Monetary Cranks Delay Reform in Cranked-Up Welfare States
To be frank, the ECB will be making European societies more krank not less. Frankfurter Allgemeine’s comments on news of the ECB’s monetary financing of overburdened welfare states was in tune with reactions of the quality German press. It was angry. It said the ECB’s decision to begin buying government debt of troubled eurozone countries effectively demolishes the wall between monetary and fiscal policy.
The Year Ahead 2018
The world’s leading thinkers and policymakers examine what’s come apart in the past year, and anticipate what will define the year ahead.
Jens Weidmann -- president of the German central bank -- has long feared the financing of peripheral debt will lead to Germany becoming Europeanised rather than the other way around. When central banks finance government deficits with the printing press -- the Bundesbank thinks the ECB bond-buying comes close to doing that -- it will be “addictive”.
The longstanding concern in Germany (accepted among right-thinking economists even in Spain and Italy) is that -- in the words of Philipp Rösler -- “If you take away the interest rate pressure on states, you take away pressure for them to reform".
At an award ceremony for Mario Draghi on the day of the ECB press conference, Mr. Schäuble, Germany’s finance minister, reiterated his scepticism about activist monetary policy -- “If we start resolving problems of financial policy through the means of monetary policy, we will have a problem”. Instead, “financial and economic stability” is the key to renewed economic growth. Clearly no patience for monetary cranks.
Nor do many commentators outside Germany believe the ECB’s promise that tough ol' IMF-style reform conditionality will be applied to indebted states. They wonder how the ECB might survive the losses if it were to cut-off a delinquent country whose bonds it had bought. One journalist described the scenario as “mutually assured destruction that will be tough to enforce”. The respected blogger Tyler Cowen believes the ECB incentivised debtor sovereigns “to load up on short-term debt”. As Simon Nixon of Wall Street Journal indicates, doubts are already setting in about aid conditionality simply because the ECB announcement immediately “provided a backstop for Spanish and Italian bond markets and will keep those countries' borrowing costs sufficiently low that they do not ask for aid”.
If indeed the ECB is crossing the line from monetary into fiscal policy with discretionary bail outs of sovereigns then it will abrogating to itself new powers of central planning and activist intervention that go way beyond inflation-management. These are, or should be, highly controversial. And since the ECB is doing it at the behest of governments needing rescue, in contravention of a ‘no bail out’ clause, ECB independence is compromised.
Policymakers need to shift discussion away from day-to-day debt restructuring, and look at the Big Picture. ECB bond buying will bail out super-sclerotic unreformed welfare states addicted to debt. The addictions will be financed by taxpayers sooner or later, which is why new economic incentives now being created, and decisions about the sustainability or prioritisation of social spending, become the topical issues.
“Heavily Subsidised” Opera-Cum-Tram Ticket:
I thought all this as I stepped around one of the many inebriated bums and bohemians who have come from all Europe to line the pavements of beautiful German city streets unabashedly cradling large bottles of premium Pilsner which are sold cheaply everywhere except in pharmacies (the 800-year monopoly of apothekes is profitable enough as it is).
I crossed the tramline which divides the ECB EuroTower from the Frankfurt Opera House. Three times I asked the well-educated ticket seller to please repeat in English. "Three-zero or one-three?" For an astonishing 13 EURO I bought a gallery seat without obstruction for Puccini’s La Boheme on Saturday night. That is slightly less than a cinema ticket in London.
“Opera in Germany is heavily subsidised” the ticket seller averred, and then explained how the barcode on the ticket would allow me free access to public transport on the day of the performance. When next I wish to use Frankfurt public transport rather than weave through foul-smelling bohemians who share the pavement with the perfumed clientele of elegant and overflowing eateries, I must remember to buy an opera ticket beforehand.
Italian Economist Observes German Precaution:
An anecdote can give the wrong impression. Germans are far more likely than French, Spanish, or Italians to grasp the danger of a runaway welfare state. I learned this from an Italian economist. Francesco Giavazzi found in his research that many Germans increase their precautionary saving, or decrease consumption, or join the labour market, or postpone retirement in response to increases in “uncertainty about the future path of income”. Since this effect is strongest when “political parties are unable to agree on how the burden of reform should be shared between various groups in society”, Giavazzi wonders if “the economy might slow down for no other reason than political uncertainty”.
Mr. Schäuble and Mr Weidmann would agree that political predictability is the precondition for legal predictability, which are the preconditions for financial and economic stability.
Mr Giavazzi said in a co-authored book on the Future of Europe: “those Germans who are becoming uneasy about the sustainability of the welfare system are ready to accept cuts in vacation time and to increase their work hours significantly”. In parts of Europe, then, the factors affecting flexibility of labour markets or elasticity of labour supply are closely bound up with sensible precaution about the relative safety and size of the safety net.
