Tagged: INDUSTRIAL POVERTY

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!

EU Economy Going Nowhere

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

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

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

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

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

Figure 1

C pr EU 24

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

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

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

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

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

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

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

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

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

Europe in Permanent Stagnation

I have explained on numerous occasions that the European economy is not at all in recovery mode. Jobless numbers are frighteningly bad, the long-term trend is still pessimistic, GDP growth is so slow that there is a credible deflation threat hanging over Europe, the OECD recently wrote down its growth forecast for the global economy, including the EU. All in all, Europe is a slow-motion economic disaster.

Now British newspaper The Guardian reports of yet another dark cloud over the European economy:

The eurozone’s fragile economic recovery suffered a setback in the first quarter after slower-than-expected growth. The combined currency bloc scraped together growth of 0.2% between January and March, in line with growth in the previous quarter but disappointing expectations of 0.4% growth.

This amounts to 0.8 percent for the entire year, which is deeply insufficient to turn around the European economy. The best you can say about this growth figure it is yet another indicator that my forecast of Europe being stuck in long-term stagnation is correct. This long-term stagnation is not a recession – it is a new era for the European economy.

There was a huge divergence in fortunes, with Germany growing at the fastest rate of all 18 countries, with gross domestic product increasing by 0.8%. It followed 0.4% growth in Europe’s largest economy in the previous quarter. The pace of recovery also accelerated in Spain, with growth of 0.4% outpacing a 0.2% increase in GDP in the previous three months.

I have explained before that the German economy is growing because of its strong exports. The gains from the exports industry do not spread to the rest of the economy, as is evident from paltry domestic spending figures for the German economy. The same is, in all likelihood, true for the Spanish economy, whose national accounts I will take a look at as soon as time permits.

When exports drive a country’s GDP growth, the country is not in a sustained recovery. The only way a sustained recovery can happen is if private consumption and corporate investments increase together. That is not yet happening in Germany, and it is certainly not happening in Spain.

At the bottom of the pile was the Netherlands, which suffered a shock 1.4% contraction in GDP, reversing 1% growth in the previous quarter. Portugal’s economy shrank by 0.7%, following growth of 0.5% in the final three months of last year. The French and Italian economies were also dealt a blow, with zero growth in France and a 0.1% contraction in Italy in the first quarter. It followed 0.2% growth and 0.1% growth in the fourth quarter of 2013.

Stagnation, for short. And the only remedy that Europe’s political leaders seem to be able to think of is to print even more money, to saturate the economy with liquidity and to thus depreciate the euro vs. other major currencies. But with the Federal Reserve continuing its Quantitative Easing policy and the Chinese facing major problems in their financial sector it is entirely possible that the attempts at eroding the value of the euro will be neutralized by similar attempts from two of the world’s other major central banks. That in turn will put a damper on exports and rob the Europeans of even the illusion that their GDP will at some point start growing again.

At the end of the day, the fact that this negative news disappoints so many people in Europe is yet another indicator that my new book, Industrial Poverty, out in late August, is badly needed.

A Slow-Motion Economic Disaster

It is no secret to readers of this blog that Europe’s political leadership is entirely out of touch with the real life conditions that people live under in Europe. The reckless fiscal policies imposed on member states by the EU leadership over the past 4-5 years have damaged the living conditions and the future prospects of perhaps as many as 200 million people in Europe. In 19 EU member states, youth unemployment exceeds 20 percent, while in at least two it is between 19 and 20 percent. In 7 member states it exceeds 30 percent, with three countries – Croatia, Greece and Spain – seeing more than half of their young go unemployed.

This is nothing short of a social and economic disaster, unfolding in slow motion without much media attention. Sometimes, though, Europe’s political leaders get an attention spurt and decide that they want to do something about that disaster. The latest fad is some sort of “social protocol” that is supposed to monitor and (in theory) initiate policies against the worst exhibits of the unfolding disaster. Euractiv.com reports:

As the European Commission prepares to issue its first-ever social policy recommendations in the framework of the strengthened European Semester of economic policy coordination, there are lingering questions as to what the whole process will actually achieve, with critics branding it a “communications exercise”. As announced last October, the EU executive will publish its assessment by next month on five “key social indicators”, together with its usual macro-economic recommendations. Poverty, inequality, household income, employment rates and youth joblessness will all come under scrutiny as part of the social monitoring process.

So now, after five years of destructive austerity policies with higher taxes and spending cuts; policies that have driven unemployment to depression levels in many countries; after five years of trying to balance government budgets in the midst of sharply rising demand for poverty relief entitlements and tax base erosion; the EU now starts wondering how people are doing in Europe.

Back to Euractiv:

This “scoreboard for employment and social indicators” is one of the “new tools to build the social dimension of the Economic and Monetary Union (EMU)”, the Commission says. It was launched in an attempt to strengthen the social dimension of the EMU as governments across Europe were feeling the backlash of austerity policies decided in the midst of the sovereign debt crisis. “The  new scoreboard of key employment and social indicators shows that we have high income inequalities in some member states and the data also shows increase in the differences of income inequalities amongst the member states of the Eurozone, between the core and the periphery. Persisting and increasing socio-economic divergence is a problem for a monetary union,” said Laurence Weerts, who is responsible for the social dimension of the EMU in the office of László Andor, the EU Employment Commissioner.

