the chronically depressed Greek economy is permitted in under the Tsipras government’s low ideological ceiling. Therefore, the following report from Euractiv should come as no surprise:

Greek Finance Minister Yanis Varoufakis said on Thursday (9 April) that the government was restarting its privatisation programme and was committed to avoiding going into a primary deficit again. Prime Minister Alexis Tsipras’ government has been opposed to some asset sales but has promised not to cancel completed privatisations, and only review some tenders as part of the terms of a four-month extension of its February bailout program me. “We are restarting the privatisation process as a programme making rational use of existing public assets,” said Varoufakis, speaking in Paris.

This is how they are going to balance the budget: by means of one-time sales of assets. It is like selling the living room couch to pay your mortgage. What are you going to sell next month?

The previous Greek government did the same thing, obviously to no avail. In fairness, though, the Greek government has very few options. Despite some weak signs of a fledgling recovery earlier this winter, there is no clear rebound in the Greek economy.

Figure 1


Private consumption, measured as four-quarter moving averages and adjusted for inflation, has stabilized a bit under €30bn per quarter. This is a substantial loss from the €37bn per quarter recorded right before the Great Recession, and it means that the Greeks have basically been sent back to 2001 in terms of standard of living.

Since private consumption is the driving force of the economy, its decline and stagnation since 2008 is the most vivid expression of the deep suffering that the Greek people has had to live through. That said, they have also asked for more by electing a socialist for prime minister whose comprehension of economics is weak, to say the least.

Tsipras, like all socialists, sees government as the indispensable economic agent; everything else is either debatable or out of the question.

With all that in mind, there is actually a flickering light in the tunnel. When Greece’s private consumption is measured per employed person, it actually looks like there is a small rebound in there:

Figure 2

GREECE cons pr emp

With consumption again measured by quarter, with four-quarter moving average adjusted for inflation, and then divided by employee, it looks like the Greeks are able to work their way up a little bit in terms of purchasing power. In the first quarter of 2011 per-employee consumption was €8,004; for the last quarter on record, Q3 of 2014 it was €8,178.

This does not look like much of an increase, but the underlying trend is weakly positive. This means that while only 54 percent of the Greek population 20-64 actually have a job, those who do are slowly beginning to establish a “new normal” of consumption. It is a normal that is characterized by stagnation, with almost no outlook toward reasonable gains in the standard of living – it is in essence life under industrial poverty – but at the very least this little rebound is an indicator that things are not going to get worse.

Ceteris Paribus, of course… And as one of my favorite economics professors from back in college loved to point out: ceteris is not always paribus. Things change. And not always for the better. Especially when you have a prime minister dedicated to the mission of bringing Chavista socialism to Europe. Come Scylla or Charybdis.

U.S. Worried about EU Stagnation

For the people who live in the European Union, daily life offers challenges in the form of zero growth, high unemployment, lack of opportunity and a gloomy outlook on the future. For a macroeconomist, however, the EU is a formidable experiment that must not be left undocumented. The union was constructed based on the European tradition of welfare statism, right when the welfare state as a socio-economic construct was beginning to show clear signs of macroeconomic ailment. For unknown reasons – though probably ideological preferences played a good part – the architects of the EU misinterpreted the symptoms of macroeconomic ailment such as persistent budget deficits. They saw them as expressions of irresponsible budget policies and therefore institutionalized budget-balancing guidelines for member-state fiscal policies. Those guidelines became the EU’s own constitutional balanced-budget requirement, also known as the Stability and Growth Pact.

The Stability and Growth Pact was created essentially to secure the fiscal sustainability of the European welfare state. The problem is that the welfare state in itself is not fiscally sustainable. A wealth of literature (which I am currently working my way through as part of my next book project) and a plethora of compelling data together convincingly show that the welfare state is in fact the fiscal venom that causes governments to go into structural deficits. So far, though, the political leaders of the European Union have not understood that their practice of the Stability and Growth Pact – known as statist austerity – has driven the European economy into a permanent recession. Their governments, consuming up to half of GDP, are subjected to spending cuts and in turn subject the private sector to higher taxes, which in turn causes the private sector to contract its activity or at the very least keep it constant.

As statist austerity causes GDP to stagnate, the welfare state’s budget problems are exacerbated. More people request assistance from its entitlement programs, while fewer people pay taxes. The budget problems that statist austerity was aimed at solving – again in order to make the welfare state look fiscally sustainable – actually cause a new round of budget problems. In response, austerity-minded governments tighten the fiscal belt yet another notch.

All in order to make the welfare state more affordable to a shrinking economy. In other words, saving the welfare state is the prime directive of European fiscal policy.

American fiscal policy has a different purpose. It aims to help the economy grow and lower unemployment. Granted, far from everything that comes out of U.S. fiscal policy is helpful in that respect, but at least the basic course of direction is right. Therefore, when representatives of the United States Treasury look at Europe and try to figure out what on Earth is going on over there, it is hardly surprising that some eyebrows go up and some foreheads are wrinkled.

From the unrelenting German quality news outlet Euractiv:

The United States warned Europe on Thursday (9 April) against relying too much on exports for growth, and urged officials to make more use of fiscal policy, saying stronger demand was essential. In its semiannual report on foreign-exchanges policies to Congress, the US Treasury Department gave a preview of the positions it will press on foreign policymakers during next week’s International Monetary Fund meetings in Washington. The world cannot rely on the United States to be the “only engine of demand,” the report insisted. It urged nations to use all tools available to accelerate growth and not rely only on their central banks to boost recovery.

Before we get to the accolades, a technical comment. Exports is also “demand”, though from foreign buyers. The Treasury economists should know better and use the term “domestic demand”.

Now for the accolades. It is refreshing and reassuring to see that the Obama administration’s Treasury understands how the economy works. This is not a sarcastic comment – this is a genuine word of appreciation. Europe, by contrast, is filled to the brim with economists and other fiscal-policy decision makers whose actions and decisions prove that they have basically no comprehension of macroeconomics whatsoever. An economy is driven by its demand side: household spending and business investments from the private side, and government spending. Since consumer spending is 65-75 percent of a well-functioning economy, the confidence and prosperity of the general population is quintessential to the survival, growth and prosperity of any nation.

