For the people who live in the European Union, daily life offers challenges in the form of zero growth, high unemployment, lack of opportunity and a gloomy outlook on the future. For a macroeconomist, however, the EU is a formidable experiment that must not be left undocumented. The union was constructed based on the European tradition of welfare statism, right when the welfare state as a socio-economic construct was beginning to show clear signs of macroeconomic ailment. For unknown reasons – though probably ideological preferences played a good part – the architects of the EU misinterpreted the symptoms of macroeconomic ailment such as persistent budget deficits. They saw them as expressions of irresponsible budget policies and therefore institutionalized budget-balancing guidelines for member-state fiscal policies. Those guidelines became the EU’s own constitutional balanced-budget requirement, also known as the Stability and Growth Pact.
The Stability and Growth Pact was created essentially to secure the fiscal sustainability of the European welfare state. The problem is that the welfare state in itself is not fiscally sustainable. A wealth of literature (which I am currently working my way through as part of my next book project) and a plethora of compelling data together convincingly show that the welfare state is in fact the fiscal venom that causes governments to go into structural deficits. So far, though, the political leaders of the European Union have not understood that their practice of the Stability and Growth Pact – known as statist austerity – has driven the European economy into a permanent recession. Their governments, consuming up to half of GDP, are subjected to spending cuts and in turn subject the private sector to higher taxes, which in turn causes the private sector to contract its activity or at the very least keep it constant.
As statist austerity causes GDP to stagnate, the welfare state’s budget problems are exacerbated. More people request assistance from its entitlement programs, while fewer people pay taxes. The budget problems that statist austerity was aimed at solving – again in order to make the welfare state look fiscally sustainable – actually cause a new round of budget problems. In response, austerity-minded governments tighten the fiscal belt yet another notch.
All in order to make the welfare state more affordable to a shrinking economy. In other words, saving the welfare state is the prime directive of European fiscal policy.
American fiscal policy has a different purpose. It aims to help the economy grow and lower unemployment. Granted, far from everything that comes out of U.S. fiscal policy is helpful in that respect, but at least the basic course of direction is right. Therefore, when representatives of the United States Treasury look at Europe and try to figure out what on Earth is going on over there, it is hardly surprising that some eyebrows go up and some foreheads are wrinkled.
The United States warned Europe on Thursday (9 April) against relying too much on exports for growth, and urged officials to make more use of fiscal policy, saying stronger demand was essential. In its semiannual report on foreign-exchanges policies to Congress, the US Treasury Department gave a preview of the positions it will press on foreign policymakers during next week’s International Monetary Fund meetings in Washington. The world cannot rely on the United States to be the “only engine of demand,” the report insisted. It urged nations to use all tools available to accelerate growth and not rely only on their central banks to boost recovery.
Before we get to the accolades, a technical comment. Exports is also “demand”, though from foreign buyers. The Treasury economists should know better and use the term “domestic demand”.
Now for the accolades. It is refreshing and reassuring to see that the Obama administration’s Treasury understands how the economy works. This is not a sarcastic comment – this is a genuine word of appreciation. Europe, by contrast, is filled to the brim with economists and other fiscal-policy decision makers whose actions and decisions prove that they have basically no comprehension of macroeconomics whatsoever. An economy is driven by its demand side: household spending and business investments from the private side, and government spending. Since consumer spending is 65-75 percent of a well-functioning economy, the confidence and prosperity of the general population is quintessential to the survival, growth and prosperity of any nation.
Furthermore, businesses invest because they ultimately will sell something to the general public. Therefore, confident households create confident businesses. A strong, forward-looking economy spends 15-20 percent of GDP on business investments.
Without growth in these two private-sector spending categories, there will be no growth in the economy as a whole. The economists of the U.S. Treasury know this, and they operate based on this basic, common-sense macroeconomic knowledge. Their criticism of Europe’s governments for not understanding the same thing is highly valid and echoes, in fact, what I have been saying on this blog for three years.
But there is one more aspect to this that the Treasury economists have not brought up – at least not as quoted by Euractiv. Let’s get back to their story:
The report singled out Europe’s biggest economy, saying “stronger demand growth in Germany is absolutely essential, as it has been persistently weak.” The US Treasury argues that policy makers in the euro area need to use fiscal policies to complement the monetary stimulus that the European Central Bank is providing. … While growth in Europe has shown some recent signs of picking up, the region remains the sick man of the global economy.
The problem for the Europeans is that they cannot do this. They cannot use fiscal policy to stimulate aggregate demand, because if they do they have to abandon statist austerity. Welfare states would again be allowed to go into deficits.
There are many reasons why the Europeans cannot let that happen. The first and most immediate reason is called “Greece”. The EU is in a very tense showdown with the socialist Greek government over repayments of loans – loans that in turn were given as part of EU-enforced statist austerity. If the EU now abandoned its austerity policies, the Greeks would rightly ask “what about us??” and the 25-percent drop in GDP that followed the harsh implementation of statist austerity in the country.
Another reason for the EU to stick to its austerity guns is the long-term concern for the welfare state’s fiscal sustainability. The Europeans are almost unanimously behind their welfare states and they are willing to sacrifice enormously for their ideologically driven big government. They have convinced themselves that the welfare state is not, has not been, and will not be the cause of their macroeconomic ailment. Therefore, they will try as best they can to defend the indefensible, namely the fiscal sustainability of the welfare state; that defense will take priority over any measures to help the private sector grow and thrive.
For these reasons, and others, there is no hope for a growth-oriented fiscal policy in Europe.
Apparently, the realization that something is structurally wrong is beginning to set in on some key policy makers. Euractiv again:
Speaking ahead of next week’s meetings, IMF managing director Christine Lagarde also warned that global recovery remained ‘moderate and uneven’ with too many parts of the world not doing enough to enact reforms even as risks to financial stability are rising. Mediocre economic growth could become the “new reality,” leaving millions stuck without jobs and increasing the risks to global financial stability, she insisted.
Ms. Lagarde and others interested in the systemic roots of this growth crisis are more than welcome to read my book Industrial Poverty about the structural problems in the European economy.
Again, it is encouraging to see American government officials notice and basically correctly analyze the differences between Europe and the United States. What is needed now is that those officials speak up about why the Europeans are ailing, and what the consequences will be for them and the world economy if they insist on protecting their welfare states at all cost.
Perhaps a President Rand Paul can take it up a notch…
When a welfare state runs out of taxpayers’ money they run a so called structural budget deficit. That is a deficit that does not go away with strong growth but remains in the government budget, theoretically forever, in practice over a period of time longer than at least one business cycle.
