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.

Government and Poverty

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

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

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

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

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

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

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

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

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

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

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

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

Greece: From Depression to Stagnation

We have heard it before: the tide is turning in Greece. Just one more austerity package, and things are finally going to get better. As I have explained repeatedly, and correctly, these predictions of better times have been nothing but hot air.

Over the weekend the EU Observer published another story predicting macroeconomic sunshine in Greece. This time, though, there is a grain of truth in the rhetorical optimism. But just a grain.

Here is what the EU Observer reported:

After six consecutive years of recession, the Greek economy might finally be allowed to leave its life support machine this year. The country’s debt burden should start to fall in 2014. So should unemployment. It may even post economic growth by the end of the year. Both Greek and EU officials insist that the tide is finally turning.

First of all, this is not a recession. When a country loses one quarter of its GDP in five years, and when more than half of its young are unemployed, it is in a depression.

That said, a look at some economic data from Eurostat indicates that for the first time since the crisis started, Greece may actually be seeing the end of its multi-year decline. More on those numbers in a moment. First, back to the EU Observer:

But if the Greek economy is no longer on the precipice of one or two years ago, it is hardly in good health. At 27 percent, Greece has the highest jobless rate in the EU. Its debt pile is also Europe’s highest at around 180 percent of GDP. More than a quarter of its economic output has been wiped out since 2007. The Greek government has forced through a programme of spending cuts, tax rises and labour reforms of unprecedented severity. … [Greek finance minister Stournaras] points out that in three years Greece’s primary budget balance has been transformed from being in deficit to the tune of 14 percent to a surplus of 6 percent.

The transformation of a deficit into a surplus has taken place while the fundamental tax base – GDP – has shrunken by one quarter, while poverty has skyrocketed and unemployment has turned into an epidemic. This means that the budget deficit has been wiped out not by means of sound, growing private-sector economic activity, but by a total recalibration of the Greek welfare state. In other words,

  • The eligibility criteria for entitlements have been totally revamped, primarily by severely cutting what people are eligible for (such as health care, unemployment benefits and subsidies for medical drugs);
  • The taxes that pay for the significantly smaller government spending programs have gone up in order to compensate for the revenue loss that follows when the tax base shrinks.

Austerity as applied to Greece and other EU member states is really nothing more than a massive recalibration effort. To see why, consider the following example. Government spends 100 euros and pays for it with 100 euros worth of taxes. GDP is 1,000 euros.

A recession hits, shrinking GDP to 950 euros. At constant tax rates – and with a very simple tax system – tax revenues fall to 95 euros.

Government now wants to close its budget gap, but not by encouraging GDP growth. Its method is instead that of traditional European austerity, combining tax hikes with spending cuts. It decides to cut spending by 2.50 euros and increase revenue by 2.50 euros. In order to accomplish the latter, government raises tax rates by 0.26 percent.

As the higher taxes and the lower spending impact the economy, GDP will continue to contract. The process can go on for years, as demonstrated in, e.g., Greece.

The recalibration is aimed at making government spending – the welfare state – fit into a tighter tax base. This is in fact the overarching purpose with austerity, a fact we should never forget when we analyze the European crisis. It explains why the EU and the Greek government have decided that one quarter of the Greek GDP is a perfectly acceptable sacrifice: their welfare state is more important than the jobs and the future prospects of more than 25 percent of the Greek workforce, and more important than the jobs and future prospects of six out of ten young Greeks.

Consider this for a moment while we hear a bit more from the EU Observer:

Labour costs have also seen a 25 percent reduction. Stournaras also says that average incomes have fallen by 35 percent in the past four years, signifying a huge drop in Greek living standards. … [Finance minister Stournaras] commented: “In economics there is no black and white but I am confident that there is going to be growth this year.” However, the pain is by no means over. Exports increased by 5.4 percent in the first eight months of 2013 to €18.28 billion but, if you exclude petroleum products, the figures are much less impressive – an overall drop of 2.6 percent worth €293.8 million. … Although an export surplus has long been a key target for the European Commission and Greece, it does not necessarily translate into a boon for the economy. Anaemic exports alongside declining consumption is a recipe for a spiral of deflation rather than growth.

