Eurozone Failure Is Warning To US
For they have sown the wind, and they shall reap the whirlwind. -- Hosea 8:7
In 1979 historian Clarence Carson of the University of Alabama published a book with an arresting title on the history and consequences of socialism: The World in the Grip of an Idea. It was at the time one of the more complete studies of the "Idea" which had by then pervaded political economy throughout the world, whether of the revolutionary (Soviet-style) variety, or that of evolutionary socialism as per Fabian England and FDR's New Deal. Still worth reading today, Professor Carson's thesis was that socialist ideology as developed in the 19th century was so alluring because it promised -- in all its variants -- nothing less than the achievement of human felicity on earth, and succor and protection from life's harsh blows and risks. Explicitly attacked as a key reason for the lack of this stability and security were the cultural proclivities, social norms and habits, and economic institutions of capitalist society, with its underlying ethos of individualism. According to the Idea, capitalism produces the market chaos and inequality of wealth that socialists have always abhorred, and their promise has always been an elimination of insecurity and "unfairness" via benevolent planning by the government. And, a collectivist ethos would eradicate and replace individualism in order to carry out the dictates of central planning.
Nowhere has the collectivist mindset become more entrenched than in Europe, with the rise and full flowering of the welfare state model. Beginning with Chancellor Otto von Bismarck's social welfare programs in Germany in the 1880's (Bismarck was the first great progenitor of a government safety net, and he introduced old age pensions, accident insurance, medical care and unemployment insurance, all of which were copied around the world over time), England, France, Sweden, and all of Europe followed suit by the early 1900s. And across the 20th century, all European governments eventually pursued varying degrees of nationalization of industry (e.g., utilities, banks, autos), pro-labor legislation, and control or oversight of the health care, housing, and education sectors.
The United States has been an aid-and-abet agent of the growth of European (and Japanese) socialism, albeit unwittingly, in two ways: government aid, and the export of our economic leadership. Taking the latter first, the United States, with just over 4% of the world's population, represents one-quarter of its GDP (down from 57% in 1945), more than a fourth of the biggest 2000 companies, more than 30% of its patents, and more than two-thirds of all venture capital placements (the same is true for private equity more broadly). It is rare to find a consumer product invention, new information technology, or industrial or commercial innovation that did not originate in the U.S. (mobile wireless technologies out of Finland are one example): beyond the degree of freedom in the U.S. that promotes entrepreneurship, this is largely considered a product of America's best-in-the-world higher education system and universities. Thus Europe has, since the U.S. passed it in living standards a century ago, been the beneficiary of prodigious American technological and management science development that has always been freely imported into the Eurozone. That is to say, a collectivist society benefits directly from an individualist one by importing the fruits of its vibrant dynamism while avoiding some of the associated costs.
Secondly, lavish "cradle-to-grave" social programs were also made possible in Europe after World War II thanks to the American defense umbrella, which allowed European states to have available considerable extra tax revenues for domestic spending that would otherwise have gone for NATO defense. The United States has been the de facto guarantor of European security since 1945: today the U.S. spends more on defense than the next 13 countries combined, and commits 5.4% of its GDP to defense (the European average is 1.7% of GDP). And, Marshall Plan and related American aid in the six years after World War II, totalling about $1.3 trillion in today's dollars, further allowed for generous public sector spending in Europe to take root. In other words, America has long subsidized the Eurozone's welfare state apparatus.
In support of the comprehensive social programs that embody the welfare state, one consequence has been higher levels of spending and, concomitantly, taxation. Spending is best viewed via the government debt-to-GDP ratio, because welfare states inevitably resort to borrowing to fuel government program growth; tax rates inevitably then rise to cover the growth in spending.
