Greek Profligacy and the Myth of Cost Free Welfare

WASHINGTON – the Greek public sector deficit crisis has attracted inordinate media coverage largely because it broke out all of a sudden. The Greek Government, led by recently elected Socialist Prime Minister George Papandreou, “discovered” that its predecessor conservative Government had cooked the books and lied about estimated public sector deficits. So, as it turned out, the fiscal imbalance in reality is double the initial projection. And this carries the Greek deficit not only beyond the theoretical European strict limit of 3% of GDP; (already broken by others, for that matter), but it brings it to around 12.7% of GDP; that is beyond any sustainable level. This is big news, even though it affects directly only a small country, at the periphery of Europe, with a relatively marginal economy. Of course, the attempt was made to gauge the likelihood of any kind of “domino effect”, whereby a potential Greek bankruptcy might drag the whole Euro zone edifice down.

Greek “contagion”?

Could we have “contagion”, given the considerable lending by many European banks to Greece? But, outstanding European loans to Greece notwithstanding, the idea that tiny Greece would bring down the whole of Europe was really farfetched. Unless, of course, other Greek-style surprises of heretofore hidden losses might spring up elsewhere. To date at least, this seems unlikely. While we know that there are other problem countries affected by huge fiscal imbalances, there is no forecast of an impending Europe wide unraveling.

Europe holding on

Greece is not that important an economic player to cause the downfall of Germany and France. The Greek budget crisis is a big problem, indeed, but not a European catastrophe. The Greeks have been told, (or better, “ordered”) by their EU partners that there will be no bailout. They must take the necessary, if politically bitter, countermeasures in terms of drastic spending cuts and this should be enough to avert bankruptcy. The Euro as the common currency shared by Greece and 15 other EU member states is not in any imminent danger.

So, case closed?

More than just debt

Well, not entirely. Greece represents an extreme example of total fiscal irresponsibility, cleverly disguised for a while and certainly driven by the politics of the welfare state. And in Greece this free spending style was nicely blended with endemic corruption, extravagant levels of tax evasion and an otherwise mediocre economic performance. But Greece is a member of the European Union. And so this debacle becomes a problem for all the other members of the EU, as it blemishes the image of Europe as a Union of modern countries. No other member of the club wants to have, within Europe, this kind of Banana Republic governance model. And I am sure that this concern has been clearly conveyed to Prime Minister George Papandreou by his European counterparts.

A larger lesson about the consequences of public largesse

But, bad image aside, even if we limit ourselves to the issue of fiscal profligacy, the Greek example indicates that at least some Western Governments are prepared to take huge risks, behaving at times most irresponsibly, in order to placate constituencies who believe that the purpose of Government is “to give” more and more; constituencies who put pressure on elected leaders so that they will deliver more and more. Greece has become a sensational story because of the extreme overspending and the sudden revelations. And again, beyond the surprise, there has been the unplesant task of selling to the public this unprecedented austerity program.

The “free lunch” pipedream is still alive

This has not gone down well; and we have seen the vociferous and at times violent street demonstrations, and the emotional reactions of those who would like to cling to the dream that there really is a free lunch; that you can do both: overspend without limits and keep giving extra this and that to all kinds of constituencies, without ever paying the bill. And so now, along with the headlines about the drastic spending cuts, we have the photos of riot police battling demonstrators who would like to believe that somehow there must be a better, less painful alternative for them.

Did anybody learn anything?

In the end, in the case of Greece, it seems that the general public, beyond the current moment of hyperventilation, will have to surrender to the hard facts, unless they want to force the Papandreou Government to exit the Euro and may be the whole EU structure –and this seems highly unlikely. So, reluctantly and despondently the Greeks will fall back in line. If they follow the plan, they will cut spending and eventually rebalance their public accounts.

