Greece just made its IMF payment due last week, indicating that the socialist government still does not think it has strong enough support among the Greek general public to secede from the euro zone. It is unlikely that any other arguments will keep them from reintroducing the drachma; high inflation – an inevitable consequence of a drachma resurrection – does not discourage socialists in other countries, such as Venezuela, from pursuing reckless domestic policies. Syriza, whose leader Tsipras is a dyed-in-the-wool Chavista socialist, wants to be the first to bring the warped ideology of Hugo Chavez to Europe, and he is not going to let his plans be spoiled by petty things like currency turbulence or 50-percent inflation like they have in Venezuela.
However, if the population generally is against a currency secession, he runs the risk of a parliamentary challenge long before the next election. His majority is very slim, and depends critically on the participation of a small nationalist party that could be peeled away by a determined opposition. In other words, Tsipras is walking a thin line to get Greece to where he wants her to be.
One of the problems with this thin line is that it does not allow for any sound economic policies. Nothing that could actually revive the chronically depressed Greek economy is permitted in under the Tsipras government’s low ideological ceiling. Therefore, the following report from Euractiv should come as no surprise:
Greek Finance Minister Yanis Varoufakis said on Thursday (9 April) that the government was restarting its privatisation programme and was committed to avoiding going into a primary deficit again. Prime Minister Alexis Tsipras’ government has been opposed to some asset sales but has promised not to cancel completed privatisations, and only review some tenders as part of the terms of a four-month extension of its February bailout program me. “We are restarting the privatisation process as a programme making rational use of existing public assets,” said Varoufakis, speaking in Paris.
This is how they are going to balance the budget: by means of one-time sales of assets. It is like selling the living room couch to pay your mortgage. What are you going to sell next month?
The previous Greek government did the same thing, obviously to no avail. In fairness, though, the Greek government has very few options. Despite some weak signs of a fledgling recovery earlier this winter, there is no clear rebound in the Greek economy.
Private consumption, measured as four-quarter moving averages and adjusted for inflation, has stabilized a bit under €30bn per quarter. This is a substantial loss from the €37bn per quarter recorded right before the Great Recession, and it means that the Greeks have basically been sent back to 2001 in terms of standard of living.
Since private consumption is the driving force of the economy, its decline and stagnation since 2008 is the most vivid expression of the deep suffering that the Greek people has had to live through. That said, they have also asked for more by electing a socialist for prime minister whose comprehension of economics is weak, to say the least.
Tsipras, like all socialists, sees government as the indispensable economic agent; everything else is either debatable or out of the question.
With all that in mind, there is actually a flickering light in the tunnel. When Greece’s private consumption is measured per employed person, it actually looks like there is a small rebound in there:
With consumption again measured by quarter, with four-quarter moving average adjusted for inflation, and then divided by employee, it looks like the Greeks are able to work their way up a little bit in terms of purchasing power. In the first quarter of 2011 per-employee consumption was €8,004; for the last quarter on record, Q3 of 2014 it was €8,178.
This does not look like much of an increase, but the underlying trend is weakly positive. This means that while only 54 percent of the Greek population 20-64 actually have a job, those who do are slowly beginning to establish a “new normal” of consumption. It is a normal that is characterized by stagnation, with almost no outlook toward reasonable gains in the standard of living – it is in essence life under industrial poverty – but at the very least this little rebound is an indicator that things are not going to get worse.
Ceteris Paribus, of course… And as one of my favorite economics professors from back in college loved to point out: ceteris is not always paribus. Things change. And not always for the better. Especially when you have a prime minister dedicated to the mission of bringing Chavista socialism to Europe. Come Scylla or Charybdis.
While the talks between the EU and the Greek government has bought the euro a little bit more time, there is a growing undercurrent of a debate over the European crisis. More writers are trying to put their finger on where Europe is going and what the continent needs. Arthur Brooks, president of the American Enterprise Institute, looks at demographics and points to some of the deeper social and cultural problems that plague Europe:
[A] country or continent will be in decline if it rejects the culture of family, turns its back on work, and closes itself to strivers from the outside. Europe needs visionary leaders and a social movement to rediscover that people are assets to develop, not liabilities to manage. If it cannot or will not meet this existential challenge, a “lost decade” will look like a walk in the park for Grandma Europe.
There are reasons why a country turns away from family, work and social, demographic and cultural reproduction. Those reasons are closely tied to self determination: when people are demoted from independent individuals to subjects of the welfare state, their desire to assume responsibility for a family weakens accordingly. When government uses economic incentives to steer people toward certain life choices, and away from others, people become less inclined to participate in the reproduction of the society they inherited. They are happy to hand that responsibility over to government – precisely along the lines of the incentives that government has created.
In other words, when government has social-engineering ambitions the consequences of its incursions into the private lives of its citizens reach far beyond what government planners initially would anticipate. Collectivization of people’s daily lives destroys much more than just the economy.
The welfare state is the collectivization vehicle that rolls all over the values that formed the foundation of Western civilization. Proponents of individual and economic freedom chronically under-estimate the destructive force of the welfare state, both short-term and long-term. Brooks represents the view that the welfare state, over its long-term existence, is somehow isolated from the cultural and social traditions and institutions of a society.
