Obama Pushing The “Buffett Rule” Tax Hike For The Rich, Even Though This Is No Tax Reform – The Point Is To Have A Crowd Pleaser – Romney And GOP Will Also Manipulate Issues – No Serious Policy Debate

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By Paolo von Schirach

April 14, 2012

WASHINGTON – Sebastian Mallaby, (The Buffettt rule is a sorry excuse for tax reform, The Financial Times, April 13, 2012), correctly points out that President Obama’s insistence in pushing the idea of tax increases for the rich (the “Buffett rule”) is bogus tax reform. Surely we could and probably should make sure that rich Americans pay more taxes and that capital gains will be taxed at the same rate as regular income. Let’s do all this in the name of fairness and social justice –just as the President says.

Buffett rule is just politics

But Obama knows full well that this particular tax hike he has been talking about so passionately would raise perhaps an additional $ 5 billion a year, not even a rounding error in a federal budget of over $ 3 trillion with projected deficits still exceeding $ 1 trillion. So, if we are seriously talking about tax reform, we have to reconsider the entire system. And this should be possible. Mallaby points out that Americans overall are not overtaxed and that tax increases will have to be part of any serious plan aimed at reducing the deficit and the national debt. And, in so doing, by all means, let’s make sure that all Americans pay their fair share.

However, reaching this objective is predicated on producing a comprehensive tax reform package. And this is not what the President is proposing. Obama wants an emotionally charged issue with which to run between now and November. This way he is showing that he is not interested either in reform or in raising real revenue.

Real tax reform

All serious policy-makers and analysts know that America needs to do away with its horrendously complicated and inefficient federal tax code. We all know that, thanks to the work of armies of special interests served by Washington lobbyists, the Congress and the President, no matter who was in the majority, overtime created an unmanageable monster that can be understood only by full time professionals.

With strong presidential leadership and a true bipartisan consensus it could be possible to do away with this wasteful and unjust way of apportioning favors through the tax code that is morally indefensible, ethically wrong and in the end economically damaging as economic decisions are often skewed by tax considerations, this way discouraging a more effective allocation of scarce resources. We could raise more revenue, at the same simplifying the system and eliminating the preferences that only the well heeled know how to navigate to their advantage. This is complicated but doable, assuming bipartisan agreement largely predicated on presidential leadership.

Obama not a victim of his staff

Mallaby politely concludes that Obama is somehow forced to be a tax populist by his campaign staff, the professionals who know that issues like the ”Buffett Rule” proposal are real crowd pleasers.

I take a different view. Just as his campaign staff, the President knows exactly what he is doing. Unfortunately, now he is not governing and he is not leading. Now he is a demagogue trying to make the other side look bad using spurious issues. Between now and November Obama will not even try to engage anybody in a serious debate about tax reform, or anything else for that matter.

He is trying to get re-elected. To do so he will continue to portray the Republicans as out of touch Wall Street & Country Club greedy fat cats who want more and more and pay no taxes, while the rest of America struggles with the high cost of everything. If this is manifestly a distortion, who cares? The focus groups and the internal polls say that this manipulation is likely to produce votes.

Romney and GOP doing the same

And this manipulative approach of course goes both ways. Romney and the Republicans no doubt are doing and will do the same. They will latch on any theme, true or false, that can damage Obama. So, forget about any enlightened debate between now and November. It will be hyperbole, manipulation and demagoguery. Nothing serious about tax reform, entitlement reform, energy policy, education or sensible incentives for economic growth. This is bad and damaging. The business of the Nation is not attended to. Voters will be offered slogans, not real programs to choose from. I dare say this old democracy could do better.

The EU “Fiscal Compact” May Not Work, Argues Martin Feldstein – Bond Markets Already Penalizing Weak EU Members – In the End Greece, Spain, Portugal And Italy May Have To Leave The Euro

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By Paolo von Schirach

April 5, 2012

WASHINGTON – Until yesterday the EU leaders and many international analysts concluded that the European debt crisis had been successfully dealt with. After the admittedly long and painful rescue of Greece and new fiscal austerity measures in Ireland, Portugal, Spain and Italy, (all accompanied by political upheaval), it seemed that the worst was over and that going forward there would be no repeat of the excesses that originated the crisis in the first place. To make sure that this will never, even happen again, the EU countries agreed on a new Fiscal Compact about to come into force that commits member states to fiscal rectitude.

Feldstein: Fiscal Compact may not work

Except that it does not, really, argues Harvard Professor Martin Feldstein in a recent WSJ op-ed piece, (Europe Needs The Bond Vigilantes, April 5, 2012). The Compact commits EU countries to a “cyclically adjusted” budget deficit no larger than 0.5% of GDP. The problem is in interpretation. There is no clear definition of “cyclically adjusted”, and each country will argue whatever it wishes to justify whatever level of spending and whatever deficit there will be, claiming that it is within the rules.