There was a vast economics literature available back when they started planning the currency union, showing that the euro zone did not meet the criteria of an optimal currency union. It would have been easy for the Eurocrats to avoid the problems caused by putting together a sub-optimal currency union – all they would have had to do was to, well, keep the national currencies.

But more importantly, the depression-level social problems in countries like Greece, Spain and Portugal would never have come about if the EU had not forced those member states to accept the EU-ECB-IMF version of austerity. Greece, as we know, lost one quarter of its GDP to austerity. One quarter. In the past six years unemployment in the 15-64 age group has tripled in Greece (it was 27.7 percent in 4th quarter of 2013) and Spain (26.1) and doubled in Italy (12.9) and Portugal (16.1). Youth unemployment, i.e., the age group 15-24, tripled in Spain (from 18.1 percent in 4th quarter of 2007 to 55.1 percent in 4th quarter of 2013), almost tripled in Greece (from 22.6 percent of 57 percent), doubled in Portugal (16.8 to 35.7) and almost doubled in Italy (23.2 to 43.5).

It is almost impossible to imagine that the EU leadership understands how their policies actually created this economic disaster. Yet, so long as they maintain their current policy priorities, where a balanced government budget is more important than any other policy goal, there will be no improvement of the situation for the perhaps 100 million Europeans whose livelihood critically depends on the welfare state. If instead the EU decided to get the welfare state out of the way, if they did away with the taxes that feed the welfare state and discourage entrepreneurship, they would quickly (by macroeconomic standards) see an improvement in the living conditions of those who are now on the dole.

However, that is probably not going to happen. The EU leadership is so stuck in its view of what is good and bad policy that its only idea of how to get the European economy going again is to depress wages. This, of course, means more people will depend on government just to survive the month. Euractiv again:

Belgian Green MEP, Philippe Lamberts, a member of the committee on economic and monetary affairs, welcomed the announcement in principle but says he doubts the recommendations will be taken into account. “I hope there will be country specific recommendations aimed at reducing inequalities. The problem is that they would be in contradiction with the usual Commission recommendations which say that we need to make the labour market more flexible, to reduce the power of social interlocutors, which clearly means putting a downward pressure on wages. If the Commission is to introduce recommendations to reduce inequalities, it would contradict itself,” Lamberts said. To really deliver on the social dimension, the Commission would need to “change directions” which “it won’t”, Lamberts said.

Two forces depress wages in Europe: high unemployment and large immigration of low-or-no skilled labor. Both forces are currently at work, which effectively means that Europe’s welfare states are going to get more clients. This in turn means that there is even less of a chance that Europe will be able to avoid a future in the economic wasteland where stagnation rules, people live in industrial poverty and there is no hope for a better future.

Think that can’t happen? Wait until late August when my book Industrial Poverty is out (Gower Applied Research). You will never see Europe the same way again.

Fiscal Panic in Argentina

Of all the countries around the world that have tried to embrace the European welfare state, Argentina is perhaps the most tragic example. From the 1920s through the 1950s the Argentine economy was one of the strongest in the world, and there were years when Argentina attracted more immigrants from Europe than the United States did. But what could have become a formidable economic powerhouse caved in to the ideas of the welfare state. As the economy began declining, social and economic stability evaporated and Argentina suffered decades of political turmoil.

The long-term suffering of the Argentine people, and of many other South American countries, is a stark warning to today’s Europeans: their continent could become the same tragedy in the 21st century that South America was in the last century. Unfortunately, the Europeans refuse to hear the warning bells from recent history, so we might just as well pile on yet another story, on top of the ones already published about the crumbling Argentine economy and what brought it down. This one is from Bloomberg.com:

Argentina reduced government subsidies on natural gas and water by an average 20 percent in a bid to narrow the largest fiscal deficit in more than a decade. The government could save as much as 13 billion pesos ($1.6 billion) and will use proceeds to cover utility company costs and finance social spending, Economy Minister Axel Kicillof and Planning Minister Julio De Vido said today at a press conference in Buenos Aires. The cuts won’t apply to industrial users.

And the reason for the big deficit?

President Cristina Fernandez de Kirchner has boosted social spending since taking office in 2007 and left utility rates largely unchanged amid average annual inflation of about 25 percent, straining the finances of power distribution companies and leading to periodic blackouts.

If you live in California (which, thank my tax God, I don’t) you recognize this behavior. Back in the ’90s the state of California wanted to compassionately make sure that everyone could always pay their utility bills. So they regulated the price that utility companies could sell power for to households, but imposed no price regulations on the market where utility companies buy power from power producers. As a fourth-grader could have figured out, if the regulated price in the retail end was too low, on average utility companies would be buying power at a market price that exceeded the retail price they could charge.