Furthermore, businesses invest because they ultimately will sell something to the general public. Therefore, confident households create confident businesses. A strong, forward-looking economy spends 15-20 percent of GDP on business investments.

Without growth in these two private-sector spending categories, there will be no growth in the economy as a whole. The economists of the U.S. Treasury know this, and they operate based on this basic, common-sense macroeconomic knowledge. Their criticism of Europe’s governments for not understanding the same thing is highly valid and echoes, in fact, what I have been saying on this blog for three years.

But there is one more aspect to this that the Treasury economists have not brought up – at least not as quoted by Euractiv. Let’s get back to their story:

The report singled out Europe’s biggest economy, saying “stronger demand growth in Germany is absolutely essential, as it has been persistently weak.” The US Treasury argues that policy makers in the euro area need to use fiscal policies to complement the monetary stimulus that the European Central Bank is providing. … While growth in Europe has shown some recent signs of picking up, the region remains the sick man of the global economy.

The problem for the Europeans is that they cannot do this. They cannot use fiscal policy to stimulate aggregate demand, because if they do they have to abandon statist austerity. Welfare states would again be allowed to go into deficits.

There are many reasons why the Europeans cannot let that happen. The first and most immediate reason is called “Greece”. The EU is in a very tense showdown with the socialist Greek government over repayments of loans – loans that in turn were given as part of EU-enforced statist austerity. If the EU now abandoned its austerity policies, the Greeks would rightly ask “what about us??” and the 25-percent drop in GDP that followed the harsh implementation of statist austerity in the country.

Another reason for the EU to stick to its austerity guns is the long-term concern for the welfare state’s fiscal sustainability. The Europeans are almost unanimously behind their welfare states and they are willing to sacrifice enormously for their ideologically driven big government. They have convinced themselves that the welfare state is not, has not been, and will not be the cause of their macroeconomic ailment. Therefore, they will try as best they can to defend the indefensible, namely the fiscal sustainability of the welfare state; that defense will take priority over any measures to help the private sector grow and thrive.

For these reasons, and others, there is no hope for a growth-oriented fiscal policy in Europe.

Apparently, the realization that something is structurally wrong is beginning to set in on some key policy makers. Euractiv again:

Speaking ahead of next week’s meetings, IMF managing director Christine Lagarde also warned that global recovery remained ‘moderate and uneven’ with too many parts of the world not doing enough to enact reforms even as risks to financial stability are rising. Mediocre economic growth could become the “new reality,” leaving millions stuck without jobs and increasing the risks to global financial stability, she insisted.

Ms. Lagarde and others interested in the systemic roots of this growth crisis are more than welcome to read my book Industrial Poverty about the structural problems in the European economy.

Again, it is encouraging to see American government officials notice and basically correctly analyze the differences between Europe and the United States. What is needed now is that those officials speak up about why the Europeans are ailing, and what the consequences will be for them and the world economy if they insist on protecting their welfare states at all cost.

Perhaps a President Rand Paul can take it up a notch…

QE and Structural Deficits

When a welfare state runs out of taxpayers’ money they run a so called structural budget deficit. That is a deficit that does not go away with strong growth but remains in the government budget, theoretically forever, in practice over a period of time longer than at least one business cycle.

A structural deficit forces government to borrow continuously, i.e., to make borrowing a permanent revenue source on par with taxation. As I explained recently, of 14 member states in the European Union ten suffer from structural deficits when GDP growth is measured in current prices. When inflation is removed from the growth data, all 14 countries run significant structural deficits.

Since this deficit analysis was limited by the availability of consistent data (only 14 states) it is not possible to firmly conclude anything about the EU as a whole. However, if 14 states, selected merely because of data availability, run structural deficits, then the likelihood is pretty high that the remaining 14 EU member states have similar problems with structural deficits.

Structural deficits create a major problem for the countries whose governments have to borrow the money. The ongoing borrowing need depresses market demand for their bonds, eventually driving some countries with extreme deficits – think Greece of Spain – to have to pay massive interest premiums on their treasury bonds in order to attract buyers. To fix this, the European Central Bank came up with its own version of the American Quantitative Easing program: the central bank buys the bonds that the free market does not like.

Quantitative Easing was a bad idea in the United States, as it allowed the federal government to continue spending money without reining in its increasingly uncontrollable welfare state. In Europe, the idea is even worse: the European welfare state is more “mature” than the American, making its structural deficit problems even more serious. Therefore, the QE program will feed a government that is even farther away from being able to pay for its ongoing expenses than the U.S. government is.

Against this background, it is astounding to read the following article at EUBusiness.com:

The European Central Bank said Thursday it is increasingly confident that its controversial bond purchase programme is helping boost the eurozone’s economic recovery, even as a top official expressed doubts about its effectiveness. In the minutes of the governing council’s meeting on March 4 and 5 released on Thursday, the ECB said that “members generally shared the assessment that significant positive effects … could already be seen” from the new bond purchase programme known as quantitative easing (QE).

First of all, the QE policy is not even a quarter of a year old yet. It would not be possible to identify causalities even if we tried with an economic microscope. Secondly, even if there are visible effects, they would be limited to lower interest rates. While it is true that the ECB has entered negative interest territory and decided to stay there for a while, it is important to remember that the negative interest rate became reality long before the QE program did. Furthermore, ultra-low interest rates do not fix Europe’s macroeconomic problems anymore than they have fixed Japan’s decades-long problems.

According to EUBusiness.com there is no shortage of critics of the QE program:

[Some] prominent ECB members — notably the head of the German central bank or Bundesbank Jens Weidmann and ECB executive board member Sabine Lautenschlaeger — have repeatedly expressed doubts about the need and impact of such a programme. Lautenschlaeger told a German magazine on Thursday that she had “doubts whether the economic effects of the purchase programme will reach the desired magnitude.” And she warned that the current very low level of interest rates could lead to the formation of asset price bubbles. Before joining the ECB’s executive board, Lautenschlaeger was vice president of the German central bank and she shares the same scepticism as Weidmann.

