Tag: Greece

The Welfare State, Taken to Its Logical Conclusion

The economic tragedy unfolding in Greece is the welfare state taken to its logical conclusion.  When groups of people use the state to live at the expense of others, the feedback loop about the costs of those transfers is attenuated – often by design.  The welfare state therefore makes commitments that it cannot honor.  By the time creditors or taxpayers say, “Enough,” the welfare state has created a clash between expectations and means that leads to unrest and hardship – a clash that never had to occur.

Reuters reports that this tragedy is playing itself out in Canada, where the Medicare system is straining the budgets of taxpayers and provincial governments – even as Canada remains infamous for providing inadequate access to care.  According to Reuters, the provincial government in populous Ontario predicts that “health care could eat up 70 percent of its budget in 12 years, if all these costs are left unchecked.”  Toronto-Dominion Bank senior economist at Derek Burleton remarks:

There’s got to be some change to the status quo…We can’t continually see health spending growing above and beyond the growth rate in the economy because, at some point, it means crowding out of all the other government services.  At some stage we’re going to hit a breaking point.

The provinces are contemplating measures that would further reduce access, such as ratcheting government price controls downward, “health taxes” on medical services, and (gasp!) charging patients. (Speaking of feedback loops, an economist at Scotia Capital reasons that patients “will use the services more wisely if they know how much it’s costing…If it’s absolutely free with no information on the cost and the information of an alternative that would be have been more practical, then how can we expect the public to wisely use the service?”)

The Greek and Canadian dramas are a preview of what the welfare state, aided by its most recent expansion, will provoke here in the United States.  Again, Reuters:

Canada, fretting over budget strains, wants to prune its system, while the United States, worrying about an army of uninsured, aims to create a state-backed safety net.

Burleton captures the problem nicely:

[F]rom an economist’s standpoint, we point to the fact that sometimes Canadians in the short term may not realize the cost.

Indeed, that’s the very essence of the welfare state, and why its logical outcome is crisis.

Europe’s Über Bailout

I’m semi-impressed with the Europeans for choosing the hog-wild approach to bailouts. Not because it is good policy, but rather because it will be a useful demonstration of the old rule that bad policy begets more bad policy (which begets God knows what, but it won’t be pretty). The background is that many European nations have been over-spending, over-taxing, and over-regulating. This has created a poisonous combination of weak economies, pervasive dependency, and political corruption, with Greece being the nation farthest down the path to Krugman-topia. Europe’s political elite at first thought they could paper over the problems with a $140 billion Greek bailout. The ostensible motives were to stop contagion and to demonstrate “solidarity,” but behind-the-scenes lobbying by big European banks (which foolishly own a lot of government debt from profligate nations such as Greece, Portugal, Spain, and Italy) may have been the most important factor. Regardless of the real motive, the original bailout was a flop, so the political class has decided to go with the in-for-a-dime-in-for-a-dollar approach and commit nearly $1 trillion of other people’s money to prop up the continent’s welfare states. The Wall Street Journal reports on the issue, noting that American taxpayers will be involuntary participants thanks to the financial world’s keystone cops at the International Monetary Fund:

The European Union agreed on an audacious €750 billion ($955 billion) bailout plan in an effort to stanch a burgeoning sovereign debt crisis that began in Greece but now threatens the stability of financial markets world-wide. The money would be available to rescue euro-zone economies that get into financial troubles. The plan would consist of €440 billion of loans from euro-zone governments, €60 billion from an EU emergency fund and €250 billion from the International Monetary Fund. Immediately after the announcement, the European Central Bank said it is ready to buy euro-zone government and private bonds “to ensure depth and liquidity” in markets, and the U.S. Federal Reserve announced it would reopen swap lines with other central banks to make sure they had ample access to dollars.

Back when Greece first began to collapse, I argued that bankruptcy was the best option. And I noted more recently that my colleague Jeff Miron reached the same conclusion. Everything that has since happened reinforces this viewpoint. Here are a few additional observations on this latest chapter in the collapse of the welfare state.

1. A bailout does not solve the problem. It just means that taxpayers bear the cost rather than the banks that foolishly lent money to corrupt and incompetent governments.

2. A bailout rewards profligate politicians and creates a moral hazard problem by letting other politicians think that it is possible to dodge consequences for reckless choices.