The result? Rolling black-outs, no investments to improve either power production or power delivery, and in the end mounting costs for everyone in the back end when the entire power infrastructure needed massive upgrades anyway. (It did not help that California at the time was falling for the global warming delusion and chasing low-cost, fossil-based fuel out of the state.)

Now, Argentina finds itself in the exact same situation. But even more importantly, the Argentine government’s focus on entitlement spending is a stark parallel to Europe. Utility price regulation, which varies from country to country in Europe, is just another form of welfare-state intervention into the private sector. When coupled with the general plethora of entitlement programs that normally comes with welfare states, the subsidy becomes just another entitlement.

As Argentina demonstrates, this has consequences when government runs into fiscal trouble. Just like every welfare state the Argentine version combines spending determined by political preferences with revenues determined by a private sector, i.e., struggling entrepreneurs and tax-burdened consumers. Entitlement spending has a strong tendency to outgrow its revenues – in fact, I am working on an article for an academic journal defining a law that shows that welfare-state entitlement programs inevitably outspend their revenue – but politicians favoring the welfare state never realize that this is actually happening. Inevitably, therefore, they run into deficit problems, but since the politicians do not see this coming they are caught by surprise and react with fiscal panic.

There are three ways that fiscally panicking politicians can respond:

1. Buy time. This means, borrowing as much as they can. When they cannot borrow any more money by flooding the world with their Treasury bonds, they print money and have the central bank buy the Treasury bonds instead. If this happens in an economy with a stable financial system and a limited system of cash entitlements, the money printing will not cause high inflation. If on the other hand cash entitlements are comparatively important for daily consumer spending, then printing money to fund them opens a dangerous transmission mechanism for the money supply to cause high inflation.

2. Raise taxes. No longer a viable option, other than marginally. There is a fair amount of research that shows that voters in both Europe and North America grew tired of constantly rising taxes already back in the 1970s. Since then, an increasing share of the growth in government spending has been deficit-funded. The same is true in Argentina.

3. Cut spending. Since most politicians in our modern welfare states want to preserve the welfare state one way or the other, they do not want to eliminate entitlement programs. But when tax revenues do not grow as fast as they would want it to they are forced to downsize the welfare state to fit within a tighter revenue framework. This means chipping away at entitlements that people have gotten used to and based on which they plan their family finances.

For common-sense minded economists and politicians this means a good opportunity to prudently reform away the welfare state. “Just cutting spending, damn it” is not the way forward, but a structurally sound phase-out model can do wonders.

Leftists, on the other hand, go even deeper into panic. Bloomberg.com again:

Argentina, which has subsidized utilities since 2003, wants to cut aid from about 5 percent of gross domestic product to 2 percent of GDP and make higher income earners pay more for their utilities, Cabinet Chief Jorge Capitanich said March 12. “In 2003 the need for subsidies was clear,” Kicillof said in reference to the period after the nation’s $95 billion default and economic crisis. “Argentina isn’t ending subsidies, just redistributing them.” For Argentine households, the increase in their gas bill may rise as much as 161 percent for the biggest consumers and 306 percent for water bills, according to a presentation distributed by the Planning Ministry.

“The Planning Ministry”… Why not just adopt the Soviet acronym GOSPLAN and get it over with? Humor aside, though, it is worth noting that the families who are now hit with enormous price increases still have to pay the same amount of taxes as before.

The way out, again, is not to restore the subsidies. The way out is to end the entitlement programs and return purchasing power to the private sector so that those who have grown dependent on government can actually support themselves. This, of course, won’t happen in Argentina. What will happen there instead is that consumers now will respond by cutting spending elsewhere, thus reducing economic activity in general. This has repercussions for the tax base, which again will take government by surprise. And the entire process is repeated, with the difference that it starts from an already lower level of economic activity.

Europe is not in as bad a shape as Argentina is. But if they continue down the current path of using spending cuts and tax increases to save the welfare state in tough times, they will perpetuate their own crisis – and thereby perpetuate the need for spending cuts and tax increases.

The end station? An economic wasteland where children grow up to be poorer than their parents. That is, in effect, where Argentina is today, and has been for a long time. Sweden has been there for a good two decades and other European countries are beginning to see that same economic wasteland on the horizon.

Europe Turns to Socialism

On February 19 I explained:

There is an important reason for my projection that the European crisis is moving into a long-term stagnation phase: the Europeans are not willing to give up their welfare state. The welfare state caused the crisis, primarily by using taxes to deplete margins in the private sector and by using entitlements to discourage work and entrepreneurship. Eventually, all it took was a regular recession spiced up with some speculative losses in the financial industry, and the entire Western world was hurled into a deep and very persistent crisis. Unfortunately, the Europeans have not yet seen the light. (Perhaps they will when my book is out this summer.) Especially European voters are very persistent in demanding that the welfare state remains in place. This is particularly evident in a pan-European poll predicting the results in the May elections for the European Parliament.