But the monetary Eurocrats seem to be dead set on finding something positive to report. EUBusiness.com again:

Nevertheless, at the governing council’s last policy meeting in Nicosia, Cyprus, in March, there appeared to be agreement that QE was indeed helping to ease financial market conditions and the cost of external finance for companies, the minutes showed. Coupled with recent positive economic data and signs of a turnaround in inflation, “this provided grounds for ‘prudent optimism’ regarding the scenario of a gradual recovery and a return of inflation rates to levels closer to 2.0 percent,” the minutes stated.

This is actually disingenuous. Corporate borrowing costs have been declining since the Great Recession started. They started falling because banks still wanted to lend to non-financial corporations, but the non-financial corporations refused to take on more debt. They were simply far too pessimistic about the future of the European economy.

In short: low corporate borrowing costs have absolutely nothing to do with QE.

All in all, it sounds like the ECB is desperately trying to grab for positive news. this makes them prone to overlook the risks associated with QE, one of them being that governments simply decide not to do much more about their notorious deficits. This means, simply, letting the structural deficits remain as they are, whereupon the underlying problem in the European economy – an over-bloated welfare state – remains unsolved.

Europe’s Structural Deficit Problem

In my book Industrial Poverty I diagnose the European economic crisis as being a permanent state of economic stagnation, caused by a fiscally unsustainable welfare state. The deficits that plague the continent’s welfare states are caused by a structural imbalance between tax revenue growth and growth in government spending. In other words, the deficits that the EU-IMF-ECB troika and member-state governments have been fighting so hard over the past 5-6 years are actually in large part structural.

As I explain in this paper, you cannot fight structural deficits with business-cycle policy measures. That is what the Europeans have tried to do for half a decade now, to no avail. In fact, their problems have only gotten worse, with no recovery in sight.

Today I am happy to report on yet another depressing angle of the crisis. A structural budget deficit is a deficit that a government cannot pay for over a long period of time. While there is no set-in-stone definition of a structural deficit, the conventional definition has been that it is the deficit that remains when the economy is operating at full employment. However, the definition of full employment changes over time; what was considered serious unemployment in the 1980s is now acceptable as full employment in many countries. With that change, obviously the definition of the structural deficit would change as well, even though government has done nothing to reduce the deficit.

A better definition of a structural deficit is one that still rises above the regular business cycle but at the same time is independent of the level of employment. In the aforementioned paper I suggested a definition based on, at minimum, ten years of economic performance: a ten-year long trend in government spending (or a specific share thereof) is compared to a ten-year long trend in tax-base growth. If spending outgrows the tax base, then the government is having to deal with a structural deficit; if the tax base grows faster than spending, then there is a structural surplus in the government budget.

To get a good idea of whether or not Europe has a structural-deficit problem, I pulled the following numbers from the Eurostat database:

Government spending defined as welfare-state spending: housing and community development; health; culture, religion and recreation; education; and social protection; and

Current-price and inflation-adjusted growth in GDP.

Not all member states report these numbers down to the level needed for a ten-year trend study; in addition to 13 EU member states I also pulled data for Norway, which turned out to be interesting.

The results are as follows (time period 2004-2013). A ratio of 100 means a perfect growth balance where welfare-state spending is growing on par with the tax base; an index number below 100 is a structural deficit while an index number higher than 100 represents a structural surplus. For current-price GDP, four of the 14 countries actually run a surplus:

Poland 120.5
Norway 116.2
Sweden 108.3
Czech Republic 100.3
Austria 97.5
Estonia 90.8
Luxembourg 82.8
Belgium 72.9
Cyprus 72.5
France 70.3
Netherlands 63.4
Finland 61.3
Italy 53.5
Portugal 53.0

While the Polish government’s broadest possible tax base is growing by 120.5 euros per 100 euros of welfare-state spending, the Portuguese tax base only grows by 53 cents per euro of growth in welfare-state spending.

This indicates structural deficits in ten of these 14 countries. It does not mean that there is an actual deficit of this magnitude, but it means that the economy of these ten countries is unable to sustain the spending that goes out through their entitlement programs.

But that aside, it looks kind of good, doesn’t it, to have such a prominent welfare state as Sweden in the structural surplus category. Does that not mean that the welfare state can be paid for?

Let us answer that question with a look at the same spending numbers, but now compared to inflation-adjusted GDP:

Poland 61.8
Sweden 47.9
Austria 44.5
Czech Republic 39.1
Luxembourg 35.4
Estonia 33.6
France 29.8
Belgium 29.2
Netherlands 29.2
Cyprus 25.9
Norway 25.4
Finland 23.1
Portugal -2.4
Italy -9.6

All of a sudden, Poland can only pay for 61.8 cents of every euro they spend on welfare-state programs. Sweden cannot pay for half of its welfare state. But worst of all: welfare-state spending in Portugal and Italy is so structurally under-funded that it outgrows the tax base by more than a euro, per euro in increased spending!

This means, in a nutshell, that the Portuguese and Italian governments draw taxes from a shrinking tax base to pay for what is undoubtedly an out-of-control welfare state.

Even if the actual growth of their tax revenues does not track the growth of GDP at all times, the GDP growth rate provides the most comprehensive picture of what the economy – and thereby taxpayers – could afford in terms of welfare-state spending. The bottom line for today, therefore, is that governments of welfare states from all corners of Europe are lucky if they see their tax revenues grow half as fast as their spending. And that is regardless of where the business cycle is: again, these numbers cover the period from 2004 through 2013.

Errors in Global Debt Analysis

Government debt is a problem. It pushes the cost of today’s government entitlement programs onto the shoulders of tomorrow’s taxpayers. The debt problems are made worse by the fact that the welfare states of Europe and North America all seem to suffer from a structural deficit: over a period of time longer than a business cycle they increase spending faster than their tax base increases. These deficits in turn are caused by entitlement programs that are purposely designed to increase in cost independently of the private sector’s ability to pay for them.

Over time, governments have raised taxes to keep funding their welfare states – and when tax increases have been politically unpalatable they have resorted to spending cuts. The net effect has been a more stingy welfare state at a higher cost to taxpayers.

Herein lies the core of the reason why the Western World has an endemic debt problem. As a share of GDP taxes have increased in every European welfare state over the past half century – in some cases the tax-to-GDP ratio has more than doubled. (See my book Industrial Poverty, pp. 75-77.)

