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Archive for the ‘Fiscal Crisis’ Category

I have repeatedly warned that nations get in fiscal trouble when government is too big and growing too fast.

In such countries, it’s very common to find high levels of government debt as one of the symptoms of excessive spending.

This can create the conditions for a fiscal crisis, particularly during an economic downturn. Simply stated, investors (the people who buy government bonds) begin to worry that governments may renege on their promises (i.e., default).

There’s a must-read story on this issue in today’s Washington Post suggesting that the economic fallout from coronavirus has created conditions for new fiscal crises in nations across the globe.

Authored by Alexander VillegasAnthony Faiola Lesley Wroughton, the report explains that the downturn has produced record levels of debt.

Around the globe, the pandemic is racking up a mind-blowing bill: trillions of dollars in lost tax revenue, ramped-up spending and new borrowing set to burden the next generation with record levels of debt. In the direst cases — low- and middle-income countries, mostly in Africa and Latin America, that are already saddled with backbreaking debt — covering the rising costs is transforming into a high-stakes test of national solvency. …By the end of 2020, total government debt worldwide was projected to soar by $9 trillion and top 103 percent of global GDP, according to the Institute of International Finance — a historic jump of more than 10 percentage points in just one year. Countries have maxed out their figurative credit cards.

Keep in mind, by the way, that spending burdens were climbing in most nations, leading to more red ink, even before the pandemic.

That was true in developed nations (the U.S., Europe, Japan), but also in developing nations.

And, the story explains that developed nations are far more vulnerable to fiscal crisis.

The pandemic is hurtling heavily leveraged nations into an economic danger zone, threatening to bankrupt the worst-affected. Costa Rica, a country known for zip-lining tourists and American retirees, is scrambling to stave off a full-blown debt crisis, imposing emergency cuts and proposing harsher measures that touched off rare violent protests last fall. …Angola, in contrast, effectively shut out of global markets, is racing to strike a deal with the Chinese, but even that might not be enough to prevent a painful debt crisis. Sri Lanka, locked in recession, needs to make $4 billion in debt payments this year with only $6 billion in the bank. Brazil’s debt, worsened by a yawning budget deficit, has surged to a crippling 95 percent of GDP — raising alarm over the medium-term ability of the Latin American giant to stay afloat. …Zambia, once a shining example of Africa’s economic renaissance, is now the Ghost of Crises Future for debt-burdened countries slammed by the pandemic. The sub-Saharan nation fell into default in November.

Here’s a visual from the report.

To simplify, it’s good to be in a lighter-colored nation and bad to be in a darker-colored country. At least in terms of national debt burdens.

All this grim data understandably raises the very important question of what choices governments should now make.

Sadly, some self-styled experts are actually urging even more spending, mostly because of a dogmatic belief in the supposed elixir of Keynesian economics. In other words, they want governments to dig a deeper hole.

Analysts argue that the need for stimulus to keep economies running during this historically challenging period still outweighs the need to balance budgets. …the IMF…is telling countries that now is not the time to scrimp, lest they jeopardize still-fragile economic recoveries.

Politicians will want to follow that advice because it tells them that their vice (buying votes with other people’s money) is a virtue (more spending magically can boost growth).

In the real world, there are two big lessons we should learn.

  • First, it’s profoundly reckless to further increase tax and spending burdens when nations are already in trouble because of previous bouts of fiscal profligacy.
  • Second, countries should focus on spending restraint in both the short run and long run, ideally by enacting caps to limit annual spending increases.

For what it’s worth, the U.S. would be in great shape today if, back in 2000, lawmakers had adopted a Swiss-style spending cap.

P.S. One reason that spending caps work so well is that there’s built-in flexibility when dealing with economic volatility.

P.P.S. Financing government with the printing press won’t work any better than financing it with taxes and debt.

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Yesterday, the Congressional Budget Office released updated budget projections. The most important numbers in that report show what’s happening with the overall fiscal burden of government – measured by both taxes and spending.

As you can see, there’s a big one-time spike in coronavirus-related spending this year. That’s not good news, but more worrisome is the the longer-run trend of government spending gradually climbing as a share of economic output (and the numbers are significantly worse if you look at CBO’s 30-year projection).

Most reporters and fiscal wonks overlooked the spending data, however, and instead focused on the CBO’s projection for government debt.

Since government spending is the problem and borrowing is merely a symptom of that problem, I think it’s a mistake to fixate on red ink.

That being said, Figure 3 from the CBO report shows that there’s also an upward-spike in federal debt.

And it is true (remember Greece) that high levels of debt can, by themselves, produce a crisis. This happens when investors suddenly stop buying government bonds because they think there’s a risk of default (which happens when a government is incapable or unwilling to make promised payments to lenders).

I think some nations are on the verge of having that kind of crisis, most notably Italy.

But what about the United States? Or Japan? And how’s the outlook for Europe’s welfare states?

In other words, what nations are approaching a tipping point?

A new study from the European Central Bank may help answer these questions. Authored by Pablo Burriel, Cristina Checherita-Westphal, Pascal Jacquinot, Matthias Schön, and Nikolai Stähler, it uses several economic models to measure the downside risks of excessive debt.

The 2009 global financial and economic crisis left a legacy of historically high levels of public debt in advanced economies, at a scale unseen during modern peace time. …The coronavirus (COVID-19) pandemic is a different type of shock that has dramatically affected global economic activity… Fiscal positions are projected to be strongly hit by the crisis…once the crisis is over and the recovery firmly sets in, keeping public debt at high levels over the medium term is a source of vulnerability… The main objective of this paper is to contribute to the stabilisation vs. sustainability debate in the euro area by reviewing through the lens of large scale DSGE models the economic risks associated with regimes of high public debt.

Here’s what they found, none of which should be a surprise.

…we evaluate the economic consequences of high public debt using simulations with three DSGE models… Our DSGE simulations also suggest that high-debt economies…can lose more output in a crisis…have less scope for counter-cyclical fiscal policy and…are adversely affected in terms of potential (long-term) output, with a significant impairment in case of large sovereign risk premia reaction and use of most distortionary type of taxation to finance the additional public debt burden in the future.

Here’s a useful chart from the study. It shows some sort of shock on the left (2008 financial crisis or coronavirus being obvious examples), which then produces a recession (lower GDP) and rising debt.

That outcome isn’t good for nations with “low” levels of debt, but it can be really bad for nations with “high” debt burdens because they have to deal with much higher interest payments, much bigger tax increases, and much bigger reductions in economic output.

For what it’s worth, I don’t think the study actually gives us any way of determining which nations are near the tipping point. That’s because “low” and “high” are subjective. Japan has an enormous amount of debt, yet investors don’t think there’s any meaningful risk that Japan’s government will default, so it is a “low” debt nation for purposes of the above illustration.

By contrast, there’s a much lower level of debt in Argentina, but investors have almost no trust in that nation’s especially venal politicians, so it’s a “high” debt nation for purposes of this analysis.

The United States, in my humble opinion, is more like Japan. As I wrote last year, “We probably won’t even have a crisis in the next 10 years or 20 years.” And that’s still my view, even after all the spending and debt for coronavirus.

The study concludes with some common-sense advice about using spending restraint and pro-market reforms to create buffers (some people refer to this as “fiscal space“).

Overall, once the COVID-19 crisis is over and the economic recovery firmly re-established, further efforts to build fiscal buffers in good times and mitigate fiscal risks over the medium term are needed at the national level. Such efforts should be guided by risks to debt sustainability. High debt countries, in particular, should implement a mix of fiscal discipline and wide-ranging growth-enhancing reforms.

Needless to say, there’s an obvious and successful way of achieving this goal.

P.S. Here’s another chart from the ECB study that is worth sharing because it confirms that not all tax increases do the same amount of economic damage.

We see that consumption taxes (red line) are bad, but income taxes on workers (green line) are even worse.

And if the study included an estimate of what would happen if there were higher income taxes on saving and investment, there would be another line showing even more economic damage.

P.P.S. History shows that nations can reduce very large debt burdens if they follow my Golden Rule.

P.P.P.S. There’s a related study from the IMF that shows how excessive spending is a major warning sign that nations will be vulnerable to fiscal crisis.

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Because of changing demographics and poorly designed entitlement programs, the burden of government spending in the United States (in the absence of genuine reform) is going to increase dramatically over the next few decades.

That bad outlook will get even worse thanks to all the coronavirus-related spending from Washington.

This is bad news for America since more of the economy’s output will be consumed by government, leaving fewer resources for the private sector. And that problem would exist even if all the spending was magically offset by trillions of dollars of unexpected tax revenue.

Many people, however, think the nation’s future fiscal problem is that politicians will borrow to finance  that new spending. I think that’s a mistaken view, since it focuses on a symptom (red ink) rather than the underlying disease (excessive spending).

But regardless of one’s views on that issue, fiscal policy is on an unsustainable path. And that means there will soon be a fight between twho different ways of addressing the nation’s grim fiscal outlook.

  • Restrain the growth of government spending.
  • Divert more money from taxpayers to the IRS.

Fortunately, we now have some new evidence to help guide policy.

A new study from the Mercatus Center, authored by Veronique de Rugy and Jack Salmon, examines what actually happens when politicians try to control debt with spending restraint or tax increases.

Here’s what the authors wanted to investigate.

Fiscal consolidation can take two forms: (1) adopting a debt-reduction package driven primarily by tax increases or (2) adopting a package mostly consisting of spending restraint. …What policymakers might not know is which of these two forms of consolidation tend to be more effective at reining in debt levels and which are less harmful to economic performance: tax-based (TB) fiscal consolidation or expenditure-based (EB) fiscal consolidation.

Here’s their methodology.

Our analysis focuses on large fiscal consolidations, or consolidations in which the fiscal deficit as a share of GDP improves by at least 1.5 percentage points over two years and does not decrease in either of those two years. …A successful consolidation is defined as one in which the debt-to-GDP ratio declines by at least 5 percentage points three years after the adjustment takes places or by at least 3 percentage points two years after the adjustment. …Episodes in which the consolidation is at least 60 percent revenue increases are labeled TB, and episodes in which the consolidation is at least 60 percent spending decreases are labeled EB.

And here are their results.

…of the 45 EB episodes, more than half were successful, while of the 67 TB episodes, less than 4 in 10 were successful. …The results in table 2 show that while in unsuccessful adjustments most (74 percent) of the changes are on the revenue side, in successful adjustments most (60 percent) of the changes are on the expenditure side. In successful adjustments, for every 1.00 percent of GDP increase in revenues, expenditures are cut by 1.50 percent. By contrast, in unsuccessful adjustments, for every 1.00 percent of GDP increase in revenues, expenditures are cut by less than 0.35 percent. From these findings we conclude that successful fiscal adjustments are those that involve significant spending reductions with only modest increases in taxation. Unsuccessful fiscal adjustments, however, typically involve significant increases in taxation and very modest spending reductions.

Table 2 summarizes the findings.

As you can see, tax increases are the least effective way of dealing with the problem. Which makes sense when you realize that the nation’s fiscal problem is too much spending, not inadequate revenue.

In my not-so-humble opinion, I think the table I prepared back in 2014 is even more compelling.

Based on IMF data, it shows nations that imposed mutli-year spending restraint and how that fiscally prudent policy generated very good results – both in terms of reducing the spending burden and lowering red ink.

When I do debates at conferences with my left-wing friends, I almost always ask them to show me a similar table of countries that achieved good results with tax increases.

Needless to say, none of them have ever even attempted to prepare such a list.

That’s because nations that repeatedly raise taxes – as we’ve seen in Europe – wind up with more spending and more debt.

In other words, politicians pull a bait-and-switch. They claim more revenue is needed to reduce debt, but they use any additional money to buy votes.

Which is why advocates of good fiscal policy should adamantly oppose any and all tax increases.

Let’s close by looking at two more charts from the Mercatus study.

Here’s a look at how Irish politicians have mostly chose to restrain spending.

And here’s a look at how Greek politicians have mostly opted for tax increases.

It goes without saying (but I’ll say it anyhow) that the Greek approach has been very unsuccessful.

P.S. For fiscal wonks, one of the best parts of the Mercatus study is that it cites a lot of academic research on the issue of fiscal consolidation.

Scholars who have conducted research find – over and over again – that spending restraint works.

In a 1995 working paper, Alberto Alesina and Roberto Perotti observe 52 efforts to reduce debt in 20 Organisation for Economic Co-operation and Development (OECD) countries between 1960 and 1992. The authors define a successful fiscal adjustment as one in which the debt-to-GDP ratio declines by at least 5 percentage points three years after the adjustment takes place. In successful adjustments, government spending is reduced by almost 2.2 percent of gross national product (GNP) and taxes are increased by less than 0.5 percent of GNP. For unsuccessful adjustments, government expenditure is reduced by less than 0.5 percent of GNP and taxes are increased by almost 1.3 percent of GNP. These results suggest that successful fiscal adjustments are those that cut spending and include very modest increases in taxation.

International Monetary Fund (IMF) economists John McDermott and Robert Wescott, in a 1996 paper, examine 74 episodes of fiscal adjustment in which countries attempted to address their budget gaps. The authors define a successful fiscal adjustment as a reduction of at least 3 percentage points in the ratio of gross public debt to GDP by the second year after the end of an adjustment. The authors then divide episodes of fiscal consolidation into two categories: those in which the deficit was cut primarily (by at least 60 percent) through revenue increases, and those in which it was reduced primarily (by at least 60 percent) through expenditure cuts. Of the expenditure-based episodes of fiscal consolidation, almost half were successful, while of the tax-based episodes, less than one out of six met the criteria for success.

Jürgen von Hagen and Rolf Strauch observe 65 episodes in 20 OECD countries from 1960 to 1998 and define a successful adjustment as one in which the budget balance stands at no more than 75 percent of the initial balance two years after the adjustment period. …it does find that successful consolidations consist of expenditure cuts averaging more than 1.2 percent of GDP, while expenditure cuts in unsuccessful adjustments are smaller than 0.3 percent of GDP. The opposite pattern is true for revenue-based adjustments: successful consolidations consist of increases in revenue averaging around 1.1 percent, while unsuccessful adjustments consist of revenue increases exceeding 1.9 percent.

American Enterprise Institute economists Andrew Biggs, Kevin Hassett, and Matthew Jensen examine over 100 episodes of fiscal consolidation in a 2010 study. The authors define a successful fiscal adjustment as one in which the debt-to-GDP ratio declines by at least 4.5 percentage points three years after the first year of consolidation. Their study finds that countries that addressed their budget shortfalls through reduced spending burdens were far more likely to reduce their debt than countries whose budget-balancing strategies depended upon higher taxes. …the typical successful adjustment consists of 85 percent spending cuts and just 15 percent tax increases.

In a 1998 Brookings Institution paper, Alberto Alesina and coauthors reexamined the research on the economic effects of fiscal adjustments. Using data drawn from 19 OECD countries, the authors assess whether the composition of fiscal adjustments results in different economic outcomes… Contrary to the Keynesian view that fiscal adjustments are contractionary, the results of this study suggest that consolidation achieved primarily through spending reductions often has expansionary effects.

Another study that observes which features of fiscal adjustments are more or less likely to predict whether the fiscal adjustment is contractionary or expansionary is by Alesina and Silvia Ardagna. Using data from 20 OECD countries during 1960 to 1994, the authors label an adjustment expansionary if the average GDP growth rate in the period of adjustment and in the two years after is greater than the average value (of G7 countries) in all episodes of adjustment. …The authors conclude, “The composition of the adjustment appears as the strongest predictor of the growth effect: all the non-expansionary adjustments were tax-based and all the expansionary ones were expenditure-based.”

French economists Boris Cournède and Frédéric Gonand adopt a dynamic general equilibrium model to compare the macroeconomic impacts of four debt reduction scenarios. Results from the model suggest that TB adjustments are much more costly than spending restraint when policymakers are attempting to achieve fiscal sustainability. Annual consumption per capita would be 15 percent higher in 2050 if consolidation were achieved through spending reductions rather than broad tax increases.