3. A bailout undermines growth by misallocating capital, both directly via bailouts and indirectly by signaling to financial markets and investors that governments are a “safe” investment.

4. A bailout will cause a short-term rise in the market by directly or indirectly replenishing the balance sheets of financial institutions, but this will be completely offset by the long-run damage caused by moral hazard and capital misallocation.

The last point deserves a bit of elaboration. Assuming markets continue to rise, the politicians will interpret this to mean their policies are effective. But that is akin to me robbing my neighbor and then boasting about how my net wealth has increased. In the long run (which is probably not too long from now), though, this system will not work. At best, Europe’s political elite have postponed the day of reckoning and almost certainly created the conditions for an even more severe set of consequences. No wonder, when I was in Europe a couple of weeks ago, I kept running in to people who were planning on how to protect their families and their money when the welfare state scam unravels. Their biggest challenge, though, is finding someplace to go. People use to think the United States was a safe option, but the Bush-Obama policies of bigger government have pushed America much closer to European levels of fiscal instability.

Doing Business in Greece and Europe’s Economic Crisis

In a telling editorial today, the Wall Street Journal extensively cites the World Bank’s Doing Business annual survey to explain an underlying cause of the Greek crisis. Burdensome regulations, high taxes, and a costly legal system make it extremely difficult to start and run a business in Greece. The country ranks last in terms of the ease of doing business among the 27 members of the European Union, and it ranks 109 out of 183 countries.

The need for fundamental structural reform, including of public pension systems, there and in much of Europe will be the message of Simeon Djankov, Bulgaria’s deputy prime minister and minister of finance, as he speaks at a Cato policy forum next Tuesday. Cato senior fellow Steve Hanke, “father” of Bulgaria’s successful currency board, will also speak.

Before his current post in Bulgaria, Djankov was the initiator and lead author of the Doing Business report that is now being so widely cited in relation to Greece’s woes. No doubt he’ll have something to say about that.

For a further description of the long-term lack of economic freedom in Greece, see this op-ed by prominent Greek journalist Takis Michas, which was based on his talk at a recent Cato policy forum.

As Goes Greece,…

Today Politico Arena asks:

What are the implications for us of the crisis in Greece?

My response:

The questions posed to Arena contributors this morning, prompted by the unfolding Greek tragedy and its implications, are several, but they go well beyond economics. “Unwise lending and excessive borrowing” led to the tragedy, Steven Pearlstein notes in the Washington Post, but he adds that “there is little doubt that Greece’s debt crisis is of its own making, the result of corruption and tax avoidance and that seductive Mediterranean coupling of high living and low productivity.”

More immediately, in the Wall Street Journal today we find that when it comes to “overall ease of doing business,” the World Bank ranks Greece 109 out of 183 countries — “dead last among the 27 members of the European Union,” the Journal notes.  “You have to go up 30 slots to find the next worst EU performer, Italy.” Pointing to Sacramento, Albany, and Washington, for good reason, the Journal’s editorialists conclude that “Greece shows that the welfare state model of development, dominated by public unions, onerous regulations, high taxes and the political allocation of capital, has hit the wall.”

Indeed it has, but notice that underpinning this tale are political and moral concerns. To touch on just two, the European Union is a textbook example of the downside of political union. To be sure, there is an upside, especially when union eliminates parochial restrictions on free association, as has happened to a substantial extent under the EU. But to move beyond creating a free market, to create instead a regime of mutual obligations as reflected in the phrase “we’re all in this together,” is to invite the very moral hazard we see before us today. Angela Merkel is in a political bind precisely because, as Pearlstein notes, prudent Germans are recoiling “at the thought of bailing out the profligate Greeks.” Milton Friedman put it simply: No one spends someone else’s money as carefully as he spends his own.

And that leads to a second concern, of particular importance in our own case. It was to gain the benefits of union while avoiding its downside that America’s Founders drafted our Constitution so carefully, giving Congress the power to override state restrictions on interstate commerce, for example, but otherwise leaving us free, as private citizens and associations, to plan our own affairs and live our own lives. That, however, was anathema to the social engineers of the Progressive Era, the elites who sought “change” through the collective undertakings of the modern administrative state. “Our task now,” said FDR, is one of “distributing wealth and products more equitably,” precisely what the Constitution forbade. And so Roosevelt, with his Court-packing threat, turned the document on its head — or, as Rexford Tugwell would later put it, “To the extent that these new social virtues [i.e., New Deal policies] developed, they were tortured interpretations of a document intended to prevent them.” There followed, of course, endless redistributive schemes, federal, state, and local, that have brought us today to the “unwise lending and excessive borrowing” that surrounds and suffocates us.