In other words, the welfare state creates a permanent spending problem, the funding of which creates a permanent slow-growth problem which in turn creates a permanent deficit problem.

This is a systemic failure for the Western World of epic proportions. Unfortunately, the “big picture” is still a mystery to many people. Let me offer two examples. The first is from The Telegraph:

The eurozone is “untenable” in its current form and cannot survive unless countries are prepared to cede sovereignty and become a “United States of Europe”, the manager of the world’s biggest bond fund has warned. The Pacific Investment Management Company (PIMCO) said that while the bloc was likely to stay together in the medium term, with Greece remaining in the eurozone, the single currency could not survive if countries did not move closer together.

What this means in a nutshell is that the member states of the EU, or at the very least the euro zone, would have to give up their individual iterations of the welfare state and hand over taxation and spending authority to a union-wide authority. That would be either the EU if it incorporated all 28 states, or some “core” European government if it was confined to the euro zone.

The idea behind this is to bring fiscal and monetary policy into some kind of jurisdictional harmony. But this will not solve anything. It is a change in form, not content. The same welfare state will cause the same problems, and the policies put in place to reduce or eliminate government deficits while preserving the welfare state will have the same negative effects as they now have at the national level.

The Telegraph again, more to the point:

PIMCO used the example of the Latin and Scandinavian unions in the 19th century, which lasted an average of 50 years before breaking up, to illustrate how monetary unions were incompatible with sovereignty. “You need to reach some sort of political agreement about how to share fiscal resources around the zone. We’re a long, long, long way from designing that and getting the political backing for it,” … “So while you’re waiting for that and you’ve got low growth, and high unemployment, you run the risk of letting these anti-euro parties to the forefront.”

Those anti-EU parties would break up the currency union – in fact, that will happen as soon as Marine Le Pen moves into the Elysee Palace in Paris – but they will not alter Europe’s fundamental socio-economic structure. They will try to defend the welfare state, too, and will eventually encounter the exact same problems that have troubled Europe’s welfare states incrementally since the late 1970s.

But let us not forget that the government debt problem is not confined to the “advanced” welfare states shoring the North Atlantic. In fact, as if to underscore the social and economic disease that the welfare state represents, The Guardian reports:

Greek ministers are spending this weekend, almost five grinding years since Athens was first bailed out, wrangling over the details of the spending cuts and economic reforms they have drawn up to appease their creditors. As the recriminations fly between Europe’s capitals, campaigners are warning that the global community has failed to learn the lessons of the Greek debt crisis – or even of Argentina’s default in 2001, the consequences of which are still being contested furiously in courts on both sides of the Atlantic.

Or, for that matter, the Danish and Swedish lessons from, respectively, the 1980s and 1990s. I discuss the Danish crisis and analyze carefully the Swedish case in my book Industrial Poverty; for those proficient in Swedish, see an abbreviated analysis in the next issue of Magasinet Neo, out next week.

Back to The Guardian:

As Janet Yellen’s Federal Reserve prepares to raise interest rates, boosting the value of the dollar, while the plunging price of crude puts intense pressure on the finances of oil-exporting countries, there are growing fears of a new debt crisis in the making.

An example. The Alaska state government gets more than 90 percent of its General Fund revenue from oil. With the oil price at a third of what it was two years ago the state government is now on the verge of fiscal panic.

Ann Pettifor of Prime Economics, who foreshadowed the credit crunch in her 2003 book The Coming First World Debt Crisis, says: “We’re going to have another financial crisis. Brazil’s already in great trouble with the strength of the dollar; I dread to think what’s happening in South Africa; then there’s Malaysia. We’re back to where we were, and that for me is really frightening.”

I have written several articles about South Africa, where I have pointed to the main problem of the country. It is not debt – that is merely a symptom of what is really wrong. The systemic error in the South African equation is the massive entitlement system that the ANC government has tried to build and fund since taking over power 20 years ago. Trained as they were by Swedish socialists, the ANC leadership that defined the course of South Africa after the fall of Apartheid had only one thing in mind: to build their own version of the Scandinavian welfare state.

The result is high inflation, low growth, very high unemployment, social instability and a tax system that punitively keeps employers from creating jobs.

Without the welfare state there would be no debt problem in South Africa.

The Telegraph again:

Since the aftershocks of the global financial crisis of 2008 died away, … next to nothing has been done about the question of what to do about countries that can’t repay their debts, or how to stop them getting into trouble in the first place.

Don’t build a welfare state. Don’t create spending programs that the private sector cannot afford. This is a particularly bad idea in developing countries where the private sector is in poor shape in the first place.

Unfortunately, this is not the direction that the global debate is moving. It is taking a different route, namely toward welfare states being given a chance to default on their debt with impunity. The Telegraph explains:

Developing countries are using the UN to demand a change in the way sovereign defaults are dealt with. Led by Bolivian ambassador to the UN Sacha Sergio Llorenti, they are calling for a bankruptcy process akin to the Chapter 11 procedure for companies to be applied to governments. Unctad, the UN’s Geneva-based trade and investment arm, has been working for several years to draw up a “roadmap” for sovereign debt resolution. It recommends a series of principles, including a moratorium on repayments while a solution is negotiated; the imposition of currency controls to prevent capital fleeing the troubled country; and continued lending by the IMF to prevent the kind of existential financial threat that roils world markets and causes severe economic hardship. If a new set of rules could be established, Unctad believes, “they should help prevent financial meltdown in countries facing difficulties servicing their external obligations, which often results in a loss of market confidence, currency collapse and drastic interest rates hikes, inflicting serious damage on public and private balance sheets and leading to large losses in output and employment and a sharp increase in poverty”.

Once this measure is in place, what are the chances anyone would buy Treasury bonds from any country that is perceived to have some debt problems? What countries would be allowed this measure? It would have to be all UN member states, or else the rules for the Chapter-11 style mechanism would be ad hoc.

The next question is what would happen if Greece used this way out of its debt problems. All of a sudden we are talking about a euro-zone member state, a European welfare state, a country that is not too different from, say, Spain or Italy. What would happen if Spain or Italy did a “Chapter 11″, countries that are not too different from, say, France?