That poll showed strong socialist gains among European voters. This is hardly surprising, given that the majority of Europe’s voters apparently believe that the last few years’ worth of austerity policies have been an ideological attack on the welfare state. In reality, it was a warped, economically stupid attempt to save the welfare state by making it fit inside a smaller, crisis-burdened economy. Higher taxes combined with spending cuts – in any combination – has the result of raising the burden of government on the private sector, hence to preserve the welfare state under tougher economic conditions.

As is well known, Europe has long history of fascination with socialism in various forms, from the light versions applied in assorted iterations of the welfare state to the full-blown totalitarian variant that plagued the Soviet sphere for decades. Generations of Europeans have grown up to a life in deep dependency on government. This is unhealthy anytime, anywhere, but it becomes economically dangerous in a crisis like the one Europe is now stuck in.

As if to compound the prospect of a collectivist victory in the May EU elections, the French socialists have launched a bold campaign to win a majority of their country’s delegation to the European Parliament. From Euractiv.com:

France’s ruling Socialist Party (PS) kicked off its European election campaign on Monday (3 March) with the ambition of securing the majority of French seats in the European Parliament, which is currently held by the country’s centre-right party, EurActiv France reports. At a press conference, the French Socialist Party’s first secretary, Harlem Désir, confirmed the Party of European Socialists’ (PES) ambition to take over the majority of seats in the EU Parliament and the job of EU Commission president. Europe, Désir said, “must turn the page of Liberal and Conservative governments, which for years have harmed the European dream. Their blind support to deregulation, widespread competition, fiscal and social dumping, has only led to austerity, unemployment and soaring populism across the continent.”

Yes, how horrible to deregulate markets so people and businesses have more choices. What a horrifying thought to let businesses compete with each other so the best one wins… I can’t wait until the socialists take over the Olympics. Imagine…

  • In the 100 meter sprint, everyone has to get to the finishing line at exactly the same time. If someone gets ahead, the distance by which he won is taxed away and given to those who were last in the race.
  • To assure there is no gender discrimination, the race has to perfectly represent the 50-something different genders that apparently exist in this world (of course, you’d have to expand the width of the race track accordingly…)
  • In hockey, if a player scores a goal for his team he will immediately have to place the puck in his own team’s goal.
  • Gymnasts can no longer be very thin and small. All sorts of women of all sizes must be given the exact same chance to participate, not to mention the same points, regardless of their performance.

Socialist Olympics – where everyone’s a winner!

Now back to the EU election and the Euractiv story, which reports that the socialists are eagerly trying to engage other parties in a debate between the candidates for the presidency of the EU Commission:

For the Socialists, the “presidential” debate is also an opportunity to equate the [liberal] EPP with the incumbent Commission’s results, notably on issues such as social dumping and crisis management. “We are starting in a European climate of sanction towards the outgoing team on the right wing, which led a policy of austerity, recession and stagnation on the economic and social plan,” said Jean-Christophe Cambadélis, the campaign director for the EU elections.

This is actually an important point. By focusing so intensely on austerity throughout the crisis years, the incumbent EU Commission has indeed added fiscal insult to Europe’s macroeconomic injury. Ironically, their policies have expanded the presence of government throughout the economy by taking more from the private sector (higher taxes), giving less back (spending cuts) and depressing private consumption and business investments (higher taxes). In doing so, the commission has gone squarely against the purported ideological foundations of the conservative and liberal parties that have held a majority in the European Parliament since the 2009 elections.

In a matter of speaking, their deviation from their own ideological platform – their endeavor into statist territory – is now paving the way for “real” statists to take over.

And take over they will, says Euractiv:

According to estimates from the website Pollwatch 2014, the European Socialists and Democrats (S&D) would get 217 seats, while the EPP would get 200. The PS secretary general stressed that employment would be at the heart of the European campaign. “Jobs will be our priority,” said socialist MEP

Sounds good when you first hear it. So what do they want to do?

Catherine Trautmann, who took part in the press conference, mentioning the fight for a minimum wage at European level. To curb youth unemployment in particular, the PS secretary general has announced plans to strengthen the budget for the Youth Guarantee Scheme.

A minimum wage across Europe?? This is as ludicrous an idea as anything I have seen recently. What is it going to be measured against? Reasonably, it would have to be against some sort of benchmark, such as a fixed percentage of mean household income.

The problem with that – well, one of the problems with it – is that the benchmark would vary enormously from country to country. The way the European socialist party puts this idea it would be based on the same benchmark across the EU, which, using mean net household income would be 17,475 euros. Let’s say now that the minimum wage is 40 percent of that (a fraction sometimes used when calculating poverty ratios). This means that an average European household living on minimum wages would earn 6,990 euros.

Sounds fine and dandy, right? The problem is that the mean household income in seven EU member states are actually below this level. In Bulgaria and Romania the the minimum-wage level household income would be more than twice the mean household income.

In other words, an exquisite recipe for crashing the labor markets – the entire economies – of Europe’s poorer countries.