The real issue, as Fedlstein notes, is that most countries at the EU Southern periphery are inherently weak and thus incapable of running at the same speed of stronger and more efficient Germany or Scandinavia. Recent rescue plans may work –for now; but unless these economic laggards learn something new, the reckoning has just been postponed.

Austerity, as Nouriel Roubini and others have noted, is inherently recessionary. Beyond spending cuts, (necessary as they are), countries need growth strategies so that they can grow out of debt and prosper. But the economic outlook for the non competitive South of Europe is not good.

Bond markets already penalizing weak economies

And the bond markets have already taken notice. A recent auction of Spanish bonds was under subscribed. Yields on Spanish 10 year bonds hit 5.81%, the highest rate since last December. Italian bonds are back up to 5.49%, the sharpest rise since last November. In contrast, Germany’s 10 year bonds are at 1.74%. The spread is wide. Quite clearly, investors do not want the bad stuff. Soon enough you will see bond prices of weak countries go further down and yields creep up even more.

Very simply, markets will not be fooled by EU Fiscal Compacts establishing iron rules that will be circumvented. Southern Europe cannot get economic efficiency and real growth through treaties. It needs vibrant economies, and Brussels cannot supply them.

Some countries too weak to stay in the Eurozone

In the end, and may be sooner than any risk averse policy maker would like, the Eurozone stronger economies will have to deal with the simple fact that some of the current members just do not belong. While getting them out of the monetary union would be extremely complicated, keeping them in may just not be viable.

Romney Will Get The Republican Nomination – Now He Will Have To Propose An Inspiring Vision Of Growth And Fiscal Discipline, But Also Of Hope And Genuine Inclusiveness – A Revival Of The America Dream

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By Paolo von Schirach

April 3, 2012

WASHINGTON – After primary wins in Maryland, the District of Colombia and Wisconsin, it appears that Mitt Romney has turned a corner. It seems now that the Republicans are finally getting the message that this acrimonious and bitterly contested primary season is not advancing their objective of creating a compelling anti-Obama front that will gather momentum between now and the November elections.

A Republican inspiring message

Alright, suppose that the GOP has gotten wise and that it will close ranks around Romney, letting Rick Santorum know that he has no chance to fill the significant delegates gap between himself and front runner Romney. Then what? Then it would be up to Romney to craft a really inspiring message of Republican change that could resonate not just with the rather narrow base –he’s got those votes anyway– but with the millions of independents who always decide presidential elections.

Until now there has been no real outreach, no inclusive Republican message. No positive message for minorities, for single mothers, for unemployed youth, for America’s poor. Until now it has been all about showing who is the most conservative of all, and thus the truly genuine standard bearer of the ultra pure orthodoxy.

Who is the most conservative?

From the very beginning of this primary season it seemed that Republican voters were longing for a champion who would be the perfect incarnation of the conservative zealot: no new taxes, drastic cuts to government, repeal Obamacare, armed foreign policy, teach China a lesson, kick Russia, never follow the Socialist Europeans, fight the Taliban, Israel-is-our-true-ally, prayer in schools, no gay marriage, no gays in the military, women should stay at home, drill and be blessed with more oil so that we can drive for ever. And this un-enlightened agenda was then enriched with a new vigorous fight over contraception and other silly stuff that, at least so far, managed to further alienate women voters.

This is a mess. This is not the agenda of a modern party with modern ideas. Remember that just a year ago Obama was the weak incumbent incapable of turning the economy around. Now Obama is an enlightened statesman who has managed to improve the economy –or so the pundits say– and will be protecting each and every bit of government program the country is used to. The not so subtle Obama message is “stick with me and the gravy train rolls on, Middle America. Switch over to the other side and super wealthy Romney who could not care less about the problems confronting the middle class will gut the welfare state, cut all your benefits and give more tax breaks to his rich backers”.

Romney cannot run on his business credentials

Running against an entrenched incumbent no longer on the defensive, Romney will not be able to run just on his resume as successful business manager. As the economy is no longer in free fall, these credentials are no longer that compelling. Nor can he run on just the pledge to repeal Obamacare, without providing an alternative people can understand. The fact is –and the polls show it– that right now most Americans are quite ready to stick with the devil they know, Barack Obama, especially since he will keep all the entitlement programs people are used to.

Americans like entitlements

Unfortunately, Americans lack the will to see that behind all these promises lies fiscal disaster. And they cannot see how this president lacks the ability and the conviction to craft and promote a pro-growth agenda. They cannot see that staying on this course of modest to minimal growth, with a suffocating and growing public debt, will guarantee economic decline.

Most Americans are not willing to think of what will happen to this country if competitiveness is not revived and public spending keeps creeping up. The notion of America’s decline is too vague and too distant. People want their goodies today. Let somebody else worry about the bills later on.

The Romney alternative vision

So, if Romney plans to take the goodies away, then he has to create an alternative and truly inspiring vision for a future America, a renewed America of optimism, can-do spirit, enterprise and inclusiveness. A welcoming America that wants to give all a real chance.