This is a Pandora’s Box of defaults that would have catastrophic effects on the financial system. It would turn now-safe Treasury bonds – or at least from those countries that still have good credit – into almost toxic assets. Who would want to buy any welfare-state Treasury bonds if that government can choose to file for bankruptcy if they consider the payments too burdensome?

Surely, there would be rules for filing for bankruptcy. But who would be writing those rules? The same welfare states that want to be able to borrow frivolously to keep their entitlement programs going.

The systemic problem with the welfare state still eludes the world’s political leaders. Ann Pettifor may very well be right in that there is another debt crisis coming, but a more accurate way of describing it would be that the same debt crisis – the ongoing, daily borrowing by unsustainable big governments – that has been cooled off for a while will erupt again.

And it will continue to do so until our political leaders get their act together and terminate the welfare state.

Growth and Deficits in Europe

As the Germans, the Greeks and the European Union leadership try to hash out a reasonable plan for Greece to secede from the currency union, the underlying question remains: has Europe managed to deal with the structural problems that brought many of its member states to their fiscal knees?

More specifically: are the problems that have sent Greece into a depression and possibly out of the euro zone unique to Greece – or are they just more concentrated there than elsewhere in Europe?

The answer to this question, presented in my book Industrial Poverty, is that the Greek crisis is merely a concentrate of an endemic European problem: a welfare state that is structurally and permanently too costly for the private sector to pay for. So long as the Europeans keep their welfare state they will continue to dwell in economic stagnation, with chronic problems of growth and budget deficits.

Over the past year countless forecasts of a strong recovery – or even a moderate recovery – in the European economy have been proven wrong. There are two reasons for this: economists normally rely on econometrics when they make their forecasts, a methodology that is not well tuned for large institutional and structural problems in the economy; and the focus on – obsession with – econometrics leads economists to ignore long-term structural trends in the economy.

Europe’s crisis is a structural one, caused by a long trend of weakening growth and increasingly persistent budget deficits. The over-arching problem, again, is the structure of entitlements imposed on the economy by the welfare state, a fact that is visible in the following, rather compelling data.

Figure 1 reports data on GDP growth and government deficits as share of GDP. The data is from 12 European welfare states, selected first and foremost based on data availability. The 12 states are then observed over a period of 48 quarters, fourth quarter of 2002 through third quarter of 2014, for annual, inflation-adjusted GDP growth and the deficit-GDP ratio. The result is a clearly visible correlation between the deficit ratio and GDP growth:



The better the deficit-to-GDP ratio, the stronger is GDP growth.

Now, let’s not rush to conclusions here. The immediate reaction among crude Austrians and crude Keynesians would be, respectively:

  • “Yes, this proves that austerity is king!”
  • “No, this can’t be – everybody knows that deficit spending is king!”

Truth is, neither side is correct. The reason why budget surpluses, or small deficits, correlate with high growth and deficits with slow or no growth, is as simple as it is independent of political-economic theory. Put simply, modern, mature welfare states are so big and difficult to pay for that a budget deficit is the normal state of affairs. Since the welfare state also depresses growth, by means of high taxes and sloth-inducing entitlements, it creates a combination of deficits and low growth.

Under unusual circumstances, high growth combines with surpluses not because government spending is low, but because GDP growth is high. In other words, observations of surpluses in Figure 1 are due entirely to a fortunate period of strong growth.

To further reinforce the point that growth is the only way to a reduced deficit in modern welfare states, consider Figure 2:


Note how the deficit-to-GDP ratio improves from 2005-2006. The reason is an improvement in GDP growth that started already in 2003. Next, note how GDP growth stagnates and starts declining in 2007 and how the deficit ratio follows downward in 2008. The upturn in the deficit ratio does not come until 2010, a year after GDP started improving.

In a nutshell: it is growth, not austerity, that fixes European budgets. (The same holds true, obviously, for the United States as well.) In absence of growth the budget deficits overwhelm their host economies and pile up more and more unsustainable debt.

The Euro and the Deficit Crisis

The fiscal stress on the euro-zone continues. Last week the EU non-solved the Greek problem:

Eurozone finance ministers on Tuesday (24 February) approved a list of reforms submitted by Athens and cleared the path for national parliaments to endorse a four-month extension of the Greek bailout, which otherwise would have run out on 28 February. “We call on the Greek authorities to further develop and broaden the list of reform measures, based on the current arrangement, in close coordination with the institutions,” the Eurogroup of finance ministers said in a press statement.

Don’t expect that to happen. Prime minister Tsipras wants Greece to secede from the euro zone so he can pursue his Chavista socialist agenda on his own. He cannot do that without a national currency, but so long as a large majority of Greeks want to keep the euro he cannot outright declare currency independence. He needs to build momentum and create the right kind of political circumstances. This extension of status quo gives him four more months to do so.

The question is what those circumstances will look like. The EU Observer article provides a hint:

[The] IMF, while saying it can support the conclusion that the reforms plan is “sufficiently comprehensive”, criticised the plan for lacking details particularly in key areas. “We note in particular that there are neither clear commitments to design and implement the envisaged comprehensive pension and VAT policy reforms, nor unequivocal undertakings to continue already-agreed policies for opening up closed sectors, for administrative reforms, for privatisation, and for labour market reforms,” IMF chief Christine Lagarde wrote in a letter to Eurogroup chief Jeroen Dijsselbloem.

These are reforms that the new socialist government in Athens would not want to carry out. It is a good guess that they will be punting on the reforms to provoke the IMF into making an ultimatum. At that point Tsipras can tell the Greek people that he will not subject them to any more IMF-imposed austerity, and the only way he can protect them is to re-introduce the drakhma.

Will this happen in four months? It remains to be seen. But there is no way that Tsipras is going to tow the line dictated by the IMF, the ECB and the EU. His very rise to political stardom is driven by unrelenting opposition to such fiscal subordination.

In other words, the Greek crisis is far from over and will continue to be a sore spot on the euro-zone map. If it were the only one, the euro zone and the entire EU political project might still have a future. That is not the case, however:

The European Commission on Wednesday (25 February) gave France another two years to bring its budget within EU rules – the third extension in a row – saying that sanctions represent a “failure”. France has until 2017, having already missed a 2015 deadline, to reduce its budget from the projected 4.1 percent of GDP this year to below 3 percent. “Sanctions are always a failure,” said economic affairs commissioner Pierre Moscovici adding that “if we can convince and encourage, it is better”.