But I doubt that the larger lesson as to what provoked the crisis –the insane, yet widespread hope that in a modern western society you can indeed get something for nothing– will be properly understood. And, as this fallacy about magically obtainable unlimited entitlements, while someone else (who?) eventually will pay the bill, is not fully understood in Greece, it is probably lost in all the other countries in which, large deficits notwithstanding, (Belgium, Spain, Italy, Portugal, the United Kingdom), there is, for now at least, a semblance of normalcy.

A stable currency does not give you growth

And here is the real problem, a problem that goes way beyond the understandable desire to protect the Euro, potentially weakened by irresponsible fiscal policies, as a credible currency. A stable currency is a good thing. And it is good that the European Central Bank will continue to act as a good steward of the Euro’s reliability. But a stable currency, while essential, is no guarantee of underlying dynamic societies and economies. The Greeks will have to swallow the bitter pill. So, they will eventually rebalance the accounts, (we hope). But, at the same time, even staying within the Euro zone, they will have less money and their standard of living will be lowered. Unless the general public will learn the simple lesson that higher standards of living are not grounded on public largesse but on individual and corporate enterprise, the real lesson will stay hidden. The Greeks may become more sober; but the people, unless they are ready to embrace the basic tenets of private sector-led growth, will be both poorer and more disgruntled.

Welfare state yes, but who pays for it?

More broadly, Greek-style extremes aside, not many in the West are getting the message of what it takes to grow. In our ongoing love affair with the notion of a public sector that will provide more and more things: subsidized public sector jobs, free grants to this and that, tax shelters, lavish pensions, health care, free education and what not, we have forgotten that none of this things in the end grow the economy, while in the end someone has to pay the bill.

If it is politically unpleasant to make anyone pay the bill, then the cost of the unpaid fun will pile up and Government will need to finance its largesse through borrowing. And when more and more borrowing becomes not just a temporary expedient for extreme situations, but a routine way to finance ever increasing public spending, this entails a shift in basic Government functions: from focusing on public administration issues to spending more time and energy in the identification of ways to finance more spending. In the end, financing the debt –not governing– becomes a top Government priority. 

If you have larger deficits, you have less economic growth

Furhermore, even in situations in which there is a huge or growing debt but this debt can still be financed (Spain, Portugal, Belgium, Italy, and Japan, among others), this comes at a high cost. While the State may be able to continue to meet its obligations towards bond holders, interest due on the outstanding debt starts eating into a larger and larger share of existing revenue. And so the State can no longer perform basic functions such as investing in R&D, infrastructure development, defense or even education. Indeed, once interest on the debt is paid out, there is the regular operating budget just to keep day to day Government activities going; and so there is very little left for any discretionary spending. The Government can perform, at best, routine operations; but it has no resources and thus no flexibility to lead, in domestic as well as international policies.

Less capital for investments

In the meantime, a larger share of national savings will be directed to financing the debt. This means less and probably more expensive residual capital available for productive investments. In the end, the State and its profligacy, due to the desire of the political leadership to satisfy the desires of more and more constituencies, becomes an objective drag on new growth. Large, (or excessive, depending on your point of view), public expenditures –and the attendant need to finance the deficit– absorb more and more limited capital that cannot be used otherwise.

Europe has chosen welfare over growth

This state of affairs is endemic in Europe. Even though most European countries have not reached the insanity of Greece, on average, the public sector absorbs a very large percentage of GDP, 40% or more. In general, high spending entails higher taxes. But, even with high taxation, there is still a need to borrow heavily to finance the rest. While these societies seem to manage somehow, the real, if hidden, cost of this setup is in a myriad of missed opportunities for new growth, as funds that could otherwise be invested have to be employed to finance entitlements and other transfer payments.

Indeed, as the primary focus of Government is the provision of services to a variety of deserving constituencies, the pool of residual public sector capital available for productive investments shrinks. Besides, high levels of taxation, (necessary to finance increased spending), along with rigid labor laws, may also contribute to discouraging new enterprises. So, in the end, there is a lot more involved here than finding a way to balance the books, trying to reconcile a high level of spending with the need to find revenue and/or resort to more borrowing.