The short-term perspective and under-estimation of the welfare state is well represented by former Polish deputy prime minister Leszek Balcerowicz. In the Fall 2014 issue of the Cato Journal, Balcerowicz offers a refreshing explanation of the crisis that caused the Great Recession. After initially attributing the crisis in the so called PIIGS countries to the financial sector, he develops a productive narrative of the crisis where the financial and fiscal sectors interact:
- In one direction the crisis causality runs from the financial sector to the fiscal sector – “fiscal-to-financial” by Balcerowicz’s terminology – when “sustained budgetary overspending … spills over ito the financial sector, as financial institutions are big buyers of government bonds”;
- In the other direction the crisis causality runs “financial-to-fiscal”, which Balcerowicz exemplifies with Ireland and Spain: “The spending boom in the housing sector fueled the growth of their economies and created a deceptively positive picture of their fiscal stance”.
While Balcerowicz is theoretically correct about the quality of the financial-to-fiscal causality, it still remains to be proven that there was enough economic activity at stake to cause such a brutal drop in employment and general economic activity as happened in 2008-2009. Balcerowicz does not offer any deeper insight into the causality, but adopts the narrative that has become the official explanation of how the Great Recession started.
Of far more interest is Balcerowicz’s “fiscal-to-financial” argument. Chronically overspending governments pull banks down with them, especially as the credit ratings of the welfare states start tumbling. I pointed to this in two articles last year, one in April and one in December. I also explain the role of the welfare state behind the crisis in my book Industrial Poverty.
The one point where Balcerowicz stumbles is when to explain why governments chronically overspend. He approaches the problem as a question:
What are the root causes of the tendency of modern political systems to systematically overspend, which results in fiscal-to-financial crises or in chronically ill public finances that act as a brake on economic growth?
He then suggests that the answer to this question “belongs to public choice”. This is an analytical mistake: public choice lacks the methodological power to penetrate the complexity of the welfare state.
Clearly, there is a need for libertarians and other friends of economic and individual freedom to learn how to understand, analyze and politically and legislatively dismantle the welfare state. Without such knowledge they will continue to make near-miss contributions such as the ones by Brooks and Balcerowicz.
But fear not. I have another book coming. Stay tuned.
Recently Eurostat released national accounts data for the third quarter of 2014. Here is a review of those numbers in the context of historical GDP data. All growth rates are in 2005 chained prices.
First, the growth rates of 28-member EY and 18-member euro zone:
The real annual growth rate of the EU-28 GDP is 1.51 percent, compared to 1.34 percent in Q2 of 2014 and 1.61 percent in Q1. Euro-zone growth is markedly lower – for first, second and third quarters of last year, respectively: 1.08, 0.65 and 0.79 percent. The difference between the euro zone and the EU-28 is primarily the work of a recovery in the British economy. In the three quarters of 2014, Britain saw its GDP growth at 1.8, 3.6 and 3.2 percent, respectively. If we subtract the U.K. economy from the EU-28 GDP, the European growth rates for 2014 fall to (with actual rates in parentheses) 1.58 (1.61), 0.89 (1.34) and 1.17 (1.51) percent. A distinct difference, in other words.
As the aforementioned numbers report, there is not much to be joyful of inside the euro zone. There are member states with strong growth, but they tend to be of marginal importance for the entire zone. In the third quarter of 2014 the strongest-growing euro-zone countries were Luxembourg (3.99 percent over Q3 2013), Malta (3.82) and Ireland (3.54). By contrast, the three largest euro economies have a tough time growing at all: Germany (1.24 percent over Q3 2013) and France (0.24) kept their nose above water, while third-largest Italy saw its GDP decline by half a percent.
Here is the growth history of the three largest euro-zone economies:
We will have to wait and see what the new Greek government will do to the future of the euro and the confidence of private-sector agents in the European economy. With Syriza teaming up with a distinctly nationalist party, the message out of Athens could not be stronger: Greece is off on a new course, and it won’t be with the best interests of the euro zone in mind.
There is a lot more to be said about these GDP numbers. It will be very interesting to look at what sectors are driving whatever growth there is – and which ones are contracting. I suspect that exports will play a larger role than domestic demand. Hopefully I am wrong, because if I am correct it means that there is still no change in overall private-sector confidence in the euro zone. But that remains to be seen; I will return to this dissemination of Europe’s national accounts as soon as possible.
The European Central Bank will plough €1.1 trillion into the eurozone economy in a last-ditch attempt to breath [sic] life into the European economy. At its monthly governing council on Thursday (January 22), the bank’s governing council agreed to start buying up to €60bn of government bonds from March in an unprecedented quantitative easing programme.
How is this supposed to happen? Private spending would accelerate if interest rates went down, but that will happen if and only if the interest rate on treasury bonds falls as a result of this new ECB spending program. That, in turn, can only happen if demand for treasury bonds increased enough to overcome the risk premium associated with euro-zone member states.
However, the risk premium was supposed to go away with the bond purchase program that the ECB announced last summer. Back then the bank pledged an open-ended purchase program for treasury bonds issued by troubled euro-zone countries: everyone and anyone who owned a treasury bond issued by, say, Greece would be guaranteed to get his money back by selling it to the ECB. This guarantee, then, would bring down interest rates and stimulate private-sector activity.