A structural deficit forces government to borrow continuously, i.e., to make borrowing a permanent revenue source on par with taxation. As I explained recently, of 14 member states in the European Union ten suffer from structural deficits when GDP growth is measured in current prices. When inflation is removed from the growth data, all 14 countries run significant structural deficits.
Since this deficit analysis was limited by the availability of consistent data (only 14 states) it is not possible to firmly conclude anything about the EU as a whole. However, if 14 states, selected merely because of data availability, run structural deficits, then the likelihood is pretty high that the remaining 14 EU member states have similar problems with structural deficits.
Structural deficits create a major problem for the countries whose governments have to borrow the money. The ongoing borrowing need depresses market demand for their bonds, eventually driving some countries with extreme deficits – think Greece of Spain – to have to pay massive interest premiums on their treasury bonds in order to attract buyers. To fix this, the European Central Bank came up with its own version of the American Quantitative Easing program: the central bank buys the bonds that the free market does not like.
Quantitative Easing was a bad idea in the United States, as it allowed the federal government to continue spending money without reining in its increasingly uncontrollable welfare state. In Europe, the idea is even worse: the European welfare state is more “mature” than the American, making its structural deficit problems even more serious. Therefore, the QE program will feed a government that is even farther away from being able to pay for its ongoing expenses than the U.S. government is.
Against this background, it is astounding to read the following article at EUBusiness.com:
The European Central Bank said Thursday it is increasingly confident that its controversial bond purchase programme is helping boost the eurozone’s economic recovery, even as a top official expressed doubts about its effectiveness. In the minutes of the governing council’s meeting on March 4 and 5 released on Thursday, the ECB said that “members generally shared the assessment that significant positive effects … could already be seen” from the new bond purchase programme known as quantitative easing (QE).
First of all, the QE policy is not even a quarter of a year old yet. It would not be possible to identify causalities even if we tried with an economic microscope. Secondly, even if there are visible effects, they would be limited to lower interest rates. While it is true that the ECB has entered negative interest territory and decided to stay there for a while, it is important to remember that the negative interest rate became reality long before the QE program did. Furthermore, ultra-low interest rates do not fix Europe’s macroeconomic problems anymore than they have fixed Japan’s decades-long problems.
According to EUBusiness.com there is no shortage of critics of the QE program:
[Some] prominent ECB members — notably the head of the German central bank or Bundesbank Jens Weidmann and ECB executive board member Sabine Lautenschlaeger — have repeatedly expressed doubts about the need and impact of such a programme. Lautenschlaeger told a German magazine on Thursday that she had “doubts whether the economic effects of the purchase programme will reach the desired magnitude.” And she warned that the current very low level of interest rates could lead to the formation of asset price bubbles. Before joining the ECB’s executive board, Lautenschlaeger was vice president of the German central bank and she shares the same scepticism as Weidmann.
But the monetary Eurocrats seem to be dead set on finding something positive to report. EUBusiness.com again:
Nevertheless, at the governing council’s last policy meeting in Nicosia, Cyprus, in March, there appeared to be agreement that QE was indeed helping to ease financial market conditions and the cost of external finance for companies, the minutes showed. Coupled with recent positive economic data and signs of a turnaround in inflation, “this provided grounds for ‘prudent optimism’ regarding the scenario of a gradual recovery and a return of inflation rates to levels closer to 2.0 percent,” the minutes stated.
This is actually disingenuous. Corporate borrowing costs have been declining since the Great Recession started. They started falling because banks still wanted to lend to non-financial corporations, but the non-financial corporations refused to take on more debt. They were simply far too pessimistic about the future of the European economy.
In short: low corporate borrowing costs have absolutely nothing to do with QE.
All in all, it sounds like the ECB is desperately trying to grab for positive news. this makes them prone to overlook the risks associated with QE, one of them being that governments simply decide not to do much more about their notorious deficits. This means, simply, letting the structural deficits remain as they are, whereupon the underlying problem in the European economy – an over-bloated welfare state – remains unsolved.
In my book Industrial Poverty I diagnose the European economic crisis as being a permanent state of economic stagnation, caused by a fiscally unsustainable welfare state. The deficits that plague the continent’s welfare states are caused by a structural imbalance between tax revenue growth and growth in government spending. In other words, the deficits that the EU-IMF-ECB troika and member-state governments have been fighting so hard over the past 5-6 years are actually in large part structural.
As I explain in this paper, you cannot fight structural deficits with business-cycle policy measures. That is what the Europeans have tried to do for half a decade now, to no avail. In fact, their problems have only gotten worse, with no recovery in sight.
Today I am happy to report on yet another depressing angle of the crisis. A structural budget deficit is a deficit that a government cannot pay for over a long period of time. While there is no set-in-stone definition of a structural deficit, the conventional definition has been that it is the deficit that remains when the economy is operating at full employment. However, the definition of full employment changes over time; what was considered serious unemployment in the 1980s is now acceptable as full employment in many countries. With that change, obviously the definition of the structural deficit would change as well, even though government has done nothing to reduce the deficit.
A better definition of a structural deficit is one that still rises above the regular business cycle but at the same time is independent of the level of employment. In the aforementioned paper I suggested a definition based on, at minimum, ten years of economic performance: a ten-year long trend in government spending (or a specific share thereof) is compared to a ten-year long trend in tax-base growth. If spending outgrows the tax base, then the government is having to deal with a structural deficit; if the tax base grows faster than spending, then there is a structural surplus in the government budget.
To get a good idea of whether or not Europe has a structural-deficit problem, I pulled the following numbers from the Eurostat database:
Government spending defined as welfare-state spending: housing and community development; health; culture, religion and recreation; education; and social protection; and
Current-price and inflation-adjusted growth in GDP.
Not all member states report these numbers down to the level needed for a ten-year trend study; in addition to 13 EU member states I also pulled data for Norway, which turned out to be interesting.
The results are as follows (time period 2004-2013). A ratio of 100 means a perfect growth balance where welfare-state spending is growing on par with the tax base; an index number below 100 is a structural deficit while an index number higher than 100 represents a structural surplus. For current-price GDP, four of the 14 countries actually run a surplus:
|CURRENT PRICE STRUCTURAL|
While the Polish government’s broadest possible tax base is growing by 120.5 euros per 100 euros of welfare-state spending, the Portuguese tax base only grows by 53 cents per euro of growth in welfare-state spending.
This indicates structural deficits in ten of these 14 countries. It does not mean that there is an actual deficit of this magnitude, but it means that the economy of these ten countries is unable to sustain the spending that goes out through their entitlement programs.
