Recovery for the PIGS?

Just a few months ago, I wrote about Germany’s fiscal decay.

Over the past eight years, government spending has grown much faster than the private sector, thus violating the Golden Rule of fiscal policy.

Given the shift to bad policy in Germany, I was very interested to see that the New York Times has a report by Liz Alderman and Melissa Eddy that explains how Germany no longer is the economic engine in Europe.

Here are some excerpts.

Something extraordinary is happening to the European economy: Southern nations that nearly broke up the euro currency bloc during the financial crisis in 2012 are growing faster than Germany… In a reversal of fortunes, the laggards have become leaders. Greece, Spain and Portugal grew in 2023 more than twice as fast as the eurozone average. Italy was not far behind. …southern European countries made crucial changes that have attracted investors, revived growth and…reversed record-high unemployment. Governments cut red tape and corporate taxes to stimulate business and pushed through changes to their once-rigid labor markets, including making it easier for employers to hire and fire workers.

It’s encouraging to read about some pro-market reforms in Southern Europe.

It’s also encouraging that the New York Times seems to be acknowledging that free markets are the way to achieve more growth.

That being said, I’m not ready to declare that the PIGS (Portugal, Italy, Greece, and Spain) are the new role models for economic policy.

For instance, the NYT story is based on just one year of economic data. And I’ve warned that it is risky to draw big conclusions without seeing decades of evidence.

But a journey of a thousand miles begins with a first step. Given my interest in fiscal policy, I looked at the IMF data to see which countries have been most responsible over the past few years.

Lo and behold, Greece and Italy have been doing a decent job.

Three years of fiscal restraint may not seem like much, but it’s worth noting that the burden of government spending in Greece has declined by more than 10 percentage points of GDP.

And the spending burden in Italy has been reduced by nearly 7 percentage points of GDP.

Keep that up for 5-10 more years, and those countries could become Switzerland.

Do it for 10-20 years, and they can become Singapore or Taiwan.

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Reassessing the War on Drugs

I disapprove of marijuana, cocaine, and other drugs. But I have libertarian views on legalization because people should have the right to do potentially stupid things to their own bodies.

And I hold to that view even though I fear decriminalization will have some negative consequences.

Indeed, I’ve never claimed legalization is a zero-cost policy. Instead, as I wrote in 2018, “I think the social harm of prohibition is greater than the social harm of legalization.”

That way of thinking seems especially relevant given the very somber tone in a recent report about Portugal’s experience with decriminalization in the Washington Post.

Written by Anthony Faiola and Catarina Fernandes Martins, the article suggests that the country is reconsidering its approach.

Portugal decriminalized all drug use, including marijuana, cocaine and heroin, in an experiment that inspired similar efforts elsewhere, but now police are blaming a spike in the number of people who use drugs for a rise in crime. …now there is talk of fatigue. Police are less motivated to register people who misuse drugs and there are year-long waits for state-funded rehabilitation treatment even as the number of people seeking help has fallen dramatically. …Is it time to reconsider this country’s globally hailed drug model? …“These days in Portugal, it is forbidden to smoke tobacco outside a school or a hospital. It is forbidden to advertise ice cream and sugar candies. And yet, it is allowed for [people] to be there, injecting drugs,” said Rui Moreira, Porto’s mayor. “We’ve normalized it.” …A newly released national survey suggests the percent of adults who have used illicit drugs increased to 12.8 percent in 2022, up from 7.8 in 2001, though still below European averages. …even proponents of decriminalization here admit that something is going wrong. …Porto’s mayor and other critics, including neighborhood activist groups, are not calling for a wholesale repeal of decriminalization — but rather, a limited re-criminalization in urban areas and near schools and hospitals.

This is a decidedly grim assessment, much less optimistic than what I wrote back in 2017.

Though I did warn in that column, “…whether redistribution programs enable reckless behavior. In other words, people may decide it’s okay to be stoners because they can rely on handouts to stay alive instead of staying clean and having a job.”

Is that happening in Portugal? Based on the limited information in the story, there’s no way of answering that question.

Regardless, nothing in the Washington Post‘s report changes my assessment about the futility of the War on Drugs.