Romney would have to talk convincingly about his belief in high quality public education for all. He will have to sketch a vision of urban renewal and enterprise zones and minority involvement and ownership. He will have to spell out his plan to restore innovation and boost US competitiveness. And, if he indeed wants to see the repeal of Obamacare, he better come up with some compelling alternative. Obamacare is a mess; but what preceded it was also a mess. Creating workable wellness programs, redoubling efforts on prevention, as opposed to wasting money on cures for diseases that could have been avoided, is an enormous job. But this is only way to contain health costs while having a system that takes care of everybody.

A tall agenda

This is a tall agenda. But, unless Romney will be able to fashion a real and truly inspiring alternative, middle America, apparently no longer scared about the economy, (and this is bad because this economy is still doing quite poorly), will stick with the devil they know.

Obama knows this and his campaign will demonize Romney as “the rich man who cannot possibly understand your problems, while I pledge to give you all the help I can provide. So, why take a chance, vote for the candidate who will keep all the government spending you are used to”.

According To The Pundits The Elections Boils Down To The Unemployment Rate And Gas Prices: Upward Trend Obama Loses, Downward He Wins – Apparently Nothing Else Matters In America – This Is A Dangerous Impoverishment Of The National Conversation

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By Paolo von Schirach

March 14, 2012

WASHINGTON – Listening to the pundits debating the upcoming presidential elections, the consensus boils down to this: if the unemployment rate stays as is (8,3%) or trends down between now and November, president Obama gets re-elected. If it goes higher, then he is in trouble and may not make it. Likewise, if gasoline prices go down he is alright. If they keep going up and they stay past the symbolic $ 4 a gallon before the vote, then Obama’s chances are diminished.

More than just jobs and gas?

Granted, these are important issues that are proxies for the overall health of the economy. But is there perhaps more? Could it be that the national political debate might include the reform of the welfare state, tax reform, foreign and security policy priorities, including this bad war in Afghanistan, science and technology issues, competitiveness, energy, infrastructure, China, relations with Europe, education? Well, not really. This stuff is mostly background noise.

Of course, all these topics are covered somewhere in speeches and policy papers posted on campaign websites. But they do not make the headlines. They do not energize the base and do not motivate Republican primary voters today and voters in the general election tomorrow to go one way or the other.

Narrow down to the essentials

As the pundits tell you, it is all very simple: with more jobs and cheap gasoline Obama gets the nod. If the opposite happens, then it is Romney, (assuming that he gets as far as getting the nomination, no longer a sure thing). In a way, it is good to see that, according to the analysts, Americans look at politics in a very practical way whereby political favor goes to whoever shows tangible results. But narrowing down the debate to a couple of metrics, as if they were the true condensation of everything else, represents a dangerous impoverishment of the national political conversation.

What about mixed scenarios?

I do agree that if a president is not even able to foster policies that will promote growth and jobs then he may not be a good steward for others policies either.

But what about a situation like the present one in which the economy is not awful but is instead mediocre, in which some jobs are created but not enough, in which the unemployment rate declined but is still extremely high by any historical standard? How do you evaluate an incumbent when trends are not terrible but hardly inspiring? And what about the impact of gigantic topics now ignored, such as the looming fiscal crisis? And equally important, how do you evaluate a challenger who has different ideas, but not a clearly discernible record?

Keep it simple

This is when serious debate (unlike the silly shows we have seen so far) and better understanding become important. But this is discouraged. In their efforts to boil down very complicated issues to a bumper sticker, the pundits have given their guidance to the voters: a few more jobs between now and November, Obama wins. Got that, American voter? You are hereby openly discouraged to delve more deploy on other policies. If under this sitting president the unemployment rate goes down, he gets the credit and you should really vote for him.

But, wait a minute –asks the voter– what if jobs growth has really nothing to do with government’s policies?”

No, no, my friend. Stick with the guidance, and keep it simple. Jobs up: Obama in. Jobs down: Obama out“.

Impossible for the average voter to become an expert

Look, it is true that it is impossible to fill the huge gap between the horrible complexity of so many public policy issues and the average voter’s time to begin to understand arcane problems that often generate hundreds of pages of legislation. We cannot expect Americans to turn into all knowing, free lancing Washington policy wonks. This will never happen.

Possible to explain without dumbing down

Still, there is nothing good in keeping the debates on complex issues within the confines of a Washington DC, “inside the Beltway”, coterie of politicians, advisers and super experts, while the general public is in the dark, because no one takes the trouble to provide simplified, yet credible summaries of the big issues the Nation is facing. No, Mr. And Mrs. America; it is not just about jobs and gas prices. There is a lot more. But nobody from high up will make it their mission to tell you. And this knowledge gap is no small thing. Remember Thomas Jefferson warnings about the impossibility of being both ignorant and free.

Germany Reformed Labor Markets And Created A Pro-Growth Environment

WASHINGTON – In a WSJ op-ed piece, Europe’s Supply-Side Revolution, by Donald L. Luskin and Lorcan Roche Kelly of Trend Macrolytics, (February 17, 2012), make predictions about the future of Europe so bright and so positive that they frankly border on absurdity.