But that aside, it looks kind of good, doesn’t it, to have such a prominent welfare state as Sweden in the structural surplus category. Does that not mean that the welfare state can be paid for?
Let us answer that question with a look at the same spending numbers, but now compared to inflation-adjusted GDP:
|REAL GROWTH STRUCTURAL|
All of a sudden, Poland can only pay for 61.8 cents of every euro they spend on welfare-state programs. Sweden cannot pay for half of its welfare state. But worst of all: welfare-state spending in Portugal and Italy is so structurally under-funded that it outgrows the tax base by more than a euro, per euro in increased spending!
This means, in a nutshell, that the Portuguese and Italian governments draw taxes from a shrinking tax base to pay for what is undoubtedly an out-of-control welfare state.
Even if the actual growth of their tax revenues does not track the growth of GDP at all times, the GDP growth rate provides the most comprehensive picture of what the economy – and thereby taxpayers – could afford in terms of welfare-state spending. The bottom line for today, therefore, is that governments of welfare states from all corners of Europe are lucky if they see their tax revenues grow half as fast as their spending. And that is regardless of where the business cycle is: again, these numbers cover the period from 2004 through 2013.
Government debt is a problem. It pushes the cost of today’s government entitlement programs onto the shoulders of tomorrow’s taxpayers. The debt problems are made worse by the fact that the welfare states of Europe and North America all seem to suffer from a structural deficit: over a period of time longer than a business cycle they increase spending faster than their tax base increases. These deficits in turn are caused by entitlement programs that are purposely designed to increase in cost independently of the private sector’s ability to pay for them.
Over time, governments have raised taxes to keep funding their welfare states – and when tax increases have been politically unpalatable they have resorted to spending cuts. The net effect has been a more stingy welfare state at a higher cost to taxpayers.
Herein lies the core of the reason why the Western World has an endemic debt problem. As a share of GDP taxes have increased in every European welfare state over the past half century – in some cases the tax-to-GDP ratio has more than doubled. (See my book Industrial Poverty, pp. 75-77.)
In other words, the welfare state creates a permanent spending problem, the funding of which creates a permanent slow-growth problem which in turn creates a permanent deficit problem.
This is a systemic failure for the Western World of epic proportions. Unfortunately, the “big picture” is still a mystery to many people. Let me offer two examples. The first is from The Telegraph:
The eurozone is “untenable” in its current form and cannot survive unless countries are prepared to cede sovereignty and become a “United States of Europe”, the manager of the world’s biggest bond fund has warned. The Pacific Investment Management Company (PIMCO) said that while the bloc was likely to stay together in the medium term, with Greece remaining in the eurozone, the single currency could not survive if countries did not move closer together.
What this means in a nutshell is that the member states of the EU, or at the very least the euro zone, would have to give up their individual iterations of the welfare state and hand over taxation and spending authority to a union-wide authority. That would be either the EU if it incorporated all 28 states, or some “core” European government if it was confined to the euro zone.
The idea behind this is to bring fiscal and monetary policy into some kind of jurisdictional harmony. But this will not solve anything. It is a change in form, not content. The same welfare state will cause the same problems, and the policies put in place to reduce or eliminate government deficits while preserving the welfare state will have the same negative effects as they now have at the national level.
The Telegraph again, more to the point:
PIMCO used the example of the Latin and Scandinavian unions in the 19th century, which lasted an average of 50 years before breaking up, to illustrate how monetary unions were incompatible with sovereignty. “You need to reach some sort of political agreement about how to share fiscal resources around the zone. We’re a long, long, long way from designing that and getting the political backing for it,” … “So while you’re waiting for that and you’ve got low growth, and high unemployment, you run the risk of letting these anti-euro parties to the forefront.”
Those anti-EU parties would break up the currency union – in fact, that will happen as soon as Marine Le Pen moves into the Elysee Palace in Paris – but they will not alter Europe’s fundamental socio-economic structure. They will try to defend the welfare state, too, and will eventually encounter the exact same problems that have troubled Europe’s welfare states incrementally since the late 1970s.
But let us not forget that the government debt problem is not confined to the “advanced” welfare states shoring the North Atlantic. In fact, as if to underscore the social and economic disease that the welfare state represents, The Guardian reports:
Greek ministers are spending this weekend, almost five grinding years since Athens was first bailed out, wrangling over the details of the spending cuts and economic reforms they have drawn up to appease their creditors. As the recriminations fly between Europe’s capitals, campaigners are warning that the global community has failed to learn the lessons of the Greek debt crisis – or even of Argentina’s default in 2001, the consequences of which are still being contested furiously in courts on both sides of the Atlantic.
Or, for that matter, the Danish and Swedish lessons from, respectively, the 1980s and 1990s. I discuss the Danish crisis and analyze carefully the Swedish case in my book Industrial Poverty; for those proficient in Swedish, see an abbreviated analysis in the next issue of Magasinet Neo, out next week.
Back to The Guardian:
As Janet Yellen’s Federal Reserve prepares to raise interest rates, boosting the value of the dollar, while the plunging price of crude puts intense pressure on the finances of oil-exporting countries, there are growing fears of a new debt crisis in the making.
An example. The Alaska state government gets more than 90 percent of its General Fund revenue from oil. With the oil price at a third of what it was two years ago the state government is now on the verge of fiscal panic.
Ann Pettifor of Prime Economics, who foreshadowed the credit crunch in her 2003 book The Coming First World Debt Crisis, says: “We’re going to have another financial crisis. Brazil’s already in great trouble with the strength of the dollar; I dread to think what’s happening in South Africa; then there’s Malaysia. We’re back to where we were, and that for me is really frightening.”
I have written several articles about South Africa, where I have pointed to the main problem of the country. It is not debt – that is merely a symptom of what is really wrong. The systemic error in the South African equation is the massive entitlement system that the ANC government has tried to build and fund since taking over power 20 years ago. Trained as they were by Swedish socialists, the ANC leadership that defined the course of South Africa after the fall of Apartheid had only one thing in mind: to build their own version of the Scandinavian welfare state.
The result is high inflation, low growth, very high unemployment, social instability and a tax system that punitively keeps employers from creating jobs.
Without the welfare state there would be no debt problem in South Africa.
The Telegraph again:
Since the aftershocks of the global financial crisis of 2008 died away, … next to nothing has been done about the question of what to do about countries that can’t repay their debts, or how to stop them getting into trouble in the first place.