Speaking of which, C.J. Ciaramella writes about the failure of America’s Drug Enforcement Agency in a column for Reason.

The DEA is celebrating its 50th anniversary this year, marking half a century of abject mission failure. During five decades as a bottomless money pit that has destroyed countless lives while targeting Americans for personal choices and peaceful transactions, the agency’s annual budget has ballooned from $75 million to $3.2 billion. The DEA currently operates 90 foreign offices in 67 countries. …Since 1986, it has arrested more than 1 million people for manufacturing, distributing, or possessing illegal drugs. Yet in 2021, the Centers for Disease Control and Prevention (CDC) counted more than 107,600 drug-related deaths—an all-time high. The DEA’s own data show a steady, gradual decline in price and rise in purity for most street drugs since the 1980s. …Democrats and Republicans ensured the drug war was not cheap, but the human tragedies continued. …tough-on-crime bills pushed by Biden and like-minded legislators bore their rotten fruit. The total incarcerated population in the United States skyrocketed from roughly 500,000 in 1980 to more than 2.3 million at its peak in 2008. …Five decades should be long enough to admit we’ve made a terrible mistake and relegate the DEA to a museum.

P.S. A downside to legalization is that politicians get a new source of tax revenue.

P.P.S. Keep in mind that the War on Drugs has led to other bad policies such as anti-money laundering laws and civil asset forfeiture laws.

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Part I: Another European Fiscal Crisis?

Why did many European nations, most notably Greece, suffer fiscal crises about a dozen years ago?

Because the burden of government spending, which already was excessive, increased even further.

And with taxes already very onerous in those countries, much of that new spending was financed with borrowing.

Investors then realized it was very risky to finance the various spending sprees. And when they stopped buying bonds from these governments (or started demanding higher interest rates to compensate for risk), that triggered the crises.

One would think that the nations most affected – Portugal, Italy, Greece, and Spain (the PIGS) – would have learned a lesson.

Nope.

As you can see from this IMF data, those governments did not use the post-crisis recovery as an opportunity to get debt under control. Instead, every nation has more debt today than it did when the crisis occurred.

And why do these nations have higher debt levels?

For the simple (and predictable) reason that they have not reduced the burden of government spending.

Instead, as you can see from this next chart, governments are now consuming even greater shares of national economic output. Which means a greater chance of more crises.

To make a bad situation even worse, the European Central Bank cranked up the figurative printing press starting in 2020 by massively expanding its balance sheet.

Dumping all that money into the system quite predictably caused prices to soar. And now that the ECB is belatedly trying to undo its mistake.

That puts the PIGS under more pressure, as Desmond Lachman explained for National Review.

Christine Lagarde, the president of the European Central Bank (ECB)…has to raise interest rates at a time when governments in the euro zone’s economic periphery are more indebted today than they were at the time of the 2010 euro zone sovereign-debt crisis. This more hawkish interest-rate policy, coupled with a shift to quantitative tightening, now risks triggering another round of the euro zone debt crisis. …One of the ECB’s problems in having to raise interest rates aggressively to contain inflation is that such a course risks exacerbating the cracks that are now emerging in the European banking system. …if current trends continue, then another round of euro zone sovereign-debt crisis, where investors lose faith in the government’s ability to repay its debt, could be just around the corner. …This is especially true for Italy, where until recently the ECB had been buying Italian government bonds equivalent to that government’s net borrowing needs.

By the way, Lachman seems to think the Fed should allow continued inflation in order to help bail out Italy and the other PIGS.

That would be a big mistake. The long-run damage of that approach would be much greater than the long-run damage (actually, long-run benefits) of letting Italy and the others go bankrupt.

P.S. The problem in Europe is too much government spending, not the euro currency.

P.P.S. Eurobonds will make things worse in the long run.

P.P.P.S. It is possible to reduce large debt burdens, so long as governments simply restrain spending.

P.P.P.P.S. From the archives, here’s some comedy (and more comedy) about Europe’s fiscal mess.

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Don’t Trust Economists, Part II

Back in 2010, I shared a remarkable graph comparing the predictions of economists to what actually happened.

Not surprisingly, the two lines don’t exactly overlap, which explains the old joke that economists have correctly predicted nine of the last five recessions.