But this did not happen. The bond buy-back program may have had a marginally visible effect on interest rates, but it certainly was not enough to encourage any sustained upswing in private-sector activity.
When that did not work the ECB pushed bank-lending interest rates through the floor by lowering the rate on overnight bank deposits to -0.2 percent. That had no effect whatsoever on private-sector activity. So after having opened two liquidity flood gates on the European economy, without coming even close to achieving desired results, the ECB has now decided to open the third flood gate.
Well, if you try the same thing enough times over and over again, then eventually it might actually work…
Back to the EU Observer story:
The programme is open-ended, and will run until September 2016 at the earliest. Speaking at a press conference following the governing council meeting, ECB president Mario Draghi said that the bond-buying programme would remain in place “until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2%” … The Frankfurt-based bank hopes to boost inflation and drive down the value of the euro against other major currencies in a bid to make the bloc’s exports more attractive.
This is a tried-and-failed strategy. Every time a country depreciates or devalues its currency to boost exports, the main result is an increase in profits among large, dominant and already-established manufacturing businesses. Those profits, in turn, are free of charge for the businesses: all they have to do is keep manufacturing the very same products, without investments toward improved competition.
If this currency-based exports rebate is maintained long enough, the result will be a decay in productivity in exporting businesses. They have no profit-based reason to make new investments – quite the contrary. Any investments toward enhanced competitiveness will divert funds from the free-cash profits.
But what will the businesses use their cash for? Financial investments. This in turn will flood the domestic economy with even more liquidity than was already injected into it by the central bank’s aggressive monetary policy. More and more money will chase fewer and fewer profitable investments. In the meantime, little to nothing is going to happen in the real sector; the only moving part will be credit-driven consumption of durable goods like cars, and private real estate. But that will require a rapid build-up of private-sector debt, which in turn is a recipe for – yet another – future financial crisis.
Overall, as I have explained before, this QE program will notch the euro yet another inch or two toward its grave. And just to make sure there is enough certainty about where the euro is heading, the other day the the EU Observer reported that Greece may be allowed to exit its tough austerity program – without having solved its underlying macroeconomic problems:
A legal opinion by the EU top court and comments by the EU economics commissioner about the end of the bailout troika have come just days before elections in Greece, where troika-imposed austerity is a central issue. … EU economics commissioner Pierre Moscovici on Monday (19 January) … said the “troika should be replaced with a more democratically legitimate and more accountable structure based around European institutions with enhanced parliamentary control”. Moscovici added that the troika “was useful and necessary” at the height of the crisis, “but now I think we need another step.” His comments come just a week after a legal opinion by the general advocate of the European Court of Justice said that the European Central Bank should not oversee reforms of countries it helps via Outright Monetary Transactions, a bond-buying scheme coupled with structural reforms modelled on what the troika has done in bailed-out countries.
In other words, the ECB can no longer come with cash in one hand and demands for austerity in the other. It has to choose either. Since the ECB has chosen to come with money, this means an end to austerity demands.
In reality this is a carte blanche to euro-zone governments in, e.g., Greece to get back to the old days of spending. The ECB promises to buy its treasury bonds, the austerity protesters in, e.g., Syriza have in the public opinion won the argument over austerity, and the ECB is desperate to see some kind of life sign in the European economy. This is a perfect storm for a massive increase in government spending.
This is, of course, exactly the wrong recipe for the European economy. Nevertheless, this is how the game is set up. More government spending, more money printing – until the euro is in so bad shape that it collapses into junk status and goes the same way the Reichsmark did in Weimar Germany.
The cold, hard, bottom line here is that government spending, bankrolled with monetary printing presses, does not create productive economic activity. All it does is dig the economy further into the same hole into which it has been slowly sinking for the past six years.
The ECB has given up. They are not even trying to play defense anymore.
This is the beginning of the end of the euro.
The truth about the European economic crisis is spreading. The latest evidence of this growing awareness is in an annual report by the European Commission. Called “Report on Public Finances”, the report expresses grave concerns about the present state as well as the economic future of the European Union. It is a long and detailed report, worthy of a detailed analysis. This article takes a very first look, with focus on the main conclusions of the report.
Those conclusions reveal how frustrated the Commission has become over Europe’s persistent economic stagnation:
The challenging economic times are not yet over. The economic recovery has not lived up to the expectations that existed earlier on the year and growth projections have been revised downwards in most EU Member States. Today, the risk of persistent low growth, close to zero inflation and high unemployment has become a primary concern. Six years on from the onset of the crisis, it is urgent to revitalise growth across the EU and to generate a new momentum for the economic recovery.
Yet only two paragraphs down, the Commission reveals that they have not left the old fiscal paradigm that caused the crisis in the first place:
The aggregate fiscal picture for the EU and the euro area is now considerably more favourable, thanks to the commendably large consolidation efforts made in the past. … this has allowed Member States to slow the pace of adjustment. The aggregate fiscal stance is now expected to be broadly neutral in 2014 and 2015, both in the EU and the euro area. This will reduce one of the drags on growth and should therefore be welcomed.