Germany’s example

As the writers put it, following Germany’s example, Europe is bravely starting its own supply side revolution. Italy and Spain will turn into business friendly, market oriented countries. The discipline of debt is driving Europe to closer political integration. If Europe’s countries could finally erase their political boundaries, their debt problems would also vanish. And so on.

Europe is stuck because there is no political will to reform

I must be looking at a different Europe. I see a Europe that is not necessarily doomed; but a Continent that is stuck, precisely because there is no political will to do most of the things that the authors consider either a done deal, or so absolutely necessary that they become inevitable. The implicit assumption in this article is that Europe has had its moment of reckoning. Now it is “do or die”. And Europe chose to live –and live bravely, at that.

No “moment of truth” in Europe, just muddling through

But this is a major fallacy. This notion that Europe had only two choices: disaster and doom or vigorous renaissance, and that it (wisely) chose renaissance is just wrong.

The idea that at this juncture all the Europeans, having just stared into the abyss of the debt crisis, have irrevocably decided to finally do the right thing, is just fanciful. By the way, I really wish that it were so. But there is zero evidence to justify this optimism. My sense is instead that many European countries –and this would include all of Southern Europe– will just muddle through, with enough wisdom to avoid complete disaster, but insufficient political courage to really start the serious reforms the authors assume to be just behind the corner.

Political union a distant dream

As for this irresistible drive towards political unification starting with fiscal union, again, I must be looking at a different Continent. Political union is nobly advocated as a goal by many well-meaning Europeans. But it is a very, very distant goal, without any agreed upon road map and clear set of mile stones.

Sure enough, the Europeans recently agreed in principle to harmonize their fiscal policies in order to avoid a repeat of the debt crisis. But this is no done deal. And nobody has the foggiest idea as to how this generic agreement will become binding and, after that, how it will be implemented and monitored.

Germany succeeded, others will follow?

The op-ed authors premise is that since Germany could see the light at the turn of the millennium and embarked in serious labor market reform through which it regained economic vibrancy, it follows that the rest of Europe will see the value of such a historic change and follow suit.

Well, that would be wonderful. But it would entail a dramatic change of politics, psychology, ethics and business practices that, while possible in principle, cannot be taken for granted only on the basis that it would be the smart thing to do.

In Italy Monti wants reforms, but the country will not follow

Getting into specifics, to say that Italy’s Mario Monti would like to liberalize and open the professions, introducing needed competition and that his heart is in the right place is not the same as saying that Italy is with him and that he will succeed. And, by the way, Monti’s government plans to reform the “Workers Statute” caused the ire of the unions who are absolutely not on board on the critical issue of flexible contracts and more labor mobility –one of the key preconditions to attract investments and generate new enterprise.

Technocrat with no political base

And the authors should also know that Monti is an economics professor and not a politician with an organized following. He did not win any elections. He has no popular mandate. Late last year he was appointed as “chief rescuer”, as a technocratic Prime Minister with the limited (and really unpleasant) job of extricating Italy from the pain of the debt crisis.

Monti came in as the trusted fire man with no political agenda of his own. He has done a good job regarding the stabilization of Italian debt. But, so far, he has done nothing to bring the national debt (now at 120% of GDP) down to the agreed Maastricht levels of 60% of GDP .

Besides, he has a limited mandate. Any serious reform aimed at making Italy a lot more like Germany would require broad and durable political agreement binding the left, the right and the powerful trade unions. Nothing like this ever happened in Italy. That does not make it impossible; but it makes it unlikely.


And let me add that other factors do not inspire confidence. Italy has third world level scores regarding corruption, (according to Transparency International) and “easiness of doing business”, (according to the World Bank). Just days ago, Italy’s ”Corte dei Conti’, something like a General Accountability Office, issued a scathing report regarding corruption and lack of ethics throughout Italys’s public administration. According to the report, this creates an environment that discourages investments, enterprise and therefore new growth. (Italy is now in a recession).

Demographic crisis

Add to all this a serious, systemic demographic crisis. Italy has  one of the lowest fertility levels among developed countries, (1.38 children per woman). While the Italians stopped having children, there is the steady arrival of difficult to assimilate, poor and mostly illiterate immigrants from Africa.

Sure enough, all this can and, in fact should, change. But let’s not mix wishful thinking and reality. Monti may like to modernize Italy; but I am not sure that the country’s mood and long-term systemic trends support optimism about success.

If Southern Europe changed its values…

If the Southern Europeans –and that includes Italy, Spain, Portugal Greece and even France– really changed their values, their ethics and their business sense, this revolution envisaged by the op-ed piece authors would take place.

But this is the same as saying that if the Indians were more organized and less corrupt, and if they put together a credible national infrastructure master plan, all kinds of good things would happen to India.

By the same token, if Angola’s leaders were not corrupt, the vast oil and mineral riches of the country could do wonders to finance sustainable development, thereby lifting millions out of poverty.