This is a non-solution similar to the Greek one, though for somewhat different reasons. In the Greek case the EU does not want to provoke an imminent Greek currency secession; in France they do not want to give anti-EU politicians more gasoline to pour on the European crisis fire.

What the European leadership does not seem to realize, or at least will not admit, is that the euro will lose either way. By pushing Greece too hard the EU Commission will give Tsipras his excuse to reintroduce the drakhma; by treating France with silk gloves the Commission hollows out the enforcement backbone of the currency union. Known as the Stability and Growth Pact – the balanced-budget requirement built into the EU constitution – it was supposed to hold sanctions as a sword over member states to minimize budget deficits. Now the EU Commission has effectively neutered the Pact and created an ad-hoc environment where austerity is forced upon some countries but not others.

With no sanctions there are no incentives for the states to comply. On the contrary: compliance means austerity, which comes with a big political price tag for the member states; non-compliance, on the other hand, comes with no price tag whatsoever.

To be blunt, the silk-glove treatment of France has put the final nail in the coffin of the Stability and Growth Pact. Aside from its consequences for the inherent strength of the euro, this silk glove stands in sharp contrast to the iron fist that the Commission presented Greece with already in 2010. The EU Observer again:

Valdis Dombrovskis, a commission vice-president dealing with euro issues, admitted that France is the “most complicated” case discussed on Wednesday. Paris is in theory in line for a fine for persistent breaching of the euro rules. However the politics of outright punishing a founding member of the EU, a large member state, and a country where the economically populist far-right is riding high in the polls, has always made it unlikely that the commission would go down this route.

This is of course a major mistake. The only mitigating circumstance is that France is not yet in a situation where it requires loans from the EU-ECB-IMF troika to pay its bills. But if the socialist government generally continues with its current entitlement-friendly, tax-to-the-max policies it will not see its budget problems go away.

Down the road there is at least a theoretical possibility that France could be sucked into the bailout hole. More likely, though, is that Marine Le Pen will be elected president in 2017 and pull France out of the euro. That will, so to speak, solve the problem for both parties.

I have said this before and I will maintain it ad nauseam: so long as Europe’s political leaders persist in their fervent defense of the welfare state, they will continue to drive their continent deeper and deeper into the macroeconomic quagmire called industrial poverty.

Socialist Momentum in Europe

The answer to the question whether or not Greece will stay in the euro will probably be given this week. New socialist prime minister Tsipras is not giving the EU what it wants, jeopardizing his country’s future inside the currency union:

Talks between Greece and eurozone finance ministers broke down on Monday with an ultimatum that Athens by Friday should ask for an extension of the current bailout programme which runs out next week. Greek finance minister Yanis Varoufakis said he would have been willing to sign off on a proposal made by the EU commission, which was more accommodating to Greek demands, but that the Eurogroup offer – to extend the bailout programme by six months – was unacceptable. The battle is about more than just semantics. EU officials say Greece cannot cherrypick only the money-part of a bailout and ignore the structural measures that have to be implemented to get the cash. “If they ask for an extension, the question is, do they really mean it. If it’s a loans extension only, with no commitments on reforms, there is an over 50 percent chance the Eurogroup will say no,” one EU official said. Failure to agree by Friday would leave very little time for national parliaments in four countries – notably Germany – to approve the bailout extension. It would mean Greece would run out of money and be pushed towards a euro-exit. … As for the prospect of letting Greece face bankruptcy to really understand what’s at stake, an EU official said “there is no willingness, but there is readiness to do it”.

The mere fact that there is now official talk about a possible Greek exit from the euro is a clear sign of how serious the situation is. It is also an indication that the EU, the ECB and the governments of the big EU member states have a contingency plan in place, should Greece leave the euro.

My bet is that Tsipras is gambling: he wants out of the euro, but with a majority of Greeks against a reintroduction of the drachma he cannot go at it straightforwardly. He has to create a situation where his country is given “no choice” but to leave. This is why he is negotiating with the EU in a way that he knows is antithetical to a productive solution.

The reason why Tsipras wants out is simple: he is a Chavista socialist and wants to follow in the footsteps of now-defunct Venezuelan president Hugo Chavez. That means socialism in one country. (A slight rephrasing of the somewhat tarnished term “national socialism”.) In order to create a Venezuelan-style island of reckless socialism in Europe, Tsipras needs to get out of the euro zone.

Should he succeed, it is likely that other countries will follow his example, though for different ideological reasons. However, there is more at stake in the Greek crisis than just the future of the euro zone. Tsipras is riding a new wave of radical socialism, a wave that began moving through Europe at the very depth of the Great Recession. Statist austerity was falsely perceived as an attempt by “big capitalism” to dismantle the welfare state. It was not – quite the contrary:  statist austerity was a way for friends of big government to preserve as much as possible of the welfare state.

However, socialists have never allowed facts to get in the way of their agenda. And they certainly won’t let facts and good analysis get in the way of their rising momentum. What started mildly with a socialist victory in the French elections in 2012 has now borne Tsipras to power in Greece and is carrying complete political newcomers into the center stage of Spanish politics. But this new and very troublesome wave of socialism is not stopping at member-state capitals. It is reaching into the hallways of EU politics as well. As an example, consider these words on the Euractiv opinion page by Maria João Rodrigues MEP, Vice-Chair of the Socialists and Democrats Group in the European Parliament, and spokesperson on economic and social policies:

The Greek people have told us in January’s elections that they no longer accept their fate as it has been decided by the European Union. For those who know the state of economic and social devastation Greece has reached, this is only a confirmation of a survival instinct common to any people. The Greek issue has become a European issue, and we are all feeling its effects.

This is a frontal attack on EU-imposed austerity, but it is also a thinly veiled threat: unless Europe moves left, the left will move Europe.