Don’t build a welfare state. Don’t create spending programs that the private sector cannot afford. This is a particularly bad idea in developing countries where the private sector is in poor shape in the first place.
Unfortunately, this is not the direction that the global debate is moving. It is taking a different route, namely toward welfare states being given a chance to default on their debt with impunity. The Telegraph explains:
Developing countries are using the UN to demand a change in the way sovereign defaults are dealt with. Led by Bolivian ambassador to the UN Sacha Sergio Llorenti, they are calling for a bankruptcy process akin to the Chapter 11 procedure for companies to be applied to governments. Unctad, the UN’s Geneva-based trade and investment arm, has been working for several years to draw up a “roadmap” for sovereign debt resolution. It recommends a series of principles, including a moratorium on repayments while a solution is negotiated; the imposition of currency controls to prevent capital fleeing the troubled country; and continued lending by the IMF to prevent the kind of existential financial threat that roils world markets and causes severe economic hardship. If a new set of rules could be established, Unctad believes, “they should help prevent financial meltdown in countries facing difficulties servicing their external obligations, which often results in a loss of market confidence, currency collapse and drastic interest rates hikes, inflicting serious damage on public and private balance sheets and leading to large losses in output and employment and a sharp increase in poverty”.
Once this measure is in place, what are the chances anyone would buy Treasury bonds from any country that is perceived to have some debt problems? What countries would be allowed this measure? It would have to be all UN member states, or else the rules for the Chapter-11 style mechanism would be ad hoc.
The next question is what would happen if Greece used this way out of its debt problems. All of a sudden we are talking about a euro-zone member state, a European welfare state, a country that is not too different from, say, Spain or Italy. What would happen if Spain or Italy did a “Chapter 11″, countries that are not too different from, say, France?
This is a Pandora’s Box of defaults that would have catastrophic effects on the financial system. It would turn now-safe Treasury bonds – or at least from those countries that still have good credit – into almost toxic assets. Who would want to buy any welfare-state Treasury bonds if that government can choose to file for bankruptcy if they consider the payments too burdensome?
Surely, there would be rules for filing for bankruptcy. But who would be writing those rules? The same welfare states that want to be able to borrow frivolously to keep their entitlement programs going.
The systemic problem with the welfare state still eludes the world’s political leaders. Ann Pettifor may very well be right in that there is another debt crisis coming, but a more accurate way of describing it would be that the same debt crisis – the ongoing, daily borrowing by unsustainable big governments – that has been cooled off for a while will erupt again.
And it will continue to do so until our political leaders get their act together and terminate the welfare state.
Yesterday I asked if libertarianism has failed as a political theory. The question is merited: in a world where government is involved in everything from health care and education to “saving” for your retirement, and where government involvement is increasing, one has to wonder why the libertarian movement has not been able to move the needle in the right direction.
Despite this pessimistic review of the lack of libertarian accomplishments, the answer to yesterday’s question is actually: No.
The libertarian movement has not failed. But its list of accomplishments is way too short. If all libertarians share the common goal of saving – and restoring – individual and economic freedom, then our combined efforts thus far have missed the target by a big margin. If we are going to reach the ultimate goal of a minimal state with a maximum of freedom, we need to reboot our operations and get back to work, but do so under two very important conditions.
Before we get to the two conditions, though, let us acknowledge what is actually on the list of libertarian accomplishments. Globally, the movement helped bring down the Soviet empire. It provided moral inspiration to liberty-minded people from Greifswald to the Black Sea. Economic literature on free-market Capitalism were studied behind the Iron Curtain long before the Wall fell in Berlin. Even Robert Nozick, who himself had Polish ancestry, influenced thinkers and inspired people to challenge the prevailing communist order.
Domestically, though, the accomplishments in Thatcher’s Britain and Reagan’s America were more of a temporary nature. They are in fact difficult to see today. The United States reaped the harvests of the Reagan tax cuts all the way through the 1990s, but unrelenting growth in government spending eventually neutralized and overwhelmed the positive effects of the tax cuts.
In retrospect, the Reagan era and its surge in the intellectual, political and economic pursuit of liberty looks less and less like a corner turned in modern American history. In the context of the decades before and after his presidency, Reagan appears to have inspired a temporary halt to, but not a termination of, a very long trend of welfare statism.
The first condition for future success is that libertarians revise their political methodology. the need for revision is well explained by the Niskanen Center, a newly founded libertarian think tank in Washington, DC. In their conspectus, declaring their raison d’etre, the Center explains:
Despite having invested tremendous time, energy, and resources in achieving political change, libertarians have produced little policy change. Of the 509 significant domestic legislative policy changes since World War II, more than half (265) expanded government while only four percent (20) contracted government. When policymakers act, they have, on balance, acted to expand state power.
They also analyze the “mechanics” of policy change in Washington, DC and how libertarians, despite major investments, thus far have failed to correctly identify and successfully use those mechanics to turn libertarian ideas into legislative practice.
In addition to misunderstanding the legislative mechanics, libertarians have also failed to fully comprehend the nature of government spending. This brings us to the second condition for future success. The Reagan-era tax cuts were accompanied by 7+ percent annual federal spending increases; the George W Bush administration repeated the pattern, combining tax cuts with 6.7-percent annual spending increases. The libertarian movement has failed to fully comprehend the reasons behind, and the complexity of, those spending increases. Therefore, they have lost the debate over government spending to the welfare statists.
This is a general observation; there are bright exceptions to it who pursue actionable reforms to welfare-state entitlement programs. But they are just that – exceptions. Their voices are simply not strong enough to set the tone for the libertarian movement in general. Instead, libertarians tend to fragment their analysis and policy approach, and in too many cases they leave the entitlement sector of our society altogether. Those who do tend to end up fighting the battle of eclectic flea killing, a.k.a., legalization of recreational drugs.
While some libertarians turn on, tune in a and drop out of the fight for economic freedom, the welfare state eats its way deeper into the flesh of the free market. The time to change course is now – and it begins with:
a) following the advice of aforementioned Niskanen Center, i.e., revising the political methodology and learning to master legislative mechanics; and
b) studying and intellectually conquering the welfare state.
I cannot stress enough how important the second condition is. Libertarians in general – again, there are exceptions – dismiss the welfare state by saying either that “just cut spending darn it” and the welfare state will go away; or by refocusing on issues that are not as intellectually intimidating or hard to navigate in terms of policy and actionable reform legislation.
In other words, there is an enormous amount of work to be done. But all is not lost. On the contrary, looking at the young generation in this great country, there are glimmers of hope. A fledgling libertarian grassroots movement has risen as a result of the Tea Party reaction. It consists for the most part of regular Americans whose interest in politics and willingness to become activists are fueled by clearly visible government over-reach.