Apparently, this is not a problem for Europe’s socialists. Their next suggestion, as per the quote above, is more tax money to a government-run artificial-employment program they so aptly call “Youth Guarantee Scheme”.

It’s a scheme alright… But humor aside, the last thing Europe needs is more regulatory incursions, higher taxes and more people dependent on government. It will only cement the continent as an economic wasteland, stuck in permanent stagnation and industrial poverty.

Welfare Statists Gain Momentum

There is an important reason for my projection that the European crisis is moving into a long-term stagnation phase: the Europeans are not willing to give up their welfare state.

The welfare state caused the crisis, primarily by using taxes to deplete margins in the private sector and by using entitlements to discourage work and entrepreneurship. Eventually, all it took was a regular recession spiced up with some speculative losses in the financial industry, and the entire Western world was hurled into a deep and very persistent crisis.

Unfortunately, the Europeans have not yet seen the light. (Perhaps they will when my book is out this summer.) Especially European voters are very persistent in demanding that the welfare state remains in place. This is particularly evident in a pan-European poll predicting the results in the May elections for the European Parliament. Reports EU Observer:

Europe’s socialists are set to top the polls in May’s European elections, according to the first pan-EU election forecast. The projections, released by Pollwatch Europe on Tuesday (19 February), give the parliament’s centre-left group 221 out of 751 seats on 29 percent of the vote, up from the 194 seats it currently holds. For their part, the centre-right EPP would drop to 202 seats from the 274 it currently holds on 27 percent of the vote across the bloc. If correct, it would be the first victory for the Socialists since 1994.

The last EU election was in 2009, before Europe’s voters had made much contact with the tough austerity measures that governments in EU member states have applied over the past few years. Those measures were actually used to try to save the welfare state – spending cuts and tax hikes recalibrated it to fit the deep-recession economy – but were in many cased received by a voting public as attacks on the welfare state.

Since 2009 there has been a voter backlash against austerity in several European elections, with Greece, Italy, Portugal and France as the best examples. Radical leftist parties have made a strong showing and, as in France, even scored major victories. This leftist momentum is now continuing into the EU elections. But voters’ desire to save the welfare state is not limited to the left. The EU Observer again:

Elsewhere, the poll projects a series of national victories for populist parties of the right and left in a number of countries. Marine Le Pen’s National Front is forecast to top the poll in France with 20 seats, while Beppe Grillo’s Five Star Movement would win in Italy with 24 seats. It also anticipates strong showings for parties in Belgium, Austria, Italy and Sweden and the Netherlands who have pledged to set up a new far-right political group with Le Pen, and are set to take a combined 38 seats.

The nationalist parties are essentially old-fashioned European social-democrats. They do not share the left’s Marxist class-warfare rhetoric against big corporations, but they also do not share the strong commitment to free markets that we libertarians cherish. Instead, they combine a re-packaged form of traditional European nation-state patriotism with redistribution-oriented policies adopted from the less extreme segments of the left. Unlike the radical leftist parties, the nationalists do not primarily blame the decline of the welfare state on austerity – they blame it on large immigration.

While few in the European political industry would ever admit this, it is an inescapable conclusion that the rise of socialists and nationalists paints a grim picture of Europe’s political and economic future. As mentioned, both flanks want to preserve the welfare state. Both flanks also share a disdain for libertarian free-market principles and policies, advocating various forms of statist government intervention into the economy. Radical leftists want to seize private property by nationalizing big corporations; nationalists want to regulate them heavily, and in some cases the regulatory incursions are difficult to tell apart from what the left offiers. A good example is Golden Dawn in Greece, whose hatred toward private,for-profit banking is secondary only to their hatred for non-European immigrants.

Since this poll reflects national election results, it is worth taking it seriously. This also means that we have to take seriously the potential, long-term political and policy consequences of that result. One of those consequences is that it will be even more difficult to educate the European public and their elected officials on the destructive role that the welfare state plays in their economy. (I am still confident, though, that my upcoming book will serve an important educational purpose here in the United States.) Since a socialist will likely become the next chair of the EU Commission – de facto the executive branch of the EU – we can rest assure that there is not going to be any change for the better in their policies.

On a somewhat more speculative note, the competition between socialists and nationalists could actually turn out to be a temporary phenomenon. Both flanks defend social collectivism and economic statism. As the second phase of Europe’s transformation into industrial poverty now unfolds – stagnation replaces depression – legislators both at the national level and in the European Parliament will fight increasingly tough battles over perennially scarce tax revenues. Dissatisfaction among voters will grow stronger over time. With youth unemployment at the 20-20 level (20 percent or more in 20 or more EU states) and with incomes stagnant, welfare-state entitlements cut or stagnant, and taxes remaining very high or even going up, the ground is getting more and more fertile for “political innovations”. One such possible innovation is the merger of socialist and nationalist movements.

Far-fetched? Maybe. But not farther than today’s Europe is from the Weimar Republic. It is up to the European electorate to decide how big that distance should be.