And we could add that, if the Arab countries would finally understand that they should adopt modern, pro-growth economic policies, this would unleash new economic growth. And so on.

Good outlook for Northern Europe

Yes, Germany reformed labor markets years ago and we can safely assume that the countries of Northern Europe that have a stronger cultural affinity with Germany have already been positively influenced by this pro-business climate.

So we can expect Germany, The Netherlands, Austria, Sweden, Denmark and Finland, and may be a few others to do well. (I am not so sure about France, flirting with the idea of electing a Socialist President).

Southern Europe a different story

But I would not bet on these wise choices to be embraced by the rest of the EU members, whatever Britain may or may not do as the perennial dissenter among the 27 EU members.

Do not count on Southern Europe getting the medicine. And do not tell me that this going go down well in far less developed Romania, Bulgaria or Hungary.

Political union a distant dream

As for Europe finally becoming a federation, with one government, one army, and one foreign policy, this is not impossible; but it is so unlikely that it is indeed peculiar to read in this article that it is sort of a “done deal”, with only a few details to be ironed out.

America Needs Adult Education In Economics, Says Harvard Professor Kenneth Rogoff – Educated People Will Not Be Swayed By Over Promising Politicians – Educated People Make Better Citizens

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By Paolo von Schirach

February 3, 2012

WASHINGTON – Famed Harvard economist and co-author, with Carmen Reinhart, of “This Time is Different“, a major work on financial crises, writes that America needs voters who understand economic policy. In his The Financial Times contribution, (Our ignorance will yield more crises in capitalism, February 2, 2012), to the ongoing debate on “Capitalism in Crisis“, Rogoff argues that, while no serious thinker or policy maker seriously doubts the superiority of private sector led capitalism, politicians muddy the waters when it comes to framing the most sensible public policies that will further the healthy advancement of democratic capitalism.

Politicians make impossible promises counting on voters’ ignorance

Politicians have purposely polluted the public policy debate by routinely making preposterous political promises that make no economic sense. And yet they get away with it, because the (uneducated) public tends to embrace what looks superficially good. And so politicians who want votes make incredible promises, hoping that the people will be swayed. And they are often right. But the politicians get away with outlandish populist promises because the people are only superficially informed, and therefore more gullible, says Rogoff.

And here is his revolutionary idea: create real opportunities for adult education in economics and public finance. The implicitly accepted (and cynical) idea whereby “The People” do not want to be bothered with complex public policy issues, and are quite happy to be ignorant or just superficially informed is just not true, argues Rogoff.

People want to learn about economics

Give people a chance, offer them an opportunity to learn through modalities that make sense and they will take advantage of them. No, people do not want to be ignorant. They want to understand. At least understand enough so that they can make an informed judgement on what is offered to them at election time, and by people in office, after the elections.

I support the idea. This endeavor may be ambitious, and a bit complicated. But it is certainly not impossible. I am not sure as to where one should start, but it is a very good plan that should not be tossed away as “nice thought, but impractical“.

America needs informed citizens

Look, many of the Founders said several times that a vibrant Republic should rest on a solid base of educated citizens. Providing avenues to further adult economics education is a good start, and a good way to strengthen America.

Italian Prime Minister Monti Tells Young People To Be Flexible and Forget About Life Time Jobs – The Young Respond That They Want Job Security – Risk Averse Italy Will Never Grow Fast

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By Paolo von Schirach

February 2, 2012

WASHINGTON– Crusty economics professor Mario Monti, the non political Prime Minister of terminally messy Italy, called upon to save the country on the edge of the fiscal abyss, sounded upbeat in recent interviews. It would appear that his souped up austerity program concocted by his team of technocrats is beginning to work. Italy’s budget deficit is headed down. The markets find the new cost cutting measures credible. It appears that the still gigantic Italian national debt may become more manageable. The almost obsessively watched interest rate “spread” between the Italian 10 treasury year bond and its German equivalent is slowly but surely shrinking, (it is now down to 4%), an indication, argues Monti, that we are no longer in a crisis management mode.

Corporatist special interests will kill Italy

But Monti issued some warnings. Using somewhat indirect language, the professor said that if the Italians want the return of “corporatist” tendencies, “then the situation will once again deteriorate and we shall crash“. At that point the Italians should study Greek, (not classical Greek like, in school), but modern Greek, a clear reference to semi-comatose Greece, whose downfall has been caused by myopic vested interests that led the country into virtual bankruptcy.

Just as in Greece, in the Italian context “corporatism” means that public policy until yesterday was dictated by special interests that care very little about the general welfare. These interests keep fighting to defend their own turf, unproductive as this effort may be. We are talking about protecting parasitical public sector jobs, money losing industries, unsustainable entitlements, and so on. Should these corporatist interests prevail, says Monti, then Italy’s public expenditures will creep up again and there will be another debt crisis. Fair warning from someone who knows a thing or two about economics and public policy.