If Europe is ever to recover; if they will ever avoid decades upon decades of economic stagnation and industrial poverty; the government of the EU must understand the macroeconomic mechanics behind this persistent crisis. To see where they go wrong, let us go through their argument in two steps.
a) “The aggregate fiscal picture for the EU and the euro area is now considerably more favourable, thanks to the commendably large consolidation efforts made in the past.” There are two analytical errors in this sentence. The first is the definition of “fiscal picture” which obviously is limited to government finances. But this is precisely the same error in the thought process that led to today’s bad macroeconomic situation in Europe: government finances are not isolated from the rest of the economy, and any changes to spending and taxes will affect the rest of the economy over a considerable period of time. The belief that government finances are in some separate silo in the economy led to the devastating wave of ill-designed attempts at saving Europe’s welfare states in 2012.
Austerity, as designed and executed in Europe, was aimed not at shrinking government but making it affordable to an economy in crisis. The end result was a permanent downward adjustment of growth, employment and prosperity. In order to get their economy out of this perennial state of stagnation, Europe’s leaders need to understand thoroughly the relations between government and the private sector.
b) “The aggregate fiscal stance is now expected to be broadly neutral in 2014 and 2015, both in the EU and the euro area. This will reduce one of the drags on growth and should therefore be welcomed.” Here the Commission says that if a government runs a deficit, it causes a “drag” on macroeconomic activity. This is yet another major misunderstanding of how a modern, monetary economy works.
Erstwhile theory prescribed that a government borrowing money pushes interest rates up, thus crowding out private businesses from the credit market. But that prescription rested on the notion that money supply was entirely controlled by the central bank; in a modern monetary economy money supply is controlled by the financial industry, with the central bank as one of many players. Its role is to indicate interest rate levels, but neither to set the interest rate nor to exercise monopolistic control on the supply of liquidity.
A modern monetary economy thus provides enough liquidity to allow governments to borrow, while still having enough liquidity available for private investments. In fact, it is rather simple to prove that the antiquated crowding-out theory is wrong. All you need to do is look at the trend in interest rates before, during and after the opening of the Great Recession, and compare those time periods to government borrowing. In a nutshell: as soon as the crisis opened in 2008 interest rates plummeted, at the same time as government borrowing exploded.
This clearly indicates that the decline in macroeconomic activity was not caused by government deficits; it was the ill-advised attempt at closing budget gaps and restore the fiscal soundness of Europe’s welfare states that caused the drag. And still causes the drag.
In other words, there is nothing new under the European sun. That is unfortunate, not to say troubling, but on one front things have gotten better: the awareness of the depth of the problems in Europe is beginning to sink in among key decision makers. What matters now is to educate them on the right path out of the crisis.
There is a lot more to be said about the Commission’s public finance report. Let’s return to it on Saturday.
I spent some time traveling Eastern Europe before the Berlin Wall came down. I have many vivid memories of my trips, such as the very low-tech cars they all were so proud of. But I was also impressed with some things, like the breakfast on the overnight train through East Germany – a gourmet experience you could not even get in first-class intercontinental flights at that time. Or the beauty of Prag and Budapest, two of Europe’s most prominent, historic cities.
Perhaps the most painful experience was the sense of perennial economic stagnation. It was almost as though they all lived in a 1950s time capsule, from the enormous, inefficient and highly polluting industrial “combinates” to the design and quality of furniture and home electronics (to the extent it even existed).
Children grew up to the same standard of living that their parents experienced. And their children had nothing more optimistic to look forward to.
Fast forward a quarter century. The Great Recession is hurricaning its way through the European economy. Panic-driven tax increases, combined with spending cuts designed not to shrink government, but to preserve the welfare state, add insult to injury in country after country. The entire continent falls into the dungeon of economic stagnation.
Year after year go by without any discernible improvement on the horizon. All of a sudden, half-a-billion people have no reason to believe in a better tomorrow.
To me, and to anyone who had the opportunity to see first hand what life was like in Communist Europe, this is a painful deja-vu experience. One generation after the fall of the Berlin Wall and the opening of unlimited opportunities to hundreds of millions of people from Saxony to Sakhalin, new skies have descended over the former Soviet empire. The part of it that remained under the Russian sphere now struggle with political instability and an economy that seems to be moving backwards.
The countries that chose the European Union for their future are not in much better shape. They are now part of a bigger economy that may have elevated them to a higher standard of living, but is now keeping them from further growth. If anything, people all over Europe now have to worry that their children and grandchildren will not be able to lead a more prosperous life than they have.
A new era – the same stagnation.
Industrial poverty, for short.
The insights of this long-term trend are slowly spreading. While 2014 has been the year of dashed hopes for a recovery, it looks like 2015 might be the year of painful insights. Those are coming little by little, slowly spreading from writer to writer, from analyst to analyst. A good example of someone who seems to be joining the ranks of the frustrated yet insightful is Peter Kohli, who writes for NASDAQ about Greece:
On November 13th, I wrote an article on this website on how to take advantage of a possible turnaround in the Greek economy, because of certain positive reports I had read. However, it seems that things have changed rather quickly and that the Presidential elections there have been moved up to next week, beginning on December 17th.