Back to Rodrigues:

European integration can only have a future if European decisions are accepted as legitimated by the various peoples who constitute Europe. Decisions at European level require compromises, as they have their origins in a wide variety of interests. But these compromises must be perceived as mutual and globally advantageous for all Member States involved, despite the commitments and efforts they entail. The key question now is whether it will be possible to forge a new compromise, enabling not only to give hope to the Greek people, but also to improve certain rules of today’s European Union and its Economic and Monetary Union.

This should not be misinterpreted as a call for return of power to the member states. The reason why is revealed next:

We need a European Union capable of taking more democratic decisions and an Economic and Monetary Union which generates economic, social and political convergence, not ever-widening divergence. If Europe is unable to forge this compromise, and if the rope between lenders and borrowers stretches further, the risks are multiple: financial pressures for Greece to leave the euro; economic and social risks of continued stagnation or recession, high unemployment and poverty in many other countries; and, above all, political risks, namely further strengthening of anti-European or Eurosceptic parties in their aspiration to lead national governments, worsening Europe’s fragmentation.

The fine print in this seemingly generic message is: more entitlement spending to reduce income differences – called “economic and social convergence” in modern Eurocratic lingo – and a central bank the policies of which are tuned to be a support function for fiscal expansion. The hint of this is in the words “If the rope between lenders and borrowers stretches further”: member states should be allowed to spend on entitlements to reduce income differences, and if this means deficit-spending, the ECB should step in and monetize the deficits.

Rodrigues offers yet another example of the same argument:

[Many of] Greece’s problems were aggravated by the behaviour of the European Union: Firstly, it let Greece exposed to speculative market pressures in 2010, which exacerbated its debt burden. Secondly, when the EU finally managed to build the necessary financial stabilisation mechanisms, it imposed on Greece a programme focused on the reduction of the budget deficit in such an abrupt way that the country was pushed into an economic and social disaster. Moreover, the austerity measures resulted in a further increase of Greece’s debt compared to its GDP.

It is apparently easy for the left to look away from such obvious facts as the long Greek tradition of welfare-state spending. But that goes with the leftist territory, so it should not surprise anyone. More important is the fact that we once again have an example of how socialists use failed statist austerity to advocate for even more of what originally caused the crisis, namely the big entitlement state. They want to turn the EU and the ECB into instruments for deficit-spending ad infinitum to expand the welfare state at their discretion.

To further drive home the point that what matters is the welfare state, Rodrigues moves on to her analysis of Greece:

What Greece needs now is a joint plan for reform and reconstruction, agreed with the European institutions. This plan should replace the Troika programme, while incorporating some of its useful elements. Crucially, it should foresee a relatively low primary surplus and eased conditions of financial assistance from other eurozone countries, in order to provide at least some fiscal room for manoeuvre for the country. In return, the plan should set out strategic reforms to improve the functioning of the Greek economy and the public sector, including tax collection, education, employment and SMEs services as well as ensuring a sustainable and universal  social protection system.

There is no such thing as a “sustainable and universal social protection system”. When Europe’s new generation of socialist leaders get their hands on the right policy instruments they will turn all government-spending faucets wide open. Deficits will be monetized and imbalances toward the rest of the world handled by artificial exchange-rate measures (most likely of the kind used by now-defunct Hugo Chavez).

If this new wave of socialism will define Europe’s future, then the continent is in very serious trouble.

A short-term measure of the strength of the momentum will come later this week when we will know whether or not Greece will remain in the currency union. Beyond that, things are too uncertain to predict at this moment.

Negative Rates a Desperate Move

Sweden has joined the club of runaway monetary policy. From Reuters:

Sweden shocked markets on Thursday by introducing negative interest rates, launching bond purchases and saying it could take further steps to battle falling prices. The central bank joins a list of those including the European Central Bank, the U.S. Federal Reserve and the Bank of England, to resort to unconventional monetary policy steps to confront an unusual combination of economic problems.

No. The Federal Reserve has reversed course. And together with The Bank of England the Fed has been helped by the fact that it is operating in an economy with moderate taxes and relatively relaxed fiscal policy. The ECB has opened the monetary flood gates in an economy that is plagued by statist austerity and more or less zero growth.

In fact, the slight uptick in economic activity in the third quarter of 2014 that I reported on earlier this week is closely correlated to the all-out liquidity bombardment that the ECB began early summer last year. On the margin there are those who will take advantage of declining interest rates. According to data from the ECB, euro-denominated loans to non-financial corporations declined noticeably in 2014. In the group of loans with a 5-10 year rate fixation, the interest on loans above 1 million euros fell by more than one percentage point, from 2.9 percent to 1.73 percent. Other collateral loan categories saw smaller declines, but the downward trend is unmistakable.

It is likely that the same thing will happen in Sweden; the question is what effect lower interest rates will have on economic activity. In the EU, gross fixed capital formation – a.k.a., business investments – did actually increase in 2014. However, broken down by quarter, the annual growth rate (i.e., over the same quarter the previous year) looks much different:

  • Q1 2014 up 3.78 percent;
  • Q2 2014 up 2.35 percent;
  • Q3 2014 up 1.86 percent.

In other words, the largest annual increase was recorded before the ECB declared a negative interest rate. It remains to be seen what happened in the fourth quarter, but even if there was an increase somewhere in the same territory as earlier in 2014, the big question is what the lasting impact is going to be on GDP growth and employment. One indicator of this is private consumption, which seems to have benefited a bit more from the ECB’s desperate interest rate cuts. Again measured as annual increases by quarter:

  • Q1 2014 up 0.68 percent;
  • Q2 2014 up 1.27 percent;
  • Q3 2014 up 1.4 percent.

For the two years Q3 2012 to Q3 2014 the annual increase was, on average, 0.3 percent. Nothing to be jubilant about, but the modestly accelerating trend during 2014 indicates a stabilization (rather than some sort of genuine recovery).

What does this mean for Sweden? The problem with that particular country is that its private-consumption increase is inflated by recklessly high household debt levels. These levels, in turn, are held up by mortgage loans with absolutely irresponsible terms, such as interest-only payments or basically life-long maturity periods. As I explained in my book Industrial Poverty, if Swedish household debt had remained a constant share of disposable income from 2000 and on, its private-consumption growth rate would almost have stalled.

Put bluntly: Sweden appears to be in reasonable economic shape only because households have increased their debt as share of disposable income from 90 percent 15 years ago to 180 percent today.

