Free Markets, Free People

Welfare State’s Death Spiral

Robert Samuelson sees what is going on with Greece and the PIIGS as the beginning of the end for the welfare state:

What we’re seeing in Greece is the death spiral of the welfare state. This isn’t Greece’s problem alone, and that’s why its crisis has rattled global stock markets and threatens economic recovery. Virtually every advanced nation, including the United States, faces the same prospect. Aging populations have been promised huge health and retirement benefits, which countries haven’t fully covered with taxes. The reckoning has arrived in Greece, but it awaits most wealthy societies.

In fact, it is more basic than that.

The welfare state’s death spiral is this: Almost anything governments might do with their budgets threatens to make matters worse by slowing the economy or triggering a recession. By allowing deficits to balloon, they risk a financial crisis as investors one day — no one knows when — doubt governments’ ability to service their debts and, as with Greece, refuse to lend except at exorbitant rates. Cutting welfare benefits or raising taxes all would, at least temporarily, weaken the economy. Perversely, that would make paying the remaining benefits harder.

Catch 22 – Countries that will, regardless of what they do, adversely effect their economy.  They must pick their poison if they want to remain afloat.  All Greece demonstrates is a country further down the road toward this death spiral than others.   Samuelson points to this in some debt figures as a percent of GDP:

Countries everywhere already have high budget deficits, aggravated by the recession. Greece is exceptional only by degree. In 2009, its budget deficit was 13.6 percent of its gross domestic product (a measure of its economy); its debt, the accumulation of past deficits, was 115 percent of GDP. Spain’s deficit was 11.2 percent of GDP, its debt 56.2 percent; Portugal’s figures were 9.4 percent and 76.8 percent. Comparable figures for the United States — calculated slightly differently — were 9.9 percent and 53 percent.

I think you can see the trend.

Dean Baker disagrees with Samuelson, claiming Samuelson seems to have forgotten there’s a recession going on and parroting the old and increasingly discredited line that this is a time governments must spend more:

During recessions budget deficits always expand as tax collections fall and spending on items like unemployment insurance and other benefits rise.

Contrary to what Samuelson claims in this column. Most European countries have been willing to pay the taxes needed to support their welfare states. And this has not prevented them from maintaining rates of productivity growth (the long-term determininat of living standards) comparable to the United States.

But a quick check of some OECD numbers don’t seem to bear Dean’s claim that they’ve maintained productivity growth has rivaled those of the US (who, btw, is also in trouble and headed down this road):

Take a look at the PIIGS. Other than Ireland, those are not productivity numbers to brag about. In fact, look at the Euro 15. Those are not numbers to sustain the type of welfare system Europe has laid on and they certainly don’t signal healthy economies. They instead point to economies which are quite fragile and susceptible to downturns at any moment.

Samuelson is right – this is the biggest and best warning welfare states are going to receive. We can’t afford what governments have been doing for decades. Greece is the canary in the coal mine. We ignore it at our peril.


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20 Responses to Welfare State’s Death Spiral

  • But there is something coming Thursday night that, to my mind, is a blunder big enough to warrant the criticism: the Greek columns on the stage of The Invesco Field where Obama is to give his acceptance speech.

    Sometimes people stumble upon the truth and don’t even know it.
    Obama has made us all “Greeks” now

  • “Most European countries have been willing to pay the taxes needed to support their welfare states”

    Yes and no.
    They have been willling to support CURRENT expenditures. It remains to be seen if they are willing, or able, to support their larger future obligated expenditures. Sweden has already reached the point where they seem to be reluctant.

  • The argument about spending your way out of a recession might have some validity if not for the fact that governments in Europe and the USA (and, if I am not mistaken, numerous other nations around the globe) also run deficits when things are going relatively well.  If deficit spending only occurred when the economy was in recession, then it wouldn’t be an issue because you could make it up once the economy rebounded.  But we’ve been digging this hole for a while now, through good times and bad, and we are finally reaching the point where we cannot simply ignore our growing debt.

    The Greek government is facing a very angry and volatile public, but they can no longer assuage that anger by writing IOUs and increasing spending.  Governments can lie and cheat in order to put off economic pain, but there comes a point when it has to be dealt with.  And by putting it off for so long, you make the moment of reckoning that much worse.