Which brings us to some Eurostat numbers for Greece:

Changes over same period previous year; adjusted for inflation
2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2 2013Q3
GDP -7.9 -4.0 -7.9 -6.7 -6.4 -6.7 -5.7 -5.5 -3.7 -3.0
Private consumption -6.5 -2.5 -7.1 -9.6 -8.8 -7.5 -9.9 -8.5 -4.5 -3.9
Government debt, pct of GDP 159.0 163.7 170.3 136.5 149.2 151.9 156.9 160.5 169.1
Unemployment, 15-64 16.6 17.9 20.9 22.8 23.8 25.0 26.3 27.6 27.3 27.2
Unemployment, 15-24 43.1 45.0 49.9 52.7 53.9 56.6 57.8 60.0 59.0 57.2

There is a slowdown in the decline of GDP, but it is still declining. The same is true for the contraction of private consumption. Both unemployment measures show jobless rates plateauing, with a possible beginning of a decline on the youth side. Government debt, though, has continued to rise just as before, a fact I discussed at length back in September.

Undoubtedly, there is a convergence of indicators – GDP, private consumption and unemployment – which could be interpreted as the beginning of the end of Greece’s long, depressive decline. Under one important condition, I am willing to predict that these indicators are right, namely that the slight downturn in youth unemployment is the result of an actual, microscopic but still real increase in employment among the young.

This is a hugely important condition. If the decline is instead the result of young Greeks emigrating, then we have to exclude that variable, and open for the possibility that the plateauing of general unemployment is also due to emigration.

The slowdown in private-consumption decline could indicate that the end of unemployment rise is in fact not caused by emigration. However, the downward trend in consumption is still pretty solid, continuing at levels that we normally see in economies in serious recessions. This means that the economy as a whole is still on the depression track. Furthermore, the decline in private consumption during the depression has been so massive that what remains at this point of people’s regular spending is the bare-bones deemed quintessential for life in a poor, but still industrialized country. In other words, there is not much left for people to cut down on.

One explanation does not exclude the other. The fact that consumption is down to its bare bones could mean that households will be flattening out their spending. This stabilizes the economy at its “survival core”, where all the extras outside of mere, industrial-life survival, are cut away. As this happens, the job loss trend also flattens out, as there fewer and fewer businesses remain in the non-survival sector of the economy. As a result, there are fewer and fewer jobs to cut away.

This is the most probable explanation. It goes well with what the OECD said in November, namely that Greece will not at all recover in 2014. It also fits well with my analysis of the European crisis as a structural transition from prosperity into industrial poverty (more on that in my new book Industrial Poverty, tentative publication date July). Under this explanation, what Greece has to look forward to is not a recovery, but a stagnation that in theory can last forever. Consider life under communism in Eastern Europe a good indicator.

I wish I could be more optimistic, but so long as the ideological preference behind the fiscal policy of both the EU and the Greek government is to preserve the welfare state at all cost, that is where Greece – and eventually the rest of Europe – is heading.


When Is Government Big Enough?

Welcome to Year of the Lord 2014. (Forget that “Current Era” crap – we are on God’s calendar for a reason!)

A lot is at stake this year. For us here in America we have upcoming midterm elections in November. Republicans have the momentum and it is not impossible that they take the Senate. The Democrats are panicking over what the Obama presidency is doing to their party; they have already suffered costly losses in state legislatures and gubernatorial offices.

We will also see an emerging field of presidential candidates for 2016. There are already some interesting Republicans lurking behind the curtains. New Jersey Governor Chris Christie is often suggested as an early front runner. Senator Ted Cruz has won many informal polls recently, and let’s not forget Senator Rand Paul, a much more realistic libertarian politician than his firebrand father.

To make matters even more interesting, there could actually be some respectable candidates on the Democrat side as well, such as New York Governor Andrew Cuomo (though he might hold off until he’s done two terms).

We also have to get really serious about our budget deficit. Fortunately, Compact for America – I am on their advisory council – is making progress with a good, realistic proposal for a constitutional amendment to bring about a budget balance.

Overall, the outlook for the United States is moderately optimistic. That includes the economy, which is not exactly steaming ahead, but definitely crawling forward faster than the European economy. The fact of the matter is that Europe, or at least the European Union, is in much bigger trouble than the United States. Yes, our interest rates on such indicators as the ten-year Treasury bond may be a bit higher than, e.g., France, but unemployment, GDP growth, taxes and welfare spending are all moving in the wrong direction in the EU.