Europe’s Industrial Rollback

One of Europe’s ailments is the persistent belief that government can engineer prosperity. You would think that the past five years of crisis had brought them to abandon that belief, or at least that the poor GDP growth of the past two decades would make them question the role of government. But no. Instead of rethinking their government-based approach to every problem, the Eurocracy is doubling down on statism. This story from EUBusiness.com is a good example:

The European Trade Union Confederation (ETUC) and IndustriAll European Trade Union welcome the adoption by the European Parliament of the report Reindustrialising Europe to Promote Competitiveness and Sustainability. “This report underlines the importance of a strong industry to support lasting and quality jobs in Europe,” said Jozef Niemiec, ETUC Deputy General Secretary.

Listen to this – it is the sound of mashed potatoes:

“Encouraging the reindustrialisation of Europe through the mobilisation of adequate financial means and through support for innovation is essential for Europe to get out of the crisis”.

Now, if there was no role for government in Mr. Niemiec’s vision, he would not be talking about it. What he is after is, of course, to have government – ostensibly the European Commission – “mobilize” the “adequate financial means” to help “reindustrialize” Europe. Again, it is fairly easy to see what that means for regular Europeans: higher taxes. The same goes for his call for “support for innovation”.

It is interesting, though, to note that there is now growing concern in Europe about the continent’s de-industrialization. Technically the term refers to a systemic loss of manufacturing jobs, either in absolute terms or in relative terms. Relatively speaking, manufacturing has been losing ground in Europe and North America over the past four decades, which is in good part due to the long-term growth of the service sector. However, during the Great Recession, the European Union (counted as the 27-country block) has lost more than 440,000 manufacturing jobs from 2008 to 2012, a 4.4-percent decline from the 10.1 million jobs in ’08.

During the same time period, the United States lost eleven percent of its 13.4 million manufacturing jobs. However, while preliminary quarterly data indicates that the European decline continues, the U.S. manufacturing sector is on a slow but visible rebound: since October 2010 U.S. manufacturers have had more employees every month than the same month a year earlier.

The difference? Less government involvement and a more flexible labor market here in the United States.

But as we return to the EUBusiness.com story, we are once again reminded that the role of government is practically never questioned in Europe:

The report is based on a comprehensive vision of industrial policy and also addresses related issues of relevancy such as training and skills of the workforce. It also strongly acknowledges the importance of industrial democracy. “There is no credible industrial policy if workers are not taken into account, that’s why it is so important to promote training and worker’s participation through social dialogue” said Ulrich Eckelmann, IndustriAll General Secretary.

And it gets better:

The report also stresses the importance of common social and environmental norms to frame the development of international trade. It also deplores the absence of action by the European Commission to tackle restructuring, or social and wage dumping in Europe.

In other words, the European Commission should throw out the remaining pieces of the free market in Europe and bet everything it has on government. So called “wage dumping” is nothing more than a decline in wages due to an excessive supply of labor. That excessive supply, in turn, is caused by high and still rising unemployment: in the third quarter of 2013 the EU-27 had a total unemployment rate of 10.9 percent, 0.4 percentage points higher than the same quarter in 2012 and 1.2 percentage points higher than the third quarter of 2011.

This rise in unemployment is happening while government has never been more involved in running economic policy in Europe. From out-of-control money supply to the tax choke hold on private businesses to top-down imposed, harmful austerity measures, the European economy is under siege by government. So long as that siege remains, the continent’s de-industrialization will continue. Other sectors will not have the thrust to pull Europe up from its decline into industrial poverty.

The only things that will continue to grow in Europe are government and the economic wasteland it is trying to live off.

Deflation: Insult to Europe’s Injury

Those who say that Europe is heading for a recovery should pay close attention today. If there was a recovery under way, the European economy would be seeing some slight increase in inflation. But according to a story from EUBusiness.com, the exact opposite is true:

Ultra-low inflation in the eurozone has sparked a divide among officials and analysts over whether the risk of deflation is a real “ogre” or just a phantom menace. The head of the IMF, Christine Lagarde, warned this past week of the “rising risks” of deflation, which she called “the ogre that must be fought decisively”. “With inflation running below many central banks’ targets, we see rising risks of deflation, which could prove disastrous for the recovery,” Lagarde said.

When Lagarde talks about the detriments of deflation, she has two things in mind. First, there is the general problem that when prices are falling businesses have a disincentive to invest. Their investment costs are paid “today” while revenues recovering the cost are earned over a series of tomorrows. Under inflation the prices earned tomorrow slowly rise, increasing the margin between the fixed investment cost and cost-recovering revenue. On the other hand, under deflation future prices fall, gradually eliminating the cost-recovery margin.

This perspective on deflation is a perfectly valid concern. What is not valid is the second reason why Lagarde is worried. When prices fall over time, tax revenues fall with them. This is especially true in economies with value-added taxes, but the deflation effect on tax revenues spills over on income taxes as well. With deflation fewer workers get raises, meaning that there is much less, if any, growth in the income-tax base.

