Wednesday, December 22, 2010

The Peak of the Welfare State Bubble

Governments have always provided social services such as streets and highways, but the concept of government providing comprehensive welfare for the people began in Germany in 1883. Socialist ideas were gaining favor throughout Europe, and Chancellor Bismark sought to reduce the appeal of the German socialist movement by fighting fire with fire. Bismark initiated statist consumer socialism in order to stifle the popularity of statist producer socialism.
Socialism arose in Europe in reaction to the growing inequalities and continuing poverty that accompanied allodial kleptocracy, the economic system in which labor and capital were private but the rent of land was redistributed to a few wealthy landowners. Much of the gains from economic expansion and progress go to higher land rent, so workers were bewildered and angry as labor suffered from periodic depressions, unemployment, insecurity, and harsh working conditions.
Socialism sought to provide as the remedy the replacement of private enterprise by government. With the means of production owned by the state, the government would then provide the goods in an egalitarian distribution. There is a superficial appeal in the thought that central planners can allocate resources for the public benefit, but as shown by the Austrian economist Ludwig von Mises in his 1922 book Socialism, state ownership of resources prevents the economic calculation needed for efficient production. Another Austrian, Friedrich Hayek, showed how central planners cannot obtain the knowledge needed to manage a large economy.
But superficial remedies are always more popular than effective remedies that require an economic understanding of implicit reality. Moreover, the effective remedies to social problems requires the reversal of the policies that subsidize the powerful interests that control the government. Since the central aim of the German Empire was to serve its landed interests, such as the Junkers of Prussia, Bismark had to appease the public with the superficial remedy, the welfare state, with the Health Insurance Act of 1883, accident insurance in 1884, and old age pensions in 1889.
Other European countries and then the United States copied the German welfare-state paradigm. There were two competing reformist ideologies in the USA during the progressive era that began with the publication of Progress and Poverty by Henry George in 1879. The Georgists promoted the single-tax movement to equalize the benefits of land while keeping private the labor, capital, and possession of land. The other ideology was a welfare state financed by a progressive income tax, thus redistributive consumer socialism.
The welfare socialists won the tax battle with the 16th amendment to the US Constitution, which removed the legal barriers that had struck down the 1894 income tax act. The Great Depression then eliminated the political and legal resistance to the welfare state. Like European countries, the US got Social Security and governmental medical provision, unemployment payments, and accident insurance.
The fatal flaw in the welfare state is that it preserved the privileges of the landed interests. While value-added taxation and progressive income taxation take some of the land rent, landowners get it back plus much more in the greater rent and land value generated by public works, civic services, and welfare-state benefits. If that were not the case, land rent would be zero.
With public revenue from land rent precluded, the welfare state has to cannibalize the economy, extracting much from wages and enterprise profits. Given the existing high level of taxation, even greater taxes are unpopular. Since the politicians of mass democracy need popular approval, they resort to unsustainable borrowing. Hence we see massive government debt in Greece, Ireland, Spain, Portugal, Italy, Japan, the United Kingdom, the USA, and many of the US states. We are now at a historic time in which unsustainable deficits can no longer be sustained.
The welfare state system peaked out in 2010, with the expansion of federal medical care in the US. With sovereign debt now considered to be increasingly risky, and with government chiefs facing promises they can no longer fulfill, welfare states in Europe are now practicing austerity, sharply cutting back on welfare-state spending, despite the public reaction of demonstrations and riots. US state governments are also cutting back.
The last remaining hold-out is the federal government United States, which still has good credit. The temporary prevention of tax-rate increases, plus a reduction in payroll taxes, will boost the economic recovery, but it will add another trillion dollars to the federal debt. The worst welfare state problem in the USA is the promised pension and medical-service promises that cannot possibly be kept in real value.
Thus the US too will have to start cutting back the welfare state. The extension of the ozo-decade tax rates has shown the political resistance to higher tax rates, so the line of least political resistance is the purchase of federal debt by money creation, as the Fed is now doing. But money creation too is unsustainable, as higher prices and higher nominal interest rates will make money creation ineffective. What then? Either we get the effective remedy of ending the subsidy and redistribution to landownership, or else an austerity that will create hardship and riots as the welfare-state bubble bursts and leaves us with a welfare hell.