The young should abandon the idea of life time employment

But Monti made headlines stating something that should not be controversial. And this is his advice to the young: stop dreaming about life time employment, which, in any event, is monotonous and even boring. Rethink of yourself as an entprepreneur, capable of making several job and career changes in the course of your working life.

In the context of any post-industrial, services-driven, modern economy Monti’s counsel about adapting to an ever changing economic environment would look fairly normal. Indeed, in the US many have theorized notions of “Me Inc.”, “Personal branding”, “Perpetual self-marketing”. In a flexible economy in which old and new employers rely more and more on mobile pools of professionals who can move around with agility, according to the needs of an ever changing market place, this notion of employment that will last only for a while is the new standard.

The Italians want life time employment

But not in Italy, apparently. Monti’s advice did not go down well at all. “Give me my monotonous life time job“, is the loud reaction of Italy’s young would-be workers. But why this resistance to flexibility and adaptation? Here it gets complicated. In Italy, precisely because of the corporatist foot dragging that Monti said is anathema to new growth, there are the privileged “haves” who enjoy safe jobs and then there are all the others, most of them young, looking in from the outside.

But here is the thing. The young do not say: “Let’s dismantle the old system so that we have a truly modern and flexible jobs market“. No. What they say is: “Give me a piece of the existing system. I see the cushy life of those who are protected by iron clad labor contracts, those who can never be fired, and this is what I want for me“.

Resistance to change

This little vignette of a Prime Minister who encourages the young to be adventurous and flexible, and the young who reply by saying “I would rather have the monotonous life time employment because it is safe“, in a way summarises Italy’s sad predicament: resistance to change. And this resistance to change, already evident in the loud protests against Monti’s proposals to reform the “Workers Statute”, by creating meausures that would allow employers to fire workers more easily, tells us that the “corporatist” spirit that Monti warned Italians against is in fact alive and well.

In theory labor mobility and real flexibility would favor enterprise and the creation of new ventures. With flexible labor arrangements, business people would be willing to expand in good times, knowing that they could shed excess labor in bad times. But now they do not invest and expand in good times because they fear the burden of redundant labor that they could not get rid off in a downturn. And so Italians entrepreneurs do not invest and Italy operates well below its potential.

But, somehow, most people do not believe that labor mobility would oxygenate the system. “May be someone else should be flexible. But not me. I want the safe, life time job“.

The quest for security kills enterprise

Inadvertently Monti touched the delicate spot of the Italian quest for ”life time security“. And the vehement reaction his advice about flexibility got is a powerful indication of how difficult it will be to change and modernize Italy. You can tax the Italians some more, you can cut free services, and increase fees on others.

But you cannot make Italians more flexible. And, without flexibility, in this global market place in which only the nimble survive and thrive, you can forget about higher rates of growth. And with rates of growth at around 1%, (in good times), Italy is condemned to stay weak and anemic. Thanks to Monti, the country will not sink, after all; but without confident, risk taking enterprise not much worth telling will happen.

How Can Western Countries Get Out of Debt? Only By Paring Down Unsustainable Entitlement Programs – A New Social Contract

By Paolo von Schirach

May 1, 2010

WASHINGTON – In the case of Greece’s nasty fiscal debacle,  everybody’s focus has been mostly on assessing the unfolding drama. Will this Eurozone-IMF rescue package work? Or will it be the next one, until finally something that would stick is cobbled together? Will Greece precipitate into the bankruptcy abyss; and, if it will precipitate, will this ruinous fall bring about further havoc within the already strained fabric of European monetary cohesion?

A growing debt, not this year’s deficit, is the issue

But, while not unreasonable, this focus on crisis management and related countermeasures takes all observers away from the real systemic problem which is not: “How to stem the hemorrhaging and thus bring down next year’s deficit”; but instead is: “How to reverse the systemic, creeping growth of public debt”. And the creeping debt crisis is by no means confined to Greece. It affects many advanced countries, in fact most of Europe and Japan, among others.

The real issue here is not about how to avoid another Greece; but about recognizing the urgency to reverse established –yet deeply  toxic– public spending trends, so that huge and growing amounts of debt will no longer weigh so heavily on so many countries, eventually crippling their ability to invest and grow, since most resources are devoted to spending or to finance borrowing to be channelled into the same spending. But nobody will act to stop this spending and borrowing until there will be a new, truly shared societal consensus that indeed, however well intentioned they may be, large and growing welfare systems, now a common feature in most advanced societies, force a progressive resources diversion from investments to entitlement spending and debt service; thus crowding out and ultimately smothering new productive investments, new research, innovation and new growth.

British elections: candidates avoid details about spending cuts

However, as things stand now, while everybody wants to avoid Greece’s fate, not many are prepared to take today the steps necessary to get out of a very similar course. Staying on this course does not guarantee becoming a basket case like Greece; but it does guarantee under performance, low growth and ultimately societal stagnation and possibly decline. And yet, as bad as all this is, getting out of this spending trap is politically dangerous, if not outright impossible. 