It’s not that economists are totally useless. It’s just that they don’t do a very good job when they venture into the filed of macroeconomics, as Russ Roberts succinctly explained. And they look especially foolish when they try to engage in forecasting.

But at least economists sometimes can be entertaining, though usually in the laughing-at-you rather than laughing-with-you way.

Consider, for instance, the escapades of one of Portugal’s leading economic analysts. Here’s some of what the UK-based Guardian recently reported.

As an ex-presidential consultant, a former adviser to the World Bank, a financial researcher for the United Nations and a professor in the US, Artur Baptista da Silva’s outspoken attacks on Portugal’s austerity cuts made the bespectacled 61-year-old one of the country’s leading media pundits last year.  …Mr Baptista da Silva…claimed to be a social economics professor at Milton College – a private university in Wisconsin, US…and to be masterminding a UN research project into the effects of the recession on southern European countries.

Promoting more government spending

Mr. da Silva was sort of the Paul Krugman of Portugal, working with the left and urging Keynesian policy.

Blessed with such an impressive CV, Mr Baptista’s subsequent criticisms of the Lisbon government’s far-reaching austerity cuts, as well as dire warnings that the UN planned to take action against it, struck a deep chord with its financially beleaguered population. According to the Spanish newspaper El País, his powerfully delivered comments at a debate at the International Club, a prestigious Lisbon cultural and social organisation last month, were greeted with thunderous applause and a part-standing ovation. Then, in a double page interview in the weekly newspaper Expresso in mid-December, Mr Baptista da Silva continued to denounce the government’s policies. That was followed by an interview for the radio station TSF, appearances in high-profile television debates and well-publicised meetings with trade union leaders to advise them on economic policies.

But it turns out that there was a tiny problem with Mr. da Silva’s resume. At least if “tiny” is the right way to describe a total fraud.

The only problem was that Mr Baptista da Silva is none of the above. He turned out to be a convicted forger with fake credentials and, following his spectacular hoodwinking of Portuguese society, he could soon face fraud charges. …in the country’s jails, Mr Baptista da Silva’s sudden appearance among the intellectual elite caused amazement among his former cellmates. …Mr Baptista da Silva’s comeuppance began when the UN confirmed to a Portuguese TV station last month that he did not work for the organisation, not even as a volunteer, as he later alleged. Further media investigations uncovered his prison record and fake university titles… Mr Baptista da Silva has now disappeared completely from public life, and there are reports he is under investigation for fraud charges by the police.

I guess if he was intentionally misrepresenting himself, that perhaps da Silva should go back to jail. Though a lot of real economists and almost all politicians should be in prison as well if that’s the standard.

Let me close by making a serious point. Economists do not hold some magic source of knowledge about public policy. So I’ve never objected when journalists, political scientists, laymen, and others engage in debates about economic policy.

The key to good economic analysis, as Bastiat explained in the 1800s, is looking at the seen and the unseen. And you don’t have to be an economist to recognize that the secondary and tertiary effects of public policy are very important.

Indeed, if Paul Krugman’s any indication, maybe it’s better not to be an economist.

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Class Warfare Tax Policy Causes Portugal to Crash on the Laffer Curve, but Will Obama Learn from this Mistake?

Back in mid-2010, I wrote that Portugal was going to exacerbate its fiscal problems by raising taxes.

Needless to say, I was right. Not that this required any special insight. After all, no nation has ever taxed its way to prosperity.

We’re now at the end of 2012 and Portugal is still saddled with a weak economy. And the higher taxes haven’t resulted in less red ink. Indeed, according to the Economist Intelligence Unit, government debt has jumped from 93 percent of GDP in 2010 to 124 percent of GDP this year.

Why did higher taxes backfire in Portugal? For the same reasons that higher taxes have failed in Greece, Spain, Bulgaria, France, Italy, the United Kingdom, and so many other nations.