German Economist Observes German Recklessness:
The economist who did more than any other to bring the looming problems of overstreched welfare systems to the attention of Germans is Hans-Werner Sinn who authored the best-selling (gripping, definitive, highly recommended) book on Germany’s welfare state, translated to English in 2007, titled Can Germany Be Saved?. It is a difficult book to excerpt from. Every page is crammed with insight, and the focus on the welfare state is actually an umbrella for examining modern Germany’s economic history.
Sinn’s argument in brief: Convincing analyses of labour market, fiscal, and demographic distortions, educational weaknesses, the “endless loop of taxes and transfers", and failure to create a European constitution to harmonise welfare systems with legislative and monetary union, are all interwoven with persuasive analyses of the “violations of basic economic laws”, of the ideologues, interest groups, and lobbies blocking reform, and of the chronic long-standing underestimation of the costs and disincentives of welfare which meshed negatively with the global and domestic factors constraining German competitiveness.
Sinn suggested back then that Germany, the country which gave the world the welfare state, had made itself sick and uncompetitive. Its position was similar to Britain before the Thatcher reforms. Germans believed the supply of generous welfare (pensions, benefits, etc.) will continue to arrive from government “as electricity comes out of a wall socket”. Voters, politicians, and labour and employer interest groups “overburdened their own economy”. “An astonishing 41% of its adult population lives on social transfers”.
Germany’s “welfare state gobbled up funds that could have been invested in education, and hurt the labour market by creating comfortable alternatives to gainful employment and educational effort”. Being too long in the“easy chair of the welfare state” created economic crisis, produced ballooning government debt, and was the reason politicians violated the EU fiscal pact on budget deficits rather than cut social expenditure.
Sinn is a moderate. There were good reasons, he says, for sharing out the gains of the post-war economic boom. He proposes reforms rather than elimination of welfare.
“The welfare state evens out people’s chances in life, and it serves as career insurance against sheer bad luck … The welfare state compensates and appeases those who lose out to technological progress and to the expanding division of labour and world trade. It helps people with low productivity and prevents them from having to resort to fraud, theft, and other criminality. It insures people against economic risks in a manner and to an extent that private insurance could not possibly provide, and thus benefits everyone … Yet just as there can be too little state insurance, resulting in an inadequate social safety net, there can be an over-provision of insurance protection, resulting in moral hazard … Germany today suffers a moral-hazard problem with respect to unemployment benefits and wage supplements”.
I wonder to what extent the specific reforms Sinn proposes in the final chapter have been implemented. Meine kleine nachtmusik experience at the Oper Frankfurt, and 2.5 weeks of casual observation in prosperous and stimulating cities -- Hamburg, Berlin, Frankfurt, Cologne -- suggest to me there is reform still to be done, and more warnings to sound.
Obviously there have been adjustments in values, behaviour, regulation, and welfare since Sinn’s book and the financial crisis. But compared with other Eurozone countries I have visited, Germany gives the impression of still being on the consumption and holiday binge that Sinn gently criticised as indicating complacency. In intellectual and scientific areas too, Sinn thought Germany was “drawing on past glory and not living in the present”.
I wondered about that as I watched crowds with kitschy sprayed hair and Sunday whites and pinks rush through Liebieghaus, one of Europe’s finest collections of medieval, Baroque, and Renaissance sculpture. I watched closely. Most ignored the permanent collection and strode toward the expressionless Jeff Koons pieces grotesquely “integrated with” but actually upending and diminishing the old masterpieces. Amid smiles at the idiosyncrasy of Koons balloons the atmosphere was in fact tense and irritated; people knew they were gawking at nothing. A reviewer recently received widespread attention for identifying this now familiar encounter with expensive banality as “contemporary art’s negotiation of its own relentless commodification, the consciousness of its capture by the circuits of casino capitalism”.
As I see it, all of this is the context for the fear and frustration voiced in the German press about ECB incentives for bankrupt states to take on dodgy debt and postpone reform. It’s like being confronted with Jeff Koons. You suspect you are being gamed. But since you don’t quite know how to react, the atmosphere becomes extremely unusual.
The Entitlement State Of The USA:
I leave analysis of the USA’s welfare state in two capable hands: Peter Lindert and Nicholas Eberstadt.
Writing in 2007, the year Sinn’s book was published in English, the well regarded economic historian (PDF) Peter Lindert was upbeat about the sustainability of the welfare state:
“The welfare state is not an endangered species among the industrialised OECD countries. There is no race to the bottom, nor is there even an inexorable policy tradeoff between efficiency and equity. In fact, international experience since 1980 does not show any clear overall negative effect of larger tax-financed transfers on national product ... The best statistical tests underline a “free lunch puzzle”: Europe’s large tax-based social budgets have apparently not lowered GDP … The main institutional mistakes in Western Europe relate to excessive protection of vested interests against competition in product and labor markets, not the welfare state. The main mistakes on the American side relate to health insurance, underinvestment in mothers’ careers, and the under-taxation of addictive goods (tobacco, alcohol, and gasoline).”