In a review of every major fiscal adjustment in the OECD since 1975, Bank of England economist Ben Broadbent and Goldman Sachs economist Kevin Daly found that “decisive budgetary adjustments that have focused on reducing government expenditure have (i) been successful in correcting fiscal imbalances; (ii) typically boosted growth; and (iii) resulted in significant bond and equity market outperformance. Tax-driven fiscal adjustments, by contrast, typically fail to correct fiscal imbalances and are damaging for growth.”

Economists Christina and David Romer investigated the impact of tax changes on economic activity in the United States from 1945 to 2007. The authors find that an exogenous tax increase of 1 percent of GDP lowers real GDP by almost 3 percent, suggesting that TB adjustments are highly contractionary.

…the IMF released its annual World Economic Outlook in 2010 and included a study on the effects of fiscal consolidation on economic activity. The results of studying episodes of fiscal consolidation for 15 OECD countries over three decades…reveals that EB fiscal adjustments tend to have smaller contractionary effects than TB adjustments. For TB adjustments, the effect of a consolidation of 1 percent of GDP on GDP is −1.3 percent after two years, while for EB adjustments the effect is just −0.3 percent after two years and is not statistically significant. Interestingly, TB adjustments also raise unemployment levels by about 0.6 percentage points, while EB adjustments raise the unemployment rate by only 0.2 percentage points.

…a 2014 IMF study…estimates the short-term effect of fiscal consolidation on economic activity among 17 OECD countries. The authors of the IMF study find that the fall in GDP associated with EB consolidations is 0.82 percentage points smaller than the one associated with TB adjustments in the first year and 2.31 percentage points smaller in the second year after the adjustment.

Focusing on the fiscal consolidations that followed the Great Recession, Alesina and coauthors…find that EB consolidations are far less costly for economic output than TB adjustments. They also find that TB adjustments result in a cumulative contraction of 2 percent of GDP in the following three years, while EB adjustments generate very small contractions with an impact on output not significantly different from zero.

A study by the European Central Bank in 2018…finds that macroeconomic responses are largely caused by differences in the composition of the adjustment plans. The authors find large and negative multipliers for TB adjustment plans and positive, but close to zero, multipliers for EB plans. The composition of adjustment plans is found to be the largest contributor to the differences in economic performance under the two types of consolidation plans.

The bottom line is that nations enjoy success when they obey fiscal policy’s Golden Rule. Sadly, that doesn’t happen very often because politicians focus mostly on buying votes in the short run rather than increasing national prosperity in the long run.

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I’ve warned that the budgetary impact of the coronavirus may trigger another fiscal crisis in Europe.

Especially Italy.

But what about the United States? Will we reach a point, as Margaret Thatcher famously warned, of running out of other people’s money?

We probably still have a couple of decades before that happens, as I speculated at the end of a recent interview, but that doesn’t mean we should continue down our current path.

The Wall Street Journal opined on this topic yesterday, citing newly released estimates from the Congressional Budget Office.

Friday’s Congressional Budget Office report on the federal fisc for April…usually a surplus month as tax payments roll in, but the Treasury postponed tax day this year until July 15. We are grateful for such small government favors. Spending more than doubled in April from the year before and revenue fell by 55%. …we are all apparently supposed to be converts to Modern Monetary Theory. This is the view that governments can spend whatever they like because the Federal Reserve can monetize it without economic harm. We may get to test this proposition. …the damage from so much spending will come in two ways. First, in resources misallocated to government rather than into private hands to invest. Second, in the tax increases that the political class will eventually impose, perhaps starting as early as 2021.

As is so often the case, the WSJ is correct in its analysis.

The fiscal crisis won’t be too much red ink. That’s merely the symptom of the real disease, which is that government is getting far too big.

As the editorial warns, this undermines prosperity because resources get diverted from the economy’s productive sector.

And as that spending burden increases, it means more and more pressure for tax increases, which further penalize growth. I’ve already noted that politicians will try to exploit the crisis by imposing a wealth tax, but I think the real prize – in the mind of statists – is a money-gobbling value-added tax.

I’ll close by sharing a chart from Brian Riedl of the Manhattan Institute, which estimates the per-capita burden of inflation-adjusted federal spending in the United States.

The red portion of the chart is coronavirus-related spending, plus future interest payments on the additional borrowing for all that spending, and the blue portion is spending in prior years plus estimates of future spending (already on an upward trajectory because of poorly designed entitlement programs).

That chart does not paint a pretty picture, but Brian’s numbers may be too optimistic. He assumes that the coronavirus-related emergency spending is just temporary and that additional interest on a bigger debt is the only long-run impact.

But if politicians make some of that spending permanent (which will be in their self-interest), then we’ll be traveling even faster in the wrong direction.

All the more reason to impose a spending cap, which is the only major fiscal reform with a track record of success.

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I’m not an optimist about Europe’s economic future.

Most nations have excessive welfare states and punitive taxes, which is hardly good news. You then have to consider demographic trends such as aging populations (i.e., more people relying on government) and falling birthrates (i.e., fewer future taxpayers).

That’s a very grim combination.

Indeed, this is a big reason why I favored Brexit. Yes, it was largely about escaping an increasingly dirigiste European bureaucracy in Brussels, but it was also about not being chained to a continent with a dismal long-run outlook.

More than one year ago, before there were any concerns about a coronavirus-instigated economic crisis, Vijay Victor, an economist from Szent Istvan University in Hungary, expressed concern about Europe’s fiscal future in a column for the Foundation for Economic Education.

The debt crisis in the Eurozone is getting no better, even in the wake of the new year. The five countries in the Eurozone with the highest debt-to-GDP ratio in the third quarter of 2018 were Greece, Italy, Portugal, Belgium, and Spain. The total debt of Greece is around 182.2 percent of its GDP and that of Italy is 133 percent… Dawdling economic growth coupled with low-yield investment options are dragging these indebted economies toward insolvency… Unemployment rates, for example, are still very high in most of these highly indebted European economies. Despite the recurrent monetary assistance and policy support, job creation is weak, which might imply that the debt financing is channelized in a nonproductive direction.

By the way, I can’t resist taking this opportunity to remind people that debt is a problem, but it also should be viewed as a symptom of en even-bigger problem, which is an excessive burden of government spending.

A bloated welfare state is a drag on economic performance, whether it’s financed by borrowing or taxes.

Though nations that try to finance big government with red ink eventually spend their way into crisis (as defined by potential default).

And we may be reaching that point.

Desmond Lachman of the American Enterprise has authored a very grim assessment, focusing primarily on Italy, for the National Interest.

Today, with Italy at the epicenter of the world coronavirus epidemic, it would seem to be only a matter of time before the durability of the Euro is again tested by another full-blown Italian sovereign debt crisis. …even before the coronavirus epidemic struck its economy was weak while its public finances and banking system were in a state of poor health. After having experienced virtually no economic growth over the past decade, the Italian economy again entered into a recession by end-2019. At the same time, at 135 percent its public debt to GDP ratio was higher than it was in 2012 while its banks’ balance sheets remained clogged with non-performing loans and Italian government bonds. …the coronavirus epidemic will seriously damage both Italy’s public finances and its banking system…by throwing the country into its deepest economic recession in the post-war period. That in turn is bound to cause Italy’s budget deficit to balloon and its banking system’s non-performing loans to skyrocket as more of its households and companies file for bankruptcy. …all too likely that the Italian economy will shrink by at least 10 percent in 2020.

All this matters because the people and institutions that purchase government debt may decide that Italy’s outlook is so grim that they will be very reluctant to buy the country’s bonds (i.e., they’ll be very hesitant about lending money to the Italian government because of a concern that they won’t get paid back).

This means that the Italian government will have to pay much higher interest rates in order to compensate lenders for the risk of a potential default.

So what are the implications? Will Italy default, or will there be some sort of bailout?

If the latter, Lachman predicts it will be huge.

One way to gauge the amount of public money that might be needed to prop up Italy is to consider that over the past decade it took around US$300 billion in official support to keep Greece in the Euro. Given that the Italian economy is around ten times the size of that of Greece, this would suggest that Italy might very well need around $3 trillion in official support to keep Italy in the Euro. …Meanwhile, Italy’s US$4 trillion banking system could very well need at least US$1 trillion in official support to counter the capital flight and the spike in non-performing loans that are all too likely to occur in the event of a deep Italian recession.

For what it’s worth, Lachman thinks a bailout would be desirable.

I disagree. Default is a better choice because it will discipline the Italian government (it would mean an overnight balanced budget requirement since nobody will lend money to the government) and also discipline foolish lenders who thought Italian politicians were a good bet.

Simply stated, we should minimize moral hazard.

I also think it’s worth noting that Italy isn’t the only government at risk of fiscal crisis. Here’s the OECD data for major nations, including a few non-European examples.

Japan wins the prize for the most red ink, though this doesn’t mean Japan is most vulnerable to a default, at least in the short run.

A fiscal crisis is driven by investor sentiment (i.e., when will people and institutions decide they no longer trust a government to pay back loans). And that depends on a range of factors, including trust.

The bottom line is that investors trust the Japanese government and they don’t trust the Italian government.

That being said, I think all of the PIGS (Portugal, Italy, Greece, and Spain) are very vulnerable.

And politicians in Ireland, Belgium, and France should be nervous as well.

I’ll close by sharing some calculations, based on the aforementioned OECD data, showing which nations used last decade’s economic recovery to improve their balance sheets.

Congratulations to Germany and Switzerland for fiscal responsibility, and mild applause for the Netherlands and Sweden.

I’ve highlighted (in red) the nations that were most reckless.

Though keep in mind that you want to look at both the trend for debt (far-right column) and the existing level of debt (the next-to-far-right column). So I’m not overly worried about Australia. Debt is still comparatively low, even though it almost doubled last decade.

But all of the PIGS are in trouble.

So if economic conditions deteriorate in Europe, the fallout could be significant.

P.S. The United Kingdom, like Japan, benefits from a high level of trust – presumably in part because the country paid off enormous debts from the Napoleonic wars and World War II. That being said, the numbers for the U.K. are worrisome, which hopefully will lead to a renewed commitment to spending restraint by Boris Johnson’s government.

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Is Greece the international version of New Jersey or is New Jersey the American version of Greece?

Is New Jersey the national version of Chicago, or is Chicago the the local version of New Jersey?

The answer is yes, regardless of how the question is phrased because – in all cases – we’re talking about examples of how politicians (and short-sighted voters) create “Goldfish Government.”

Let’s examine Chicago to see how this process works.

The Washington Post noted early last year that the new mayor was going to face an enormous fiscal challenge because of the reckless choices made by previous generations of politicians.

The city has been underfunding its pensions for decades, with dire results. Chicago’s pension plans collectively have only about a quarter of the assets they’ll need to pay benefits, one of the worst funding ratios in the nation. To put that hole in dollar terms, Chicago is about $28 billion short of what it needs, even under relatively favorable assumptions about future returns, or about $10,000 for every man, woman and child living in the city. …radical surgery still needed. Within a few years, pension contributions are projected to suck up more than 20 percent of the city’s budget. And Chicago can’t count on much help from the state, which is dealing with its own, equally severe case of pension underfunding. …what’s happening in Illinois is merely the earliest and most extreme manifestation of a quandary that will soon be dominating the public conversation in many states: how to pay for retirement promises to public employees without entering a fiscal death spiral. …shoddy accounting allowed generations of politicians all over the country to curry favor with public-sector workers by offering them ever-fatter pension packages, gaining immediate benefit while deferring the political cost of paying for all those benefits until much later. Later is now arriving. …Chicago has been losing lower- and middle-class residents for years, in part because of its heavily regressive tax burden. And when Chicago and Illinois both start raising the rates on upper earners — as they will have to, and soon — they run the risk that those people ,too, will start trickling away, either to smaller cities without the burdensome pension-legacy costs.

Megan McArdle pointed out that Chicago is a mess because of “public choice” – i.e., politicians make short-sighted and irresponsible decisions in order to maximize votes and power.

Throw in a recession sometime in the next couple of years, and Chicago is going to be in a full-blown crisis. …it’s the fault of generations of politicians before them who promised an ever-richer array of benefits to government workers. Particularly, they liked to raise the retirement benefits. …The whole point of giving workers pension benefits instead of cash was that you didn’t have to pay for them; you could promise the benefits now and gather up the votes that the grateful workers tossed at your feet, all without costing current taxpayers a single dime. …Future taxpayers mostly weren’t voting in 1982 municipal elections. …Chicagoans, welcome to “later.” The municipal pensions only have about 25 percent of the assets they’ll need to cover projected benefits, a shortfall of roughly $28 billion. …If you use a more cautious method, you come up with a shortfall of more than $40 billion. …Moody’s Investors Service rates the city’s general obligation debt as junk bonds. …Chicago is now approaching the point where the growth of its obligations will outpace the growth of any possible revenue stream it might use to cover them. It’s a few steps from there to municipal bankruptcy.

Unsurprisingly, Chicago’s relatively new mayor wants to keep the scam going.

As reported by the Chicago Tribune, she wants to extract more money from taxpayers.

Chicago Mayor Lori Lightfoot…said there’s “no question” residents will need to pay more in taxes or fees to plug a looming city budget shortfall… “There’s no question we’re going to have to come to the taxpayers and ask for additional revenue.” …Lightfoot did not specify what sort of revenue she expects to raise — whether it would come in the form of new taxes, a property tax hike or increased fees. …referring to her campaign promise to seek cuts before asking taxpayers for more money, Lightfoot added, “I meant what I said on the course of the campaign: We have a lot of hard choices we’re going to have to make regarding city finances.”

Like previous mayors, she’s buying votes with other people’s money.

The Wall Street Journal opined last year about her surrender to the teacher unions (a Chicago tradition, as illustrated by the adjacent cartoon by Lisa Benson).

Except it wasn’t really a surrender since she was already on their side (as perfectly captured by this Ramirez cartoon).

So the net result is a combination of bad fiscal policy and bad education policy.

Chicago Mayor Lori Lightfoot and the Chicago Teachers Union on Thursday struck an agreement to end an 11-day strike, and by the looks of it the union was bargaining with itself. The mayor is touting the new contract as the most generous in Chicago history, and she’s right. …The new contract includes a 16% raise over five years (not including raises based on longevity), a three-year freeze on health insurance premiums, lower copays, …and more than 450 new social workers and nurses. …you can bet it will be expensive. Last week the mayor proposed a slew of tax increases including levies on ride-hailing services and restaurant meals. This week her staff suggested that property taxes may have to increase . . . again. Michelle Obama the other day complained that white people were leaving the city to escape minorities who are moving in. No, they’re fleeing Chicago’s high taxes and lousy schools—and so are minorities.

This story from Reason is a powerful (and nauseating) example of how a money-hungry city is making life miserable for ordinary people.

Chicago police pulled Spencer Byrd over for a broken turn signal. Byrd says his signal wasn’t broken, but that detail would soon be the least of his worries. …Byrd was giving a client, a man he says he had never met before, a ride… Police pulled both of them out of the car and searched them. Byrd was clean, but in his passenger’s pocket was a bag of heroin… Police released Byrd after a short stint in an interrogation room without charging him with a crime. But when Byrd went to retrieve his car, he found out the Chicago Police Department had seized and impounded it. …The program impounds cars when the owner beats a criminal case or isn’t charged with a crime in the first place. It impounds cars even when the owner isn’t even driving, like when a child is borrowing a parent’s car. …Byrd calls his car his “livelihood,” and he has been fighting for close to two years now to recover it. He says he has $3,500-worth of tools locked in the trunk, and he can’t retrieve them. …Like tens of thousands of other Chicagoans, Byrd was a victim of years of the city’s fiscal negligence. …to try and nickel-and-dime…out of these massive budget gaps. …The result is a uniquely punitive impound system, in which Chicago profits off restricting the ability of its residents to drive.