    • That’s a good point. It seems that the political class believes, with some justification based on the last 70 years, that they can excuse deficits during bad times with Keynesian arguments, and that no one will pay much attention to what’s happening during the upward part of the cycle. So they get to run deficits that they never pay back.

      (And for goodness sake, I wish the economically illiterate people who talk about “Clinton’s surpluses” understood enough accounting to know that federal liability went up every year of his term, even when the semi-rigged on-the-books budget temporarily ran a surplus. In fact, I consider TARP part of the reconciliation of the federal liabilities racked up in housing during Clinton’s term.)

      • Keynesian economics has never worked.  It did not work during the depression.  It did not work for Japan.  It has not worked for the US during this recession.  Keynesian economics is nothing more than a pseudo justification for politicians to do what they do best… spend money.  When the politicians are done with their spending, all that is left is more debt.
        It is sad to see Rohmer, who wrote a paper showing tax cuts had a higher multiplier than government spending, now tying herself into knots trying to show the nearly $1 trillion  “stimulus” actually did something.
        Samuelson is right and Dean Baker is wrong.  But, it easier and more fun for our politicians to pretend the opposite.  That is why I have little hope the current crop of politicians will get the message of Greece.
        We have just seen the European politicians and central bankers decide to follow the US lead and socialize losses by taking unpayable Greek debt off the balance sheets of the banks and onto the backs of the taxpayers.  Both the welfare state and the sovereign debt loads will implode.  But, as Aragon said “Today is not that day”.  We will muddle along a lot further before it is too late to take any useful action and we will be looking at misery and ruin.
        But, maybe I am being too optimistic.  Over to Scott.

  • As if on cue …

    Democratic leaders are looking in the next three weeks to send President Barack Obama a slew of measures that cost more than $200 billion, including a multiyear extension of unemployment benefits, an extension of expiring tax provisions and Medicare doctor payments totaling $180 billion and a $33 billion Afghanistan war supplemental bill.
    Because most of those costs won’t be paid for, Republicans plan to use those bills and the Democrats’ budget blueprint to highlight massive deficits ahead of the congressional midterm election. Republicans have recently been pointing to Greece’s dismal fiscal situation as a warning, claiming that the U.S. will be headed for a similar fate unless the deficits are curtailed.

  • Most economists would disagree with Rick about Keynes — he’s still the king of the hill for economic theory, especially now that supply side’s weaknesses have been shown.  But I see what he’s saying, a misunderstanding of Keynes is often used to rationalize constant spending and increased governmental scope.   But that’s not what Keynes was all about.
    Keynes would not have wanted increased deficit spending during booms, which is what almost all countries have been doing — the US really pushed in that direction starting in the eighties.  Moreover, a correct understanding of Keynes would not be to say he was arguing for a welfare state, only that you can manipulate demand to impact macro economic cycles.
    As to Europe — Greece is not Germany, the corruption rampant in southern European economies stems from a weak state and legal structure.   Germany and Scandinavian states could afford rational social welfare systems and there is no inherent problem with providing a rational safety net.   What we see in Greece, besides basic skimming off the government, is irrational social welfare programs which thwart economic activity.   Some of that exists in northern Europe, and in the US (social security is one).
    The only solution I see is: a) short term economic stimulus to get back to growth; b) radical welfare reform to cut spending.   But it should be pragmatic, not ideological — the current financial crisis shows us that trusting markets as if they operate best doesn’t work either.    Have safety nets and social protections, along with such basics as education and health care, accessible to all.   That does not mean equal access to all (again, that’s ideology from the left), and wealthier folk may need to give up pensions and social security.    We need a social welfare system that fosters equal opportunity, but it has to be affordable in these demographic trends; c) preparation for the decline of oil resources and its impact on the economy — this is potentiially as big a problem as demographics, and higher oil prices can also halt economic gain.   Here governments need to collaborate with private sector actors; and finally d) a spirit of working together to solve this rather than ideological jihad.
    I see the far left increasingly lashing out at Obama as a centrist “sell out” to big money and the GOP.   I see the far right calling him a socialist and delusional, using smears to discredit him.  The two groups live in different political universes, every issue, every individual and every problem means something fundamentally different to each group.   They cannot communicate or cooperate because they are speaking different languages.   If that continues, there can be no solution to this crisis.   People seem to assume those who think differently than themselves are inherently ignorant or of bad character, and thus close the door to communication — on all sides of the political spectrum.   Unless that changes, solutions can’t be reached.