The lack of steady economic recovery is taking a political toll on the country. This is not surprising – the channels between politics and the economy are strong in Europe’s welfare states, where government is promising to cater to almost every need people may have. During the fall from relative prosperity in 2007 to the dark, frustrating dungeons of economic depression in 2012, Greek voters expressed their very deeply felt dissatisfaction with their government by voting for two radical and fundamentally anti-democratic parties: Syriza with its Hugo Chavez-style bolivarian socialist platform, and Golden Dawn, the first openly Nazi party to take seats in a European parliament since the 1930s.
Earlier this year it looked like there might be a recovery under way in Greece. However, as more data came online, it quickly became clear that this was merely a transition from depression to stagnation, an insight that very likely has made its way into the hallways of Greek political power. Alas, the election concerns that Kohli writes about. Back to his article:
Ordinarily this would not be a problem, except that there are no candidates for the post yet. In Greece, the election of a president is done by the legislators, who need a supermajority – which they don’t have. If after three successive elections they fail to install a candidate, a general election will be called, and here is where the real problem lies. Currently, the far left anti-austerity party, Syriza, is way ahead in the polls and they are promising to basically roll back nearly all the plans to put the country back on the path of prosperity instituted by the current government.
Well, that path is not exactly a path. It is more of a picture on the wall. But that is a minor point here. Let’s listen to Kohli’s conclusion:
This sent shivers down the spines of many investors, causing the ATHEX Composite Index (GD) to plummet 12.78% on December 9th, another 1% the following day, and then down a further 7.35% the next. Subsequently, the only single-country Greece ETF (GREK), has been hit hard and is down a whopping 39.28% YTD. After making some significant positive steps, I thought the Greeks were on their way back, but this is another Greek tragedy in the making.
It is indeed. If the Greeks do elect Syriza, there is a not-insignificant risk of two major crises forming a perfect storm:
- The attempt to roll back austerity will lead to the only thing worse than those policies, namely reckless tax hikes; an abandonment of EU-imposed austerity could also lead to a Greek euro exit, with currency free-fall and massive inflation as a result; the economy would be hurled back into depression; and
- The Nazis in Golden Dawn will not tolerate a government they would consider to be downright Communist; with their penchant for “creative” extra-parliamentary politics, and their deep support among the armed forces and the police, this would pose a direct threat to Greek democracy.
Europe needs to choose between the welfare state and prosperity. Irrefutable evidence shows they cannot get both. The question is: what will it take for them to realize the terms of the choice? The Greek situation may be extreme, but it is extreme in quantity, not in quality. The architecture for a similar development is present in several other European countries: Spain, Portugal, France…
In a few articles recently I have pointed to some evidence of an emerging economic recovery in Spain and Greece. This is not a return to anything like normal macroeconomic conditions, but more a stagnation at a depressed level of economic activity. To call it a “recovery” is a stretch, but given the desperate circumstances of the past few years, an end to the depression is almost like a recovery.
The transition from a depression with plunging GDP, vanishing jobs and overall an economy in tailspin, to stagnation where nothing gets neither better nor worse, is in fact a verification of my long-standing theory. Europe has entered a new era of permanent stagnation – an era best described as industrial poverty – and is slowly but steadily becoming a second-tier economy on the global stage. The path into that dull future is paved with decisions made by political leaders, both at the EU level and in national governments. While they do have the power to actually return Europe to global prosperity leadership, they choose not to use that power. Instead, their economic policies continue to destroy the opportunities for growth, prosperity and full employment.
In fact, Europe’s leaders have the opportunity on a daily basis to choose which way to go. The difference is made in their responses to the economic situation in individual EU member states. Let us look at two examples.
First out is an article from Euractiv a month ago:
Greece is “highly unlikely” to end its eurozone bailout programme without some new form of assistance that will require it to meet targets, a senior EU official said on Monday (3 November). “A completely clean exit is highly unlikely,” the official told reporters, on condition of anonymity. “We will have to explore what other options there are. Whatever options we may be adopting, it will be a contractual relationship between the euro area institutions and the Greek authorities,” the official said.
How will the EU, the European Central Bank and the International Monetary Fund respond to this? Will they continue to impose the same austerity mandates that they began forcing upon Greece four years ago? Back to Euractiv:
The eurozone and IMF bailout support of €240 billion began in May 2010. Greece is in negotiation with EU institutions and the International Monetary Fund ahead of the expiry of its bailout package with the European Union on 31 December. Athens has said it wants its bailout to finish when EU funding stops, though the IMF is scheduled to stay through to early 2016. The EU official said he expected eurozone ministers and Greece to decide on how best to help Athens at a meeting of finance ministers in Brussels on 8 December.
If the EU decides to continue with the same type of bailout program, thus continuing to demand government spending cuts and tax hikes, then their response to this particular situation will continue the economic policies that keep Europe on its current path into perpetual industrial poverty.
The second example, France, also presents Europe’s political leadership with a fork-in-the-road kind of choice. From the EU Observer:
France’s finance minister cut the country’s deficit forecast for 2015 on Wednesday (3 November) adding that Paris will be well within the EU’s 3 percent limit by 2017. Michel Sapin told a press conference that he had revised France’s expected deficit down to 4.1 percent from the 4.3 percent previously forecast, as a consequence of extra savings worth €3.6 billion announced by Sapin in October.