Amazingly, Chicago’s politicians want to dig an even deeper hole.

The Wall Street Journal has a new editorial examining a scheme to borrow even more money in hopes of keeping the gravy train rolling.

Chicago has been seeking to take advantage of historically low interest rates by refinancing debt—even as its credit rating has deteriorated amid swelling budget deficits and pension payments. …In 2017 state and city politicians contrived a shell scheme to lower the city’s borrowing costs. The city essentially sold off sales-tax revenue that it receives from the state to a corporation specially created to pay creditors. …Voila, Chicago’s financial magicians spun junk into gold. …Chicago’s budget woes are mounting, and financial alchemists are diluting the claims of existing creditors. If the city were to renege on its $8 billion in GO debt, those bondholders would surely demand a slice of the sales-tax revenue now pledged to other creditors. This is what happened in Puerto Rico. …Chicago’s population has declined for each of the past four years, and taxpayers are getting tapped out. On top of a $50 million increase in property taxes this year, Mayor Lori Lightfoot has imposed a new “congestion” fee on Uber and taxi rides, doubled the tax on restaurant meals, and raised a special personal property tax on computer cloud software. Yet a recession would probably blow a gigantic hole in its budget and could cause its pension funds to run dry. Does anyone think that city politicians wouldn’t prioritize public workers over bondholders?

So when will this house of cards collapse?

I have no idea. There’s a famous quote from the late economist Rudiger Dornbusch, who observed that, “In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”

The people buying bonds from Chicago are betting that the collapse won’t happen in the near future.

But that was the same mentality of the people who bought Greek bonds in, say, 2005.

I’ll simply observe that what’s happening in Chicago is confirmation of my “First Theorem of Government.”

And I’ll also make an easy prediction that the people buying Chicago bonds will want a bailout when the you-know-what hits the fan.

Needless to say, the answer should be a resounding no.

P.S. If you want to know all my Theorems of Government, click here.

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I point out in this interview that the 2011 Budget Control Act (BCA) was the only big victory for taxpayers this century. It imposed spending caps on discretionary spending and led to a sequester in early 2013, which was Barack Obama’s biggest defeat.

The bad news is that the BCA is merely legislation. That means politicians can conspire to bust the spending caps – which is what they did at the end of 2013, as well as in 2015, 2018, and again this year.

This most recent deal may be the worst of the worst. The Committee for a Responsible Federal Budget (CRFB) shows that it brings discretionary spending almost up to the level we reached during Obama’s pork-filled stimulus.

By the way, the chart also shows that Bush was a big spender and that we actually had a bit of spending restraint after the Tea Party-themed 2010 mid-term elections.

But let’s focus on today.

Here’s one more chart from CRFB. It shows that Trump is doing a good job of impersonating Obama with huge, across-the-board spending increases.

These charts show why I’m so depressed. And let’s not forget that they are only measures of discretionary spending. The outlook for entitlement spending is even worse!

In other words, we’re on the path to fiscal crisis. Is there a solution?

Yes, we could adopt constitutional restraints on the growth of government. I mentioned Colorado’s Taxpayer Bill of Rights in the interview, as well as the “debt brake” in Switzerland.

But there’s zero chance that today’s crop of politicians will enact this kind of sensible reform. We’ll probably have to wait until a crisis occurs. At which point it may be too late.

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One of the few theoretical constraints on Washington is that politicians periodically have to raise a “debt ceiling” or “debt limit” in order to finance additional spending with additional red ink.

I have mixed feelings about this requirement. I like that there is some limit on spending, even if it’s only a potential restraint.

On the other hand, fights over the debt limit are mostly just opportunities for Republicans and Democrats to engage in posturing and finger pointing rather than adopt positive reforms.

Moreover, the scholarly research clearly suggests that spending caps are the only effective fiscal rule, so what’s the point of having a debt limit if potential spending restraint never turns into actual spending restraint?

Catherine Rampell of the Washington Post looks at the current fight and opines that we shouldn’t even have a debt limit.

The government is about to run out of money because of an arbitrary cap on how much it can borrow… Lawmakers and the White House are haggling over  the conditions under which they will, once again, temporarily raise that cap, known as the debt ceiling. But the better solution would be to abolish it entirely… Most recently, the government hit the official debt limit on March 1 . Since then, the Treasury Department has engaged in “extraordinary measures” to shift money around and continue paying its bills… Initially Treasury predicted that its extraordinary measures would get us to October, but more recent forecasts suggest we will hit the wall as soon as early September. Which means the drop-dead deadline before we become global deadbeats could happen while Congress is away on summer vacation.

She worries that a failure to raise the debt ceiling could have very negative consequences.

So what happens if we default on our debt obligations? Well, for one, it would violate the Constitution, which says the “validity of the public debt of the United States . . . shall not be questioned.” No small thing. …U.S. debt instruments are currently considered the safest of safe assets because creditors believe they’ll be paid back on time and in full. …Calling our creditworthiness into question could therefore set off a chain reaction of global financial panic.

I agree.

Defaulting on the debt (i.e., not paying bondholders what they’ve been contractually promised) would be very damaging to financial markets.

In reality, however, what we’re really talking about is potentially a delay in making promised payments. Which would be harmful, though presumably not nearly as bad as long-run default.

And even a delay in payments might not happen if the Treasury Department made sure that tax revenue was set aside to make all promised payments to bondholders.

Though Ms. Rampell doesn’t like this idea, which is sometimes called “prioritization.”

Some right-wingers…have in the past suggested  that defaulting is no big deal, perhaps even desirable. They (mistakenly) think that a debt default would allow those in charge to unilaterally decide which bills deserve payment and which don’t, bypassing the democratic budget process.

I’m not sure why she says prioritization is a “mistaken” view.

I testified to Congress about this issue in 2013 and in 2016. If the debt limit isn’t raised, meaning no ability to issue new debt, that would be the same as an overnight balanced budget requirement (i.e., spending could only equal current tax revenue).

If that happened and Treasury made sure to prioritize interest payments (to avoid the potentially bad results Ms. Rampell and others warn about), who would have the power to stop that from happening?

I’m guessing lawsuits would be filed, but I can’t imagine a judge would issue an injunction to require a default.

Let’s dig deeper into this issue. Back in 2017, when a similar fight occurred, Heather Long of the Washington Post identified five reasons to worry.

Unless Trump and Congress pass a law raising the U.S. debt limit — a legal cap on how much the U.S. government is allowed to borrow — the Treasury Department will soon run out of money to pay its bills, triggering a first-in-modern-U.S.-history default that threatens to turn the world economy on its head. …The danger…is that at some point someone will miscalculate and the government will actually hit the debt limit, sparking a default, intentional or otherwise. Here are five reasons that would cause global panic.

How persuasive are these reasons?

First, it would trigger a wild ride for stocks and bonds. Wall Street doesn’t like bad surprises. …There would probably be an immediate, negative reaction in the markets.

If there’s an actual default, that would be horrible news.

If there’s a temporary default, that also would be bad news, though presumably far less catastrophic than a permanent default (though some will fan the flames of hysteria).

Second, America’s cheap funding source would end. …As soon as the United States actually defaults, investors would start suing the country, and they would almost certainly insist on much higher interest rates in the future.

Interest rates surely would climb because of the perception of added risk for investors.

Though I wonder by how much. I think Italy is heading toward a fiscal/financial crisis, yet investors are buying up plenty of that government’s debt at very low interest rates.

Third, real people won’t get paid. …The Trump administration would have to either stop payments to everyone or they would have to pick who gets paid and who does not. That means deciding between bondholders, Social Security recipients, welfare recipients, …etc.

Interesting, Ms. Long accepts that prioritization would happen.

For what it’s worth, I’m guessing bondholders and Social Security recipients would be at the front of the line.

Fourth, America’s global power would decline. …The U.S. dollar is the world’s reserve currency. People carry dollars and hold U.S. bonds all over the world because they believe America is their best and safest bet. A default would probably cause the value of the dollar to drop and global investors to shift some money out of U.S. assets.

This is an interesting claim.

The U.S. dollar is the world’s reserve currency.

Does drama over the debt limit, or even a temporary default, lead investors to shift, en masse, to another currency?

Perhaps, though I don’t see an alternative. The euro is compromised because the European Central Bank surrendered its independence by engaging in indirect bailouts of some of Europe’s decrepit welfare states.

The Chinese financial system is too debt ridden and too opaque to give investors confidence in that nation’s currency. And other nations are simply too small.

Fifth, a recession is possible. …hitting the debt limit could cause a sharp drop in markets and sentiment around the world as everyone worries that if the United States defaults, who’s next? Investors might start panicking and ditching bonds of other countries in Europe and Asia, too.

These are all reasonable concerns.

It all depends, of course, whether there’s a temporary default and how long it lasts.

And since we may be in the midst of a debt bubble fueled by easy money, any triggering event could lead to very bad outcomes.

Which is why it would make sense for lawmakers to embrace prioritization. There has been legislation to make that happen.

For what it’s worth, it should be quite feasible to prioritize.

Here’s the latest 10-year forecast from the Congressional Budget Office. As you can see from the parts I’ve circled, the government is projected to collect far more revenue than would be needed to fulfill obligations to bondholders.

To be sure, prioritization means that some recipients of federal largesse would have to wait in line. This would be unseemly and unwelcome, but it already happens in profligate states such as Illinois without causing any economic or fiscal disarray.

Who knows, maybe politicians would even decide that it’s time to jettison some federal programs. But since I understand “public choice,” I won’t be holding my breath awaiting that outcome.

I’ll close with two observations.

The first, which I’ve already discussed, is that a failure to increase the debt limit should not result in default. Unless, of course, the Treasury Department wants that to happen. But that’s inconceivable, which is why I fully expect prioritization if we ever get to that point.

The second is that debt limit fights are messy and counterproductive, but I don’t want it abolished since there’s a chance that one of these battles eventually may force politicians to deal with our fiscal mess – thus saving the country from a future Greek-style economic and fiscal meltdown.

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In the absence of genuine entitlement reform, the United States at some point is going to suffer from a debt crisis.

But red ink is merely a symptom. I used numbers from Greece in this interview to underscore the fact that the real problem is government spending.

The discussion was triggered by comments from the Chairman of the Federal Reserve.

Federal Reserve Chairman Jerome Powell said Wednesday that reducing the federal debt needs to return to the forefront of the agenda, warning that the government’s finances are unsustainable. “I do think that deficits matter and do think it’s not really controversial to say our debt can’t grow faster than our economy indefinitely — and that’s what it’s doing right now,” Powell said.

As I noted in my comments, Powell is right, but he’s focusing on the wrong variable.

The real crisis is that spending is growing faster than the private sector (Powell needs to learn the six principles to guide spending policy).

To be more specific, politicians are violating my Golden Rule.

Spending grew too fast under Bush. It grew too fast under Obama (except for a few years when the “Tea Party” was in the ascendancy). And it’s growing too fast under Trump.

Most worrisome, the burden of spending is expected to grow faster than the private sector far into the future according to the long-run forecast from the Congressional Budget Office.

That doesn’t mean we’ll have a crisis this year or next year. We probably won’t even have a crisis in the next 10 years or 20 years.

But I cited Greek data in the interview to point out that excessive spending eventually does create a major problem.

Here’s the data from International Monetary Fund’s World Economic Outlook database. To make matters simple (I should have done this for the interview as well), I adjusted the numbers for inflation.

So how can America avoid a Greek-style fiscal nightmare?

Simple, just impose a spending cap. At the end of the interview, I added a plug for the very successful system in Switzerland, but I’d also be happy if we copied Hong Kong’s spending cap. Or the Taxpayer Bill of Rights from Colorado.

The bottom line is that spending restraint works and a constitutional spending cap is the best way to achieve permanent fiscal discipline.

P.S. By contrast, proponents of “Modern Monetary Theory” argue governments can finance ever-growing government by printing money. For what it’s worth, nations that have used central banks to finance big government (most recently, Venezuela and Zimbabwe) are not exactly good role models.

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The long-run fiscal outlook for most developed nations is very grim thanks to demographic change and poorly designed entitlement programs.

For all intents and purposes, we’re all destined to become Greece according to long-run projections from the International Monetary Fund, Bank for International Settlements, and Organization for Economic Cooperation and Development.

Are there any solutions to this “most predictable crisis“?

Politicians such as Alexandria Ocasio-Cortez and Bernie Sanders would like us to believe the answer involves never-ending tax increases. But such an approach is a recipe for more debt because the economy will weaken and governments will spend more money (look at what’s been happening in Europe, for instance).

A more sensible approach is a spending cap. I’ve pointed out, for instance, how Swiss government debt has plummeted ever since voters imposed annual limits on budgetary growth.

We also can learn lessons from history according to new research from the International Monetary Fund.

The report contains some very interesting economic history and the evolution of government finance, including the Bank of England being created and given a monopoly so the government would have a vehicle for borrowing money (as I observed in my video on central banking).

But it mostly tells the story of how governments and public finance simultaneously evolved.

Although the written record points to instances of public borrowing as long as two thousand years ago, recent scholarship points to 1000-1400 A.D. as when borrowing agreements with states were concluded with regularity and debt contracts entered into by sovereigns were standardized. …The supply of loans from city-states and territorial monarchies was driven by the need to finance military campaigns and secure borders. …From the 16th century, Europe’s political geography coalesced into the nation states recognized at the Peace of Westphalia in 1648. In parallel, many European states evolved from absolutist regimes to more limited government. …Fiscal states thus evolved in response to the efforts of rulers to secure borders, expand territory and survive. After 1650, larger, more centralized states increasingly possessed the fiscal machinery to raise revenue in uniform ways and had a veto player, such as a parliament, to monitor and discipline public expenditure.

There’s also lots of information in the report about how some governments, primarily outside of Europe, began to borrow money.

In many cases, this produced bad results, with defaults and economic crisis. As the authors wrote, “Debasement and restructuring also have a long history.”

But the part of the report that caught my eye was the description of how three advanced nations – the United Kingdom, the United States, and France – successfully dealt with large debt burdens before World War I.

…we describe three notable debt consolidation episodes before World War I: Great Britain after the Napoleonic Wars, the United States in the last third of the 19th century, and France in the decades leading up to 1913. While the colorful debt crises and defaults of the first era of globalization have been much discussed, less attention has been paid to these successful consolidation episodes. We focus on these three cases because they involved three of the largest economies of the period, but also because their debt burdens were among the heaviest. British public debt as a share of GDP was higher in the aftermath of the Napoleonic Wars, for example, than Greek public debt in 2018. But in all three cases, high public debts were successfully reduced relative to GDP.

In each case, war-time spending was the cause of the debt buildup.

The Napoleonic Wars, Franco-Prussian War and U.S. Civil War were the three most expensive conflicts of the 19th century. …debt accounted for the single largest share of wartime financing.

Here’s a table showing that these nations dramatically reduced their debt burdens.

To be sure, there were differences in the three nations.

The reduction in the British debt-GDP ratio was by far the largest and longest: the debt ratio fell from 194 percent in 1822 to 28 percent nine decades later. …The French public-debt-GDP ratio fell from 96 percent in 1896 to 51 percent in 1913… This case ranks second in size but first in pace. U.S. (federal or union) government debt was not as high at the end of the Civil War, and the subsequent consolidation was more leisurely; however, the process is notable for having reduced the debt-GDP ratio to virtually zero by World War I.

When the authors investigated how these nations reduced their debt burdens, they found that limited government was a common answer.

This was true in the United Kingdom.

Britain achieved the impressive feat of maintaining an average primary surplus of 1.6 percent of GDP for nearly a century (the only deficit in Figure 2 is at the time of the Boer War). One of the political legacies of Peel and Gladstone was a fiscal theory or philosophy of “sound finance” emphasizing budget surpluses, low taxes and minimal government expenditure. …demands for spending on welfare relief from the disenfranchised masses were kept in check. In exchange, the self-taxing class of income-tax-paying electors relieved the non-electors from the burden of direct taxation… Budget surpluses then made feasible further reductions in tariffs and taxes, which reduced the cost of living for the working class

It was true in the United States.