• Higher taxes undermine incentives for productive behavior, thus reducing an economy’s potential for growth. This means less economic output, which also means a smaller tax base. This Laffer Curve effect doesn’t necessarily mean less revenue, but it certainly means that tax increases rarely raise as much money as initially projected.
• Higher taxes usually are a substitute for the real solution of spending restraint (i.e., Mitchell’s Golden Rule). Politicians oftentimes refuse to reduce the burden of government spending because of an expectation of additional tax revenue. Heck, in many cases, higher taxes trigger an increase in the size and scope of the public sector.

So did Portugal learn any lessons from this failed experiment in Obamanomics?

Hardly. Indeed, the government plans to double down on this approach – even though it’s increasingly apparent that higher tax burdens won’t translate into much – if any – additional tax revenue. Here are some excerpts from a report in the Financial Times.

Lisbon plans to lift income tax revenue by more than 30 per cent, raising the effective average rate by more than a third from 9.8 to 13.2 per cent. Anyone receiving more than the minimum wage of €485 a month, including pensioners, will also pay an extraordinary tax of 3.5 per cent on their income. …the steep tax increases facing many families have made the outlook for 2013 – the third consecutive year of austerity, recession and rising unemployment – the grimmest yet. Total tax revenue has fallen considerably below target this year, forcing the government to implement additional austerity measures… The coalition will be relying on increased state revenue to account for about 80 per cent of the fiscal adjustment required in 2013 – a reversal of the original bailout plan, in which consolidation was to be achieved mainly through spending cuts.

Amazing. The government imposes huge tax hikes, which don’t generate any positive results. Yet even though “tax revenue has fallen considerably below target,” confirming that there are significant Laffer Curve issues, the government chooses to repeat the snake-oil fiscal therapy of higher taxes.

Anybody want to guess what’s going to happen? The answer, of course, is that this will further dampen incentives to generate income and comply with the government’s fiscal demands.

The latest increases have stretched the tax system to the limit, says Carlos Loureiro, a tax partner at Deloitte. “The current model is exhausted. We need to do something different,” he says. “Any further increase in tax rates is unlikely to result in increased revenue.” Income from value added tax, the government’s biggest source of tax revenue representing about 36 per cent of the total, has been falling since 2008, despite a sharp increase in the rate – the main rate is now 23 per cent. Both the government and the European Commission have acknowledged the risks of depending on increased tax revenue, which is more growth sensitive, to meet fiscal targets and contingency spending cuts amounting to 0.5 per cent of national output have prepared in case of another tax shortfall.

I almost want to laugh at the part of the excerpt which notes that tax revenue “has been falling…despite a sharp increase in the rate.”

Maybe it’s time for these fiscal pyromaniacs to realize that revenues might be falling because rates are higher. In other words, Portugal not only isn’t at the ideal point on the Laffer Curve (collecting the amount of revenue needed to finance legitimate activities of government), it may even be past the revenue-maximizing part of the curve.

To be fair, there are lots of factors that determine economic performance, so higher tax burdens are just one possible explanation for why the tax base is shrinking or stagnant.

The one thing we can state with certainty, though, is that Portugal’s fiscal problem is too much government spending. The failure to address this problem then leads to very unpleasant symptoms, such as lots of red ink and self-destructive class-warfare tax policy.

If all that sounds familiar, that’s because it’s also a description of what President Obama is proposing for the United States.

Ummm…shouldn’t they be targeting politicians?

P.S. I don’t want to imply that Portugal is a total basket case. True, I’m not optimistic about the country’s future, but at least some lawmakers now acknowledge that Keynesian spending was a big mistake. And there are even signs that Portuguese officials are beginning to realize that lower tax rates should be part of the solution. But good policy may be impossible since so many people now have a moocher mentality.

P.P.S. At the risk of bearing bad news to close the year, research from both the Bank for International Settlements and the Organization for Economic Cooperation and Development shows the United States actually faces a bigger long-run fiscal challenge than Portugal.

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Portugal May Become the First of Europe’s Bankrupt Welfare States to Stumble upon a Genuine Recovery Formula: Less Spending AND Lower Tax Rates

There aren’t many fiscal policy role models in Europe.

Switzerland surely is at the top of the list. The burden of government spending is modest by European standards, in part because of a very good spending cap that prevents politicians from overspending when revenues are buoyant. Tax rates also are reasonable. The central government’s tax system is “progressive,” but the top rate is only 11.5 percent. And tax competition among the cantons ensures that sub-national tax rates don’t get too high. Because of these good policies, Switzerland completely avoided the fiscal crisis plaguing the rest of the continent.