To make matters worse for Europe, the current crisis, which I have described as a state of industrial poverty, is far from over. In fact, it may very well make a big turn for the worse, a fact that very few people speak openly about. We find a notable exception in one of the world’s few remaining respectable journalists, namely Ambrose Evans-Pritchard at The Telegraph, who does not mince his words when discussing the mounting debt crisis in the industrialized world:

Much of the Western world will require defaults, a savings tax and higher inflation to clear the way for recovery as debt levels reach a 200-year high, according to a new report by the International Monetary Fund. The IMF working paper said debt burdens in developed nations have become extreme by any historical measure and will require a wave of haircuts, either negotiated 1930s-style write-offs or the standard mix of measures used by the IMF in its “toolkit” for emerging market blow-ups. “The size of the problem suggests that restructurings will be needed, for example, in the periphery of Europe, far beyond anything discussed in public to this point,” said the paper, by Harvard professors Carmen Reinhart and Kenneth Rogoff.

Some telling examples of what we are talking about:

  • The EU, with 28 member states, had a gross government debt of 86.8 percent of GDP in the second quarter of 2013, up from 84.8 percent in Q2 2012;
  • The 17-member euro zone’s debt ratios were 93.4 percent in Q2 2013 and 89.9 percent in Q2 2012;
  • Greece: 169.1 percent, up from 149.2;
  • Spain: 92.3, up from 77.6;
  • France: 93.5, up from 90.8;
  • Italy: 133.3, up from 125.6;
  • The Netherlands: 73.9, up from 68.4.

Very few EU member states show a falling debt ratio, and when they do, the decline is marginal compared to the rise in other countries.

There is an implicit premise in the IMF report about the relation between the private sector and government. Before we get to it, let’s hear more from Evans-Pritchard:

The [IMF] paper said policy elites in the West are still clinging to the illusion that rich countries are different from poorer regions and can therefore chip away at their debts with a blend of austerity cuts, growth, and tinkering (“forbearance”). The presumption is that advanced economies “do not resort to such gimmicks” such as debt restructuring and repression, which would “give up hard-earned credibility” and throw the economy into a “vicious circle”. But the paper says this mantra borders on “collective amnesia” of European and US history, and is built on “overly optimistic” assumptions that risk doing far more damage to credibility in the end.

Very important indeed. Remember the Greek partial debt default? Not to mention the Cypriot Bank Heist when the government of Cyprus confiscated private savings deposits to pay for a bank bailout. Both these measures are now part of the legislative toolkit as the governments of the EU continue to fight their hopeless fight against the debt.

In reality, this fight is about something else than the debt itself. It is about the very heart and soul of the European economy. If the EU chooses to deal with its current crisis the way the IMF hints at, then it will automatically put government above the private sector. The measures proposed will save government at the expense of the private sector. This is the implicit premise in the IMF report, one that Evans-Pritchard does not address. However, as we return to his column we get some hints of how this premise would inform actual policy:

While use of debt pooling in the eurozone can reduce the need for restructuring or defaults, it comes at the cost of higher burdens for northern taxpayers. This could drag the EMU core states into a recession and aggravate their own debt and ageing crises. The clear implication of the IMF paper is that Germany and the creditor core would do better to bite the bullet on big write-offs immediately rather than buying time with creeping debt mutualisation. The paper says the Western debt burden is now so big that rich states will need same tonic of debt haircuts, higher inflation and financial repression – defined as an “opaque tax on savers” – as used in countless IMF rescues for emerging markets.

Aside the implied acknowledgement that the private sector will have to give in order for Europe’s welfare states to take, this paragraph is an effective IMF acknowledgement that Europe is now in a state of long-term economic stagnation.

The two issues actually connect. If there was any prospect of strong economic growth in the EU, there would not be any need to push for practically authoritarian measures to “save” governments from their own debts. Yet the IMF report cleverly opens for precisely that, namely debt defaults on a much wider scale than happened in Greece, as well as inflation and widespread use of so called “financial repression”:

Most advanced states wrote off debt in the 1930s, though in different ways. … Financial repression can take many forms, including capital controls, interest rate caps or the force-feeding of government debt to captive pension funds and insurance companies. Some of these methods are already in use but not yet on the scale seen in the late 1940s and early 1950s as countries resorted to every trick to tackle their war debts. The policy is essentially a confiscation of savings, partly achieved by pushing up inflation while rigging the system to stop markets taking evasive action.

We hear more and more about inflation as a “solution” to the debt crisis. This is disturbing, especially since when the inflation genie is out of the bottle, he is mighty reluctant to get back in there again. While it is difficult for politicians to cause inflation, it is not impossible, and if they are delusional enough to believe that they can turn off the inflation faucet just as easily as they can turn it on, they are going to use it.