And one indisputable fact about the fiscal history of welfare states is that they run into spending trouble: indeed, economic growth sharply diminishes in high-debt economies. In recent years, in the esteemed pages of the American Economic Review, in a full length book (This Time Is Different: Eight Centuries of Financial Folly), and in popular writings, economists Carmen Reinhart of the Peterson Institute of International Economics and Kenneth Rogoff of Harvard University have exhaustively described their path-breaking research showing the effects of debt and deficit-spending on economic growth and prosperity. Across data involving more than 40 countries going back 200 years in some cases for their statistical analysis, their seminal finding is one that should be enshrined as a canon of economic law: at ratios of gross national debt to GDP north of 90%, economic growth is sharply diminished. The U.S. has reached the 100% level, while for Japan, in the midst of economic torpor for the better part of 20 years, the ratio is approaching 200%. Greece, Italy, and Spain with its 20% unemployment are other countries among many now grappling with high debt.
Specifically, Reinhart and Rogoff found that countries north of the 90% gross debt-to-GDP ratio experienced median growth rates of one percentage point less than those below 90%, and mean growth rates that were four percentage points lower. That is a devastating empirical result for welfare state proponents, and sadly implies the likelihood of an emerging era of lower progress in American living standards.
In the Eurozone, debt-to-GDP ratios have doubled in the post-war era, and are now quite high in most member states. For example, the ratio for the Eurozone as a whole will pass 90% this year; Greece (+150%), Italy (+120%), and Belgium (+100%) are all hard-pressed now with low growth and unsustainable debt burdens, one reason the region is now in a virtual recession.
As a result, taxation in the Eurozone is uniformly higher than in the United States as a result. In Denmark, for example, the highest marginal income tax rate is 59.5%; they have a 25% VAT tax on consumption and purchasing; and their corporate tax is 25% - they also tax capital gains (up to 42%) and estates more than the U.S. But per capita income is about $36,000 in Denmark, right at the OECD average, whereas it is $48,000 in the U.S.
But that 25% gap is actually low - the real gap in the standard of living between Denmark and the U.S. is greater, because the U.S. is a 24/7 society, with greater variety, quality, and choice of goods. Additionally, consumer prices are generally lower here in the U.S., and thus the *real* standard of living differential may well be 40% or more (for example, the cost of a Combo Meal in the U.S. is typically $6.00 or below, whereas in Denmark the same purchase is roughly $11.43). Further, unemployment has usually been lower here in the U.S. than in western Europe for most of the post-war era (though that is no longer true at the moment).
Robert Samuelson summed up the European situation nicely this week when he said
Government expansion was one of the 20th century's great transformations. Wealthy nations adopted programs for education, health care, unemployment insurance, old-age assistance, public housing and income redistribution.
"Public spending for these activities had been almost nonexistent at the beginning of the 20th century," writes economist Vito Tanzi in his book "Government versus Markets."
The numbers - to those who don't know them - are astonishing. In 1870, all government spending was 7.3% of national income in the U.S., 9.4% in Britain, 10% in Germany and 12.6% in France. By 2007, the figures were 36.6% in the U.S., 44.6% for Britain, 43.9% for Germany, 52.6% in France.
That is to say, the mess in Europe today is the logical and necessary consequence of the policies of the welfare state: a cycle of higher borrowing, spending and taxes stifles the entrepreneurship, capital formation, and economic growth that alone can sustain the higher spending. Said again differently, Europe is now living through a torpor of its own making, largely in Brussels alongside sovereign capitals, but entirely the fault of the political class. Worse, dependence on the de facto subsidies borne of American dynamism last only as long as America itself remains vibrant - that is to say, that American policies do not replicate those of Europe. Sadly, Europeans may well over time feel the inevitable consequence of their favorite American President Obama's reverence for the European model, as American trade and investment dries up due to slower growth here. Sow the wind, reap the whirlwind.
The long awaited "day of reckoning" is at hand for the Eurozone. The inability of seventeen sovereign governments so far to address a looming catastrophe on the continent's periphery is often blamed on the lack of unified fiscal authority in the Eurozone. That the recent SuperCommittee negotiations in the U.S. Congress ended in equal failure suggests rather that the problem is deeper: the real void here is effectiveness of the political class to mediate the inevitable conflicts that arise in the redistributive state. The U.S. is not Greece yet by any means and nothing in our future is fore-ordained; policy change at some level is coming. But it is not a happy prospect, this holiday season, to watch the convulsions in Europe and recognize the warning echo pinging American shores.