A stagnant or a shrinking tax base is not exactly what the governments of Europe’s welfare states want to have on the horizon. However, there is a very simple solution to this deflation problem: dismantle the welfare state. Reform away entitlement programs, privatize education and health care and individualize income security programs.

Back to EUBusiness.com:

Data released this past week showed that the annual inflation rate in the 18-nation eurozone dipped to 0.8 percent in December, considerably below the European Central Bank’s target of just below 2.0 percent. That masks large differences between countries, however. While average inflation came in at 2.6 percent in the Netherlands in 2013, it was just 1.0 percent in France, the eurozone’s second largest economy. In crisis-hit Greece, prices actually fell by 0.9 percent on average over 2013, according to data from EU data agency Eurostat.

The fact that Greece is suffering from deflation should end all talk about the country’s economy turning a corner. In fact, deflation is not just a problem in Greece for December 2013 – take a look at this figure, which reports Eurostat’s harmonized consumer price indices over the past three years (annual changes broken down per month):

eu DEflation

According to this index, Greece has suffered from deflation for ten months in a row. For the five last months of 2013, deflation was at one percent or more!

This is not the climate for an economic recovery. The only silver lining in this is that those who live on government handouts will probably experience a slight increase in their purchasing power. Ostensibly, those who still have a job are not seeing their money wages cut to deflation parity, which could help explain why the Greek economy seems to be reaching the trough of its depression.

At the same time, it is always important to remember that deflation also means declining per-unit revenue for businesses. Unless they can compensate with vast gains in volume of sales – an unlikely scenario in Greece today – they are not prone to invest or otherwise expand their businesses. While deflation may help bring the economic decline to an end, it will not help bring about a recovery.

EUBusiness.com adds yet another aspect to deflation:

An extended period of deflation — falling prices in real terms — can encourage consumers to put off buying goods in the expectation that if they wait, they will become cheaper. That in turn weakens the economy as companies reduce output accordingly, hitting employment and demand, thereby setting off a very damaging downward spiral.

This is not a very strong effect, especially not in an economy like the Greek where consumers have lost, on average, one quarter of their standard of living during the crisis. What remains there is, in effect, an industrialized version of subsistence consumption. That said, the depressing effect on consumption as described by the EUBusiness article could very well throw a wet blanket over durable-goods consumption, which is often financed by credit. If a consumer wants a loan for a new car and the bank has good reasons to expect that new cars will actually decline in price for each new model year, then they can expect the car considered today to depreciate even faster than it otherwise would. This forces the bank to demand a very fast repayment schedule, or a prohibitively high interest rate. Either way, deflation will hold back consumption by restricting consumer credit.

In other words, Lagarde’s concerns are valid. However, as the EUBusiness.com article reports, the Eurocracy resort to the hunky-dory attitude they always take:

[For] the head of Germany’s Bundesbank, Jens Weidmann, “the risk is limited that we’ll see broad-based deflation in the euro area.” Weidmann, who also sits on the ECB board, said the eurozone was on brink of an economic recovery, which would tend to push up prices. The ECB forecasts a modest recovery in growth of 1.1 percent for the eurozone in 2014 after contracting in 2013. Weidmann’s scepticism is shared by economist Holger Schmieding at Berenberg Bank. “The widespread concerns that the eurozone could fall victim to malign deflation are overdone,” he said in a recent note to clients.

Perhaps the reason for this attitude is that deflation in the EU is at least partly caused by austerity. In the figure above, the euro-zone harmonized CPI starts its decline in late 2011, when the EU-ECB-IMF troika in a concerted effort forced austerity policies upon several euro-area economies. An admission that deflation, caused by austerity, is a problem would indirectly be an admission that austerity has not exactly helped bring about a turnaround in Europe.

Of all the economists that EUBusiness.com talked to, only one brought up this aspect:

[Countries] that have been making the biggest progress in reducing deficits have been doing that with austerity policies of cutting spending, which has also dampened prices. “What is strange is that the question is only being posed now because the European strategy is profoundly deflationist,” said Isabelle Job-Bazille, head of economic research at the French bank Credit Agricole. She warned against relying too much on medium-term inflation expectations, which have so far remained anchored near the ECB’s two percent target, as deflationary tendencies could set in by the time such expectations change.

Deflation is a likely indicator of stagnation. Its presence in the Greek economy reinforces my conclusion that the country leads Europe into the shadowy economic wasteland of industrial poverty.

Austerity Leaves Ireland in Stagnation

On Monday I explained that Greece has begun a transition from depression to stagnation. The transition is visible in macroeconomic data: the decline in GDP and private consumption, both of which have been going on for years, are not as fast anymore, and unemployment seems to be plateauing. Government debt is still growing, though, especially when measured as a ratio to GDP. In the second quarter of 2013, the latest number available, the quarter-to-quarter increase in the ratio was faster than it was in any of the three preceding quarters.