More specifically, the Obama presidency is actually a gift to the libertarian movement. After having promised “hope” and “change” and rallied millions of young voters and activists, the 44th president burdened job creators with massive regulations that made it very difficult for young workers and professionals to find jobs; he put health insurance out of reach for many of those who got jobs; and he vigorously defended government surveillance programs, invading the electronic integrity of a young generation who takes the privacy of their cell phones as seriously as the privacy of their own pockets.
Young voters turned away from Obama in his re-election bid. Thanks only to an unbelievably out-of-touch Romney campaign, Obama managed to prevail. But this has not made disappointment among the young go away – on the contrary. When today’s 20-somethings look at the career opportunities their parents had, and when they know that the government is intercepting and storing their text messages, their minds are open to arguments on government over-reach, individual freedom – and libertarianism.
The growing interest in individual liberty is a promising platform for a renewed effort to end America’s slow but steady transformation into a European welfare state. High school and college students are flocking in growing numbers to internships and educational offerings by liberty-promoting organizations. Dedicated donors provide financial support, and sharp minds at think tanks and advocacy groups can turn that money into intellectual firepower.
Only two pieces are missing. One of them is the right use of the legislative mechanics. Explains Niskanen Center president Jerry Taylor, whose operational credo “terrain dictates tactics” sets the prelude for his verdict:
The political terrain could not be clearer. Despite our best efforts, America is a center-left nation. Libertarians constitute no more than 5 percent of the public. And if a Republican manages to win the White House in 2016, the recent erosion in the public support for more government will almost certainly reverse.
Europe’s record is even more disappointing. Anyway, Taylor continues:
Until some political tectonic plate shift occurs, radical libertarian policy change is not in the cards. Repealing the Great Society, much less the New Deal, is unlikely. Business regulation of some sort is not going away. The EPA, FCC, SEC, etc. will not be abolished. Less radical improvements in public policy are possible. But to do that, we need to stop making “the better” the enemy of “the best” and cease complaining that the former commits the unpardonable sin of “compromising on principle.” By definition, advocating anything short of the night watchman state “compromises on principle,” and the night watchman state—for now anyway—is a fantasy.
While Taylor unintentionally overlooks the rekindled interest in libertarian ideas during the Obama years, he is correct in that the road from today’s welfare state to the night watchman state is long and littered with road bumps and uphill battles. But if libertarians can intellectually conquer the welfare state, and if they can learn to master the legislative mechanics that Taylor points to, then no road bump or uphill will stand in their way.
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.
The answer to the question whether or not Greece will stay in the euro will probably be given this week. New socialist prime minister Tsipras is not giving the EU what it wants, jeopardizing his country’s future inside the currency union:
Talks between Greece and eurozone finance ministers broke down on Monday with an ultimatum that Athens by Friday should ask for an extension of the current bailout programme which runs out next week. Greek finance minister Yanis Varoufakis said he would have been willing to sign off on a proposal made by the EU commission, which was more accommodating to Greek demands, but that the Eurogroup offer – to extend the bailout programme by six months – was unacceptable. The battle is about more than just semantics. EU officials say Greece cannot cherrypick only the money-part of a bailout and ignore the structural measures that have to be implemented to get the cash. “If they ask for an extension, the question is, do they really mean it. If it’s a loans extension only, with no commitments on reforms, there is an over 50 percent chance the Eurogroup will say no,” one EU official said. Failure to agree by Friday would leave very little time for national parliaments in four countries – notably Germany – to approve the bailout extension. It would mean Greece would run out of money and be pushed towards a euro-exit. … As for the prospect of letting Greece face bankruptcy to really understand what’s at stake, an EU official said “there is no willingness, but there is readiness to do it”.
The mere fact that there is now official talk about a possible Greek exit from the euro is a clear sign of how serious the situation is. It is also an indication that the EU, the ECB and the governments of the big EU member states have a contingency plan in place, should Greece leave the euro.
My bet is that Tsipras is gambling: he wants out of the euro, but with a majority of Greeks against a reintroduction of the drachma he cannot go at it straightforwardly. He has to create a situation where his country is given “no choice” but to leave. This is why he is negotiating with the EU in a way that he knows is antithetical to a productive solution.
The reason why Tsipras wants out is simple: he is a Chavista socialist and wants to follow in the footsteps of now-defunct Venezuelan president Hugo Chavez. That means socialism in one country. (A slight rephrasing of the somewhat tarnished term “national socialism”.) In order to create a Venezuelan-style island of reckless socialism in Europe, Tsipras needs to get out of the euro zone.
Should he succeed, it is likely that other countries will follow his example, though for different ideological reasons. However, there is more at stake in the Greek crisis than just the future of the euro zone. Tsipras is riding a new wave of radical socialism, a wave that began moving through Europe at the very depth of the Great Recession. Statist austerity was falsely perceived as an attempt by “big capitalism” to dismantle the welfare state. It was not – quite the contrary: statist austerity was a way for friends of big government to preserve as much as possible of the welfare state.
However, socialists have never allowed facts to get in the way of their agenda. And they certainly won’t let facts and good analysis get in the way of their rising momentum. What started mildly with a socialist victory in the French elections in 2012 has now borne Tsipras to power in Greece and is carrying complete political newcomers into the center stage of Spanish politics. But this new and very troublesome wave of socialism is not stopping at member-state capitals. It is reaching into the hallways of EU politics as well. As an example, consider these words on the Euractiv opinion page by Maria João Rodrigues MEP, Vice-Chair of the Socialists and Democrats Group in the European Parliament, and spokesperson on economic and social policies:
The Greek people have told us in January’s elections that they no longer accept their fate as it has been decided by the European Union. For those who know the state of economic and social devastation Greece has reached, this is only a confirmation of a survival instinct common to any people. The Greek issue has become a European issue, and we are all feeling its effects.
This is a frontal attack on EU-imposed austerity, but it is also a thinly veiled threat: unless Europe moves left, the left will move Europe.
Back to Rodrigues:
European integration can only have a future if European decisions are accepted as legitimated by the various peoples who constitute Europe. Decisions at European level require compromises, as they have their origins in a wide variety of interests. But these compromises must be perceived as mutual and globally advantageous for all Member States involved, despite the commitments and efforts they entail. The key question now is whether it will be possible to forge a new compromise, enabling not only to give hope to the Greek people, but also to improve certain rules of today’s European Union and its Economic and Monetary Union.