In the U.S., primary surpluses were consistently achieved… Southern states opposed an expansive role for the federal government, while entitlements limited to Civil War pensions contained pressure for public spending.

And it was true even in France.

In France, debt reduction was entirely accounted for by primary surpluses. Those surpluses exceeded British levels, reaching 2.5 percent of GDP on average, albeit over a shorter period.

Remember, this was a period when total government spending only consumed about 10 percent of economic output.

And this was a period when there was no welfare state. Redistribution was virtually nonexistent. Not even in France.

So it shouldn’t be a surprise that debt quickly fell in all three countries.

The common thread was small government.

…in all three of these large-scale debt consolidations, governments and societies went to great lengths to service and repay heavy debts. …it reflected prevailing conceptions of the limited functions of government, and limited popular pressure for public programs, entitlements and transfers.

What’s equally important is to note what didn’t happen.

No default. No inflation. No indirect confiscation.

…there was no restructuring or renegotiation of official or privately-held debts in these cases. Nor was there financial repression, i.e., measures artificially depressing interest rates. …Governments for their part did little to bottle up savings at home or to otherwise use regulation and legislation to artificially depress yields. …None of these three governments undertook involuntary restructurings despite the inheritance of heavy debt.

Now let’s shift from the past to the future

The authors point out how debt is rising today because of the welfare state rather than war.

The end of the last century also saw, for the first time, a secular increase in public-debt-to-GDP ratios in a variety of countries in conjunction not with wars and crises but in response to popular demands on governments for pensions, health care, and other often unfunded social services.

Given the demographic changes I mentioned at the beginning of the column, this does not bode well.

So what are the likely implications? As the authors note, there are two ways of dealing with high debt levels.

Countries have pursued two broad approaches to debt reduction. The orthodox approach relies on growth, primary surpluses, and the privatization of government assets. In turn this encourages long debt duration and non-resident holdings. Heterodox approaches, in contrast, include restructuring debt contracts, generating inflation, taxing wealth and repressing private finance.

At the risk of understatement, I fear Robert Higgs is right and that today’s politicians (and today’s voters!) will choose the latter approach.

Given that those policies will make a bad situation even worse, I’m not overflowing with confidence about the future.

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Less than 10 years ago, many European nations suffered fiscal crises because of a combination of excessive spending, punitive taxes, and crippling debt.

The crises have since abated, largely because of direct and indirect bailouts. But the underlying policy mistakes haven’t been fixed.

Indeed, the burden of government spending has increased in Europe and debt levels today are much higher than they were when the previous crisis began.

Unsurprisingly, these large fiscal burdens have resulted in anemic economic performance, which helps to explain why middle-class French taxpayers launched nationwide protests in response to a big increase in fuel taxes.

The French President, Emmanuel Macron, capitulated.

But some have suggested that Macron’s problem is that he wasn’t sufficiently bold.

I’m not joking. Led by Thomas Piketty, a few dozen European leftists have issued a Manifesto for bigger government.

We, European citizens, from different backgrounds and countries, are today launching this appeal for the in-depth transformation of the European institutions and policies. This Manifesto contains concrete proposals, in particular a project for a Democratization Treaty and a Budget Project… Our proposals are based on the creation of a Budget for democratization which would be debated and voted by a sovereign European Assembly. …This Budget, if the European Assembly so desires, will be financed by four major European taxes, the tangible markers of this European solidarity. These will apply to the profits of major firms, the top incomes (over 200,000 Euros per annum), the highest wealth owners (over 1 million Euros) and the carbon emissions (with a minimum price of 30 Euros per tonne).

Here are the taxes they propose as part of their plan to expand the burden of government spending.

I’m surprised they didn’t include a tax on financial transactions.

And here’s a video (in French, but with English subtitles) explaining their scheme.

To put it mildly, this plan is absurd. It would impose another layer of government and another layer of tax on a continent that already is suffocating because the public sector is too large.

I’m not the only one with concerns.

In a column for Bloomberg, Leonid Bershidsky points out why he is underwhelmed by Piketty’s proposal.

The reforms proposed by Piketty and a group of intellectuals and politicians — notably Pablo Iglesias, leader of Spain’s leftist Podemos party — include the creation of a European Assembly. It would have the power to shape a common budget and impose common taxes… Piketty advocates four measures that would collect a total equivalent to 4 percent of Europe’s GDP… What is being proposed is essentially a return to the fiscal policies of the 1970s, which provoked Astrid Lindgren to write her satirical essay “Pomperipossa in Monismania.” In 1976, the children’s author was confronted with a tax bill of 102 percent of her income. …Hit them with new taxes and watch them flee to the U.S. and Asia. They won’t stay like patriotic Lindgren, whose essay helped to topple the Swedish government in 1976. And no amount of government funding…will repair the damage that envy-based taxation can wreak on economies already finding it hard to innovate.

Let’s not forget, by the way, the many thousands of French households who also have suffered 100 percent-plus tax rates.

But let’s not digress.

Writing for CapX, John Ashmore explains why Piketty’s plan will make Europe’s problems even worse.

…a group of politicians, academics and policy wonks spearheaded by…French economist Thomas Piketty…have put their names to a new Manifesto for the Democratisation of Europe. …For the most part, the manifesto reads like a souped up version of the kind of policies we’ve heard time and again from leftwing politicians. …The details of today’s ‘manifesto’ make Labour’s Marxist Shadow Chancellor John McDonnell look like a moderate centrist. Where Labour advocate putting corporation tax back up to 26 per cent, Piketty and co want it hiked to 37 per cent. And while we Brits spent plenty of the Coalition years discussing whether income tax should be 45p or 50p in the pound, the Manifesto goes all guns blazing for a 65 per cent top rate… these measures are projected to raise 800bn euros, equivalent to four times the current EU budget. …that would be a huge transfer of power, not from the rich from the poor, but from taxpayers to politicians.

A 65-percent top tax rate? At the risk of understatement, that’s a recipe for less entrepreneurship and less innovation.

Moreover, based on America’s experience during the Reagan years, it’s safe to say that actual tax receipts would fall far, far short of the projection.

But the higher spending would be real, as would the inevitable increase in red ink. And it’s worth noting that the Manifesto proposes to subsidize the debt of bankrupt welfare states. Very much akin to the eurobond scheme, which I pointed out would be like cosigning a loan for an unemployed alcoholic with a gambling addiction.

P.S. During my recent trip to London, I repeatedly warned people that a real Brexit was the only sensible choice because the European Union at some point will fully morph into a transfer union (i.e., a European budget financed by European taxes). It was nice of Piketty to issue a Manifesto that confirms my concerns. Simply stated, the United Kingdom will be much better off in the long run if it escapes.

P.P.S. Let’s not forget that Piketty’s core argument for class warfare has been thoroughly and repeatedly debunked. Indeed, only 3 percent of economists agree with his theory.

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I don’t like writing about deficits and debt because I don’t want to deflect attention from the more important underlying problem of excessive government spending.

Indeed, I constantly explain that spending is what diverts resources from the productive sector of the economy, regardless of whether outlays are financed by taxes or borrowing. This is why a spending cap is far and away the best rule for fiscal policy.

That being said, red ink does matter when politicians incur so much debt that investors (i.e., the folks in the private sector who buy government debt) decide that a government no longer is trustworthy. And when that happens, interest rates climb because investors insist on getting a higher return to compensate for the risk of default.

And if things really deteriorate, a government may default (i.e., no longer make promised payments) and investors obviously will refuse to lend any more money. That’s basically what happened in Greece.

Sadly, most governments have not learned from Greece’s mistakes. Indeed, government debt in Europe is now significantly higher than it was before the 2008 recession.

This suggests that there will be another fiscal crisis when the next recession occurs. Italy presumably will be the big domino to fall, though there are many other nations in Europe that could get in trouble.

But the problems of excessive spending and excessive debt are not limited to Europe. Or Japan.

The World Bank has a new report that shows that red ink is a growing problem in the rest of the world. More specifically, the report is about “fiscal space,” which some see as a measure of budgetary flexibility but I interpret as an indicator of budgetary vulnerability. Here’s how it is defined in the report.

…fiscal space is simply defined as the availability of budgetary resources to conduct effective fiscal policy. …some studies define it as the budgetary room to create and allocate funding for a certain purpose without threatening a sovereign’s financial position. …Debt service capacity is a critical component of fiscal space. It has multiple dimensions, including financing needs that are related to budget positions and debt rollover, access to liquid markets, resilience to changes in market valuations of debt, and the coverage of contingent liabilities. …Market participants’ perceptions of sovereign risk reflect and, in turn, influence an economy’s ability to tap markets and service its obligations. Thus, fiscal space can function as an essential instrument of macroeconomic risk management.

And what is “effective fiscal policy”?

From the World Bank’s misguided perspective, it’s the ability to engage in Keynesian spending.

Countries with ample fiscal space can use stimulus measures more extensively.

But let’s set aside that anti-empirical assertion.

I found the report useful (though depressing) because it had data showing how debt levels have increased, especially in emerging market and developing economies (EMDEs).

Fiscal space improved during 2000−07, but has shrunk around the world since the global financial crisis. …debt sustainability indicators, including government debt and fiscal sustainability gaps, have deteriorated in at least three-quarters of countries in the world. …and perceptions of market participants on sovereign credit risks have worsened. …Since 2011, fiscal space has shrunk in EMDEs. …fiscal deficits widened to 3 to 5 percent of GDP in 2016, on average… Government debt has risen to 54 percent of GDP, on average, in 2017. …EMDEs need to shore up fiscal positions to prevent sudden spikes in financing costs… Fiscal space has been shrinking in EMDEs since the global financial crisis. It needs to be strengthened.

Here is a set of charts from the report, showing both developed nations (red lines) and developing nations (yellow lines). The top-left chart shows debt climbing for EMDEs and the bottom-right chart shows debt ratings dropping for EMDEs.

The EMDEs have lower debt levels, but their debt is rated as more risky because poorer nations don’t have a very good track record of dealing with recessions and fiscal crises (would you lend money to Argentina?).

In any event, the yellow lines in the top-left chart and bottom-right chart are both headed in the wrong directions.

The bottom line? It won’t just be European welfare states that get in trouble when there’s another recession.

By the way, the report from the World Bank offers some policy advice. Some of it potentially good.

Pension reforms could…support fiscal credibility and generate long-term fiscal gains… credible and well-designed institutional mechanisms can help support fiscal discipline and strengthen fiscal space. …Fiscal rules impose numerical constraints on budgetary aggregates—debt, overall balance, expenditures.

But most of it bad.

Fiscal sustainability could be improved by increasing the efficiency of revenue collection… Measures to strengthen revenue collection could include broadening tax bases to remove loopholes for higher-income households or profitable corporates. In countries with high levels of informality, taxing the informal sector—for example, by promoting a change in payment methods to non-cash transaction and facilitating collective action by informal sector associations—could help raise revenues directly, as well as indirectly… In EMDEs, reforms to broaden revenue bases and strengthen tax administration can generate revenue gains.

At the risk of stating the obvious, the problem in developing nations is bad government policy, not insufficient revenue in the hands of politicians.

P.S. I included the caveat that some of the recommendations were “potentially good” since the report didn’t specify the type of pension reform or the type of fiscal rule. I like to think the authors were referring to personal retirement accounts and spending caps, but it’s not clear.

P.P.S. The IMF subsidizes and encourages bad fiscal policy with bailouts. Fortunately, there is a much more sensible approach.

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With the exception of 2010-2014, when the Tea Party briefly had a grip on the Republican Party, the burden of government spending has been increasing in the United States.

This unfortunate trend can’t continue indefinitely, so sooner or later we’ll reach a point where politicians will feel pressured to address growing fiscal imbalances.

The crowd in Washington will want some sort of “budget summit,” which – if history is any guide – means that the senior lawmakers who created the problem go behind closed doors to craft a deal involving real tax increases and fake spending cuts.

Unsurprisingly, that approach doesn’t work. At best, the tax hike is a substitute for much-needed spending restraint. And in many cases, politicians treat the expectation of higher revenues as an excuse to increase outlays.

This isn’t just the pattern in the United States. Politicians all over the world have been raising taxes, yet debt levels continue to climb.

The right solution, indeed the only solution, is spending restraint. Which is the lesson Steve Davies expounds upon in this video for Learn Liberty.

Every single example Steve cites is supported by strong evidence.

Indeed, I’ve written about each and every nation he mentions.

What makes this debate so frustrating is that all the evidence is on the side of spending restraint.

It’s not just academic scholars who have shown that fiscal consolidations based on spending restraint are far more successful. Even left-leaning bureaucracies have admitted that spending control is the only approach that produces good results.

I’ve shown how limiting the growth of spending is the sensible way to reduce the fiscal burden of government and control red ink. And when I share this table during debates, I always ask my friends on the left to show their collection of nations that got good results with tax increases.

They’ve never answered my challenge.

Not once.

The bottom line is that we know that the Golden Rule of spending restraint is good for growth, and we know spending restraint is the way to reduce red ink.

That’s the good news. The bad news is that politicians have a “public choice” incentive to instead raise taxes. That game doesn’t end well.

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I’ve warned many times that Italy is the next Greece.

Simply stated, there’s a perfect storm of bad news. Government is far too big, debt is too high, and the economy is too sclerotic.

I’ve always assumed that the country would suffer a full-blown fiscal crisis when the next recession occurs. At that point, tax receipts will fall because of the weak economy and investors will realize that the nation no longer is able to pay its bills.

But it may happen even sooner thanks to a spat between Italy’s left-populist government and the apparatchiks at the European Commission.

Here’s what you need to know. There are (poorly designed) European budget rules, known as the Maastricht Criteria, that supposedly require that nations limit deficits to 3 percent of GDP and debt to 60 percent of GDP.

With cumulative red ink totaling more than 130 percent of GDP, Italy obviously fails the latter requirement. And this means the bureaucrats at the European Commission can veto a budget that doesn’t strive to lower debt levels.

At least that’s the theory.

In reality, the European Commission doesn’t have much direct enforcement power. So if the Italian government tells the bureaucrats in Brussels to go jump in a lake, you wind up with a standoff. As the New York Times reports, that’s exactly what’s happened.

In what is becoming a dangerous game of chicken for the global economy, Italy’s populist government refused to budge on Tuesday after the European Union for the first time sent back a member state’s proposed budget because it violated the bloc’s fiscal laws and posed unacceptable risks. …the commission rejected the plan, saying that it included irresponsible deficit levels that would “suffocate” Italy, the third-largest economy in the eurozone. Investors fear that the collapse of the Italian economy under its enormous debt could sink the entire eurozone and hasten a global economic crisis unseen since 2008, or worse. But Italy’s populists are not scared. They have repeatedly compared their budget, fat with unemployment welfare, pension increases and other benefits, to the New Deal measures of Franklin D. Roosevelt.

Repeating the failures of the New Deal?!? That doesn’t sound like a smart plan.

That seems well understood, at least outside of Italy.

The question for Italy, and all of Europe, is how far Italy’s government is willing to go. Will it be forced into submission by the gravity of economic reality? Or will Italian leaders convince their voters that the country’s financial health is worth risking in order to blow up a political and economic establishment that they say is stripping Italians of their sovereignty? And Brussels must decide how strict it will be. …the major pressure on Italy’s budget has come from outside Italy. Fitch Ratings issued a negative evaluation of the budget, and Moody’s dropped its rating for Italian bonds to one level above “junk” last week.

So now that Brussels has rejected the Italian budget plan, where do things go from here?

According to CNBC, the European Commission will launch an “Excessive Deficit Procedure” against Italy.