    • Your example of Social Security underlines another problem, one that we’re seeing in action in Greece.  Namely, once you bring people to the trough, it is very difficult to ask them to step back.  Especially when they spent a lifetime filling the trough for others.  Social Security is a huge problem for us going forward.  We spent the funds as quickly as they were being collected, and it is already paying out more than it collects, a gap that will widen quickly with time.

      But if you ask Mr. and Mrs. Jones, who are in their 70s and spent decades paying into SS, to just give it up for the greater good, they are not going to be happy about that.  They’re facing the last years of their lives, and they’re being told that the rug is being yanked out from under their feet.  With less justification (IMO) the workers in Greece who were handed overly generous pay, health, and retirement packages are protesting vigorously (and in some cases, violently) at being told that their free lunch will now feature much smaller portions.

      The idea that politicians can responsibly manage an economy is folly.  The market may not be perfect, but at its heart it is designed to reward good business behavior and punish bad decisions and wanton greed.  Government does not have that hedge– even many self-proclaimed fiscal hawks will reach for the pork when it’s time to run for re-election.  A politician who tries to get us to take that bad but necessary medicine will be hung in effigy (if not literally).  I think that the biggest problem in places like Greece, and soon the USA, is that even now, any attempts at getting our fiscal house in order will be political suicide.

      • I agree with a lot of what you say.  I agree that governments cannot manage the economy.  What one needs is rational regulation so that powerful actors can’t subvert the market, or use their position, knowledge or power to gain an unfair advantage.  Regulations are not meant to destroy markets, but protect their ability to function.  But we are definitely not Greece, your example is right there.  The scope and nature of Greece’s problems are qualitatively different than ours or even Germany’s.    It was really short sighted of the EU to let Greece into the Eurozone back in 2001 (they originally were left out when the original decision was made in 1998).

        • Texas is not California either, but if Texas has to pay for California, its a big issue. Germany is an export machine, but its banks are not so good and now the export machine will have to pay for all of the hinky debt the ECB just bought. (Though the depreciation of the Euro will help them.)
          Germany, Netherlands, and Scandinavia have quietly been scaling back the welfare state and lowering unit labor costs. They have private retirement accounts and school vouchers in Sweden. Plus, for their tax dollar they get some decent education and infrastructure…meanwhile California is more like Greece – poor return on tax dollars. It will be a pulling political teeth the get it fixed, and raising taxes just will push companies to relocate to better locales in the USA – something Greek companies can’t do so easily.
          I also suspect there may be serious, serious political issues in Germany if the people feel they are propping up multiple “foreign” countries and those countries don’t show true commitment to austerity. I think even Texans who pay federal taxes to bail out California at least have some cultural and national affinity for Californians…but Germans and Greeks? Not so much.
          I am not so sanguine either the USA or the EU will see growth pick up to cover up these deficits. Banking crisis recessions last a long time. Demographics are working against the recovery. Leverage has been pushed onto the sovereign…not good combinations.

    • There was a time most people thought the earth was flat.  What matter about Keynes is if his theories work.  They do not.  It is not at all clear what Scott means by “supply side’s weaknesses have been shown”.  Offhand, I know of no example where the Keynes theory of running surpluses during boom times has ever actually been done.

      Obama has made no attempt to invoke supply side, but instead invoked Keynes to no avail.   Even worse, the administration derailed any possibility of a stimulus by railing about increasing taxes and letting the Bush tax cuts expire, talking about and then passing health care which is coming in with substantially increased  costs and increased burdens on business and letting the minimum wage increases make it even more difficult for marginal workers to find actual jobs.

      Greece may not be Germany, but Germany is also  not Spain, Portugal, or Italy either.  All that is happening is the hapless German taxpayer is assuming other countries debt (as well as the hapless US taxpayer via the IMF).   And, the German taxpayers have noticed as Merckel has just found out.  I believe a large part of failure of the Vittner amendment to audit the Fed is because our politicians really don’t want us taxpayers to understand what they have let the Fed do to us and for the banks.