The Baltic nations of Estonia, Lithuania, and Latvia also deserve some credit. They allowed spending to rise far too rapidly in the middle of last decade – an average of nearly 17 percent per year between 2002 and 2008! But they have since moved in the right direction, with genuine spending cuts (unlikely the fake cuts that characterize fiscal policy in nations like the United States and United Kingdom). Yes, the Baltic countries did raise some taxes, which undermined the positive effects of spending reductions, but at least they focused primarily on spending and preserved their attractive flat tax systems. No wonder growth has rebounded in these nations.

The situation in the rest of Europe is more bleak, particularly for the so-called PIIGS. To varying degrees, Portugal, Italy, Ireland, Greece, and Spain have lost the ability to borrow, received bailouts, and been mired in recession.

The silver lining is that the fiscal crisis has forced them to finally cut spending. All of those nations implemented real spending cuts in 2011 according to European Commission data, bringing spending below 2010 levels. Final figures for 2012 aren’t available, of course, but the International Monetary Fund estimates that spending will drop in every nation other than Italy (where it will climb by less than 1 percent).

That’s the good news. The public sector finally is being subjected to some long-overdue fiscal discipline.

The bad news is that politicians also imposed very significant tax increases on the private sector. Income tax rates have been increased. Value-added taxes have been hiked, and other taxes have climbed as well. These penalties on productive activity undermine potential growth.

The politicians say that this is a “balanced approach,” but this view is misguided, First, as Veronique de Rugy has shown, it generally means lots of new taxes and very little spending restraint. Second, it is based on the IMF view of “austerity,” which mistakenly focuses on the symptom of red ink rather than the underlying disease of too much spending.

What Europe really needs is a combination of lower spending and lower tax rates.

Portugal may actually be moving in that direction, according to a report in the Wall Street Journal.

The Portuguese government is seeking to cut its corporate tax rate for new businesses to one of the lowest in Europe as part of a plan to attract investment and revitalize ailing industries, the minister of economy said. The government is in talks with the European Commission’s competition agency in Brussels to get approval to cut the tax on corporate income for new investors to 10% from the current 25%, the minister, Alvaro Santos Pereira, said in an interview. …”We want to make Portugal one of the most attractive countries in Europe for new investment,” Mr. Santos Pereira said. “We believe that by providing very strong fiscal incentives to new investments we will safeguard the budget side and at the same time become a lot more competitive,” he added. …While wealthy euro-zone countries and the IMF are beginning to recognize the need for measures to boost growth in austerity-hit countries, they have been reluctant to endorse tax cuts in countries under bailout programs. If implemented, the proposed tax cut would be a departure from a series of tax increases that countries including Portugal, Greece and Spain were forced to take as part their bailout conditions.

Before getting too excited, it’s important to note that the Portuguese proposal is a bit gimmicky. It’s not a corporate tax rate of 10 percent, it’s a special rate of 10 percent for new investment, however that’s defined.

But at least it might be a small step in the right direction. As the article indicates, it “would be a departure from a series of tax increases.” And Portugal definitely has been guilty in recent years of raping and pillaging the private sector.

To be fair, though, this chart shows that government spending in Portugal did decline last year. And the IMF is projecting that it will fall again this year and next year.

But the key to good fiscal policy is reducing government spending as a share of economic output. And if tax increases keep the private economy in the dumps, then the actual burden of government spending doesn’t change much even when nominal outlays decline.

A pro-growth policy is needed to boost economic performance. Portugal’s corporate tax rate proposal, by itself, won’t make much of a difference. But if it’s the start of a trend, that could be significant.

By the way, it’s amusing to see that one of the bureaucrats from the European Commission is pouring cold water on the plan, implying that a decision to take less money from a company somehow is akin to government assistance.

“We would want to be sure that anything proposed would help the competitiveness of the economy,” said spokesman Simon O’Connor, “but at the same time it would have to be in line with state aid rules,” referring to EU regulations that limit the assistance governments can give to the private sector. “There really isn’t any scope for them to reduce revenue,” he added.

