Europe’s Structural Deficit Problem

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:

Poland 120.5
Norway 116.2
Sweden 108.3
Czech Republic 100.3
Austria 97.5
Estonia 90.8
Luxembourg 82.8
Belgium 72.9
Cyprus 72.5
France 70.3
Netherlands 63.4
Finland 61.3
Italy 53.5
Portugal 53.0

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:

Poland 61.8
Sweden 47.9
Austria 44.5
Czech Republic 39.1
Luxembourg 35.4
Estonia 33.6
France 29.8
Belgium 29.2
Netherlands 29.2
Cyprus 25.9
Norway 25.4
Finland 23.1
Portugal -2.4
Italy -9.6

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.

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