As goes Greece,…

Greece’s Problem Is High Tax Rates, Not Tax Evasion

The New York Times has an article describing widespread tax evasion in Greece, along with an implication that the country’s fiscal crisis is largely the result of unpaid taxes and could be mostly solved if taxpayers were more obedient to the state. This is grossly inaccurate. A quick look at the budget numbers reveals that tax revenues have remained relatively constant in recent years, consuming nearly 40 percent of GDP. The burden of government spending, by contrast, has jumped significantly and now exceeds 50 percent of Greek economic output.

The article also is flawed in assuming that harsher enforcement is the key to compliance. As this video shows, even the economists at the Paris-based Organization for Economic Cooperation and Development admit that tax evasion is driven by high tax rates (which is remarkable since the OECD is the international bureaucracy pushing for global tax rules to undermine tax competition and reduce fiscal sovereignty).

Ironically, the New York Times article quotes Friedrich Schneider of Johannes Kepler University in Austria, but only to provide an estimate of Greece’s shadow economy. The reporter should have looked at an article that Schneider wrote for the International Monetary Fund, which found that:

Macroeconomic and microeconomic modeling studies based on data for several countries suggest that the major driving forces behind the size and growth of the shadow economy are an increasing burden of tax and social security payments… The bigger the difference between the total cost of labor in the official economy and the after-tax earnings from work, the greater the incentive for employers and employees to avoid this difference and participate in the shadow economy. …Several studies have found strong evidence that the tax regime influences the shadow economy. …In Austria, the burden of direct taxes (including social security payments) has been the biggest influence on the growth of the shadow economy… Other studies show similar results for the Scandinavian countries, Germany, and the United States. In the United States, analysis shows that as the marginal federal personal income tax rate increases by one percentage point, other things being equal, the shadow economy grows by 1.4 percentage points. …A study of Quebec City in Canada shows that people are highly mobile between the official and the shadow economy, and that as net wages in the official economy go up, they work less in the shadow economy. This study also emphasizes that where people perceive the tax rate as too high, an increase in the (marginal) tax rate will lead to a decrease in tax revenue.

It is worth noting the Schneider’s research also shows why Obama’s tax policy is very misguided. The President wants to boost the top tax rate by nearly five percentage points, and that’s on top of the big increase in the tax rate on saving and investment included in Obamacare. Based on Schneider’s research, we can expect America’s underground economy to expand.

Shifting back to Greece, Schneider does not claim that tax rates are the only factor determining compliance. But his research indicates that more onerous enforcement regimes are unlikely to put much of a dent in tax evasion unless accompanied by better tax policy (i.e., lower tax rates). Moreover, compliance also is undermined by the rampant corruption and incompetence of the Greek government, but that problem won’t be solved unless politicians reduce the size and scope of the public sector. Needless to say, that’s not very likely. So when I read some of the details in this excerpt from the New York Times, much of my sympathy is for taxpayers rather than the greedy politicians that turned Greece into a fiscal mess:

In the wealthy, northern suburbs of this city, where summer temperatures often hit the high 90s, just 324 residents checked the box on their tax returns admitting that they owned pools. So tax investigators studied satellite photos of the area — a sprawling collection of expensive villas tucked behind tall gates — and came back with a decidedly different number: 16,974 pools. That kind of wholesale lying about assets, and other eye-popping cases that are surfacing in the news media here, points to the staggering breadth of tax dodging that has long been a way of life here. …Such evasion has played a significant role in Greece’s debt crisis, and as the country struggles to get its financial house in order, it is going after tax cheats as never before. …To get more attentive care in the country’s national health system, Greeks routinely pay doctors cash on the side, a practice known as “fakelaki,” Greek for little envelope. And bribing government officials to grease the wheels of bureaucracy is so standard that people know the rates. They say, for instance, that 300 euros, about $400, will get you an emission inspection sticker. …Various studies have concluded that Greece’s shadow economy represented 20 to 30 percent of its gross domestic product. Friedrich Schneider, the chairman of the economics department at Johannes Kepler University of Linz, studies Europe’s shadow economies; he said that Greece’s was at 25 percent last year and estimated that it would rise to 25.2 percent in 2010.