But I guess that’s not too surprising. Along with their tax-free colleagues at the Organization for Economic Cooperation and Development, the European Commission has been trying to undermine tax competition and make it easier for nations to impose bad tax policy.

Returning to our main topic, what’s next for Portugal?

Your guess is as good as mine, but Portugal’s leaders already have acknowledged that Keynesian fiscal policy is ineffective. Perhaps they’ve gotten to the point where they realize punitive tax systems also are destructive.

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Portuguese Finance Minister Admits Keynesian Stimulus Was a Flop, but Don’t Hold Your Breath Waiting for Obama to Make a Similar Confession

President Obama imposed a big-spending faux stimulus program on the economy back in 2009, claiming that the government needed to squander about $800 billion to keep the unemployment rate from rising above 8 percent.

How did that work out? One possible description is that the so-called stimulus became a festering pile of manure. About three years have passed, and the joblessness rate hasn’t dropped below 8 percent. But the White House has been sprinkling perfume on that pile of you-know-what and claiming that the Keynesian spending binge was good policy.

But not every politician is blindly ideological like Obama. Vitor Gaspar, Portugal’s Finance Minister, is willing to admit error. Here are some relevant excerpts from a New York Times report.

Unlike Obama, willing to admit mistakes

Mr. Gaspar, speaking to The New York Times last week, has a message for observers who say Europe needs to substantially relax its austerity approach: We tried stimulus and it backfired. Like some other European countries, Portugal tried what Mr. Gaspar called “a Keynesian style expansion” in 2008, referring to a theory by economist John Maynard Keynes. But it didn’t turn things around, and may have made things worse.

Why does the Portuguese Finance Minister have this view? Well, for the simple reason that the economy got worse and more spending put his country in a deeper fiscal ditch.

The yield on Portuguese government bonds – more than 11 percent on longer-term bonds — is substantially higher than the yields on debt issued by Ireland, Spain or Italy. …The main fear among investors is that Portugal is going to have to ask for a second bailout from the International Monetary Fund and the European Union, which committed $103 billion of financial aid in 2011.

Maybe the big spenders in Portugal should import some of the statist bureaucrats at Congressional Budget Office. The CBO folks could then regurgitate the moving-goalposts argument that they’ve used in the United States and claim that the economy would be even weaker if the government hadn’t wasted more money.

But perhaps the Portuguese left doesn’t think that will pass the laugh test.

Amazingly, the Germans, who have a disturbing affinity for powerful government, decided against Keynesianism and that’s paid dividends for their economy.

In any event, some of us can say we were right from the beginning about this issue.

Not that being right required any keen insight. Keynesian policies failed for Hoover and Roosevelt in the 1930s. So-called stimulus policies also failed for Japan in 1990s. And Keynesian proposals failed for Bush in 2001 and 2008.

Just in case any politicians are reading this post, I’ll make a point that normally goes without saying: Borrowing money from one group of people and giving it to another group of people does not increase prosperity.

But since politicians probably aren’t capable of dealing with a substantive argument, let’s keep it simple and offer three very insightful cartoons: here, here, and here.

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Miracles Do Happen: Someone in Brussels Accurately Analyzes Europe’s Fiscal Crisis!

With the exception of a few top-notch thinkers such as Pierre Bessard and Allister Heath, there are very few people in Europe who can intelligently analyze public policy, particularly with regard to fiscal issues.

I don’t know if Fredrik Erixon of the Brussels-based European Centre for International Political Economy is even close to being in the same league with Pierre and Allister, but he has a very good article that correctly explains that government spending and the welfare state are the real fiscal problems in Europe.

Here are some excerpts from his Bloomberg column.

When it comes to overspending on social welfare, …Europe has no angels. Even the “good” Scandinavians, and governments that appeared to be in sound fiscal shape in 2008, …were spending too much and will have to restructure. …Greece, Ireland, Portugal and Spain…are in many ways different, but they have three important characteristics in common. …government spending in those nations grew at remarkably high rates. In Greece and Spain, nominal spending by the state increased 50 percent to 55 percent in the five years before the crisis started, according to my calculations based on government data. In Portugal, public expenditure rose 35 percent; in Ireland, almost 75 percent. No other country in Western Europe came close to these rates.