…a three-week negotiation period follows in which a potential agreement could be found on how to lower the deficit (essentially, Italy would have to re-submit an amended draft budget). If that’s not reached, punitive action could be taken against Italy. Lorenzo Codogno, founder and chief economist at LC Macro Advisors, told CNBC…“it’s very likely that the Commission will, without making a big fuss, will move towards making an ‘Excessive Deficit Procedure’…to put additional pressure on Italy…” Although it has the power to sanction governments whose budgets don’t comply with the EU’s fiscal rules (and has threatened to do so in the past), it has stopped short of issuing fines to other member states before. …launching one could increase the already significant antipathy between Brussels and a vociferously euroskeptic government in Italy. Against a backdrop of Brexit and rising populism, the Commission could be wary of antagonizing Italy, the third largest euro zone economy. It could also be wary of financial market nerves surrounding Italy from spreading to its neighbors… Financial markets continue to be rattled over Italy’s political plans. …This essentially means that investors grew more cautious over lending money to the Italian government.

For those who read carefully, you probably noticed that the European Commission doesn’t have any real power. As such, there’s no reason to think this standoff will end.

The populists in Rome almost certainly will move forward with their profligate budget. Bureaucrats in Brussels will complain, but to no avail.

Since I’m a nice guy, I’m going to give the bureaucrats in Brussels a much better approach. Here’s the three-sentence announcement they should make.

  1. The European Commission recognizes that it was a mistake to centralize power in Brussels and henceforth will play no role is overseeing fiscal policy in member nations.
  2. The European Commission (and, more importantly, the European Central Bank) henceforth will have a no-bailout policy for national governments, or for those who lend to national governments.
  3. The European Commission henceforth advises investors to be appropriately prudent when deciding whether to lend money to any government, including the Italian government.

From an economic perspective, this is a far superior approach, mostly because it begins to unwind the “moral hazard“that undermines sound financial decision making in Europe.

To elaborate, investors can be tempted to make unwise choices if they think potential losses can be shifted to taxpayers. They see what happened with the various bailouts in Greece and that tells them it’s probably okay to continue lending money to Italy. To be sure, investors aren’t totally blind. They know there’s some risk, so the Italian government has to promise higher interest payments

But it’s highly likely that the Italian government would have to pay even higher rates if investors were convinced there would be no bailouts. Incidentally that would be a very good outcome since it would make it more costly for Italy’s politicians to continue over-spending.

In other words, a win-win situation, with less debt and more prudence (and maybe even a smaller burden of government!).

My advice seems so sensible that you’re probably wondering if there’s a catch.

There is, sort of.

When I talk to policy makers, they generally agree with everything I say, but then say my advice is impractical because Italy’s debt is so massive. They fret that a default would wipe out Italy’s banks (which imprudently have bought lots of government debt), and might even cause massive problems for banks in other nations (which, as was the case with Greece, also have foolishly purchased lots of Italian government debt).

And if banks are collapsing, that could produce major macroeconomic damage and even lead/force some nations to abandon the euro and go back to their old national currencies.

For all intents and purposes, the Greek bailout was a bank bailout. And the same would be true for an Italian bailout.

In any event, Europeans fear that bursting the “debt bubble” would be potentially catastrophic. Better to somehow browbeat the Italian government in hopes that somehow the air can slowly be released from the bubble.

With this in mind, it’s easy to understand why the bureaucrats in Brussels are pursuing their current approach.

So where do we stand?

  • In an ideal world, the problem will be solved because the Italian government decides to abandon its big-spending agenda and instead caps the growth of spending (as I recommended when speaking in Milan way back in 2011).
  • In an imperfect world, the problem is mitigated (or at least postponed) because the European Commission successfully pressures the Italian government to curtail its profligacy.
  • In the real world, though, I have zero faith in the first option and very little hope for the second option. Consider, for instance, the mess in Greece. For all intents and purposes, the European Commission took control of that nation’s fiscal policy almost 10 years ago. The results have not been pretty.

So this brings me back to my three-sentence prescription. Yes, it almost certainly would be messy. But it’s better to let the air out of bubbles sooner rather than later.

P.S. The so-called Basel Rules contribute to the mess in Europe by directing banks to invest in supposedly safe government debt.

P.P.S. If the European Union is going to impose fiscal rules on member nations, the Maastricht criteria should be jettisoned and replaced with a Swiss-style spending cap.

P.P.P.S. Some of the people in Sardinia have the right approach. They want to secede from Italy and become part of Switzerland. The Sicilians, by contrast, have the wrong mentality.

P.P.P.P.S. Italy is very, very, very well represented in the Bureaucrat Hall of Fame.

P.P.P.P.P.S. You’ll think I’m joking, but a columnist for the New York Times actually argued the United States should be more like Italy.

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I’m not a big fan of the International Monetary Fund and I regularly criticize the international bureaucracy for its relentless advocacy in favor of higher taxes.

But that’s not what worries me most about the IMF.

To be sure, higher fiscal burdens undermine economic vitality, and I regularly warn that such policies will reduce an economy’s potential long-run growth rate.

That being said, tax increases generally don’t threaten macroeconomic stability.

If we’re looking at policies that can trigger short-run crises, I’m more concerned about the IMF’s bailout policies. For all intents and purposes, the IMF subsidizes “moral hazard” by reducing the perceived cost (to financial institutions) of lending money to dodgy governments and reducing the perceived costs (to governments) of incurring more debt.

Why not take more risk, after all, if you think the IMF will step in to socialize any losses? In other words, when the IMF engages in a few bailouts today, it increases the likelihood of more bailouts in the future.

That’s the bad news. The worse news is that the bureaucrats want a bigger figurative checkbook to enable even bigger future bailouts.

The good news is that the U.S. government can say no.

But will it? The U.K.-based Financial Times reported a few days ago that the United States might support an expansion of the IMF’s bailout capacity.

The Trump administration has left the door open for a US funding boost to the IMF, calling for a “careful evaluation” of the global lender’s finances to make sure it has enough money to rescue struggling economies. …The IMF — led by Christine Lagarde, a former French finance minister — is hoping to get its members to increase the fund’s permanent reserves… This year, the Trump administration has been among the most enthusiastic supporters of the IMF’s $57bn loan package to Argentina— its largest in history.

The next day, the FT augmented its coverage.

The IMF is set to embark on a major fundraising drive…the success of Ms Lagarde’s campaign is highly uncertain, with potentially profound consequences not only for the fund but for the global economy. …supporters of the fund say there are many possible scenarios in which it would be essential. If a recession and financial crisis were to hit in the coming years,central bankers may well struggle to find monetary remedies… a US Treasury spokesman left the door open to new possible contributions from America to the IMF. …Optimists point to a surprise decision by the Trump administration in April to support a $13bn boost to World Bank resources… there is still scepticism of the IMF among his top lieutenants at the Treasury department, including David Malpass, the undersecretary for international affairs. …Even if they were on board, economic and national security hawks at the White House who disdain multilateralism as a loss of sovereignty could be an additional obstacle, not to mention Republican lawmakers on Capitol Hill. The previous IMF quota increase, pushed by the Obama administration — which raised America’s permanent commitment to the fund to about $115bn — finally scraped through Congress in 2016, after a half-decade delay.

I was very saddened a couple of years ago when the GOP Congress agreed to expand the IMF’s bailout authority, especially since a similar effort was blocked in 2014 when Democrats still controlled the Senate.

The issue today is whether the Trump Administration will repeat that mistake.

Back in 2012, I stated that the IMF issue was a “minimum test” for Republicans. Well, the issues haven’t changed. Everything I wrote then still applies today.

I hope Trump does the right thing and rejects expanded bailout authority for the IMF for the sensible reason that it’s foolish to subsidize more borrowing by badly governed nations.

But I’m not picky. I’ll also be happy if Trump says no simply because he’s miffed that the IMF attacked him (accurately but unfairly) during the 2016 campaign and dissed his tax plan earlier this year.

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I’ve been in Lebanon for the past few days, but not because I’m seeking a replacement for the Princess of the Levant.

Instead, I’m here because the Lebanese Institute for Market Studies arranged a briefing in the Parliament on the perilous state of the nation’s finances.

Lebanon is in trouble because policy makers have violated my Golden Rule by allowing spending to grow too fast. As such, even though the overall fiscal burden of government is relatively modest, red ink has climbed to about 150 percent of economic output. That’s higher than Italy today, and higher than Greek debt when that nation’s fiscal crisis occurred.

I’ve pointed out before that there’s not an automatic tipping point when a debt crisis occurs. It happens whenever investors decide that they no longer trust that a government will pay its debt.

I’m not going to predict exactly when Lebanon reaches that point, but I suspect sooner rather than later. Unless, of course, Lebanon changes direction.

And that’s exactly what I’m recommending. I made three points.

First, higher taxes are not a solution. Given the IMF’s awful track record of pushing tax hikes in the region, I repeated my standard joke about arresting any of those bureaucrats who enter the country.

Second, a rule requiring a balanced budget is not the ideal solution. Not because balanced budgets are a bad idea, but because such rules put fiscal policy at the mercy of the business cycle.

This chart showing Lebanon’s revenue makes my point. When there’s strong growth and revenues are increasing rapidly (between 2001-2004 and 2006-2009), big spending increases are possible. But when the economy is weak and revenues are flat (between 2004-2006 and 2009-2016), politicians are very resistant to fiscal discipline during a downturn.

Even the IMF and OECD agree with me that this is a big reason why anti-deficit rules don’t work.

Which leads me to my third point, which is that Lebanon should copy Hong Kong and Switzerland by adopting an annual limit on spending growth.

I didn’t specify a specific number for a spending cap. Instead, I emphasized that the key goal is to make sure spending – over time – grows slower than the private sector.

But I did show what would have happened if lawmakers had limited nominal annual spending increases to 6 percent starting in 1992 (that sounds far too high, but keep in mind that inflation averaged about 4 percent over the past 25 years).

I told the audience that they would have a budget surplus today, and also very little debt, if a spending cap had been in effect (same results would hold for America).

And I also pointed out that lawmakers could avoid boom-bust budgeting with a long-run spending cap. With a fixed limit on annual spending increases, they would not have to cut outlays during a recession, but they also would not be able to have a spending orgy during a boom.

That’s a good recipe for Lebanon. It’s also the right recipe for the United States.

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Way back in early 2011, I wrote about the likelihood of various nations suffering a Greek-style meltdown. After speculating on the importance of debt burdens and interest payments, I concluded that

…which nation will be the next domino to fall? …Some people think total government debt is the key variable…that’s not necessarily a good rule of thumb. …Japan’s debt is nearly 200 percent of GDP, yet Japanese debt is considered very safe… The moral of the story is that there is no magic point where deficit spending leads to a fiscal crisis, but we do know that it is a bad idea for governments to engage in reckless spending over a long period of time. That’s a recipe for stifling taxes and large deficits. And when investors see the resulting combination of sluggish growth and rising debt, eventually they will run out of patience.

As I noted earlier this year, it’s not easy to predict the point at which “investors no longer trust that they will receive payments on government bonds.”

Though that would be useful information, which is why a new study from the International Monetary Fund could be very helpful. The researchers look at how to measure fiscal crisis.

The literature on fiscal crises and on early warning indicators is limited, although it has expanded in recent years. Most of the past literature focused on sovereign external debt defaults alone …the canonical fiscal crisis is a debt crisis, when the government is unable to service the interest and or principle as scheduled. … It is important to note, however, that fiscal crises may not necessarily be associated with external debt defaults. They can be associated with other forms of expropriation, including domestic arrears and high inflation that erodes the value of some types of debt. …a fiscal crisis is identified when one or more of the following distinct criteria are satisfied: …Credit events associated with sovereign debt (e.g., outright defaults and restructuring). …Recourse to large-scale IMF financial support. …Implicit domestic public default (e.g., via high inflation rates). …Loss of market confidence in the sovereign.

The goal is to figure out the conditions that precipitate problems.

…The objective of this paper is to better understand the structural weaknesses that make countries prone to entering a fiscal crisis. …We use two of the more common approaches to build early warning systems (EWS) for fiscal crises: the signal approach and logit model. …event studies indicate that a fiscal crisis tends to be preceded by loose fiscal policy (Figure 3.1). In the run-up to a crisis, there is robust real expenditure growth.

Some of the obvious variables, as noted above and also in Figure 3.1 (the dashed vertical line is the year a crisis occurs), are whether there’s a rising burden of government spending and whether the economy is growing.

For readers who like wonky material, the authors explain the two approaches they use.

In order to construct early warning systems for fiscal crises, we adopt two alternative approaches that have been used in the literature. We first use the signal approach, followed by multivariate logit models. …The signals approach involves monitoring the developments of economic variables that tend to behave differently prior to a crisis. Once they cross a specific threshold this gives a warning signal for a possible fiscal crisis in the next 1-2 years. …Logit model…early warning systems…draw on standard panel regression…with a binary dependent variable equal to one when a crisis begins (or when there is a crisis). …The main advantage of this approach is that it allows testing for the statistical significance of the different leading indicators and takes into account their correlation.

Then they crunch a bunch of numbers.

Here’s what they find using the signal approach.

…current account deficit, degree of openness, use of central bank credit to finance the deficit, size of the fiscal (overall or primary) deficit and pace of expansion in public expenditures—all these increase the probability of a future crisis.

And here’s what they conclude using the logit approach.

The results, by and large, highlight similar leading indicators as the signals approach… The probability of entering a crisis increases with growing macroeconomic imbalances due to large output gaps and deteriorating external imbalances. The results also indicate a role for fiscal policy, via public expenditures growth. … high expenditure growth could contribute to a deterioration in the current account and a large output gap, making the fiscal position vulnerable to changes in the economic cycle.

The bottom line is that both approaches yield very similar conclusions.

Our results show that there is a small set of robust leading indicators (both fiscal and non-fiscal) that help assess the probability of a fiscal crisis. This is especially the case for advanced and emerging markets. For these countries, we find that domestic imbalances (large output or credit gaps), external imbalances (current account deficit), and rising public expenditures increase the probability of a crisis. …Our results suggest that indeed fiscal variables matter. Strong expenditure growth and financing pressures (e.g., need for central bank financing) can help predict crises.

Some of this data is reflected in Figure 5.2.

And here’s the bottom line, starting with the claim that governments are being semi-responsible because we don’t actually see many fiscal crises.

…we find that some types of vulnerabilities are consistently relevant to explain fiscal crises. This raises the question why governments do not act as they see signals. In large measure they do, as crises among advanced economies are rare. Still, the occurrence of crises may reflect overly optimistic projections about the future… Our results show that a relatively small set of robust leading indicators can help assess the probability of a fiscal crisis in advanced and emerging markets with high accuracy. …countries can reduce the frequency of fiscal crises by adopting prudent policies and strengthening risk management. Fiscal crises are more likely when economies build domestic and external imbalances. This calls for avoiding excessively loose polices when domestic growth is above average. For fiscal policy, this means avoiding procyclical increases in expenditures.

The key takeaway is that spending restraint is a very important tool for avoiding a fiscal crisis.

Yes, a few other factors also are important (central bankers should avoid irresponsible monetary policy, for instance), but some of these are outside the direct control of politicians.

Which is why this new research underscores the importance of some sort of spending cap, preferably enshrined in a jurisdiction’s constitution like in Hong Kong and Switzerland.

P.S. While there haven’t been many fiscal crises in developed nations, that may change thanks to very unfavorable demographics and poorly designed entitlement programs.

P.P.S. I hope the political decision makers at the IMF read this study (as well as prior IMF studies on the efficacy of spending caps) and no longer will agitate for tax increases on nations that get into fiscal trouble.

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A few days ago, I shared some academic research investigating whether economic crises lead to more liberalization (Naomi Klein’s hypothesis) or more statism (Robert Higgs’ hypothesis).

Given the dismal long-run outlook for the United States and most other developed nations, this is not just a theoretical issue.

Well, the good news is that the evidence shows that economic turmoil appears to be associated with pro-market reforms. At least with regard to regulatory policy.

Today, I’m going to share more good news. We now have some empirical research from two Danish economists showing that voters like good policy.

