2010 May 23 Sunday
Welfare States Headed For Death Spiral?

Robert J. Samuelson sees welfare states in a death spiral.

What we're seeing in Greece is the death spiral of the welfare state. This isn't Greece's problem alone, and that's why its crisis has rattled global stock markets and threatens economic recovery. Virtually every advanced nation, including the United States, faces the same prospect. Aging populations have been promised huge health and retirement benefits, which countries haven't fully covered with taxes. The reckoning has arrived in Greece, but it awaits most wealthy societies.

Americans dislike the term "welfare state" and substitute the bland word "entitlements." Vocabulary doesn't alter the reality. Countries cannot overspend and overborrow forever. By delaying hard decisions about spending and taxes, governments maneuver themselves into a cul-de-sac.

I've been arguing for years that the unfunded entitlements (old age medical care and state-supplied pensions) would finally hit a crisis stage in the 2010s. The real estate bubble and the oil price spike of 2008 have moved up the crisis point in many countries. The creation of the euro zone in 1999 has accelerated the arrival of the crisis in southern Europe by creating a false belief in the fiscal soundness of the PIIGS and therefore enabled them to run up more debt than the markets otherwise would have allowed them to do.

The financial troubles in Greece, California, and other nations and states serve as a warning of what's to come for nations that are not as close to the full maturation of their sovereign debt crises. Therefore the worst off American states (e.g. California, Illinois) and European countries (Ireland, Greece, Portugal) provide us with a view into our future. What we can see so far: cuts in salaries and benefits of public employees, lay-offs of public employees, cuts in welfare state programs that were previously viewed as sacrosanct, higher taxes, and varying degrees of public opposition to taxes as part of the solution.

The most important pattern I've seen so far: So far it looks like cuts in outlays (cuts welfare entitlements and cuts in public employee salaries and staffing) are playing a bigger role than tax increases in attempts balance government budgets. Will this trend continue to hold up as more governments hit the crisis stage in their finances? Cutting compensation of employees will become even more necessary once Peak Oil hits.

A New York Times piece by Steve Erlanger reports on growing realization in Europe that the younger folks are getting shafted by older folks. (not that he used such explicit terminology)

The reaction so far to government efforts to cut spending has been pessimism and anger, with an understanding that the current system is unsustainable.

In Athens, Aris Iordanidis, 25, an economics graduate working in a bookstore, resents paying high taxes to finance Greece’s bloated state sector and its employees. “They sit there for years drinking coffee and chatting on the telephone and then retire at 50 with nice fat pensions,” he said. “As for us, the way things are going we’ll have to work until we’re 70.”

In Rome, Aldo Cimaglia is 52 and teaches photography, and he is deeply pessimistic about his pension. “It’s going to go belly-up because no one will be around to fill the pension coffers,” he said. “It’s not just me; this country has no future.”

Will the younger people in Europe turn against the welfare state as the size of the inter-generational wealth shift from them to older people grows?

Michael Gerson says we are entering a new age of austerity in the United States and Europe. However Obama and the Democratic Congress are still acting like Business As Usual (BAU).

In 2009, the federal government spent $1.67 for every $1 it collected in taxes. The Obama administration's budget proposals would dramatically increase publicly held debt as a percentage of the economy over the next decade, eventually slowing economic growth, fueling inflation and making America more dependent on the kindness of creditors.

How has our political system responded? Congress recently found $60 billion in savings in the federal student-loan program -- and promptly spent most of it on other education projects. President Obama's health-care reform cut more than $350 billion from Medicare spending -- and soaked up all of it and more into new health entitlements.

In Greece it is no longer BAU. In Ireland and Iceland BAU are well past BAU. Spain and Portugal have begun to enter the era of post-BAU. But in spite of record high deficits and persistent high unemployment the mood inside the Washington DC beltway is still very much one of denial and of hanging onto BAU assumptions. The US government is living beyond its means in its foreign policy of war and aid spending and it is living beyond its means in health care spending, old age spending, and educational spending.

Tyler Cowen sees the big crisis for the US still many years into the future. But I am confident that the crisis will hit much sooner when oil production starts declining.

That’s bad, but the American economy probably can manage it, at least if nothing else major goes wrong between now and then. A wealthy, diversified country which can borrow on its own currency, and indeed has the world’s global reserve currency, should still find investors willing to buy its bonds, especially since many other parts of the world face greater fiscal problems. And then there’s what happens after that. Rising health care costs, if they continue, will likely bankrupt the nation over a 20 to 30 year time horizon, most immediately through the Medicare program. It’s not as easy to control those costs as it may seem.

The way I see it BAU has less than 5 years to run in the United States.

Share |      By Randall Parker at 2010 May 23 11:18 AM  Economics Government Costs


Comments
Mercer said at May 23, 2010 1:29 PM:

Bruce Bartlett has what I think is the best prediction of how a US doomsday would unfold:

http://www.forbes.com/2010/05/20/economy-fiscal-crisis-money-opinions-columnists-bruce-bartlett.html

Randall Parker said at May 23, 2010 4:06 PM:

Mercer,

Good link. The second page where Bartlett mentions that the credit ratings agencies will downgrade US government debt once 20% of revenue goes to interest payments is most interesting. I agree with him that the timeline is sooner than the 2020 that the Congressional Budget Office projects. Peak Oil will see to that.

But I disagree with Bartlett's support of the VAT tax. California's recent experience cutting spending shows that if the money isn't available and a government is forced to balance its budget it will find lots of ways to cut spending. The US government could cut salaries, retirement benefits, military spending, and welfare programs. Absent an absolute need to cut spending lots of optional government activities will remain funded.


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