Following the news from Europe is educational. Europe is ahead of America on the downward slope into an abyss of government debt and an unsustainable welfare state. There are plenty of good examples over there of what big government debt and big government spending can do to a country, but the most notorious one is Greece – a country whose government is desperately trying to stay avoid outright default.
Greece ended up in its current mess because its elected officials refused to take action in time. Now they are in fiscal panic mode, adopting one austerity package after another.
The most frightening part of this sad Greek drama is that our own legislators in Congress have been acting exactly the same way for a long time. They have been in the same state of denial as their Greek colleagues, which opens some rather unpleasant perspectives for the future: panic-driven austerity.
It is unlikely that Americans will respond to such measures the way the Greek people have. There, people have responded to the latest austerity bills by vandalizing buildings, setting fire to cars and staging massive unrest in the streets. But this does not mean that we should welcome harsh austerity as a response to our federal deficit. An orderly retreat of government spending is infinitely more preferable.
The problem is that it is hard to convince our Congress – not to mention the president – that we actually must reduce government. They seem to believe that America is somehow isolated from the world where the laws of economics apply. One way to shake them out of this state of denial is to examine the causes of the Greek crisis and point to American parallels.
To begin with, it is important to dispel the myth, proposed by far-left groups especially in Europe, that “the financial system” is to blame for the fiscal crisis in Greece. One need not take any deeper look at macroeconomic data to see how wrong this is. The true cause of the problems in Greece is, plain and simple, a government that has been overspending and overburdening the private sector for a very long time.
An important step on the way to showing the role of government in the Greek crisis is to examine the role of a big, strong currency. Just like the United States has its dollar, Greece has the European common currency – the euro. The theory behind a big currency is that it somehow reduces the risk taken by those who lend money to a government under that currency. This lower risk is reflected in lower interest rates – and thus lower borrowing costs for that government. But this did work for Greece. As explained by, e.g., the insightful Across the Pond blog out of Indiana University,
Once Greece joined the Eurozone, its interest rates dramatically fell compared those of Germany. As a result, it was then much easier for the Greek government to borrow money internationally.
In other words, under the euro the Greek government suddenly had borrowing privileges that resembled those of the U.S. government under the dollar. This led to a surge in borrowing for projects that eerily resemble what the Obama administration wanted to pay for with the ARRA Stimulus Bill: large-scale investments, especially in infrastructure.
But the low cost of borrowing for the Greek government not only allowed an infrastructure boom – just as with the U.S. government, it also allowed Greece to borrow for regular government spending at very low cost. With the currency union, the country-specific risks that lenders faced when all European nations had their own currency were wiped out at the “storefront”. Prior to the currency union there were two ways for lenders to set a price on the risks associated with lending to national governments: the interest rate on the national treasury bonds, and the exchange rate of the nation’s currency. With the euro the latter price mechanisms vanished. The former mechanism, namely the interest rate, practically also went away, as the European Central Bank became the lender of last resort within the euro system. (The ECB formally is banned from serving in that capacity, but has, predictably, taken that role anyway since it otherwise would not be able to defend its currency in a crisis.)
As a result, the Greek government saw the price of deficit spending drop dramatically. This explains their zest for fiscal recklessness, as evident in Eurostat macroeconomic data: from 2005 to 2009 – four short years – government spending in Greece, measured as share of the country’s GDP, increased by almost one fifth: from 44 percent of GDP to 53.2 percent.
In two years alone, 2006 and 2007, government consumption (not counting retirement benefits and welfare) increased by more than ten percent, adjusted for inflation.
While government in the U.S. is not yet at these exorbitant levels, it has been growing steadily over the past decade. Taken together, the federal government and the states are closing in on 40 percent of GDP. And let’s keep in mind that more than one third of state spending is funded by the federal government.
Furthermore, in Greece just as in America, the spending sins of recent years are merely the tip of the iceberg. Government spending has averaged 45 percent of the Greek economy for at least the past 15 years. In the meantime, the private sector has exhibited a very volatile behavior: private corporate investment in Greece has undergone violent swings over the past decade, since Greece joined the euro zone. After some remarkable increases early in the past decade, investments took a deep plunge in 2008. By 2010 corporate investments in Greece were back at where they were in 1997, adjusted for inflation.
This investment volatility has in good part been driven by the fact that the euro eliminated the currency part of the risk pricing mechanisms mentioned earlier. In part, they have also been driven by the government’s lavish spending: much like the failed ARRA Stimulus Bill here in America, Greece’s government-spending-gone-wild failed to generate a reliable trajectory of private sector growth. Once the government runs out of other people’s money, economic activity collapses. (And it may be worth noticing that corporate investment in the American economy is currently at almost depression levels.)
When GDP growth slows to a crawl or even reverses – i.e., when the economy begins to shrink – so do tax revenues. Taxes are always paid out of current income (technically, this is true even if you take money out of your savings account to pay them) which has caused some major problems for the Greek government, on top of its exorbitant borrowing.
Again, excessive government is nothing new to the past few years in Greece. Going back to 1965, and counting taxes as a percentage of GDP, we witness a disturbing track record of ever growing government:
- In 1965 Greece had lower taxes than even the United States: 17.8 percent of GDP vs. 24.7 percent here;
- By 1985 Greece had caught up with America: taxes were, respectively, 25.5 and. 25.8 percent of GDP;
- In 2005 government in Greece were claiming 31.4 percent of the nation’s GDP in taxes (27.5 in the U.S.).
The sharp-eyed reader will notice that the taxes in Greece, as share of GDP, are much lower in 2005 than government spending as share of the same GDP. There are three reasons for this. First, the tax-to-GDP ratio is reported in current prices, not constant prices as is the case with government spending. This usually does not create significant disparities, but in a country like Greece, which has a documented track record of high inflation and currency devaluations, the difference between inflation-adjusted and current-price GDP data makes a big difference: it under-estimates the burden of taxes by simply inflating away that burden.
Secondly, Greece has a long history of deficit spending. While never reaching dimensions that could explain the entire gap between the tax and spending ratios reported here, it does account for up to one third of it in isolated years. Third: a good part of the funding of entitlements in Greece has been counted as “fees” instead of taxes. Due to finicky accounting methods used historically, this has allowed some governments in Europe to “cook the books” when it comes to government accounting. Fees have slipped under the radar of national accounting, resulting in an under-estimation of the nation’s tax burden.
With all this in mind, the conclusion stands: the Greek mess is entirely the work of excessive government and an over-the-top spending welfare state.
As such, Greece stands as a warning sign to all of us, even here in America. There is no way we can imagine today that we would end up in the Greek hole, with a government literally running out of credit – and cash. But then again, let us not forget that only four years ago we would never have imagined that we would have a Congress that would violate its constitutional obligation and not pass a budget.
Or a president that would happily sign on to borrowing 41 cents of every dollar the federal government spends. Year in and year out.
Just like Greece, if we continue to do nothing, we will reach a point where we have no other option than panic-driven austerity measures. We are a couple of years away from that point, and we can still start an orderly retreat from the welfare state. As I explain in my new book, Ending the Welfare State, we can indeed make that retreat.
But we need to act now. Time is running out fast.