Here’s what Niclas Berggren and Christian Bjørnskov wanted to ascertain in their research

Since the early 1980s a wave of liberalizing reforms has swept over the world. While the stated motivation for these reforms has usually been to increase economic efficiency, some critics have instead inferred ulterior motives…with the claim that many of the reforms have been undertaken during different crises so as to bypass potential opponents, suggests that people will dislike the reforms and even be less satisfied with democracy as such. We test this hypothesis empirically, using panel data from 30 European countries in the period 1993–2015. The dependent variable is the average satisfaction with democracy, while the reform measures are constructed as distinct changes in four policy areas: government size, the rule of law, openness and regulation. …We moreover include a set of control variables, capturing economic circumstances, political institutions and features of politics.

In other words, we’ve seen considerable liberalization over the past 20-plus years. Were voters happy or unhappy as a result?

Here’s a way of visualizing what they investigated.

For what it’s worth, I’ve argued that Reagan showed good policy is good politics.

And the good news is that this research reaches a similar conclusion. Here are their main results.

Our results indicate that while reforms of government size are not robustly related to satisfaction with democracy, reforms of the other three kinds are – and in a way that runs counter to the anti-liberalization claims. Reforms that reduce economic freedom are generally related to satisfaction with democracy in a negative way, while reforms that increase economic freedom are positively associated with satisfaction with democracy. Voters also react more negatively to left-wing governments introducing reforms that de-liberalize. …the hypothesis of a general negative reaction towards liberalizing reforms taking the form of reduced satisfaction with democracy does not stand up to empirical scrutiny, at least not in our European sample.

Wonky readers may want to spend some time with this table, which shows the results of the statistical analysis

I’ll close with a couple of specific observations from the research, all of which deal with whether some reforms are more popular than others.

The good news is that voters are most satisfied when there’s less protectionism.

It turns out that the most immediately important type of reform here is liberalizations that increase market openness, such as reductions in protectionism and removal of obstacles to capital movements.

(Methinks the folks in the White House may want to reconsider their protectionist policies. It seems people understand that trade wars cause blowback.)

The bad news is that voters don’t seem to get excited about reforms to restrain government spending, whereas other types of pro-market reforms are popular.

Reforms that involve government size are rarely statistically significant; reforms that involve the other three reform areas typically are.

Though voters sometimes aren’t happy when government gets bigger, so I guess that’s partial good news.

Crises only seem to matter when government size increases, and then they make the effect on satisfaction with democracy much more negative.

Perhaps this is evidence that people recognize Keynesian “stimulus” schemes aren’t a good idea? I hope that’s the right interpretation. Heck, maybe this is yet another reason to stop sending tax dollars to subsidize the OECD.

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When I give speeches about modern welfare states, I’ll often cite grim data from the IMF, BIS, and OECD about the very depressing fiscal consequences of ever-expanding government.

And if I really want to worry an audience, I’ll augment those numbers by talking about the erosion of societal capital and explain it’s very hard to adopt necessary reforms once the work ethic and self-reliance have been replaced by a culture of dependency and entitlement.

I basically warn people that many western nations (including the United States) are doomed to suffer Greek-style fiscal collapse. Depending on the type of speech, this is where I sometimes share a slide suggesting that there are two possible outcomes once an economic crisis occurs.

  • Does a crisis caused by bad government lead to even more bad government, which is the pessimistic hypothesis in Robert Higgs’ classic, Crisis and Leviathan?
  • Or does an economic crisis force politicians to actually scale back the size and scope of government, which is the hypothesis in Naomi Klein’s The Rise of Disaster Capitalism.

I’ve generally sided with Higgs, though there obviously are cases – such as Chile – where bad statist policies were followed by sweeping economic liberalization.

But, based on new research from the International Monetary Fund, it may be that Klein has a stronger argument (which would be a depressing outcome for her, since she favors bigger government).

Here are some of the issues that the authors investigated.

Relying on a new database of major past labor and product market reforms in advanced countries, we test a large set of variables for robust correlation with reform in each area. …structural reforms are notoriously difficult to implement…one of the most prominent hypotheses put forward in the literature, namely that crisis induces reform… we attempt to minimize value judgements and measurement error by employing a newly constructed “narrative” dataset of major reforms in four areas namely product market regulation (PMR) in network industries, EPL for regular workers, EPL for temporary workers, and unemployment benefit systems. … The large welfare costs of economic or financial crisis can break the deadlock over welfare-enhancing measures that could not be adopted otherwise due to conflict over their distributional consequences.

In short, they wanted to find out whether bad economic news (as captured by data on “GDP growth, deep recession, unemployment, crisis”) leads to pro-market reforms.

The answer is yes.

Our main result supports some form of the crisis-induces-reform hypothesis across all four reform areas. High unemployment, recession and/or an open economic crisis tend to be associated with a greater likelihood of reform. The effect is economically significant. For example, an increase of 10 percentage points in unemployment (as seen in several European economies in the aftermath of the Great Recession) is associated with an increase in the probability to undertake a major EPL reform for regular contract of about 5 percentage points — that is, about twice the average probability in the sample.

Here’s a chart from the report showing a big spike in deregulation in late 1990s/early 2000s.

And here’s a chart showing nations that took steps to cut back on unemployment subsidies.

Keep in mind, by the way, that some nations (such as Austria) may not have reformed because they never adopted bad policies in the first place.

Kudos to Denmark for implementing so much reform. And Greece wins a Booby Prize for failing to adopt desperately needed reforms.

I was also happy to see some results that bolster my argument in favor of jurisdictional competition as a tool to encourage better policy.

We also find evidence that outside pressure increases the likelihood of reform in certain areas. Reforms are more likely when other countries also undertake them.

Interestingly, it doesn’t appear that ideology plays a major role.

…we do not find any evidence for an ideological bias—there is no robust difference between left- and right-of-center governments’ propensity to undertake reform. …In the context of labor and product market reforms, while a reforming right-of-center government may face the combined resistance of the leftwing electorate, trade unions and other civil society groups, a left-of-center government will be less likely to be accused of pushing through reforms on ideological grounds and may therefore be more likely to succeed.

My two cents is that ideology can play a role (think Reagan and Thatcher, for instance), but that there are plenty of instances of putative right-of-center politicians making government bigger (Nixon and Bush, to cite US examples) and several instances of supposed left-of-center politicians overseeing pro-market reforms (Bill Clinton being the obvious example from America).

I’ll close with a very important caveat. The IMF study looked at regulatory policy. There are no lessons to be learned from this research about whether crises produce better fiscal policy.

For what it’s worth, based on all the post-financial-crisis tax increases that were imposed in Europe, I suspect that the Higgs hypothesis is still very relevant.

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Shortly after the fiscal crisis began in Greece, I explained that the country got in trouble because of too much government spending.

More specifically, I pointed out that the country was violating my Golden Rule, which meant that the burden of spending was rising relative to the private economy.

That’s a recipe for trouble.

Unfortunately, thanks in large part to bad advice from the International Monetary Fund, Greek politicians decided to deal with an overspending problem by raising taxes.

Then doing it again.

And raising taxes some more.

And raising them again.

Then adding further tax hikes.

The tax burden is now so stifling that even the IMF admits the country may be on the wrong side of the Laffer Curve.

And establishment media sources are noticing. Here are some excerpts from a report in the Wall Street Journal.

Greece is…raising taxes so high that they are strangling the small businesses that form the backbone of its economy. …The tax increases have left Greece with some of Europe’s highest tax rates across several categories, including 29% on corporate income, 15% on dividends, and 24% on value-added tax (a rough equivalent of U.S. sales tax). Individuals pay as much as 45% income tax, plus an extra “solidarity levy” of up to 10%. Furthermore, workers and employers pay social-security levies of up to 27% of their salaries. …small and midsize businesses and self-employed people…are fighting the government in court over having to pay what they say is up to 80% of their average monthly takings in taxes and levies. Some also have to pay retroactive social-security contributions, to the point where professional associations say some of their members are having to pay more to the state than they make.

Paying more than they make? Francois Hollande will applaud when he learns that another nation has an Obama-style flat tax.

…economists and Greek entrepreneurs say heavy taxation doesn’t help. The tax burden is considered the most problematic factor for doing business in Greece, according to the World Economic Forum. “The tax burden creates a serious disincentive for economic activity. It mainly hits the most productive part of the Greek society… Aris Kefalogiannis, the CEO of olive-oil and food company Gaea, said the fiscal straitjacket is keeping highly qualified executives he would like to hire from coming to Greece. It has also made him more sparing with investments. …“But this abusive taxation is not backed by any actual reforms that would make the state efficient.”

Of course the state hasn’t been made more efficient. Why would politicians shrink government if higher taxes are an option?

It’s not as if Greek voters are poised to elect a Ronald Reagan or Margaret Thatcher, after all.

In any event, all of the tax increases are having predictably bad effects.

Tax evasion has led to higher tax rates on those Greeks who can’t or won’t evade taxes. The so-called gray economy is estimated at 26.5% of GDP… “Overtaxation is a vicious circle, which is not fixing the problem,” said 40-year-old electrician Antonis Alevizakis. “Only a third of customers want a receipt. The incentive to avoid a 24% value-added tax surcharge is big for them.” …More than 100,000 self-employed professionals have closed their businesses since mid-2016, to avoid rising taxation and social-security contributions, according to Finance Ministry data. Some of these people stopped self-employment, while others turned to the gray economy. …tax consultant Chrysoula Galiatsatou said. “A financially active part of the population sees no reason to try to do more.”

Why “try to do more” when the government gets the lion’s share of any additional income?

And why even stay in the country when there are better (less worse) tax systems in neighboring nations? Indeed, Greece is one of the few nations to raise corporate tax rates as the rest of the world is taking the opposite approach.

Here are some of the details. It appears that Bulgaria is a preferred destination for tax exiles.

Greece’s direct competitors for investment in its poorer, southeastern region of Europe have much lower taxes. For that reason, many Greek businesses and professionals are migrating to neighboring countries such as Bulgaria and Cyprus. …Around 15,000 Greek companies are registered in Bulgaria. Greece’s Finance Ministry estimates that 80% of them have a registration number but no activity in Bulgaria, and are only there to avoid Greek taxes. “If I stayed in Greece I would most certainly be in jail by now,” said John Douvis, who used his remaining savings in 2015 to move his family’s furniture factory from Athens to Blagoevgrad in Bulgaria. In Greece, he said, “it’s almost impossible for a company to survive unless it evades tax.”

In other words, the problem is tax rates, not tax evasion.

Lower the rates and evasion falls.

Let’s wrap up today’s column with a final observation. The WSJ story states that there have been spending cuts in addition to tax increases.

That’s basically true, but net effect of the Greek fiscal crisis is that government has become a bigger burden, relative to private economic output. Here’s a chart, based on data from the IMF.

The bottom line is that Greek politicians did way too much spending last decade and now they’re augmenting that mistake with way too much taxing this decade.

P.S. To reward everyone who read to the end, here’s some Greek-related humor.

This cartoon is quite  good, but this this one is my favorite. And the final cartoon in this post also has a Greek theme.

We also have a couple of videos. The first one features a video about…well, I’m not sure, but we’ll call it a European romantic comedy and the second one features a Greek comic pontificating about Germany.

Last but not least, here are some very un-PC maps of how various peoples – including the Greeks – view different European nations. Speaking of stereotypes, the Greeks are in a tight race with the Italians and Germans for being considered untrustworthy.

P.P.S. If you want some unintentional humor, did you know that Greece subsidizes pedophiles and requires stool samples to set up online companies?

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If you did man-on-the-street interviews across America and asked people about Social Security, I suspect most of them would have some degree of understanding about the program’s looming fiscal crisis.

Since they’re not policy wonks, they presumably wouldn’t know the magnitude of the problem (not that I blame them since I once underestimated the shortfall by $16 trillion).

I also doubt many of them would be able to explain why the so-called Trust Fund is an accounting fiction, which is understandable since even supposedly knowledgeable people pretend IOUs are real assets.

But at least they know the program’s finances are a giant mess and that we face a fiscal crisis.

That being said, there’s a second crisis in the program that doesn’t get nearly as much attention. Simply stated, the program is a rotten deal for workers.

I explained both crises in this video I narrated for the Center for Freedom and Prosperity.

Today, thanks to a new report from the Heritage Foundation, we have a great opportunity to peruse up-to-date numbers on the second Social Security crisis.

Here’s the problem, succinctly defined.

With Social Security consuming such a large component of workers’ paychecks and offsetting their own private savings, it is important that workers receive a valuable benefit from Social Security—one at least as good as they, as a whole, could obtain from saving on their own. This analysis looks across the United States and across generations to see if Social Security does in fact provide that.

Sadly, Social Security does a crummy job of giving workers a decent amount of retirement income.

Taking an average of all 50 states and the District of Columbia, the average worker receives significantly less from Social Security than he would have if he had conservatively invested his Social Security payroll taxes in the market. …Individuals with lower life expectancies often lose greatly. This occurs because they receive little or nothing in benefits and cannot pass along all their lost contributions to their surviving family members. …Younger workers face lower, and even negative, returns from Social Security compared to older workers. This comes as a result of paying higher average Social Security tax rates over their lifetimes, coupled with a two-year increase in Social Security’s normal retirement age—as well as the benefit cuts that will occur.

The bottom line is that the implicit rate of return from Social Security is very inadequate compared to the genuine rate of return that could be obtained if workers could invest their payroll taxes in personal retirement accounts.

Here’s the key table from the Heritage study, showing rates of return for today’s young workers based on how long they live.

You have to wonder why so many young people are intrigued by socialism when they’re the ones getting screwed by big government!

Anyhow, there are 12 tables in the report showing lots of additional data, including breakdowns based by state. The entire study is worth a look.

But for those short on time, the conclusion is a very clear summary of why we need to fix Social Security’s rate-of-return crisis as well as the program’s fiscal crisis.

The results are overwhelmingly clear. Americans would be better off keeping their payroll tax contributions and saving them in private retirement accounts than having to sacrifice them to the government’s broken Social Security system. Social Security’s design has, over the decades, presumed that many Americans are too incompetent to make informed decisions for themselves, but few Americans believe that the government knows better than they do what is best for them and their families. Moreover, Social Security’s financial structure effectively guarantees that workers will receive extremely low, or even negative, returns on their payroll taxes.

P.S. Fixing Social Security is simple, but it won’t be easy. Benefits would have to be preserved for current retirees and older workers, so there would be a “transition cost” as we shift to a “funded” system of personal accounts.

P.P.S. But reform is possible. If you want real-world role models of retirement systems based on private saving, take a look at the Australian system, the Chilean system, the Hong Kong system, the Swiss system, the Dutch system, the Swedish system, or even the system in the Faroe Islands.

P.P.P.S. Our friends on the left have a solution – albeit misguided – for Social Security’s fiscal crisis. But their approach would greatly worsen the rate-of-return crisis.

P.P.P.P. S. You can enjoy some Social Security cartoons here, here, and here. And we also have a Social Security joke if you appreciate grim humor.

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I wrote yesterday about the continuing success of Switzerland’s spending cap.

Before voters changed the Swiss constitution, overall expenditures were growing by an average of 4.6 percent annually. Ever since the “debt brake” took effect, though, government spending has increased by an average of just 2.1 percent.

For all intents and purposes, Switzerland is getting good results because it is now complying with fiscal policy’s Golden Rule.

Unfortunately, the same cannot be said for the United States. The Congressional Budget Office just released its new long-run forecast of the federal budget.

The most worrisome factoid in the report is that the overall burden of federal spending is going to expand significantly over the next three decades, jumping from 20.6 percent of the economy this year to 29.3 percent of economic output in 2048.

And why will the federal budget consume an ever-larger share of economic output? The chart tells you everything you need to know. Our fiscal situation is deteriorating because government is growing faster than the private sector.