That sounds good, but what is the reason for this improved forecast – and, as always with optimistic outlooks in Europe, can we trust it?
The extra money does not come from additional spending cuts but instead from lower interest expenses from servicing France’s debts, a reduction in its contributions to the EU budget, and extra tax revenues from a clampdown on tax evasion and a new tax on second homes. “We have revised the 2015 deficit … without touching the fundamentals of French economic policy,” Sapin told reporters.
This also means they have done their debt revision without seeing a change for the better in “the fundamentals” of the French economy. In other words, no stronger growth outlook, no sustainable improvement in business investments or job creation. As a matter of fact, a closer look at the measures that Mr. Sapin refers to reveals a frail, temporary improvement that will not put France on the right side in any meaningful macroeconomic category:
- A lower interest rate on French government debt is almost entirely the work of the European Central Bank and its irresponsible money-printing; the French are paying lower interest rates on ten-year treasury bonds than we do here in the United States, but that will last only for as long as investors remain confident in the ECB’s version of Quantitative Easing; interest rates will quickly start rising again once that confidence is shattered – and it will be shattered as soon as investors realize that, unlike in the United States, the European economy will not start growing again;
- Reduced French EU contributions come at the expense of other countries and likely won’t last very long; as soon as other countries have grown impatient with the French, they will force Paris to increase its contributions again; besides, this “reduced EU contributions” thing is basically just an accounting trick – effectively it means that the EU has reduced their demands on how much France needs to cut its deficit to be “compliant”;
- A new second-home tax is a tax increase to which taxpayers will make the necessary adjustments; they will move from owning a home to renting one or to extended-stay vacations at luxury hotels; once that adjustment reaches a critical point the French government will have lost the new revenue and their hopes of being “compliant” with the EU deficit requirement will fade away.
If the French government spent all the political and legislative efforts that went into these measures, on structural reforms to the French government, then France would be en route to a major improvement in growth, jobs creation, business investments and the standard of living of their citizens. But that is not going to happen. All they do is try to comply with the same old statist rules that have forced them to balance their budget – and save their welfare state – instead of promoting the prosperity of their people.
There is a painful shortsightedness in European fiscal policy, one that almost entirely prevents the political leadership of that continent to look beyond the next fiscal year. It is time for them to stop, raise their eyes to the horizon and think about where they want their continent to be ten years from now.
If they don’t, I can surely say where they are going to be: in an era of industrial poverty, colored by three shades of grey, where children are destined to – at best – live a life no better than what their parents could accomplish. Think Argentina since the decline and fall of their 15 years of global economic fame.
Think Eastern Europe under Soviet rule.
Whenever government creates an entitlement, it makes a promise to its citizens. The promise is defined in terms of a cash value, or an in-kind service of a certain quality; in terms of duration and of who is, or can become, eligible.
Over time, people adjust their lives to these promises. They come to rely on government being there for them when it really matters, and therefore stop – or never start – saving for contingencies such as unemployment or major health care expenses. Their incentives to stop providing for unforeseen events are reinforced by the taxes that go toward paying for government’s promises.
There you have it, in a nutshell: the welfare state.
In the early years of its existence, the welfare state provided for people with relative ease. Many adults still lived by the old creed of keeping current expenses moderate in order to have enough in the bank for most of what life could throw at them. Taxes were also relatively moderate, allowing people the cash margins to do the saving they still thought they needed.
Over time, though, it became harder and harder for government to keep its welfare-state promises. The incentives structure that government had created began sinking in to the fabric of the economy. Not only did people cut down on their savings, thus relying more on the welfare state, but they also responded to the higher taxes by working less.
Dependency on government increased while independence decreased. This created a trend where the ability of government to pay for its promises was slowly but inevitably eroded. The cost of its promises crept upward, beyond what the creators of the welfare state had originally imagined; work disincentives eroded tax revenues, also beyond what the architects of the welfare state had pictured.
In the early 1970s most of Europe’s welfare states hit a point where the cost of the welfare state began rising above what the private sector of the economy could afford. Various accommodating measures were taken, varying from higher taxes and benefits cuts – as in Denmark – to supply-side tax cuts aimed at accelerating growth in tax revenue – as in Sweden. (Notably, the Reagan tax cuts were coupled with seven-percent-per-year federal spending growth, a clear indication that the supply-side policies were there to fund government, not part of a strategy to reduce the size of government.) But these were merely stopgap measures; inevitably, the welfare state overwhelmed the private sector with its entitlement costs, its high taxes, its incentives toward a lifestyle of government dependency.
The crisis of 2008 was the straw that broke the camel’s back. Europe’s welfare states plunged into the dungeon of economic stagnation and began their march into a new era of industrial poverty.
