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The end of Socialism but not the end of Social Welfare

di - 3 Dicembre 2012
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The most successful fiscal policies in postwar United States were the Kennedy-Johnson and Reagan tax cuts for households and businesses. These programs marshaled profit incentives to guide investment choices. The Obama program, like most political decisions were less concerned about gaining economic efficiency. Their primary interest was to choose who paid and who received. One of the major flaws in what are called Keynesian policies is that the designers act on the premise that what matters is the amount spent, not the way spending is allocated. Keynes did not make that mistake.
In the European Union and the ECB, the daily discussion is about getting Germany and a few other fiscally responsible countries to bail out welfare state spending in the debtor countries. I am frankly appalled by the pressure from bankers and their friends to get Germany to subsidize foreign welfare states. The Financial Times is particularly outrageous.
Prime Minister Thatcher said that welfare states would shrink when they ran out of other people’s money. We are there. But instead of adjusting down, the bankrupt governments propose institutional changes that, if adopted, would sustain profligate redistributive policies. High unemployment and prolonged recession or slow recovery are serious problems that require rational policy action. Most welfare states are so large that rational policies are politically unpopular, perhaps unacceptable.
We are reaching the point at which welfare state promises of redistribution will shrink. Or we will lose democratic capitalism. Voters will not end the welfare state and redistribution, but promises in many countries greatly exceed resources available for payment. Sweden, once the envied model welfare state has made a start by reducing some transfers.
The crisis is here now in the European Union and the United States. Even those who favor programs and policies that transfer responsibility and decisions from the market to the bureaucracy must see how difficult it is for government to develop meaningful reforms. No one believes that the unfunded promises that drive future U.S. debt and deficits will be paid if nothing is done. On the contrary, everyone who seriously discusses the future welfare state debt and deficits uses the word “unsustainable.”
Many in the European Union point their finger at the “rich” Germans requesting, even demanding, transfers of one kind or another. The German government responds by saying “we have given ample support. You, the debtors, must reduce domestic transfers and become more competitive by reducing real wages.” Another continuing stalemate. Reluctance to recognize the problems of welfare states prevents a solution.
I find it appalling that almost all the daily discussion of the European crisis is about the debt incurred by Greece, Italy, Spain, and Portugal. Almost daily the Financial Times publishes pieces that urge Germany to accept more inflation to bail out the banks and other lenders. Do the writers and the editor think that the problem is entirely monetary, to be solved by lowering interest rates and printing money?
Germany recognizes that the problem is real, not just monetary or debt related. Costs of production are 25 to 30 percent greater in Greece, Italy, Spain and Portugal than in Germany. Without lowering costs in these countries, growth cannot resume, or remain even if some stimulus gives temporary relief. Germany wants real reform of labor, commodity markets, and government policy.
There are two ways to reduce real wages in a fixed exchange rate system. The so-called austerity favored by Germany would both reform the economies and force reductions in real wages. After three years of economic decline, getting an additional 25 to 30 percent reduction in real wages in this way seems to me to be politically impossible. Voters will not retain in office a government that adopts that policy; political opportunists oppose “austerity.”
Devaluation is an alternative way to reduce real wages. The ECB should permit the indebted southern countries to form a weak euro temporarily. The strong euro countries would adopt the fiscal restrictions to which their own representatives have agreed. The weak euro countries would float down against the strong euro. Once devaluation reduced real wages, countries in the weak euro would rejoin the strong euro by agreeing to the fiscal rules.
Devaluation would work quickly. It is not without cost. Two are of particular importance. First, the devaluing countries must limit bank runs or currency runs by enforcing temporary exchange controls. And they must avoid subsequent inflation. Second, German and French banks would suffer losses on their holdings of foreign bonds. The French and German governments should require their banks to raise half of their capital shortfall. Government would supply the other half at concessional rates. If a bank failed to raise its half in the market, it would be declared insolvent and taken over by regulators. That gives the bank an incentive to raise its share of the capital infusion.
Social welfare state governments in Europe cannot agree on a solution to their major problem. They resist imposing the requisite costs on their voters. Often they fail to carry out the pledges they make.
They cannot agree to change who pays and who receives, the main point of the welfare state. Most common is a demand for Germany to be more generous. The German public refuses to pay more transfers to foreigners.
The euro problems are common problems for fixed exchange rate systems. Governments must limit their budget deficits, the size of outstanding debt, and must keep their terms of trade close to their exchange rate. Like many other fixed exchange rate systems, the euro failed to meet these requirements. And it has not been able to agree on a program to restore stability and growth. These failures will restrict the welfare state and egalitarianism. It will not end pressures for redistribution.

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