Indeed, days before critical national elections in Britain, none of the leaders of the three main parties dared to articulate what they would do to cut the monstrous UK debt, in case the voters may not like what they hear and punish at the polls who may tell them the truth about losses of benefits. And so Britain, as The Financial Times recently commented, goes into a critical national election without any idea of what any debt reduction plan may be; with the negative political consequences that whoever will end up governing will have no clear electoral mandate to take the harsh measures that, one way or the other, will have to be taken. (Unless Britain decides to do nothing, thus setting the stage to become the next Greece).

Greece will be fixed, somehow

Greece’s crisis eventually will get under control. Greece is, after all, a small country. Its problems, however dramatic and unprecedented for the Eurozone, are not unmanageable. But the issue of systemic growth of public debt in so many countries: Italy, Spain, Belgium, Britain, Portugal, Japan, and the US, among others, is a different story. The fact that higher and higher debt is eventually unsustainable is now blatantly obvious in Greece’s case. But we do not seem ready to acknowledge that the same disease, albeit in a less acute phase, is everywhere.

Between Greece and the other countries the difference is only about the speed of debt accumulation. All these countries are ailing. But many, for the moment, (and this includes the US), manage to mask the severity of the problem, thanks to the availability of sufficient credit that allows them to finance their chronic fiscal shortfalls.

The real lesson from the Greek crisis

Indeed, the real lesson from Greece is not about how to avoid Athens’ extravagant level of recklessness –this is not that difficult. The real problem is how to get out of the far less obvious trap of creeping higher and higher debt levels that may or may not degenerate into a Greece-like crisis; but that are nonetheless very damaging, in as much as too much debt saps precious energy from the economy. Just like a parasite, without being necessarily lethal, severely weakens the body, debt damages society’s fabric, even though it may not deal a mortal blow. The society somehow survives, just like the human body afflicted by the parasite; but it loses vitality, energy and dynamism.

This is the real problem.

But since it is a problem that grows subtly and incrementally; it is relatively easy to ignore it or to explain it away, in the meantime readjusting goals and expectations down. The Minister of Finance of a leading European power just recently said in Washington that a 1.5% projected growth rate for his country is acceptable. Coming out of a severe recession, 1.5% is fine? Not for people who believe in the need to do all you can to nurture the economy. But if 1.5% is alright now, then may be next year 1% growth will also be acceptable. Lowering goals and thus expectations is not too difficult, apparently.

Debt is like “termites in the basement”

Everybody understands a crisis when we are already in it. But before getting to where Athens is today, there is a long journey featuring, among other things, increased levels of public spending unmatched by corresponding revenue and thus higher borrowing requirements as its key milestones. But the problem with an increased debt level is that its damage is slow and incremental; and so this damage  does not manifest itself all of a sudden, as an immediate crisis.

The crisis comes later, some time much later, once debt has piled up beyond some threshold that convinces some key players that it is too much. With that judgment, warranted or not, comes the creditors’ mad rush to unload the bonds, now deemed to be junk, panic and thus the whole thing just falls apart, just as in the current case of Greece. But until debt can be financed with reasonable rates of interest, the process is fairly painless and thus it is easy to ignore its highly damaging and truly corrosive consequences, not just for public finances, but for the netire economic fabric.

As it has been observed: “Debt is not the wolf at the door; it is more like termites in the basement”. So, growing debt levels are not an imminent, visible threat; but rather a subtle, invisible enemy that literally “eats its way into your home”. If you do not catch it and eliminate it, it will destroy your property.

You can fix the immediate crisis without seriously addressing the debt problem

But if we look at Greece purely as a unique crisis, then we shall evaluate everything purely in terms of the success of a rescue package. If the EU-IMF 60 billion or 100 billion dollars rescue package over so many years comes along, Greece will not go belly up. Somehow, it will manage to cut spending, increase revenue collection, streamline public administration, at least to some degree. And so, everybody, (except the Greeks who will have to live through all this), will be happy. Crisis resolved, let’s all go out and celebrate over dinner.

And yet the larger issue is not Greece’s almost fantastic levels of both private and public irresponsibility. Historic evidence shows that crises brought about by extravagantly bad behavior can be dealt with and managed. However, the real systemic problem is not this year’s or next year’s deficit; but the long term fiscal trajectory created by excessive spending and insufficient revenue growth resulting in high debt. The Wall Street Journal of 1-2 May 2010, (“Athens Confronts Sisyphean Task in Austerity Program”), cites a revealing consideration from a report released by the Brussels based Centre for European Policy Studies: “The goal of the large fiscal adjustments is to make public finances sustainable. However….this goal was rarely achieved”. In plain language, you may avert disaster; but this does not imply successful inoculation against the debt malady. So, in the end you may not die, but you will be chronically ill.

Ad why is that? 