Again, inflation is but one of the measures that politicians would resort to in order to save the welfare state from its own debt. The measures to save the welfare state would by necessity tax the private sector in every way possible, thus forcing voluntary economic activity – the heart and soul of a free society – to take the back seat while coercive economic activity – the welfare state – lives on unperturbed by the weight of its own debt.

The comparison to World War II debt is an egregious way to elevate the welfare-state crisis above the responsibility of statist politicians who built and nurtured it. World War II was an exceptional, disastrous event. The current debt crisis was not caused by a disaster. It was caused by deliberate, long-term political action to take one man’s money and time and give to someone else, for no other reason than that the recipient was considered “entitled”.

Through the build-up of the welfare state, government spending ran amok, demanding far more money than taxpayers could afford, over a long period of time. I explain this in detail in my forthcoming book Industrial Poverty; the short story is that Europe’s welfare states allowed entitlement spending to creep up above tax revenues, little by little, until the combined effect of taxes, entitlements and work discouragement had pushed back the private sector to where it was structurally unable to pay for the welfare state.

At this point it was only a matter of time before the debt that the welfare state brought about would explode. The financial crisis came along and helped the debt balloon inflate – notably the financial crisis was aggravated by banks’ exposure to deteriorating government debt!

This means two things. First, it is high time to stop imposing more regulations on the private sector. The more governments regulate the private sector, the more hindrances they put in place for the only engine that can pull Europe out of its crisis. Secondly, there is no way out of the debt crisis unless we are willing to say farewell to the welfare state. Its entitlement systems and its taxes will continue to weigh down the private sector for as long as the welfare state exists. The same crawling debt crisis that exploded in 2008-09 will begin again as soon as governments all over Europe stop their austerity measures.

At the same time, austerity has only made a bad crisis worse. The design of austerity measures used thus far is clearly to save the welfare state and make it fit within a tighter economy. Yet the burden of entitlement programs has not eased – on the contrary, it has increased. For every new austerity measure that has increased taxes and cut government spending, the economic crisis has worsened, thus giving rise to the need for even more austerity.

Europe must break this vicious circle, and the only way to do this is to abandon the desperate hunt for the balanced budget. Instead, Europe’s political leadership must focus on structurally phasing out the welfare state. They must privatize health care, income security and education – and cut taxes proportionately to their structural spending cuts. They must let the private sector take over what government has failed at delivering, both in terms of producing services and in terms of funding those services. Permanent spending cuts coupled with well designed tax cuts.

Only then can Europe see growth and prosperity again. If they do not choose this path, but instead stick to the old recipe of keeping the welfare state and trying to starve it into a stagnant economy, they will perpetuate their debt crisis.

That, in turn, means static or even declining private-sector activity while more and more people will clamor to the welfare state’s entitlement programs just to be able to make ends meet every month. Government will continue to grow, both in absolute and in relative terms. That growth will continue ad infinitum, until there is nothing but a planned, Sovieticized economy left.

Europe does not need that. Europe needs massive doses of economic freedom.


Europe’s Destructive Pessimism

Europe can only get out of its crisis by structurally reforming its big welfare state. The austerity-driven attempts at saving the welfare state over the past six years have worsened the crisis, made the crisis permanent in some countries and essentially sentenced an entire generation of Europeans to doom, gloom and a life in the economic wasteland.

This video from the EU Observer provides a glimpse of what life is like for Europe’s young – and puts on full display the lack of insight among “experts” into the true nature of the European crisis:

The lack of crisis insight is particularly telling. At about 1:30 into the video a certain Dr. Howard Williamson suggests that the “older” generations have to give away part of what they have earned in order to provide more opportunities for the young. His argument suggests that Europe cannot get back to a growing economy, therefore public policy boils down to distributing a fixed amount of money and opportunities between generations.

This is, needless to say, a rather ludicrous argument. Europe’s growth problems are related to the size of its government and the disastrous execution of austerity policies over the past few years. Growth is attainable, and certainly desirable, and all we have to do is get obstacles, thresholds, regulations, red tape and taxes out of the way so creative men and women of all ages can pursue their entrepreneurial dreams.

To make matters even more confusing for the young in Europe, at 2:40 the reporter then turns to Hungarian economist Csaba Kancz. He suggests, in pure contradiction of facts and macroeconomic data, that Europe has “bumped into a wall of perpetual growth based on debt creation or creating fiat money”. The “fiat money” remark alludes to government deficits being paid for with newly printed money, implying that somehow Europe experienced a growth boom in the years leading up to the current crisis.