Actually, the chart doesn’t tell you everything you need to know. It doesn’t tell us, for instances, that tax increases simply make a bad situation worse since politicians then have an excuse to avoid much-need reforms.

And the chart also doesn’t reveal that entitlement programs are the main cause of ever-expanding government.

But the chart does a great job of showing that our fundamental problem is growth of government. Which presumably makes it obvious that the only logical solution is a spending cap.

The good news is that there already is a spending cap in Washington.

But the bad news is that it only applies to “appropriations,” which are a small share of the overall federal budget.

And the worse news is that politicians voted to bust that spending cap in 2013, 2015, and earlier this year.

The bottom line is that we know spending restraint works, but the challenge is figuring out a system that actually ties the hands of politicians. Switzerland and Hong Kong solved that problem by making their spending caps part of their national constitutions.

Sadly, there’s little immediate hope of that kind of reform in the United States.

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I’ve half-joked in the past that spending restraint is the answer to every fiscal problem.

But I wouldn’t be surprised if it’s the right answer to 98 percent of fiscal problems. Some fiscal discipline is what we need in America, for instance, and it’s certainly an approach that works whenever and wherever it is tried.

Could it also be the answer in Jordan, which has stumbled into a fiscal crisis and is now facing domestic unrest?

The trouble began in January when the government announced a big IMF-supported tax increase. Here’s some of what was reported by Reuters.

Jordans cabinet announced on Monday a major package of IMF-guided tax hikes… The package announced on state media includes removing exemptions on general sales tax and unifying low 4 to 8 percent rates on a large number of items at 10 percent while leaving it at 16 percent ceiling for others, alongside raising special taxes on tobacco, premium gasoline and streamlining customs duties.

Interestingly, the article acknowledged that the country got in a fiscal mess because of too much spending.

The debt is at least in part due to successive governments adopting an expansionist fiscal policy characterized by job creation in the bloated public sector, and by lavish subsidies for bread and other staple goods. …Economists said Jordans ability to maintain a costly subsidy system and a large state bureaucracy was increasingly untenable in the absence of large foreign capital inflows or infusions of foreign aid.

But politicians almost always prefer tax hikes rather than spending restraint (even though – or perhaps because – higher taxes are not an effective way of controlling red ink).

The victims of those tax increases are not happy. As reported earlier this month, they took to the streets.

Jordanians took to the streets of the capital Amman on Sunday in a fourth day of nightly protests against IMF-backed price increases that have shaken the kingdom, witnesses said. …demonstrators who converged near the cabinet office chanted slogans calling for the sacking of Prime Minister Hani Mulki and saying they would disband only if the government rescinded a tax bill it sent to parliament last month which critics say worsens living standards. …Public anger over IMF-driven government policies has grown since a steep general sales tax hike earlier this year… The government says it needs more funds for public services and argues that tax reforms reduce social disparities by placing a heavier burden on high earners.

And the protests worked.

The New York Times has the cheerful news.

The government of Jordan announced on Thursday that it would withdraw a divisive tax bill after nationwide protests rocked the country, leading to the resignation of the prime minister and his cabinet. The newly appointed prime minister, Omar Razzaz, said in a statement that he had consulted members of both houses of Parliament, and that there was a consensus that the tax bill should be withdrawn. …The decision to withdraw the bill, which proposed increasing the tax rate on workers by at least five percentage points and on businesses by 20 to 40 percentage points, was lauded by many in Jordan.

Incidentally, taxpayers in the United States have been subsidizing Jordanian profligacy.

In 2015, the Obama administration and Jordan signed a three-year agreement in which the United States pledged $1 billion in assistance annually, subject to the approval of Congress. More recently, Washington pledged $6.3 billion in aid through 2022, making Jordan one of the top recipients of American foreign assistance.

These three news reports were interesting, but I wondered if they told the full story.

Maybe, just maybe, the IMF is right and tax increases are necessary because there is no leeway to reduce the burden of government spending. Perhaps the government already has been complying with Mitchell’s Golden Rule and has slashed the budget, meaning that higher revenues are the only feasible option still on the table.

So I decided to check the IMF’s World Economic Outlook database. Lo and behold, I discovered that the budget has soared from 2 billion dinar in 2000 to more than 9 billion dinar this year. What’s especially remarkable is that government spending has grown far faster than needed to keep pace with inflation.

In other words, what happened in Jordan is exactly what happened in Greece. Government grew too fast. But not just Greece. The mess in Jordan is a repeat of what happened in Western Australia. In Puerto Rico as well. And don’t forget Alberta and Alaska. The list could go on and on.

It’s sort of like the sun rising in the east and setting in the west. Or the swallows returning to Capistrano.

And for those who value predictability, it’s no surprise to once again see the IMF pushing for higher taxes. Those bureaucrats are the Dr. Kevorkian of the global economy and there’s only one medicine they prescribe.

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As a general rule, we worry too much about deficits and debt. Yes, red ink matters, but we should pay more attention to variables such as the overall burden of government spending and the structure of the tax system.

That being said, Greece shows that a nation can experience a crisis if investors no longer trust that a government is capable of “servicing” its debt (i.e., paying interest and principal to people and institutions that hold government bonds).

This doesn’t change the fact that Greece’s main fiscal problem is too much spending. It simply shows that it’s also important to recognize the side-effects of too much spending (if you have a brain tumor, that’s your main problem, even if crippling headaches are a side-effect of the tumor).

Anyhow, it’s quite likely that Italy will be the next nation to travel down this path.

This in in part because the Italian economy is moribund, as noted by the Wall Street Journal.

Italy’s national elections…featured populist promises of largess but neglected what economists have long said is the real Italian disease: The country has forgotten how to grow. …The Italian economy contracted deeply in Europe’s debt crisis earlier this decade. A belated recovery now under way yielded 1.5% growth in 2017—a full percentage point less than the eurozone as a whole and not enough to dispel Italians’ pervasive sense of national decline. Many European policy makers view Italy’s stasis as the likeliest cause of a future eurozone crisis.

Why would Italy be the cause of a future crisis?

For the simple reason that it is only the 4th-largest economy in Europe, but this chart from the Financial Times shows it has the most nominal debt.

So what’s the solution?

The obvious answer is to dramatically reduce the burden of government.

Interestingly, even the International Monetary Fund put forth a half-decent proposal based on revenue-neutral tax reform and modest spending restraint.

The scenario modeled assumes a permanent fiscal consolidation of about 2 percent of GDP (in the structural primary balance) over four years…, supported by a pro-growth mix of revenue and expenditure reforms… Two types of growth-friendly revenue and spending measures are considered along the envisaged fiscal consolidation path: shifting taxation from direct to indirect taxes, and lowering expenditure and shifting its composition from transfers to investment. On the revenue side, a lower labor tax wedge (1.5 percent of GDP) is offset by higher VAT collections (1 percent of GDP) and introducing a modern property tax (0.5 percent of GDP). On the expenditure side, spending on public consumption is lowered by 1.25 percent of GDP, while productive public investment spending is increased by 0.5 percent of GDP. The remaining portion of the fiscal consolidation, 1.25 percent of GDP, is implemented via reduced social transfers.

Not overly bold, to be sure, but I suppose I should be delighted that the IMF didn’t follow its usual approach and recommend big tax increases.

So are Italians ready to take my good advice, or even the so-so advice of the IMF?

Nope. They just had an election and the result is a government that wants more red ink.

The Wall Street Journal‘s editorial page is not impressed by the economic agenda of Italy’s putative new government.

Five-Star wants expansive welfare payments for poor Italians, revenues to pay for it not included. Italy’s public debt to GDP, at 132%, is already second-highest in the eurozone behind Greece. Poor Italians need more economic growth to generate job opportunities, not public handouts that discourage work. The League’s promise of a pro-growth 15% flat tax is a far better idea, especially in a country where tax avoidance is rife. The two parties would also reverse the 2011 Monti government pension reforms, which raised the retirement age and moved Italy toward a contribution-based benefit system. …Recent labor-market reforms may also be on the block.

Simply stated, Italy elected free-lunch politicians who promised big tax cuts and big spending increases. I like the first part of that lunch, but the overall meal doesn’t add up in a nation that has a very high debt level.

And I don’t think the government has a very sensible plan to make the numbers work.

…problematic for the rest of Europe are the two parties’ demand for an exemption from the European Union’s 3% GDP cap on annual budget deficits. …the two parties want the European Central Bank to cancel some €250 billion in Italian debt.

Demond Lachman of the American Enterprise Institute suggests this will lead to a fiscal crisis because of two factors. First, the economy is weak.

Anyone who thought that the Eurozone debt crisis was resolved has not been paying attention to economic and political developments in Italy…the recent Italian parliamentary election…saw a surge in support for populist political parties not known for their commitment to economic orthodoxy or to real economic reform. …To say that the Italian economy is in a very poor state would be a gross understatement. Over the past decade, Italy has managed to experience a triple-dip economic recession that has left the level of its economy today 5 percent below its pre-2008 peak. Meanwhile, Italy’s current unemployment level is around double that of its northern neighbors, while its youth unemployment continues to exceed 25 percent. …the country’s public debt to GDP ratio continued to rise to 133 percent, making the country the most indebted country in the Eurozone after Greece. …its banking system remains clogged with non-performing loans that still amount to 15 percent of its balance sheet…

Second, existing debt is high.

…having the world’s third-largest government bond market after Japan and the United States, with $2.5 trillion in bonds outstanding, Italy is simply too large a country for even Germany to save. …global policymakers…, it would seem not too early for them to start making contingency plans for a full blown Italian economic crisis.

Since he writes on issues I care about, I always enjoy reading Lachman’s work. Though I don’t always agree with his analysis.

Why, for instance, does he think an Italian fiscal crisis threatens the European currency?

…the Italian economy is far too large an economy to fail if the Euro is to survive in anything like its present form.

Would the dollar be threatened if (when?) Illinois goes bankrupt?

But let’s not get sidetracked.3

To give you an idea of the fairy-tale thinking of Italian politicians, I’ll close with this chart from L’Osservatorio on the fiscal impact of the government’s agenda. It’s in Italian, but all you need to know is that the promised tax cuts and spending increases are on the left side and the compensating savings (what we would call “pay-fors”) are on the right side.

Wow, makes me wonder if Italy has passed the point of no return.

By the way, Italy may be the next domino, but it’s not the only European nation with fiscal problems.

P.S. No wonder some people want Sardinia to secede from Italy and become part of “sensible” Switzerland.

P.P.S. Some leftists genuinely think the United States should emulate Italy.

P.P.P.S. As a fan of spending caps, I can’t resist pointing out that anti-deficit rules in Europe have not stopped politicians from expanding government.

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Five former Democratic appointees to the Council of Economic Advisers have a column in today’s Washington Post asserting that we should not blame entitlements for America’s future fiscal problems.

The good news is that they at least recognize that there’s a future problem.

The bad news is that their analysis is sloppy, inaccurate, and deceptive.

They start with an observation about red ink that is generally true, though I think the link between government borrowing and interest rates is rather weak (at least until a government – like Greece – gets to the point where investors no longer trust its ability to repay).

The federal budget deficit is on track to exceed $1 trillion next year and get worse over time. Eventually, ever-rising debt and deficits will cause interest rates to rise. …the growing debt will take an increasing toll.

But the authors don’t want us to blame entitlements for ever-rising levels of red ink.

It is dishonest to single out entitlements for blame.

That’s a remarkable claim since the Congressional Budget Office (which is not a small government-oriented bureaucracy, to put it mildly) unambiguously shows that rising levels of so-called mandatory spending are driving our long-run fiscal problems.

CBO’s own charts make this abundantly clear (click on the image to see the original column with the full-size chart).

So how do the authors get around this problem?

First, they try to confuse the issue by myopically focusing on the short run.

The primary reason the deficit in coming years will now be higher than had been expected is the reduction in tax revenue from last year’s tax cuts, not an increase in spending.

Okay, fair enough. There will be a short-run tax cut because of the recent tax legislation. But the column is supposed to be about the future debt crisis. And that’s a medium-term and long-term issue.

Well, it turns out that they have to focus on the short run because their arguments become very weak – or completely false – when we look at the overall fiscal situation.

For instance, they make an inaccurate observation about the recent tax reform legislation.

…the tax cuts passed last year actually added an amount to America’s long-run fiscal challenge that is roughly the same size as the preexisting shortfalls in Social Security and Medicare.

That’s wrong. The legislation actually increases the long-run tax burden.

And that’s in addition to the long-understood reality that the tax burden already is scheduled to gradually increase, even measured as a share of economic output.

Once again, the CBO has a chart with the relevant data. Note especially the steady rise in the burden of the income tax (once again, feel free to click on the image to see the original column with the full-size chart).

The authors do pay lip service to the notion that there should be some spending restraint.

There is some room for…spending reductions in these programs, but not to an extent large enough to solve the long-run debt problem.

But even that admission is deceptive.

We don’t actually need spending reductions. We simply need to slow down the growth of government. Indeed, our long-run debt problem would be solved if imposed some sort of Swiss-style or Hong Kong-style spending cap so that the budget couldn’t grow faster than 3 percent yearly.

In any event, they wrap up their column by unveiling their main agenda. They want higher taxes.

Additional revenue is critical…responding to the looming fiscal challenge required a balanced approach that combined increased revenue with reduced spending. Two bipartisan commissions, Simpson-Bowles and Domenici-Rivlin, proposed such approaches that called for tax reform to raise revenue as a percent of GDP…set tax policy to realize adequate revenue.

As I already noted, the tax burden already is going to climb as a share of GDP. But the authors want an increase on top of the built-in increase.

And it’s very revealing that they cite Simpson-Bowles, which is basically a left-wing proposal of higher taxes combined with the wrong type of entitlement reform. To be fair, the Domenici-Rivlin plan  has the right kind of entitlement reform, but that proposal is nonetheless bad news since it contains a value-added tax.

The bottom line if that the five Democratic CEA appointees who put together the column (I’m wondering why Austan Goolsbee didn’t add his name) do not make a compelling case for higher taxes.

Unless, of course, the goal is to enable a bigger burden of government.

Which is the message of this very appropriate cartoon.

Needless to say, this belongs in my “Government in Cartoons” collection.

P.S. Entitlement spending is not only to blame for our future spending problems. It’s also the cause of our current spending problems.

P.P.S. In a perverse way, I actually like the column we discussed today. Five top economists on the left put their heads together and tried to figure out the most compelling argument for higher taxes. Yet what they produced is shoddy and deceptive. In other words, they didn’t make a strong argument because they don’t have a strong argument. Reminds me of Robert Rubin’s anemic argument last year against the GOP tax plan.

P.P.P.S. Four former presidents offer good advice on the topic of taxation.

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I’m a big fan of federalism because states have the flexibility to choose good policy or bad policy.

And that’s good news for me since I get to write about the consequences.

One of the main lessons we learn (see here, here, here, here, and here) is that high-earning taxpayers tend to migrate from states with onerous tax burdens and they tend to land in places where there is no state income tax (we also learn that welfare recipients move to states with bigger handouts, but that’s an issue for another day).

In this interview with Stuart Varney, we discuss whether this trend of tax-motivated migration is going to accelerate.

I mentioned in the interview that restricting the state and local tax deduction is going to accelerate the flight from high-tax states, which underscores what I wrote earlier this year about that provision of the tax bill being a “big [expletive deleted] deal.”

I suggested that Stuart create a poll on which state will be the first to go bankrupt.

And there’s a lot of data to help people choose.

Technically, I don’t think bankruptcy is even possible since there’s no provision for such a step in federal law.

But it’s still an interesting issue, so I decided to create a poll on the question. To make it manageable, I limited the selection to 10 states, all of which rank poorly in one of more of the surveys listed above. And, to avoid technical quibbles, the question is about “fiscal collapse” rather than bankruptcy, default, or bailouts. Anyhow, as they say in Chicago, vote early and vote often.

P.S. I asked a similar question about bankruptcies in developed nations back in 2011. Back then, it appeared Portugal might be the right answer. Today, I’d pick Italy.