The roots of the debt problem are in the promises of the welfare state

In most western nations a key pillar of public policy is the firm belief that the state is supposed to take care of people. And so, to this end, we have created entitlement programs, ever more complex and ever more onerous, largely based on the fantasy that somehow any level of spending is affordable, that there is enough revenue to finance education, health, pensions and assorted subsidies to more and more constituencies. Policy makers who know that this is not possible, for fear of alienating voters, instead of telling the truth, borrow the difference between what they promised and the actual revenue in hand. Hence growing debt.

But, since borrowing has some limits, policy-makers, as they focus on financing what is politically more important to them, that is social welfare programs, short change discretionary spending, cutting spending in all the sectors that do not have huge, clamoring constituencies. And so they cut defense spending, (now, on average it is about 1% of GDP in Europe and Japan); thus creating the foreign policy of the weak, grounded on crisis avoidance, rather than on meeting threats. And they cut capital investments in infrastructure and in research and development. In so doing, they keep their voters happy, thus gaining confidence that they can face the next election. In all this, there is no concern for the aggregate, long term consequences of a trend that, by privileging social spending while shortchanging investments, objectively weakens the economic foundations and the chances of future growth.

No more babies: welfare spending levels become unsustainable

But other parallel trends will make it harder and harder to sustain this act in the future. Until now, growing debt notwithstanding, it was possible to keep financing this onerous welfare system. Looking ahead, this is going to be more difficult. Indeed, most advanced societies are facing negative fertility rates: well below population replacement levels.

In simple language, this means fewer young tax payers and growing numbers of old people who depend on the state for various costly benefits. A growing number of elderly citizens –and they are those who receive the most in terms of welfare—will have to be supported by the shrinking revenue produced by a dwindling number of younger, active citizens. At some point the mismatch between too many old people receiving benefits and too few active young ones paying into the system will become unsustainable. Recurring to debt will no longer be enough to fix the gap between what has been promised and what is financially possible.

Too late to change course?

What will happen then? Who knows. But we can bet that at that point it will be way too late to reverse the cumulative effects of policies that for decades have privileged social spending over productive investments. Sure enough, some benefits will be curtailed, some may be eliminated altogether, in order to diminish the fiscal imbalance. But I very much doubt that it will be possible to bring before the public and then successfully implement a new public policy philosophy strongly grounded on the basic notion that by far the best way to ensure public welfare is to maintain and safeguard above all else the full functionality of a vibrant economic system; in as much as this is the only engine for wealth generation. If you want to distribute wealth, you have to produce it first.

Until people will be prisoners of the idea that welfare is a basic right and that we can think about how to pay for it later, we shall privilege distribution of benefits and shortchange policies aimed at keeping the economic engine going full force. It should be clear to all that in the end you have to produce some added value in order to be able to distribute it. But the established distortions that make welfare policies untouchable allow most people to overlook this rather basic consideration. And so, we keep on distributing benefits financing the expenditures via borrowed funds.

Strong focus on welfare means less attention for growth

The end game of insisting with these entitlement policies in societies that are becoming less productive, (because the money goes to finance these very entitlements), is that over time there will be less and less to distribute. These societies will be progressively more impoverished, while their standing in the world will be diminished. My hunch is that Europe as a whole is well on its way to economic and societal decline, while I do not see any significant new tendencies that would reverse course. Japan is not too far behind.

What will happen in the US?

In the US it is still a toss up. Certainly there are large, powerful, mostly urban, constituencies located in the large states on the two coasts that aspire to something close to the European model. There are others, witness the spontaneous, if boisterous, anti-government, anti-tax “Tea Party Movement” phenomenon, who instinctively abhor statism and the attendant welfare state public policy approach. Can America find a reasonable balance between maintaining some sort of public safety net and a focus on doing whatever is necessary to keep investments and innovation at the highest possible rate? As of now, because of the impact of the 2008-2009 recession, our debt is  approaching European levels. We can retreat from this bad course and once again emphasize growth, while doing what it takes to keep this economy nimble and competitive. But this benign outcome is not a sure thing. The Obama administration repeatedly stated that high spending is a temporary counter cyclical remedy because of the horrible recession and that it will soon announce a convincing long term decifit and debt reduction strategy. And when will this be? Well…soon. Somehow, I think that we shall have to wait until at least after the November congressional elections. And, after the November elections, we shall be gearing up for the 2012 presidential elections. If, just like other governments, the Obama administration does not want to upset voters by announcing serious spending cuts, there are good chances that we shall not see any bold deficit and debt cutting strategy.

Will we learn anything from the wider debt story highlighted by the Greek crisis?

In the end, the Greek crisis is not an especially useful example of what to avoid, as Greece is clearly an extreme case, whose specific circumstances are not going to be easily replicated. Few other modern countries will accumulate so many distortions and so many inefficiencies.

But the Greek crisis did illuminate in some fashion the debt issue and the cumulative damage brought about by growing and growing public debt. Not as clear, by reading the copious commentary, is whether we are in agreement on the primary cause of structural debt: growing social spending out of sync with revenue. Will anybody, be it in London, Lisbon or Washington DC look at the nasty consequences embedded in spiraling debt and realize that it would be good to change course as fast as possible?