The truth is that Europe experienced higher growth rates when its governments were not borrowing money back in the 1980s than in the 2000s. In fact, the sluggish growth rates in the 2000s actually paved the way for the current welfare-state crisis: with low growth comes insufficient tax revenues and excessive spending through entitlement programs.

Sadly, the video generally conveys the same pessimistic outlook on the future that Mr. Kancz expresses at 4:30, when he suggests that:

The youth, currently, seeking jobs or just entering the job market, will not have the same kind of career opportunities that their parents have had. And actually, they will have to curtail back their expectations.

If we assume that the current crisis is going to become a permanent state of affairs in Europe – in other words, if we assume that Europe is indeed in a state of industrial poverty – then Mr. Kancz is correct. However, if – which I find more likely – his comment is based in his genuine analysis of what the absolute potential is for Europe’s economy in the future; then he is flat-out wrong. The right kind of structural reform to the European economy can release half-a-billion people from the shackles of a morbidly obese government.

This view, however, is very rarely heard in the public conversation on Europe’s future. Quite the contrary, the loudest voices are those who advocate for the resignation of hope, ambition and aspirations (as the “experts” in the video suggest) or for a full return to the heydays of the welfare state. A good representative of the latter view is Mark Blyth of The Guardian, here commenting on a speech by British Prime Minister David Cameron on what the future entails for the British economy:

The prime minister’s speech at the lord mayor’s banquet was notable in part because its main message, that “we need to do more with less. Not just now, but permanently,” was delivered from a throne bedecked in gold to applause from members of the financial elite.

Alas, the prime minister shares the view of the aforementioned “experts” that the current crisis, with its economic stagnation, is permanent. This of course does not sit well with those who want a return to the welfare state, among them again Mark Blyth:

But it’s the other less commented upon aspects of the speech that signal why the government feels confident enough to reveal its true colours. David Cameron’s claims simply don’t add up to a coherent explanation as to why “more with less” – perma-austerity – is a policy worth pursuing. First of all, he insisted that “the biggest single threat to the cost of living in this country is if our budget deficit and debts get out of control again”. Yet while the deficit rose to 11.2% of GDP in 2010, the markets that fund British debt never once thought the situation “out of control”. Quite the contrary occurred as the interest payments due on UK bonds have gone steadily down since 2006, and have only risen now, when the UK is supposedly in recovery.

One reason why interest rates went down is that the ECB promised to flood the world with euros if necessary to support the most critically troubled of Europe’s welfare states. the recent uptick is related to the general concern for inflation, both in the United States and in Europe.

That said, Blyth’s comment is valid in that some governments can borrow exorbitant amounts of money without having to pay an interest rate penalty. The problem arises when we draw policy conclusions from this fact, as Blyth does:

A much more likely culprit for the drop in living standards is the fall in British real wages of over 5% since 2010 coupled with high price inflation, but that doesn’t fit with the story of “out of control” spending needing to be reined in for the common good. Second, when you have a deficit, you can either raise taxes or cut spending to fill the gap, and the coalition have favoured the latter. And because of these efforts British government debt has gone up, not down, despite the cuts, from 52.3% of GDP in 2009 to 90.7% in 2013. This is hardly a surprise given that exactly this same pattern of cuts leading to more debt as the underlying economy shrinks has been the story throughout the Eurozone too.

In short, Blyth wants higher taxes and quite possibly more government spending. He does, after all, suggest that there is a positive correlation between government spending and GDP growth: less government spending means lower GDP growth and vice versa.

The problem for him is that evidence points in the exact opposite direction:

Academic research clearly shows that government spending, once it reaches above the level needed to finance core responsibilities such as the rule of law hinders economic growth by misallocating labor and capital. Indeed, there is even a well established relationship, illustrated by the Rahn Curve, showing how larger levels of government spending are associated with slower growth and economic stagnation. Researchers do not agree on the precise number, but there is general agreement that the growth maximizing level of government is between 15 percent of GDP and 25 percent of GDP, far below current levels.

Nevertheless, this unbreakable belief in government as the economic savior is what keeps Europe from evolving beyond the welfare state. This belief is in fact so pervasive in Europe that whenever experts or “experts” speculate about what to do about the sinking ship they end up with the kind of introvert table talk littered throughout the video above.

Europe needs a complete macroeconomic reboot, one where the free market and the free individual is made the first priority of all policy.