The transition from depression to stagnation is largely made possible by two factors. First, the Greeks have lost one quarter of their economy, which includes an enormous drop in standard of living. Most Greeks have had to forfeit consumption that people in other industrialized countries take for granted. What remains is essentially the bare-bones kind of consumption that you realistically cannot sustain without in an industrialized country. At this “core consumption” level of economic activity, it is harder for people to cut away anything more. As a result, they will increase their efforts to protect what they have left.

Secondly, years of austerity has recalibrated the Greek welfare state. The reason why it ran enormous deficits for years is that its tax rates could not produce enough revenue for the spending that the welfare state required. This was a problem before the Great Recession but it exploded into pure urgency as the crisis started unfolding. Instead of trying to turn around the implosion of the economy, the EU and the Greek government decided to recalibrate the welfare state: taxes were raised to produce more revenue at a lower GDP, and spending programs were cut to spend less at that same lower GDP. Each new austerity program effectively constituted another recalibration. Eventually, during last year, the recalibration efforts caught up with the imploding GDP, and austerity tapered off.

Once you release an economy from its austerity stranglehold it will transition from decline to stagnation. However, it will not recover – other than marginally – for one very simple reason: the welfare state is now recalibrated to balance the budget at an abysmally low activity level. Therefore, as soon as economic activity picks up the government budget will suck in excessive amounts of money from the private sector, creating substantial surpluses early on in the recovery. Politicians who have fought the people to subject them to round after round of austerity will not be inclined to cut taxes; they will see the surpluses as yet another sign that “austerity worked”. While they throw victory parties, the economy continues to putter along at permanently higher unemployment and a permanently lower standard of living.

This is exactly what happened in Sweden in the ’90s (I have an entire chapter on that crisis in my upcoming book Industrial Poverty) and the Greek situation is not much different.

Yet despite glaring evidence to the contrary, there are people out there who willingly and eagerly claim that in the austerity war on the crisis, austerity won. In an opinion piece for the EU Observer, Derk Jan Eppink, Member of the EU Parliament from Belgium and vice president of the Parliament’s Conservatives and Reformists group, has this to say:

Irish Premier Enda Kenny has announced his country will exit its bailout programme in December. When he took office in 2011, Ireland’s budget deficit was over 30 percent of GDP. Narrowing it to projections of 7.3 percent this year and 4.8 percent next, Kenny has restored market confidence in Dublin’s ability to sort out its long-term debts. Investors are again willing to buy Irish bonds, raising funds and lowering borrowing costs. In mid-2011, interest on Irish debt stood at 15 percent. Now it is below 4 percent and Ireland has raised sufficient cash balances to cover all its debt payments next year. Standard & Poor’s and Fitch have both returned their Irish rating to investment grade. Without repairing its ability to manage its debts, Ireland’s government could not function for very long as a provider of essential public services. Irish recovery could not have happened without the fiscal consolidation which commentators attack as “austerity.”

It is interesting to notice what metrics Mr. Eppink uses to measure the Irish “success”. The austerity program has recalibrated the Irish welfare state to produce a budget balance at a vastly lower activity level than before the crisis. This means that the Irish government has no incentive to run a fiscal policy that brings the economy back to its higher activity levels; as in the Greek case, its tax-and-spend ratios will actually discourage private-sector growth beyond what is needed for the newly calibrated budget balance.

What this means in practice is easy to see in Eurostat employment numbers. Irish unemployment has fallen over the past two years, with total unemployment down from 15.1 percent in January 2012 to 12.3 percent in November 2013; during the same period of time youth unemployment declined from 31.1 percent to 24.8 percent. This looks like a solid recovery, especially since one in four unemployed aged 15-24 is no longer unemployed. However, if we cross-check these numbers with the employment ratio we get a somewhat different picture:

  • In the years before the crisis the employment ratio for 15-64 year-olds was 65-70 percent; in the third quarters of 2010, 2011, 2012 and 2013 it has averaged 59.7 percent, with no visible trend either up or down;
  • In the years before the crisis Irish unemployment for the group aged 15-24 was 45-55 percent; in the third quarters of 2010, 2011, 2012 and 2013 it has averaged 30.9 percent, with no visible trend either up or down.

It is troubling when unemployment falls but employment ratios remain steady. It means that people are either leaving Ireland in desperation or, more likely, that they are leaving the work force. A closer look at the enrollment in various income-security programs would probably give a detailed answer. (I will try to return to that later.)

A glance at GDP data also indicates stagnation rather than recovery. In the third quarter of 2013 the Irish seasonally adjusted, constant-price GDP grew by 1.7 percent over the same quarter in 2012. However, the four preceding quarters GDP contracted. There was more growth in the Irish economy in 2011 than what appears to be the case in 2013. Private consumption has been falling six of the last eight quarters, with entirely negative numbers thus far for 2013.

There is only one conclusion to draw from these numbers: there is no Irish recovery under way. If anything, the end of the Irish austerity campaign has marked the starting point of economic stagnation for the Irish economy just as it has in Greece.