For more on that part of the story, see my book on the European crisis. For now, though, there is another aspect of the crisis of the welfare state that deserves attention. In response to the overwhelming cost of the welfare state, most of Europe’s countries have resorted to a kind of austerity not yet known to Americans. They cut government spending and raise taxes not to reduce the size of government, but to resize their welfare states to slim-fit them into a smaller economy (make them more “affordable” as Michael Tanner so aptly put it in his foreword to my book). The metrics for whether or not austerity has succeeded have nothing to do with how the private sector is doing – they are all focused on whether or not the welfare state will survive.
The primary measurement of survivability is whether or not the budget deficit has been reduced.
In order to get there, though, most European governments have had to cut deeply into their welfare state programs. That would be fine under the right circumstances – if people were given tax cuts corresponding to the spending cuts and thus a chance to buy the same services on a private market. But in the European, statist version of austerity, reduced spending means cutting the size of government without giving more room to the private sector. As much as this sounds like a contradiction in terms, consider the fact that while spending is reduced, taxes remain high or go up even higher.
As a direct result of this statist version of austerity, government breaks its promises to its citizens, and does it on many fronts at the same time. This is now statistically visible.
Broadly speaking, welfare-state spending consists of two parts: cash benefits and in-kind benefits. The latter is health care, elderly care, child care and similar services. Both these two categories can then be subdivided into means-tested and non-means tested benefits.
When a government is faced with the need to cut spending, and its motive for cutting spending is to save as much as possible of the welfare state, it will make its cuts based on two criteria:
- what cuts will give the most bang for the political and legislative effort; and
- what cuts will stir up the least political protests among voters.
These two criteria do not always work in tandem, and it varies from country to country, from government to government, which one weighs more heavily. However, as a general rule it is easier to cut in-kind benefits than cash benefits: while people see the reduction in cash benefits immediately, it takes a while for them to experience the reduced quality or availability of services such as health and child care.
We can see this rule at work in Europe. In countries that have been hit hard by statist austerity, there were tough cuts to in-kind benefits spending (Eurostat data; changes to annual total spending; current prices):
By contrast, countries that have not suffered as hard statist austerity measures:
Now compare the cuts to in-kind benefits in “austerity countries” to what they did with cash benefits:
What is the lesson from all this? There is, again, the broader, long-term lesson of a future in economic stagnation and a life in industrial poverty. But already today there are tangible consequences felt by citizens whom welfare statists often refer to as “vulnerable”. They have first been lured into dependency on government, then – when austerity strikes – they are left without access to services monopolized by government.
When the welfare state breaks its promises, having the right to health care is one thing; getting health care when needed is a totally different matter.
The European economic stagnation is now becoming a concern for the rest of the world. The OECD – Organization for Economic Cooperation and Development – is sounding the alarm in their latest Economic Outlook. From their news release:
The Economic Outlook draws attention to a global economy stuck in low gear, with growth in trade and investment under-performing historic averages and diverging demand patterns across countries and regions, both in advanced and emerging economies.
Put bluntly, the EU with its 500 million residents and supposedly first-world standard of living is spreading its stagnation to other countries and continents. An economy that is not growing is not growing its imports; it offers fewer, and less profitable, investment opportunities than a growing economy.
Many emerging economies have their own problems to deal with, from a heavy-handed government in India and clumsy deregulation in China to dangerous political corruption and violence in South Africa. But there is no doubt that entrepreneurs in those countries who can participate in global trade would be much more able to make a difference for the better if they had a growing global market on which to sell their products. While the U.S. economy sticks to its lazy recovery – the latest job numbers are moderately good but not exciting – the Japanese upturn is still fledgling. But the big drag on the global economy is, no doubt, Europe.
The OECD notes this…
“We are far from being on the road to a healthy recovery. There is a growing risk of stagnation in the euro zone that could have impacts worldwide, while Japan has fallen into a technical recession,” OECD Secretary-General Angel Gurria said.
…but when it comes to prescriptions for what to do about this, the OECD falls short. Before we get there, though, it is important to note one aspect of the OECD report that hints of what kind of solutions they may be prescribing:
The euro area is projected to grow by 0.8% in 2014, before slight acceleration to a 1.1% rate in 2015 and a 1.7% rate in 2016. A prolonged stagnation in the euro area could drag down global growth and have knock-on effects on other economies through trade and financial links. A scenario in the Outlook shows how a negative shock could lead an extended period of very low growth and very low euro inflation, resulting in unemployment remaining at its current unacceptably high level.
I have lost count of all forecasts over the past two years that predict a rising GDP growth rate for the euro zone or the EU as a whole. The reason why so many economists make these predictions is that they base their modeling on the standard notion that every economy eventually, long term, gravitates back toward full-employment equilibrium. They are no doubt mystified by the protracted nature of the current European crisis, but instead of rethinking the fundamentals of their forecasting they stick to their default, which is a long-term full-employment equilibrium.
This is, however, not a regular crisis that allows itself to be analyzed in terms of standard macroeconomic models. It is a structural crisis, systemic in nature and by default perennial in duration. Its cause is a permanent imbalance between government-promised entitlements and the ability of the private sector to pay for those entitlements. This imbalance will remain forever unless Europe’s legislators actively reform away entitlements and alleviate the burden of the welfare state on the shoulders of the private sector.
In short: it does not take another negative shock to keep there European economy depressed forever. All it takes is absence of drastic structural reform.