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Way back in 2009, I narrated a video explaining that people worry too much about deficits and debt. Red ink isn’t desirable, to be sure, but I pointed out that the real problem is government spending.

And the bottom line is that most types of government spending are bad for an economy, regardless of whether they are financed by taxes or borrowing.

It is possible, of course, for a nation to have a debt crisis. But keep in mind that this simply means a government has accumulated so much debt that investors no longer trust that they will receive payments on government bonds.

That’s not a good outcome, but replacing debt-financed spending with tax-financed spending is like jumping out of the frying pan and into the fire. Or the fire into the frying pan, if you prefer. In either case, politicians are ignoring the real problem.

Greece is a cautionary example. Thanks to a period of overspending, Greek politicians drove the country into a debt crisis. But this dark cloud had a silver lining. The good news (at least relatively speaking) is that the government no longer could borrow from the private sector to finance more spending.

But the bad news is that Greek politicians subsequently hammered the economy with huge tax increases in hopes of propping up the country’s bloated welfare state. And the “troika” made a bad situation worse with bailout funds (mostly to protect big banks that unwisely lent money to Greek politicians, but that’s a separate story).

In other words, Greece got in trouble because of too much government spending and it remains in trouble because of too much government spending. As is the case for many other European nations.

And I fear the United States is slowly but surely heading in that direction. I elaborate about the problem of government spending – and the concomitant symptom of red ink – in this interview with the Mises Institute.

For all intents and purposes, I’m trying to convince people that deficits and debt are bad, but they’re bad mostly because they are a sign that government is too big. Sort of like a brain tumor being the real problem and headaches being a warning sign.

I feel like Goldilocks on this issue. Except instead of porridge that is too hot or too cold, I deal with people on both sides who think red ink is either wonderful or terrible.

For an example of the former group, here’s some of what Stephanie Kelton wrote for the New York Times last October.

…bigger deficits wouldn’t wreck the nation’s finances. …Lawmakers are obsessed with avoiding an increase in the deficit. …It’s also holding us back. Politicians of both parties should stop using the deficit as a guide to public policy. Instead, they should be advancing legislation aimed at raising living standards and delivering…long-term prosperity.

Hard to disagree with the above excerpt.

But here’s the part I don’t like. She’s a believer in the perpetual motion machine of Keynesian economics. She thinks deficits are actually good for the economy and she wants to use debt to finance an ever-larger burden of government spending.

Government spending adds new money to the economy, and taxes take some of that money out again. …we should think of the government’s spending as self-financing since it pays its bills by sending new money into the economy. …the deficit itself could be deployed as a potent weapon in the fights against inequality, poverty and economic stagnation.

Ugh.

Now let’s check out the view of the so-called deficit hawks who think red ink is an abomination.

Here are some passages from a Hill report on the battle over last year’s tax plan.

A handful of GOP deficit hawks are worried that their party’s tax plan could add trillions to the deficit, deepening a debt crisis for future generations. …The tax plan could cost the government $1.5 trillion in revenue over the next decade… Sen. Bob Corker (R-Tenn.), who recently announced his retirement at the end of this Congress, has warned he’ll oppose the tax plan if it adds to the deficit. …In a separate interview, he told The New York Times that the debt is “the greatest threat to our nation,” more dangerous than the Islamic State in Iraq and Syria, or North Korea.

Ugh, again.

The threat isn’t the red ink. The real danger is an ever-increasing burden of government spending, driven by entitlements.

Besides, the GOP tax bill actually is a long-run tax increase!

Let’s close with a video on the topic from Marginal Revolution. It has too much Keynesianism in it for my tastes, but the discussion of Argentina’s default is useful for those who wonder about whether the United States is going to have a debt meltdown at some point.

P.S. I don’t agree with Keynesians and I don’t agree with the self-styled deficit hawks. But I can appreciate that both groups have a consistent approach to public finance. What really galls me are the statist hypocrites who are cheerleaders for debt when there are proposals to increase government spending, but then do a back flip and pretend that debt is terrible and must be reduced when tax increases are being discussed.

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I’ve narrated a video on why big government is theoretically bad for an economy, another video looking at the empirical evidence on government spending and economic performance, and also a video on the growth-maximizing size of the public sector.

But if you want to see a lot of what I said condensed into one video, here’s Dennis Prager talking about differences in how the left and right view government. The opening part of the video is interesting, though I suspect his descriptions only apply to philosophically motivated activists on each side.

The part I want to focus on begins about 1:15, when he outlines seven adverse consequences of ever-growing government.

I think he put together a very good list. Here’s my two cents on his seven points.

  1. More Corruption – He points out that a government with lots of power and control will be very susceptible to misbehavior as interest groups and politicians figure out ways of scamming the system. Very similar to the message in one of my videos.
  2. Less Liberty – It is basically a tautology that ever-larger government necessitates a reduction in liberty. Not in a totalitarian sense, but taxes and regulations constrain the freedom of individual to earn and control income.
  3. Fiscal Crisis – He warns that big government is a recipe for fiscal crisis. I’m not sure if this has to be inevitable, but from a practical perspective, he is right. Demographic change and entitlements are a poisonous combination.
  4. Punitive Taxation – If government consistently expands faster than the productive sector of the economy, that almost certainly means ever-higher taxes, which ultimately will be self defeating because of the Laffer Curve.
  5. Unsustainable Debt – An expanding burden of government spending also will mean ever-higher levels of red ink, especially once the tax burden is so high that additional levies don’t produce much – if any – revenue.
  6. Totalitarianism – This is probably Prager’s weakest point. He’s right that bad people do very bad things when they control a government, but I suspect western nations will suffer societal breakdown rather that dictatorship.
  7. Dependency – He closes very strong with observations about the danger of luring people into reliance on government. This concern about the erosion of societal capital is much more important than most people think.

For all intents and purposes, Prager’s video is a very good description of “goldfish government.”

This is the term I use to describe the unfortunate tendency of politicians to over-tax and over-spend until a society faces a crisis.

For what it’s worth, I don’t think western nations necessarily will collapse (though some almost certainly will depending on the degree to which societal capital has been destroyed).

But I will acknowledge that politicians generally don’t like taking the necessary steps to avert fiscal crisis.

Which is one of the reasons I’m such a big fan of tax competition. I don’t want politicians to think that endless tax increases are a way of postponing the fiscal day of reckoning.

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At some point in the next 10 years, there will be a huge fight in the United States over fiscal policy. This battle is inevitable because politicians are violating the Golden Rule of fiscal policy by allowing government spending to grow faster than the private sector (exacerbated by the recent budget deal), leading to ever-larger budget deficits.

I’m more sanguine about red ink than most people. After all, deficits and debt are merely symptoms. The real problem is excessive government spending.

But when peacetime, non-recessionary deficits climb above $1 trillion, the political pressure to adopt some sort of “austerity” package will become enormous. What’s critical to understand, however, is that not all forms of austerity are created equal.

The crowd in Washington reflexively will assert that higher taxes are necessary and desirable. People like me will respond by explaining that the real problem is entitlements and that we need structural reform of programs such as Medicaid and Medicare. Moreover, I will point out that higher taxes most likely will simply trigger and enable additional spending. And I will warn that tax increases will undermine economic performance.

Regarding that last point, three professors, led by Alberto Alesina at Harvard, have unveiled some new research looking at the economic impact of expenditure-based austerity compared to tax-based austerity.

…we started from detailed information on the consolidations implemented by 16 OECD countries between 1978 and 2014. …we group measures in just two broad categories: spending, g, and taxes, t. …We distinguish fiscal plans between those that are expenditure based (EB) and those that are tax based (TB)… Measuring the macroeconomic impact of a plan requires modelling the relationship between plans and macroeconomic variables.

Here are their econometric results.

There is a large and statistically significant difference between the effects on output of EB and TB austerity. EB fiscal consolidations have, on average, been associated with a very small downturn in output growth: a spending based plan worth one percent of GDP implies a loss of about half of a percentage point relative to the average GDP growth of the country, which lasts less than two year. Moreover, if an EB austerity plan is launched when the economy is not in a recession, the output costs are zero on average. …On the other hand TB plans are associated with large and long lasting recessions. A TB plan worth one per cent of GDP is followed, on average, by a two percent fall in GDP relative to its pre-austerity path. This large recessionary effect lasts several years.

Here’s a chart from the study showing that economic performance drops farther and farther to the extent taxes are part of an austerity package.

In addition to the core results, the authors explain why tax-based austerity packages are bad for capital…

…investment growth responds very differently following the introduction of the two types of austerity plans. It responds positively to EB plans and negatively to TB plans. …in their sample of OECD countries, business confidence increases immediately at the start of an EB consolidation plan, much more so that at the beginning of a TB plan.

…and why tax-based austerity packages are bad for labor.

…clearly tax hikes and spending cuts – beyond other effects – have different effects on labor supply. …EB plans are the least recessionary the longer lived is the reduction in government spending. Symmetrically, TB plans are more recessionary the longer lasting is the increase in the tax burden and thus in distortions.

Since capital and labor are the two factors of production, the obvious and inevitable conclusion is that the economy does worse when taxes are higher.

The study also make a critical point about the futility of tax increases when the burden of government spending is rising faster than the private sector. Simply stated, that’s a recipe for ever-increasing taxes, sort of like a dog chasing its tail.

…a TB plan which does not address the automatic growth of entitlements and other spending programs which grow over time if much less like likely to produce a long lasting effect on the budget. If the automatic increase of spending is not addressed, taxes will have to be continually increased to cover the increase in outlays.

That’s why spending restraint is the only way to successfully address red ink.

It doesn’t even require dramatic spending cuts, even though that would be desirable. All that’s needed is some modest fiscal restraint so that spending grows slower than the productive sector of the economy.

Nations that follow this approach for a multi-year period always get good results. But if you want examples of nations that have achieved good outcomes with tax increases, you’ll have to explore a parallel universe because there aren’t any on this planet.

P.S. I need to update the table because both the United States (between 2009-2014) and the United Kingdom (between 2010-2016) enjoyed dramatic improvements in fiscal outcomes in recent years because of spending restraint.

P.P.S. Politicians don’t like spending restraint, which is why most periods of good fiscal policy come to an end. To achieve good long-run outcomes, some sort of constitutional spending cap is probably necessary.

P.P.P.S. The study cited above builds upon research I cited in 2016.

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I gave a speech last night at the University of Texas Arlington on the topic of “Is America turning into Greece? How the growth of government and debt risk creating a dismal future for young Americans.”

Not a very succinct title, I realize, but I wanted to warn students that they are the ones who will suffer if today’s politicians fail to enact genuine entitlement reform. And since I told them I wasn’t expecting reform with Trump in the White House, my message was rather gloomy.

My only good news is that I told students that nations such as Italy, Japan, and France likely would suffer fiscal crises before the you-know-what hit the fan in America.

Though it would have been better if my speech was today. I could have cited this Robert Samuelson column from the Washington Post.

No one can say we weren’t warned. For years, scholars of all shapes and sizes — demographers, economists, political scientists — have cautioned that the populations of most advanced countries are gradually getting older, with dramatic consequences for economics and politics. But we haven’t taken heed by preparing for an unavoidable future. The “we” refers not just to the United States but to virtually all advanced societies. In fact, America’s aging, though substantial, is relatively modest compared with that of many European countries and Japan. …The problem is simple. Low birth rates and increasing life expectancies result in aging populations. Since 1970, average life expectancy at age 60 in OECD countries has risen from 18 years to 23.4 years; by 2050, it’s forecast to increase to 27.9 years — that is, to nearly 90. The costs of Social Security and pensions will explode. …The implication: Unless retirement ages are raised sharply or benefits are cut deeply, more and more of the income of the working-age population will be siphoned off through higher taxes or cuts in other government spending to support retirees.

Here’s a table from the article that shows the radical erosion in the age-dependency ratio for selected nations. To give you an idea what the numbers mean, a ratio of 33 (Greece today) means that each worker is supporting one-third of a retiree while a ratio of 73 (Greece in 2050) means that each worker is supporting three-fourths of a retiree.

The Greek numbers are grim, of course, and Italy and Japan are also in very bad shape.

And it’s worth noting that the ratio in China will rapidly deteriorate.

An article in New Scientist makes a similar observation about dramatic demographic change.

Could the population bomb be about to go off in the most unexpected way? Rather than a Malthusian meltdown, could we instead be on the verge of a demographic implosion? To find out how and why, go to Japan, where a recent survey found that people are giving up on sex. Despite a life expectancy of 85 and rising, the number of Japanese is falling thanks to a fertility rate of just 1.4 children per woman… Half the world’s nations have fertility rates below the replacement level of just over two children per woman. Countries across Europe and the Far East are teetering on a demographic cliff, with rates below 1.5. On recent trends, Germany and Italy could see their populations halve within the next 60 years.

The most sobering information is contained in a new report from my “friends” at the Organization for Economic Cooperation and Development. I’m definitely not a fan of the OECD’s policy work, but it does a good job of collecting apples-to-apples data.

Let’s start with the OECD’s calculations of how the old-age dependency ratio will change in various nations.

It’s not good to have a very tall black line in Figure 1.1, so we can confirm the bad news about Italy, Greece, and Japan. But note that Spain, Portugal, and South Korea also face a grim future. Simply stated, tomorrow’s workers will face an enormous burden.

There are two reasons for these grim numbers.

First, we’re living longer. That’s good news for us, but it’s bad news for the sustainability of tax-and-transfer entitlement programs (i.e., this partially explains why Social Security in the U.S. has a $44 trillion shortfall).

This chart shows that increasing longevity is a big reason why both men and women are spending more years in retirement (though there’s a glimmer of good news since the data shows that we’re no longer retiring at ever-younger ages).

In addition to living longer, we’re also having fewer kids.

This is a big deal because more babies today mean more future taxpayers.

But you can see from this table that birthrates have declined in America, as well as in other developed nations (keep in mind that a fertility rate of 2.1 is needed to keep the native-born population from shrinking).

Even more shocking, check out the demographic data for Japan and South Korea. Birth rates in Japan already had fallen by 1960 and they’re even lower today. But the numbers for South Korea are staggering.

Wow.

I guess it’s now easy to understand this story from South Korea.

Students at two South Korean universities are being offering courses that make it mandatory for them to date their classmates as the country battles to reverse one of the lowest birth rates in the world. Seoul’s Dongguk and Kyung Hee universities say the courses on dating, sex, love and relationships target a generation which is shunning traditional family lives. …She said: ”Korea’s fall in population has made dating and marriage important but young Koreans are too busy these days and clumsy in making new acquaintances.” And as part of the course, students have to date three classmates for a month… Seoul has spent about £50 billion trying to boost the birth rate.

I don’t know what’s the strangest part of the article, the part about having to date your classmates as part of homework (do you get extra credit if the girl gets pregnant?!?) or the part about the government squandering an astounding 50 billion pounds (about 67 billion dollars) on trying to encourage kids (I guess politicians never learn).

Or this story from Japan that brings back painful memories of high school.

Talk about a shrinking population. A survey of Japanese people aged 18 to 34 found that almost 70 percent of unmarried men and 60 percent of unmarried women are not in a relationship. Moreover, many of them have never got close and cuddly. Around 42 percent of the men and 44.2 percent of the women admitted they were virgins. The government won’t be pleased that sexlessness is becoming as Japanese as sumo and sake. The administration of Prime Minister Shinzo Abe has talked up boosting the birthrate through support for child care, but until the nation bones up on bedroom gymnastics there’ll be no medals to hand out. …Boosting the birthrate is one of the coveted goals of the Abe administration, which has declared it will raise the fertility rate from the current 1.4 to 1.8 by 2025 or so.

The bottom line, as Samuelson suggested in his column, is that western nations are facing a baked-in-the-cake demographic-fiscal crisis.

What’s sad is that we know the crisis will happen, but politicians in most nations have no intention of solving the problems.

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