When Is Government Big Enough?

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

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

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

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

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

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

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

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

Some telling examples of what we are talking about:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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