      • It would help if you’d give a substantive criticism of Keynes’ theories.  You seem to be criticizing the politicians for not following the kind of advice Keynes would give.  I agree.  That’s a problem of the politicians, not neo-classical economics.   The economic world seems to be acting as Keynesian theory would predict, given the economic policies made.   The high debt levels and social welfare systems in places like Greece would no doubt be condemned by Keynes if he were still around.
        It’s pretty clear why we’re bailing Greece out (and the Fed involved in swaps and other under the radar aid to Greece).   There is palpable fear that if the contagion spreads, we’ll have a catastrophic world catastrophe.    I do think that can be avoided, but I don’t see how it can without some kind of bailout.  I’m not sure taxpayers understand the risk of doing nothing — this may be a case where politicians have to act in the good of the country even if the mass public opposes it.  I don’t see any good options here.

        • The problem is that Keynes spoke out of both sides of his mouth. You are correct that his original theories stated that you were to run up surpluses in good times and spend them in bad times.
          However, he quickly changed his tune and advocated deficit spending when he was being tapped for advice by both the USA and British governments.
          Furthermore, the type of spending he advocated is fairly worthless. He was quite OK with substanceless make work projects.

        • Also, most people by Keynesism do not mean Keynes alone but the school of thought – probably now most taken up by Krugman.
          Didn’t Keynes eventually say that government spending would always be too slow, and ended up more or less saying tax cuts were  a better way?
          And, yes, he did talk out of both sides of his mouth.
          Austrian economics is slowly gaining more acceptance, especially as it explains this sort of recession far better than Keynes can.

          • I think the Austrian school has insights, as does Keynesian neo-classical economics (I’m more interested in the theory than the advice he gave governments).   The problem is that economic theory is by definition a vast over simplification of reality.   More likely there are true insights in the Austrian school and Keynesianism that pragmatically can be used to understand the situation.  The idea one “school” would be completely right and the other completely wrong makes no sense — the world isn’t so easily simplified and turned into pure theory.

        • Scott, it does not matter what Keynes actually proposed.  It is how his prescription is implemented.  Marx would have been horrified at how the Soviets, Chinese, Koreans, and Cubans  implemented Marxism, but those implementations are inevitable.    Keynesian economics will always be implemented by politicians as increasing debt.  Yet, as debt increases, the ability to monetize the debt and the impact of any fiscal stimulus declines.

          This chart has been floating around on various sites.  This version addresses monetization, but other variants address a similar result for increasing stimulus:

          The net of it all is “the more Keynesian you are, the less Keynesian economics works”.

          I fully expect the bailouts to ultimately fail.  We are just delaying the catastrophe and making it bigger.  Greenspan delayed the impact of the dot com bubble, but created the real estate bubble.  It is all a big marshmallow: push one place and it will pop out somewhere else.  But, it will pop out bigger.

          Does anybody really think Greece will be able to send 6% of its GDP to foreigners as interest payments?  That is what this bailout contemplates.  Given that, how likely is there to be a solution for Portugal, Italy, and Spain.  Already, the Germans consider themselves the schmucks if Europe:

          How much more will the Germans take?  This bailout is an “all in” Ponzi scheme.  There is nothing in reserve
          Now, France is threatening England over England not helping Greece.  Lovely.

          Meanwhile, the band plays on in the US stock market.

  • Its also demography. Higher taxes on a smaller population may not work to pay for all the old retired folks.

    • It won’t.   I understand the talk about social security as a promise or a guarantee.  But sometimes reality simply can’t sustain such promises, and social security is likely one of those times.   On this issue, by the way, I clearly break with what almost all Democrats would argue!

      • To be fair, I think almost all Democrats know this too. Only the politicians and some partisans in Washington think its something they can keep on paying. Its very handy lie to beat up the opposition with.
        That said, so far its political poison to touch it. I suspect this financial crisis and recession is starting to reveal these lies though – and it will not be pretty.

  • Harun, Rick and Kyle — I know this looks like a plug of my own website, but it’s actually a result of your comments getting me to think through the issue represented by Greece and also questioning my own understandings.   Rather than post a long response in the comment section here, I have my own blog entry “Avoiding a Great Depression” today on my blog.   Essentially I argue that we have three structural changes: too much debt (public and private), demographic change, and reliance on cheap energy.   This means that economic practices that we are used to are no longer sustainable.   To avoid a global depression, we need to fundamentally rethink how our system functions.   There is a path  out, I think, but also a risk that we’ll end up with political division, populist rebellion to change, and ultimately even civilizational stagnation.