That, however, is not what the OECD is prescribing:
“With the euro zone outlook weak and vulnerable to further bad news, a stronger policy response is needed, particularly to boost demand,” said OECD Chief Economist Catherine L Mann. “That will mean more action by the European Central Bank and more supportive fiscal policy, so that there is space for deeper structural reforms to take hold. A Europe that is doing poorly is bad news for everyone.”
More action from the ECB? Let’s look at some recent annual growth rates in euro-zone M1 money supply, courtesy of the European Central Bank, and current-price GDP growth, courtesy of Eurostat:
Current-price GDP growth represents growth in money demand. The liquidity pumped out by the ECB in excess of that goes straight into the financial system where, to be a bit crude, it will slush around in search of profitable investment opportunities.
For example, in 2013 the ECB printed €7.36 for every €1.00 in increased current-price GDP. Technically this adds €245 billion of liquidity into the financial system. The result of this monetary policy, zero to negative interest rates, has not made a bit of a difference to the euro-zone economy.
As for the fiscal-policy part of the OECD recommendations, this would take a complete abandonment of welfare-state saving austerity. Are the Europeans ready to do that? And more importantly: are they ready to use active fiscal policy to roll back government and provide more growth room to the private sector?
So far, neither the EU Commission nor key member-state governments have showed any inclination in that direction. But I am not even sure the OECD actually would recommend the right kind of fiscal policy; the farthest they would go is probably a traditional mainstream-Keynesian fiscal stimulus. That would only serve to preserve status quo.
With all this in mind, though, it is good that the OECD is now waking up to the European crisis. Next step is to lead them to the right conclusion as to the nature of that crisis…
European third-quarter GDP growth data is beginning to make its way out in the public. What we have seen so far is just more of the same new normal – the same new stagnated way of life in industrial poverty.
Starting from the aggregate level, Eurostat’s third-quarter growth report says that the EU-28 grew at 1.3 percent per year in Q3 of 2014 over the same quarter 2013. The euro zone’s growth rate was half-a-percentage point lower at 0.8. This difference is the same as over the past few years: the last quarter where the euro zone grew faster than the entire EU was in Q1 of 2011. It shows that austerity is still taking a tougher toll on Europe’s core countries than its non-euro members on the outer rim.
Or, to make the same argument from the other side: if you are a European welfare state, it pays to keep your own currency.
The growth numbers for the EU and the euro zone are poor in and by themselves. By not even coming close to two percent per year, Europe is not even able to reproduce its own standard of living. But even worse is the fact that the U.S. economy grew by more than two percent annually for the second quarter in a row: 2.3 percent in Q3 of 2014, compared to 2.6 percent in Q2 of 2014. This growth disparity is slowly becoming a self-reinforcing phenomenon: when global investors see that the U.S. economy is growing while the Europeans are standing still, they choose to reallocate their investments to the United States. That way investments and new jobs go to where investments and new jobs are already going.
But does not that mean that the U.S. economy will run into inflation problems that, in turn, will even out the differences between the United States and Europe? No, not necessarily. In fact, that is a very unlikely scenario. We are now rising to become the global leader in producing energy, with costs far below those of European countries. Right-to-work states offer a union-free manufacturing environment, something that, e.g., Volkswagen successfully took advantage of when they opened their new plant in Tennessee. The large US-only Passat they build there is a runaway sales success, $7,000 cheaper and selling ten times more (100K units per year) than its German-built predecessor.
Long-term, it looks like manufacturing is making its way back to the United States. This does not bode well for Europe, whose exporting manufacturing industry has, basically, been the only part of the economy that has not sunken into the three shades of gray that is industrial poverty. That European manufacturing is in trouble is well proven by the Eurostat report, according to which Germany has seen a decline in growth for two quarters in a row: now down to 1.2 percent on an annual basis.
Another supposedly big manufacturing economy, France, barely finished the third quarter with growth at all: 0.4 percent over Q3 of 2013. Austria’s growth is also dwindling, with 0.3 percent this quarter compared to 0.5 in Q2 and 0.9 in Q1.
The only real positive news is that the Greek economy showed annual growth for the second quarter in a row – at 1.4 percent this quarter – with growth numbers improving steadily for a year now. Spain also shows positive growth, 1.6 percent, with a similar upward long-term trend.
Neither the Greek nor the Spanish number is anything to write home about, but it looks like the two countries are slowly recovering from the bad austerity beating they took in 2012 and 2013. It is an extremely hard journey back for both of them, though, especially for Greece which lost one quarter of its economy to destructive austerity policies. The welfare states of both Spain and Greece have now been recalibrated, so that government budgets paying for the welfare states will balance at a much lower employment level than before. This means, effectively, that government will begin to net-tax the economy and thereby cool off a growth trend long before full employment is restored.
This structural problem is entirely unknown to Europe’s lawmakers – and, frankly, to almost every economist on the planet. I defined the problem in my book Industrial Poverty; if unsolved, this problem will guarantee permanent economic stagnation in Europe for, well, ever.
That said, I don’t want to spoil the fun for Greek and Spanish families who are now seeing the first glimpse of daylight after a long, horrible nightmare. Let them celebrate today; tomorrow they will still be living in industrial poverty.