If we choose to devote resources to service delivery, we have to understand the implications

In the end the real issue on the table is a philosophy of Government and the shaping of a societal consensus whereby the essence of public policy is to provide services and to alleviate hardships, as opposed to the creation and the nurturing of an enabling environment conducive to the expansion of the economy.

Nothing wrong, in principle with espousing this approach focusing on making today’s life more comfortable, as opposed to devoting more resources to future growth.

More entitlements, less growth

But, if this is indeed the choice, it should be fisrt of all clearly articulated, (as opposed to being incrementally implemented), and fully understood by all citizens in all its immediate and long term implications. If our goal is to live today as comfortably as possible, almost like retirees, then we do indeed create public policies geared towards the delivery of services and the growth of entitlements at the expense of investment and growth. But it should be clear to all that, unless we become extravagantly rich due to fantastic levels of high value innovation and strong productivity growth, we cannot at the same time spend most of what we have today and have enough left for new investments. Maybe Norway can do it, as it has a very small, educated population and the extra bonus of significant revenue coming from oil and gas exports. But there are not many such examples.

What about the US?

And what about the US? Well, we are in an interesting, yet delicate, position right now. By European standards, we still have a miserly state that provides comparatively little in terms of services and entitlements. (Our combined total public outlays: Federal, State and Local amount to roughly 33% of GDP). But, quite apart from the recent extraordinary recession that caused an explosion of public spending to fund huge emergency countermeasures, we know that, unless we change our basic system rather drastically and soon, we are geared towards a dramatic increase of public spending. The cause is in  systemic demographic changes (more elderly Americans receiving public moneys) and the after inflation cost explosion of services such as medical care for the elderly.

Which way is America headed?

And here is our problem. Are we going in the direction chosen by Europe, or are we going to revert to a model of a Government that spends less on the provision of services, thus freeing up more resources that will be hopefully directed to the expansion of the pie and thus more prosperity? Long term, quite apart from how soon the current recession and related spending will end, this is the real strategic choice before us.

Former Massachusetts Governor Mitt Romney, warming up for a likely new bid for the Republican nomination for White House, argues in a new book, (“No Apology: The Case for American Greatness”), that we should be repairing our system so that it can be once more geared towards investing in new growth, while providing a modicum of a safety net, via the delivery of social services and some entitlements.


Balancing growth and the expansion of opportunity

Yet, even if one agrees philosophically with the limited government model reproposed by Romney, the really complicated issue is to determine the proper balance between being pro-growth and the need to provide to the disadvantaged in a way that will really help them transform their lives, by granting them real solid options –such as good education–that will increase their opportunities. How much and what do you provide? And in what way do you provide effectively? A mountain of historic evidence shows that providing “more”, while nice, does not necessarily help to solve problems.

It is once again the old and worn story: “Give a fish to the hungry everyday, or invest resources teaching them how to fish, so that they will catch their own fish and become self-sufficient”? it is a shop worn, tired little example, and yet its wisdom still escapes us. Try as we may, we are still struggling with this. If we are at all reasonable, we should want to push for growth. But our sense of social cohesion and human decency also tells us that deep down we do not really believe in social Darwinism, whereby the fittest survive and for all the others, well… tough luck. They are lost along the trail because they could not make it.

Understanding the difference between social spending and social investments

The European story tells us about the penalties paid in terms of missed growth, plus huge debt overhang, via an excessive tilt towards equality and public interventions in the shape of hardship alleviation. Can we, as would be President Mitt Romney suggests, be decisively pro-growth, yet mindful of the need to have everybody on board, by providing to all the tools necessary to advance –first and foremost via a truly vibrant, modern, comprehensive education system? Can we invest in this kind of “fishing” education for those who will otherwise depend on future handouts? And are we willing, as a society, to recognize the qualitative distinction (and choose wisely) between investing in the future (education) and relief payments (welfare, unemployment checks, and so on)?

Our future is not going to be Greek-like. But it could be closer to Italy or Japan: low levels of investment, stagnation and slow decline. Less dramatic; but equally unappealing.

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