This should not be misinterpreted as a call for return of power to the member states. The reason why is revealed next:
We need a European Union capable of taking more democratic decisions and an Economic and Monetary Union which generates economic, social and political convergence, not ever-widening divergence. If Europe is unable to forge this compromise, and if the rope between lenders and borrowers stretches further, the risks are multiple: financial pressures for Greece to leave the euro; economic and social risks of continued stagnation or recession, high unemployment and poverty in many other countries; and, above all, political risks, namely further strengthening of anti-European or Eurosceptic parties in their aspiration to lead national governments, worsening Europe’s fragmentation.
The fine print in this seemingly generic message is: more entitlement spending to reduce income differences – called “economic and social convergence” in modern Eurocratic lingo – and a central bank the policies of which are tuned to be a support function for fiscal expansion. The hint of this is in the words “If the rope between lenders and borrowers stretches further”: member states should be allowed to spend on entitlements to reduce income differences, and if this means deficit-spending, the ECB should step in and monetize the deficits.
Rodrigues offers yet another example of the same argument:
[Many of] Greece’s problems were aggravated by the behaviour of the European Union: Firstly, it let Greece exposed to speculative market pressures in 2010, which exacerbated its debt burden. Secondly, when the EU finally managed to build the necessary financial stabilisation mechanisms, it imposed on Greece a programme focused on the reduction of the budget deficit in such an abrupt way that the country was pushed into an economic and social disaster. Moreover, the austerity measures resulted in a further increase of Greece’s debt compared to its GDP.
It is apparently easy for the left to look away from such obvious facts as the long Greek tradition of welfare-state spending. But that goes with the leftist territory, so it should not surprise anyone. More important is the fact that we once again have an example of how socialists use failed statist austerity to advocate for even more of what originally caused the crisis, namely the big entitlement state. They want to turn the EU and the ECB into instruments for deficit-spending ad infinitum to expand the welfare state at their discretion.
To further drive home the point that what matters is the welfare state, Rodrigues moves on to her analysis of Greece:
What Greece needs now is a joint plan for reform and reconstruction, agreed with the European institutions. This plan should replace the Troika programme, while incorporating some of its useful elements. Crucially, it should foresee a relatively low primary surplus and eased conditions of financial assistance from other eurozone countries, in order to provide at least some fiscal room for manoeuvre for the country. In return, the plan should set out strategic reforms to improve the functioning of the Greek economy and the public sector, including tax collection, education, employment and SMEs services as well as ensuring a sustainable and universal social protection system.
There is no such thing as a “sustainable and universal social protection system”. When Europe’s new generation of socialist leaders get their hands on the right policy instruments they will turn all government-spending faucets wide open. Deficits will be monetized and imbalances toward the rest of the world handled by artificial exchange-rate measures (most likely of the kind used by now-defunct Hugo Chavez).
If this new wave of socialism will define Europe’s future, then the continent is in very serious trouble.
A short-term measure of the strength of the momentum will come later this week when we will know whether or not Greece will remain in the currency union. Beyond that, things are too uncertain to predict at this moment.
Only a couple of days after the European Central Bank raised white flag and finally gave up its attempts at defending the euro as a strong, global currency, Greek voters drove their own dagger through the heart of the euro. Reports The Telegraph:
Greece set itself on a collision course with the rest of Europe on Sunday night after handing a stunning general election victory to a far-Left party that has pledged to reject austerity and cancel the country’s billions of pounds in debt. In a resounding rebuff to the country’s loss of financial sovereignty, With 92 per cent of the vote counted, Greeks gave Syriza 36.3 percent of the vote – 8.5 points more than conservative New Democracy party of Prime Minister Antonis Samaras.
That is about six percent more than most polls predicted. But even worse than their voter share is how the parliamentary system distributes mandates. The Telegraph again:
It means they will be able to send between 149 and 151 MPs to the 300-seat parliament, putting them tantalisingly close to an outright majority. The final result was too close to call – if they win 150 seats or fewer, they will have to form a coalition with one of several minor parties. … Syriza is now likely to become the first anti-austerity party in Europe to form a government. … The election victory threatens renewed turmoil in global markets and throws Greece’s continued membership of the euro zone into question. All eyes will be on the opening of world financial markets on Monday, although fears of a “Grexit” – Greece having to leave the euro – and a potential collapse of the currency has been less fraught than during Greece’s last general election in 2012.
It does not quite work that way. The euro is under compounded pressure from many different elements, one being the Greek economic crisis. The actions by the ECB themselves have done at least as much to undermine the euro: its pledge last year to buy all treasury bonds from euro-zone governments that the market wanted to sell was a de facto promise to monetize euro-denominated government debt. The EU constitution, in particular its Stability and Growth Pact, explicitly forbids debt and deficit monetization. By so blatantly violating the constitution, the ECB undermined its own credibility.
Now the ECB has announced that in addition to debt monetization, it will monetize new deficit. That was the essence of the message this past Thursday. The anti-constitutionality of its own policies was thereby solidified; when the Federal Reserve ran its multi-year Quantitative Easing program it never violated anything other than sound economic principles. If the ECB so readily violates the Stability and Growth Pact, then who is to say it won’t violate any other of its firmly declared policy goals? When euro-zone inflation eventually climbs back to two percent – the ECB’s target value – how can global investors trust the ECB to then turn on anti-inflationary policies?
Part of the reason for the Stability and Growth Pact was that the architects of the European Union wanted to avoid runaway monetary policy, a phenomenon Europeans were all too familiar with from the 1960s and ’70s. Debt and deficit monetization is a safe way to such runaway money printing. What reasons do we have, now, to believe that the ECB will stick to its anti-inflationary pledge when the two-percent inflation day comes?
This long-winded explanation is needed as a background to the effects that the Syriza victory may have on the euro. I am the first to conclude that those effects will be clearly and unequivocally negative, but as a stand-alone problem for the ECB the Greek hard-left turn is not enough. In a manner of speaking, the ECB is jeopardizing the future of the euro by having weakened the currency with reckless monetary expansionism to the point where a single member-state election can throw the future of the entire currency union into doubt.