Thursday, December 09, 2010

Can Ireland be Saved from Econeurosis?

Ireland is one of the countries whose governments have fallen into deep deficits. The Irish deficit, including bank bailouts, is 32 percent of its gross domestic product. The bonds of Ireland are now regarded as highly risky. Ten-year bonds from Ireland, Greece, and other indebted members of euro-land are paying over 7.5 percent.
To avoid a default on its debt, the European Union and International Monetary Fund will provide a loan of 85 billion euros (US$ 113 billion). The chiefs of the European Union fear contagion, as a default by one country will induce others such as Spain to also default, and the loan losses would cause another financial crash.
As in the U.S.A. and other countries, the fiscal crisis in Ireland was caused by its unsustainable real estate boom, when its capital was doubling. Irish house prices have fallen by 50 percent. The Irish economy suffers an unemployment rate of 14 percent. The Irish government had previously resisted an aid program from the EU and IMF for fear of having to abide by the harsh terms of a loan agreement.
As with Greece, and aid package only postpones the fiscal program. The government of Ireland plans to increase tax rates and reduce its spending by 20 percent. Future generations of Irish will have to pay for the failed policy of subsidizing the Irish landed interests and their banking allies.
The economist Paul Krugman wrote a column in the New York Times entitled “Eating the Irish.” He invokes Jonathan Swift’s satiric “Modest Proposal” for Ireland to sell its children as food. The Irish were poor and starving in the 1700s and 1800s as the nation’s wealth went to the landlords. The Irish learned neither from economics nor from history, as they repeated the error of letting the gains from their great economic expansion go to ever higher land values, until real estate prices inevitably collapsed, which also crashed their banks.
But Krugman, like most other economists, has misdiagnosed the problem. He writes that these days, the problem is not the landlords, it’s the bankers. Wrong, it’s still the landlords, as the bank losses come from fueling the real estate bubble. But the real problem is not the landowners, but with the government subsidies to real estate in the form of public goods paid for by taxes on wages instead of land, thus generating higher rent and escalating land values.
The reaction of the government of Ireland, as in Greece and other indebted countries, is austerity. Of course excessive government spending should be cut, but vital services should be transferred to the private sector rather than eliminated. There have been huge demonstrations in Ireland in opposition to the cut in welfare spending.
The justification for government welfare spending is that it is compensation for denying economic opportunity to labor, by imposing burdens on enterprise and taking away much of the earnings of labor. By taxing wages, government prevents labor from buying the goods it produces. Government then provides the goods with welfare spending, but the taxes also create a resource waste, a deadweight loss that has to be made up by borrowing, and thus we get to the fiscal crisis. Higher taxes on labor and enterprise will make the problem that much worse.
There is an alternative to austerity and a new Irish economic famine. The Irish need to confront their centuries-old land problem. Ireland needs to stop subsidizing the landowners. The Irish need to keep their value-added tax at the minimum required by the European Union, and replace all their other taxes with user fees, pollution charges, and a tax on all their land value.
Ireland also needs to quit the euro and restore its own currency. They can call it the eireo (pronounced eye-row). The new central bank of Ireland can then pay off the bank loans with eireos. Usually, such money creation is bad, but just as sticking a knife into somebody is normally evil, when a dying patient is undergoing an operation, one needs to perform surgery. The monetary inflation of eireos would reduce the real value of the loans to the Irish banks, but the lenders should have realized that they were fueling a risky speculative land boom. Why should the Irish people suffer and not the financial fat cats who hold the Irish debt?
Land value taxation plus paying off the debts with new currency will save Ireland. Why are they not doing this? Why are economists not screaming this remedy to the world? Perhaps there is a mental disease one can call “econeurosis,” analogous to psychoneurosis. Econeurosis is a disorder of economic thought, the mental confusion of refusing to confront economic logic and reality, rooted in ego defense mechanisms and anchoring to learned doctrines.
At any rate, the Irish will suffer an economic famine for no good reason other than their refusal to understand economic logic.