This is remarkable. Someone in Europe who is focusing on the growth of government spending. He doesn’t mention that the solution is a spending cap (something akin to Mitchell’s Golden Rule), but that’s an implication of what he says. Moreover, I’m just glad that someone recognizes that the problem is spending, and that debt and deficits are best understood as symptoms of that underlying disease.

In any event, Mr. Erixon also has the right prognosis. The burden of the welfare state needs to shrink. And he seems reasonably certain that will happen.

Europe’s crisis economies will now have to radically reduce their welfare states. State spending in Spain will have to shrink by at least a quarter; Greece should count itself lucky if the cut is less than a half of the pre-crisis expenditure level. The worse news is that this is likely to be only the first round of welfare-state corrections. The next decade will usher Europe into the age of aging, when inevitably the cost of pensions will rise and providing health care for the elderly will be an even bigger cost driver. This demographic shift will be felt everywhere, including in the Nordic group of countries that has been saved from the worst effects of the sovereign-debt crisis. …Europe’s social systems will look very different 20 years from now. They will still be around, but benefit programs will be far less generous, and a greater part of social security will be organised privately. Welfare services, like health care, will be exposed to competition and, to a much greater degree, paid for out of pocket or by private insurance. The big divide in Europe won’t be between North and South or left and right. It will be between countries that diligently manage the transition away from the universal welfare state that has come to define the European social model, and countries that will be forced by events to change the hard way.

I’m not quite so optimistic. While I agree that current trends are unsustainable, I fear that the “optimistic” scenario is for governments to semi-stabilize their finances with both taxes and spending consuming about 50 percent of gross domestic product.

That’s obviously far beyond the growth-maximizing size of government, which means European nations  – on average – would be condemned to permanent economic stagnation. Some of the nations that have very laissez-faire policies in areas other than fiscal policy, such as the Nordic nations, might experience some modest growth, but that would be offset by permanent recession in nations that have both big government and lots of intervention.

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Is Portugal an “Adult Baby” Nation?

Yesterday, I took aim at a truly pathetic human being who lives as an “adult baby.” But what got me upset was not his lifestyle, but rather the fact that he was mooching off the taxpayers thanks to the dumb bureaucrats at the Social Security Administration, who granted him “disability’ status, which means he gets to live the rest of his life at the expense of taxpayers.

Is it possible, though, for an entire nation to live as an adult baby? I don’t know the answer, but some people in Portugal want to give it a try. Here is an excerpt from the EU Observer, featuring some jaw-dropping assertions by a Portuguese union boss.

Speaking at a rally in the western German town of Meschede on Tuesday evening, Merkel suggested southern Europeans are not working enough, while Germans are expected to bail them out. “It is also about not being able to retire earlier in countries such as Greece, Spain, Portugal than in Germany, instead everyone should try a little bit to make the same efforts – that is important,” she said. …”Yes Germany will help but Germany will only help when the others try. And that must be clear,” she said. Her comments sparked outrage on the German political scene, with the Social Democratic opposition calling her “populist” for giving a “coarse representation of Greek realities,” while the European Greens labelled her remarks “absurd.” In Portugal, trade unionist were also angered by the suggestion that southern Europeans are having a nice time on the beach while the Germans are working hard for their bailouts. “This is the purest colonialism,” Portuguese trade union chief Manuel Carvalho da Silva said, as quoted by DPA. He blasted Merkel for showing “no solidarity” and supporting a system where “the rich continue to live at the expense of the poorest countries in a disastrous system of exploitation.”

Let’s parse Mr. da Silva’s remarks. He starts by accusing Merkel of colonialism, but he never explains why refusing to write more blank checks means the German Chancellor is a colonialist.

Mr. da Silva then says Merkel is failing to show “solidarity.” But this assumes that German taxpayers have a moral obligation to support fiscally reckless politicians and interest groups in Portugal and other nations.