Greek Chutzpah

There’s an old joke that if you owe a bank $10,000, you have a problem, but if you owe a bank $10,000,000, the bank has a problem. The Greek government certainly seems to have that attitude. Short-sighted and corrupt politicians in Athens have spent their nation into a fiscal ditch and they now want to mooch from both the IMF and other European nations (especially Germany). The German Prime Minister (if only for political reasons) is talking tough, saying that Greece should do more to reduce subsidies and handouts. Why should Germans work until age 67, after all, so Greeks can enjoy overpaid government jobs and retire at age 61? So what is the response from the Greeks? Amazingly, one of the politicians had the gall to say his nation “cannot accept” further wage cuts. Here’s an excerpt from the Daily Telegraph:

It is far from clear whether Athens will agree to further austerity as strikes hit the country day after day. Andreas Loverdos, Greece’s labour minister, said the EU-IMF team wants further wages cuts. “We cannot accept that.” Greece knows it can opt for default at any time, setting off an EMU-wide crisis and bringing down Europe’s banks. It also knows that key figures in the Bundestag favour debt restructuring. ‘Those who chased high yield by purchasing Greek debt must share the costs,’ said Volker Wissing, chair of Bundestag’s finance committee. Leo Dautzenberg from the Christian Democrats said banks should prepare for a `haircut’ of up to 50pc. The ECB, Brussels, and the IMF have been fighting feverishly to head off such a move, fearing a financial chain-reaction.

If the Germans have any brains and pride, they will tell the Greeks to go jump in a lake (other phrases come to mind, but this is a family-oriented blog). And if this means that German banks take a loss on their holdings of Greek government debt, there’s a silver lining to that dark cloud since it is time for financial institutions to realize that they should not be lending so much money to corrupt and wasteful governments.

Greetings from Spain

I arrived in Madrid yesterday for a speech to the annual Convention of Independent Financial Advisors, and it is somehow fitting that Spain was downgraded by Standard and Poor’s as I entered the country. I’m not a fan of the bond-rating agencies, and the fact that it has taken so long for Spain to be downgraded simply reinforces my skepticism about their value. So let’s focus instead on identifying the sources of Spain’s fiscal crisis. If you look at the OECD’s fiscal database, you will see that Spain’s short-run problem is solely the result of a growth in the burden of government spending. Over the past seven years, the budget in Spain has skyrocketed from 38.4 percent of GDP to 47.2 percent of GDP. And since tax revenues have stayed the same as a share of national economic output, it is difficult to see how anyone can conclude that the fiscal crisis is the result of inadequate revenue. In the long run, the problem also is excessive government spending, largely because demographic factors such as an aging population will push up outlays for pensions and health care.

In other words, Spain is in trouble for the same reason that Greece is in trouble. Government is too big and politicians are unwilling to take the modest steps that are needed to rein in dependency. This, of course, is exactly why there should not be a bailout. Subsidizing Greek politicians and Spanish politicians – regardless of whether the bailout comes from German taxpayers and/or the IMF – will send a signal to other European nations that there is an easy way out. But the “easy way out” simply postpones the day of reckoning and makes the eventual adjustment much more challenging. Here’s an excerpt from the Washington Post report:

European and International Monetary Fund officials on Wednesday were considering a dramatically increased $158 billion bailout package for Greece as the country’s debt crisis continued to ripple across Europe, with Standard & Poor’s downgrading the credit rating on Spain, the continent’s fourth-largest economy. …In Europe, the most intense focus remains on Greece, but fears were intensifying elsewhere, especially in Portugal and Spain. Though analysts noted that both countries are in better shape than Greece – with lower ratios of debt – they both shared large fiscal deficits and poor long-term economic prospects. On Wednesday, the government in Portugal announced that it would move up a program of painful spending cuts to shrink its budget deficit and shore up confidence amid signs that fearful depositors were moving capital out of Lisbon banks. After lowering Greek debt to junk bond status on Tuesday, Standard & Poor’s kept Spain at investment grade status, but lowered its rating one notch, to AA.