What this means is, plain and simple, that it is exceptionally irresponsible to make more credit available at even lower costs. But it also means that on the margin, the Swedish Riksbank will get less new economic activity out of every negative interest point than the ECB gets; the higher the household debt, the less inclined banks are to let people pile on new debt.

Unfortunately, the Riksbank president, Mr. Stefan Ingves, does not see this problem. Reuters again:

“Should this not be enough, we want to be very clear that we are ready to do more,” said Central bank governor Stefan Ingves. “If more is needed, we are ready to make monetary policy even more expansionary.” The central bank said this would mean further repo-rate cuts, pushing out future rate hikes and increasing the purchases of government bonds or loans to companies via banks.

As the Reuters story also explains, the Riksbank is ready to move into debt monetization – unthinkable only a year ago:

The Riksbank said it would “soon” make purchases of nominal government bonds with maturities from 1 year up to around 5 years for a sum of 10 billion Swedish crowns ($1.17 billion). But with the ECB printing 60 billion euros a month in new money the Riksbank’s much more limited program may have little effect on bond yields – already at record lows. “In terms of GDP, the mini-QE program amounts to about 0.25 percent,” banking group Morgan Stanley said in a note. “Therefore, this measure should be seen more as a signal that the Riksbank is ready to do more and remain dovish for the foreseeable time.”

In other words, here again the marginal payoff is going to be small. The only exception would be if the Swedish government decides to throw out  its balanced-budget rules and start a major spending drive funded by the Riksbank. This seems unthinkable today – just like negative interest rates and a QE program seemed unthinkable a year ago.

Quantitative Easing is not a recession remedy. It is a defensive monetary strategy. So is the negative interest rate. Together, these two measures declare that a government and its central bank has reached the end of the road in trying to get their economy moving again. The big problem for Europe, Sweden included, is that they have come to this point almost seven years after the Great Recession started. With a recovery being half-a-decade overdue, with tapped-out monetary policy and fiscal policies restrained by ill-designed balanced-budget measures, Europe is firmly planted on the road straight into industrial poverty.

Sweden, with its imbalanced real estate market and very deeply indebted households, is on the same road, only with a more volatile ride.

Europe Invented Statist Austerity

In December I took a first look at the European Commission’s “Report on Public Finances”, with the intention of returning to this important document later. It has been almost a month, longer than I expected, but here we are.

In my first review of the report I explained that the strict focus by Europe’s political leadership on government finances has led to a systemic error in their fiscal policy priorities:

Austerity, as designed and executed in Europe, was aimed not at shrinking government but making it affordable to an economy in crisis. The end result was a permanent downward adjustment of growth, employment and prosperity. In order to get their economy out of this perennial state of stagnation, Europe’s leaders need to understand thoroughly the relations between government and the private sector.

This is a kind of prioritization that has guided European fiscal policy for two decades now. Under the Stability and Growth Pact, EU member states in general are forced to adopt a fiscal policy that inherently has a contractionary – austerity – bias. But it is not the kind of austerity that reduces the size of government. It is the kind that tries to shrink a budget deficit in order to keep government finances in good order and save the welfare state from insolvency.

So long as contractionary fiscal policy – austerity – is focused on balancing the budget and saving the welfare state, it won’t reduce the size of government. For that, it takes specifically designed austerity measures. Those measures are indeed possible, even desirable, but they cannot be launched unless government is allowed by its own constitution to prioritize less government over a balanced budget.

Unfortunately, the Stability and Growth Pact does not permit that member states prioritize shrinking government over budget balancing. Instead, the Stability and Growth Pact forces them to always pay attention to deficits and debt, but never worry about running too large surpluses. Part A of the Pact caps government deficits at three percent of GDP and debt at 60 percent of GDP. At the same time, there are no caps on budget surpluses; since a surplus is excess taxation, and since excess taxation drains the private sector for money in favor of a government savings account, this means that governments can drain the private sector for all the money it wants to without violating the European constitution.

Unlike a budget surplus, which is contractionary in nature, a budget deficit is, at least in theory, always stimulative. However, by capping deficits the European constitution restricts the stimulative side of fiscal policy, while at the same time leaving the contractionary end unrestricted.

In addition to the technical aspects of this contractionary bias, there is also the political mindset that is born from a legislative construct of this kind. Lawmakers and elected cabinet members – primarily treasury secretaries – are concerned with avoiding deficits, thus quick to resort to contractionary policy measures, but pay little attention to the need for counter-cyclical policies. Over time, this political mindset becomes “one” with the Stability and Growth Pact to the extent where parliaments do not think twice of passing budgets that impose harsh contractionary measures in order to balance a budget.

Think Europe in 2012. And read chapters 4a and 4b in my book Industrial Poverty to get an idea of how deep roots in Europe’s legislative mindsets that this “gut reaction” bias toward contractionary measures has actually grown.

With its contractionary bias, Europe’s fiscal policy has permanently downshifted growth in Europe. This in turn has perpetuated the budget problems that said contractionary policies were intended to solve. It left the European economy fragile and frail, vulnerable to a tough recession. All it took was the downturn in 2008-09 with its spike in deficits – and once the fiscal-policy gut reaction kicked in, there was nowhere to go for Europe other than into the dungeon of budget-balancing contractionary measures; statist-driven austerity; mass unemployment; and perpetual budget problems.

Never did Europe’s leaders think twice of trying to actually release its member states from the shackles of the Stability and Growth Pact. Never did they think twice of permitting a widespread downward adjustment of the size of government.

The Commission’s “Report on Public Finances” cements this statist approach to contractionary fiscal policy. It has an entire section that suggests further collaboration and coordination among EU member states on the fiscal policy front. So long as the Stability and Growth Pact remains in place, such coordination would be a thoroughly bad idea. All that such coordination would accomplish is to cement statist austerity as the prevailing “fiscal policy wisdom” ruling the economy that feeds 500 million people.

I will return in more detail to this report. In the meantime, do take a minute and read my paper Fiscal Policy and Budget Balancing: The European Experience. It is part of a five-paper series of discussion papers on the ups and downs of a balanced-budget amendment to the United States constitution.