Last but not least, Mr. da Silva claims Merkel is promoting a system that allows the rich to exploit the poor. This accusation actually is true, but not in the way Mr. da Silva means. This post, using a chart put together by the New York Times, shows that the bailouts are mostly for the purpose of bailing out the big European banks that foolishly bought bonds from irresponsible governments. In other words, poor German taxpayers are subsidizing rich (and foolish) German bankers.

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Which Nation Will Be the Next European Debt Domino…or Will It Be the United States?

Thanks to decades of reckless spending by European welfare states, the newspapers are filled with headlines about debt, default, contagion, and bankruptcy.

We know that Greece and Ireland already have received direct bailouts, and other European welfare states are getting indirect bailouts from the European Central Bank, which is vying with the Federal Reserve in a contest to see which central bank can win the “Most Likely to Appease the Political Class” Award.

But which nation will be the next domino to fall? Who will get the next direct bailout?

Some people think total government debt is the key variable, and there’s been a lot of talk that debt levels of 90 percent of GDP represent some sort of fiscal Maginot Line. Once nations get above that level, there’s a risk of some sort of crisis.

But that’s not necessarily a good rule of thumb. This chart, based on 2010 data from the Economist Intelligence Unit (which can be viewed with a very user-friendly map), shows that Japan’s debt is nearly 200 percent of GDP, yet Japanese debt is considered very safe, based on the market for credit default swaps, which measures the cost of insuring debt. Indeed, only U.S. debt is seen as a better bet.

Interest payments on debt may be a better gauge of a nation’s fiscal health. The next chart (2011 data) shows the same countries, and the two nations with the highest interest costs, Greece and Ireland, already have been bailed out. Interestingly, Japan is in the best shape, even though it has the biggest debt. This shows why interest rates are very important. If investors think a nation is safe, they don’t require high interest rates to compensate them for the risk of default (fears of future inflation also can play a role, since investors don’t like getting repaid with devalued currency).

Based on this second chart, it appears that Italy, Portugal, and Belgium are the next dominos to topple. Portugal may be the best bet (no pun intended) based on credit default swap rates, and that certainly is consistent with the current speculation about an official bailout.

Spain is the wild card in this analysis. It has the second-lowest level of both debt and interest payments as shares of GDP, but the CDS market shows that Spanish government debt is a greater risk than bonds from either Italy or Belgium.

By the way, the CDS market shows that lending money to Illinois and California is also riskier than lending to either Italy or Belgium.

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.

The Bush-Obama policy of big government has moved America in the wrong direction. But if the data above is any indication, America probably has some breathing room. What happens on the budget this year may be an indication of whether we use that time wisely.

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Portugal Digs Itself into a Deeper Hole with Tax Increases

I feel like a broken record when I write about European fiscal policy. In almost all cases, I cite OECD data showing that countries are in fiscal trouble because of excessive spending rather than inadequate tax revenue. I then show that the politicians are using the spending-caused crisis as an excuse to raise taxes even further. The higher taxes, needless to say, undermine growth, which then creates more pressure for higher redistribution and welfare spending. And so the downward spiral continues. The latest example is Portugal, which is in trouble because the burden of government spending has jumped from 43 percent of GDP to 51 percent of GDP in the past 10 years. The tax burden also has increased, from 40 percent of GDP to 43 percent of GDP, so there’s zero legitimacy for those who want to argue that there’s a revenue shortfall. But Portugal’s greedy political class respond with higher taxes – including an increase in the value-added tax (a familiar refrain all throughout Europe) and higher personal and corporate income tax rates. The Financial Times reports on Portugal’s fiscal self-destruction (including the silly assertion that seizing more money from taxpayers somehow is “tough” and a sign of “austerity” when such moves should be characterized as business-as-usual):

José Sócrates, Portugal’s prime minister, on Thursday announced tough new austerity measures, including a “crisis tax” on wages and big companies, designed to more than halve the country’s gaping budget deficit in less than two years. …Describing the measures as essential to defend Portugal’s credibility in international financial markets, Mr Sócrates announced a one percentage point increase in value-added tax to 21 per cent and increases of up to 1.5 per cent in income tax. The increases, which are being called a “crisis tax”, include a 2.5 percentage point rise in corporate tax to 27.5 per cent on annual profits above €2m.

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