It would be interesting to put Lindert and Sinn head-to-head on specific issues like pay-as-you-go-pensions and education, since both have much to say on these topics. However, I am unable find any update or reflection by Lindert in the light of the financial crash and new constraints on social spending. Does he stick to the claims in his 2-volume magnum opus that there will be no efficiency constraints on the welfare state in the 21st century, the welfare state will continue to be a viable alternative to reform and privatisation?
A quite different negative perspective was presented only 10 days ago in the Wall Street Journal by political economist Nicholas Eberstadt. In a blog link to Eberstadt’s article Greg Mankiw supplied a dramatic chart courtesy of the US Census Bureau, which showed 50% of Americans are now living in a household receiving state benefits.
“What is monumentally new about the American state today is the vast empire of entitlement payments that it protects, manages and finances. Within living memory, the federal government has become an entitlements machine. As a day-to-day operation, it devotes more attention and resources to the public transfer of money, goods and services to individual citizens than to any other objective, spending more than for all other ends combined.”
“A half-century of unfettered expansion of entitlement outlays has completely inverted the priorities, structure and functions of federal administration as these were understood by all previous generations. Until 1960 the accepted task of the federal government, in keeping with its constitutional charge, was governing. The overwhelming share of federal expenditures was allocated to some limited public services and infrastructure investments and to defending the republic against enemies foreign and domestic.”
“In 1960, entitlement payments accounted for well under a third of the federal government's total outlays—about the same fraction as in 1940, when the Great Depression was still shaping American life. But over subsequent decades, entitlements as a percentage of total federal spending soared. By 2010 they accounted for just about two-thirds of all federal spending, with all other responsibilities of the federal government making up barely one-third. In a very real sense, entitlements have turned American governance upside-down.”
“The U.S. is now on the verge of a symbolic threshold: the point at which more than half of all American households receive and accept transfer benefits from the government. From cradle to grave, a treasure chest of government-supplied benefits is there for the taking for every American citizen—and exercising one's legal rights to these many blandishments is now part of the American way of life.”
“As Americans opt to reward themselves ever more lavishly with entitlement benefits, the question of how to pay for these government transfers inescapably comes to the fore. Citizens have become ever more broad-minded about the propriety of tapping new sources of finance for supporting their appetite for more entitlements.”
“The U.S. is a very wealthy society. If it so chooses, it has vast resources to squander. And internationally, the dollar is still the world's reserve currency; there remains great scope for financial abuse of that privilege. Such devices might well postpone the day of fiscal judgment: not so the day of reckoning for American character, which may be sacrificed long before the credibility of the U.S. economy.”
That speaks for itself. I have nothing to add except a sigh.
“The Fairy Tales of Monetary Cranks” Will Make Everything Grimmer:
I will write separately on the political theory of the inescapable and ever-expanding welfare state. Yet on present trends, as described above (excepting Peter Lindert), the size and scope of the welfare state in major advanced countries looks unaffordable.
1. The financial crisis has revealed -- quite aside from the secondary causes and effects of bank regulation and other factors -- that welfare states have needed unprecedented debt and deficits to sustain continual expansion. That made countries fragile, over-vulnerable to greatly magnified effects from very predictable periodic slowing of the engines of growth.
2. The welfare state damages incentives to improve productivity and competitiveness. That should especially concern countries like the USA and Germany where entrepreneurship, innovation, productivity and competitiveness are the only things permitting the luxury of still overburdening their welfare state in the teeth of crisis. When Eberstadt talks of “character sacrificed” I think he means the destruction of capitalist incentives.
Of course, the percentage of social expenditure as a share of GDP remains much greater in Germany than in the USA. The additional dilemma faced in Germany is that its finances are hostage to the debt crisis of Eurozone welfare states which passed their respective points of sustainability relative to productivity and competitiveness. Cheap euro loans helped them prematurely past their optimum level of safety net. As Germans suspect, the ECB is proposing actions that offer more free lunch to peripheral welfare states.
In summary - The ECB hopes to contain the crisis by easing the borrowing costs of bankrupt sovereigns. But by removing interest rate pressure on states the ECB removes the pressure to reform and creates incentives for short term debt. The reason America and Germany are not going down the toilet at the speed of Spain, Italy, and France is that their workers are more productive and their entrepreneurs more innovative.
The European Centralised Bailout orchestrated on the upper floors of the EuroTower across from the Opera House hastens the moment when German politics catches fire. Conflict over policy and burden sharing will be bad for economic growth, but at least it will cause Germans to re-intensify their precautionary behaviour. They really are better at precaution than the Italians. The Frankfurt performance of ‘La Boheme’ was very good, by the way. Afterwards I walked with the bohemians. The subsidised tram ticket looked too complicated.