Exactly how the end of the euro will play out remains to be seen. What we do know, though, is that Thursday’s deficit-monetization announcement and the Greek election victory together put the euro under lethal pressure. The deficit-monetization pledge is effectively a blank check to countries like Greece to go back to the spend-to-the-end heydays. Since the ECB now believes that more deficit spending is good for the economy, it has handed Syriza an outstanding argument for abandoning the so-deeply hated austerity policies that the ECB, the EU and the IMF have imposed on the country. The Telegraph again:
[Syriza], a motley collection of communists, Maoists and socialists, wants to roll back five years of austerity policies and cancel a large part of Greece’s 320 billion euro debt, which at more than 175 per cent of GDP is the world’s second highest proportional to the size of the economy after Japan. … If they fulfil the threats, Greece’s membership of the euro zone could be in peril. Mr Tsipras has toned down the anti-euro rhetoric he used during Greece’s last election in 2012 and now insists he wants Greece to stay in the euro zone. Austerity policies imposed by the EU and International Monetary Fund have produced deep suffering, with the economy contracting by a quarter, youth unemployment rising to 50 per cent and 200,000 Greeks leaving the country.
Youth unemployment was up to 60 percent at the very depth of the depression. Just a detail. The Telegraph concludes by noting that:
Mr Tsipras has pledged to reverse many of the reforms that the hated “troika” of the EU, IMF and European Central Bank have imposed, including privatisations of state assets, cuts to pensions and a reduction of the minimum wage. But the creditors have insisted they will hold Greece to account and expect it to stick to its austerity programmes, heralding a potentially explosive showdown.
Again, with the ECB’s own Quantitative Easing program it becomes politically and logically impossible for the Bank and its two “troika” partners to maintain that Greece should continue with austerity. You cannot laud government deficit spending with one side of your mouth while criticizing it with the other.
As a strictly macroeconomic event, the ECB’s capitulation on austerity is not bad for Greece. The policies were not designed to lift the economy out of the ditch. They were designed to make big government more affordable to a shrinking private-sector economy. However, a return to government spending on credit is probably the only policy strategy that could possibly have even worse long-term effects than statist austerity.
Unfortunately, it looks like that is exactly where Greece is heading. Syriza’s “vision” of reversing years of welfare-state spending cuts is getting a lot of support from various corners of Europe’s punditry scene. For example, in an opinion piece at Euractiv.com, Marianna Fotaki, professor of business ethics at University of Warwick, England, claims that the Syriza victory gives Europe a chance to “rediscover its social responsibility”:
Greece’s entire economy accounts for three per cent of the eurozone’s output, but its national debt totals €360 billion or 175 per cent of the country’s GDP and poses a continuous threat to its survival. While the crippling debt cannot realistically be paid back in full, the troika of the EU, European Central Bank, and IMF insist that the drastic cuts in public spending must continue. But if Syriza is successful – as the polls suggest – it promises to renegotiate the terms of the bailout and ask for substantial debt forgiveness, which could change the terms of the debate about the future of the European project.
As I explained recently, so called “debt forgiveness” means that private-sector investors lose the same amount of money. The banks that received such generous bailouts earlier in the Great Recession had made substantial investments in Greek government debt. Would Professor Fotaki like to see those same banks lose even more money? With the new bank-rescue feature introduced as the Cyprus Bank Heist, such losses would lead to confiscation of the savings that regular families have deposited in their savings accounts.
Would professor Fotaki consider that that to be an ethically acceptable consequence of her desired Greek debt “forgiveness”?
Professor Fotaki then goes on a long tirade to make the case for more income redistribution within the euro zone:
The immense social cost of the austerity policies demanded by the troika has put in question the political and social objectives of an ‘ever closer union’ proclaimed in the EU founding documents. … Since the economic crisis of 2007 … GDP per capita and gross disposable household incomes have declined across the EU and have not yet returned to their pre-crisis levels in many countries. Unemployment is at record high levels, with Greece and Spain topping the numbers of long-term unemployed youth. There are also deep inequalities within the eurozone. Strong economies that are major exporters have benefitted from free trade, and the fixed exchange rate mechanism protecting their goods from price fluctuations. But the euro has hurt the least competitive economies by depriving them of a currency flexibility that could have been used to respond to the crisis. Without substantial transfers between weaker and stronger economies, which accounts for only 1.13 per cent of the EU’s budget at present, there is no effective mechanism for risk sharing among the member states and for addressing the consequences of the crisis in the eurozone.
In other words, Europe’s welfare statists will continue to blame the common currency for the consequences of statist austerity. But while professor Fotaki does have a point that the euro zone is not nearly an optimal currency area, the problems that she blames on the euro zone are not the fault of the common currency. Big government is a problem wherever it exists; in the case of the euro zone, big government has caused substantial deficits that, in turn, the European political leadership did not want to accept – and the European constitution did not allow. To battle those deficits the EU, the ECB and the IMF imposed harsh austerity policies on Greece among several other countries. But countries can subject themselves to those policies without being part of a currency union: Denmark in the 1980s is one example, Sweden in the ’90s another. (I have an entire chapter on the Swedish ’90s crisis in my book Industrial Poverty.) The problem is the structurally unaffordable welfare state, not the currency union.
Professor Fotaki again:
The member states that benefitted from the common currency should lead in offering meaningful support, rather than decimating their weaker members in a time of crisis by forcing austerity measures upon them. This is not denying the responsibility for reckless borrowing resting with the successive Greek governments and their supporters. However, the logic of a collective punishment of the most vulnerable groups of the population, must be rejected.
What seems to be so difficult to understand here is that austerity, as designed for Greece, was not aimed at terminating the programs that those vulnerable groups life off. It was designed to make those programs fit a smaller tax base. If Europe’s political leaders had wanted to terminate those programs and leave the poor out to dry, they would simply have terminated the programs. But their goal was instead to make the welfare state more affordable.
It is an undeniable fact that the politicians and economists who imposed statist austerity on Greece did so without being aware of the vastly negative consequences that those policies would have for the Greek economy. For example, the IMF grossly miscalculated the contractionary effects of austerity on the Greek economy, a miscalculation their chief economist Olivier Blanchard – the honorable man and scholar he is – has since explained and taken responsibility for.
Nevertheless, the macroeconomic miscalculations and misunderstandings that have surrounded statist austerity since 2010 (when it was first imposed on Greece) do not change the fact that the goal of said austerity policies was to reduce the size of government to fit a smaller economy. That was a disastrous intention, as shown by experience from the Great Recession – but it was nevertheless their goal. However, as professor Fotaki demonstrates with her own rhetoric, this point is lost on the welfare statists whose only intention now is to restore the welfare state to its pre-crisis glory:
The old poor and the rapidly growing new poor comprise significant sections of Greek society: 20 per cent of children live in poverty, while Greece’s unemployment rate has topped 20 per cent for four consecutive years now and reached almost 27 per cent in 2013. With youth unemployment above 50 per cent, many well-educated people have left the country. There is no access to free health care and the weak social safety net from before the crisis has all but disappeared. The dramatic welfare retrenchment combined with unemployment has led to austerity induced suicides and people searching for food in garbage cans in cities.
There is nothing wrong factually in this. The Greek people have suffered enormously under the heavy hand of austerity, simply because the policies that aim to save the welfare state for them also move the goal post: higher taxes and spending cuts drain the private sector of money, shrinking the very tax base that statist austerity tries to match the welfare state with.
The problem is in what the welfare statists want to do about the present situation. What will be accomplished by increasing entitlement spending again? Greek taxpayers certainly cannot afford it. Is Greece going to get back to deficit-funded spending again? Professor Fotaki gives us a clue to her answer in the opening of her article: debt forgiveness. She wants Greece to unilaterally write down its debt and for creditors to accept the write-down without protest.
The meaning of this is clear. Greece should be able to restore its welfare state to even more unaffordable levels without the constraints and restrictions imposed by economic reality. This is a passioned plea for a new debt crisis: who will lend money to a government that will unilaterally write down its debt whenever it feels it cannot pay back what it owes?
This kind of rhetoric from the emboldened European left rings of the same contempt for free-market Capitalism that once led to the creation of the modern welfare state. The welfare state, in turn, brought about debt crises in many European countries during the 1980s and ’90s, in response to which the EU created its Stability and Growth Pact. But the welfare states remained and gradually eroded the solidity of the Pact. When the 2008 financial crisis hit, the European economy would have absorbed it and shrugged it off as yet another recession – just as it did in the early ’90s – had not the welfare state been there. Welfare-state created debt and deficits had already stretched the euro-zone economy thin; all it took to sink Europe into industrial poverty and permanent stagnation was a quickly unfolding recession.
Ironically, the state of stagnation has been reinforced by austerity policies that were designed in compliance with the Stability and Growth Pact; by complying with the Pact, those policies, it was said, would secure the macroeconomic future of the euro zone and keep the euro strong. Now those policies have led the ECB to a point where it has destroyed the future of its own currency.
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.
Europe’s perennial recession is depriving the welfare state of revenue. This in turn is causing frustration, especially among those who still defend the welfare state and the big, redistributive government it represents. And the welfare statists are getting vocal, as shown by a contribution from Klaus Heeger, Secretary General of the European Confederation of Independent Trade Unions. Heeger does his best to blame the welfare state’s revenue starvation on corporate tax planning:
What the recent tax scandals in Luxembourg have shown is that governments are stripping back public services, while at the same time encouraging companies to engage in complex tax schemes. The promotion of tax evasion has deprived public services of crucial resources at a critical time.
No, it is not tax planning that “deprives” government of “crucial resources”. It is the recession. A government spending program is a promise, or a bundle of promises, to a designated segment of the population. Government defines that segment as “entitled” to a cash or in-kind government service, specifies the quality and quantity of that entitlement and then starts pouring out the money. There is almost never a funding source tied to the entitlement – funding comes out of general revenue – and on the rare occasions when there is a dedicated funding source, the entitlement is not conditioned on available tax revenue.
This is, in essence, like me promising my children a flat screen TV each for Christmas without first looking at my bank account. (And never mind the risk of spoiling them to the point where they won’t work for what they want…) But somehow this aspect of the welfare state is lost on its fervent proponents, Klaus Heeger being one of them.
He does, however, make one interesting point:
This public financing has been critical for the banking sector in the past 5 years and is now critical for citizens and workers. Lost revenue means less means of financing public services used by citizens and companies alike, and less redistribution towards a fairer and more sustainable society.
If we forget about the programmatic rhetoric about “fairer and more sustainable”, the argument about the banks is not without merit. But the problem, again, is that elected officials think that it is perfectly fine to use government – and thereby tax revenue – for everything and anything. But corporate welfare is not a government function in a free society.
Heeger’s little jab about businesses taking tax money is of course aimed at getting them to give back in the form of higher taxes:
Concrete measures need to be implemented now in order to put the spotlight on tax justice across Europe. The [recent] G20 summit shows that solutions exist; there is just a lack of political will in Europe to put them in place. While Europe is still hesitating on how to approach the sensitive issue of tax rulings, the G20 have underlined the need to fight these “harmful tax practices”.
There is a sense of desperation in calling tax planning “harmful”. Businesses that create jobs, provide people with products that improve their standard of living; businesses that produce medicine and high-quality food, that build safe and comfortable ways for us to travel; businesses that produce power to we can warm our homes; those businesses need to make sure they can make their ends meet and have enough money for future investments. They need to be able to compete, to improve their products, to pay their workers more.
When they take steps to reduce an already onerous tax burden, they are not engaging in “harmful” activities. They are trying to avoid harm to their own operations, their employees and their customers.
The harm is done by over-reaching governments extending their taxation beyond what is economically sustainable.
Unfortunately, union leader Klaus Heeger does not see this side of the issue. On the contrary, he wants the EU and its member states to further tighten the tax noose around the corporate neck. The goal, says Heeger, is “a common tax base”:
Starting with more transparency on tax ruling, Europe then needs to push ahead with legislation on a directive on a common tax base with binding harmonisation at the heart of the proposals. A single tax base will ensure profits are taxed once and redistributed amongst countries hosting the company.
Today, companies in Europe can choose a country of residence where they file their taxes. What Heeger and other proponents of a perpetually large government are pushing for is, simply, the elimination of that ability. Exactly how this would happen is not clear at this point, but there are two options: either the EU takes over the taxation of corporations, eliminating the member-state corporate income tax; or the EU dictates to member states what tax rate – or bracket of rates – they can tax at.
Either solution is frankly a bit brutal. Today the member states of the EU and the two remaining countries within the former EES system, Switzerland and Norway, compete for corporate headquarters with competitive taxes; in a future Europe where all tax competition is eliminated it will be the continent that competes against the rest of the world.
It is a safe bet to predict that a “tax harmonized” Europe will maximize its “common tax base”, thus making itself uncompetitive against a resilient United States, a steadily improving Canada, an increasingly industrialized Africa and, of course, the entire pack of Asian Tigers.
Heeger suggests a slew of other measures to squeeze more taxes out of corporations. While motivating his rhetoric with fairness and transparency, the real goal is to eliminate tax competition and to monopolize fiscal policy aimed at paying for the welfare state. That can only deprive Europe’s workers of yet more jobs and opportunities. It will most certainly drive yet another generation of Europeans into perennial dependency on government and destroy yet more of the prosperity generators in what was once a world-leading economy.