Europe's social failure

(By Oliver Marc Hartwich, a German economist who has now fled to sunnier climes and a more relaxed lifestyle in Australia)

Capital markets are not loquacious storytellers. They condense the world into simple numbers. For this reason, the surge in Greek, Italian and Spanish bond yields could be mistaken for a mere technicality, a simple recalibration between the forces of demand and supply that happens in markets every day.

But these are no ordinary times. Through bond yields, credit spreads and bets on government defaults, capital markets are delivering the clearest possible verdict on the grand European experiment of social democracy.

Italy now needs to pay more than 7 per cent interest on its long-term borrowing, which means investors no longer believe that the country has a future in its present state. They doubt Italy can return from the brink of bankruptcy after wrecking its public finances through decades of overspending and over-borrowing.

Politicians and intellectuals still refuse to understand what is easily discernible on the cold-hearted trading floors of the world's bond markets: The European social model, the romantic idea of an omnipotent and omni-responsible state, has passed its use-by date.

Ironically, in today's Europe there are only social democrats left, who face the unenviable task of cleaning up the mess of social democracy.

Almost 30 years ago, in a book published in 1983, the great Anglo-German sociologist Ralf Dahrendorf declared the end of social democracy. Not because it had failed but because it had reached all of its traditional goals: "We have all absorbed a few core ideas and made them look self-evident, which define the theme of the social-democratic century: growth, equality, work, reason, state, internationalism."

The social-democratic program was so attractive that it had been accepted by political parties Left, Right and Centre, argued Dahrendorf. This rendered the original social democrats strangely visionless because they no longer had anything to fight for, at least nothing that would distinguish them from other political parties.

In hindsight, Dahrendorf's obituary to social democracy came too early because he had underestimated social democrats' desire to extend the reach of the state. What he also probably did not realise was that, in the 1980s, social democracy had moved beyond workers' movements to activism in fields such as gender equality, environmentalism and political correctness.

In fact, Europe's social democracy turned away from its traditional labour roots and replaced them with a new statism of the inner-city elites.

The only constant was social democracy's unwavering trust in the power of the state to organise the economy and society. Nothing could deter social democrats from their belief in the primacy of politics over economics, not even the giant bill that came with it. Instead of questioning their underlying philosophy, they glossed over its inherent contradictions by running massive deficits.

In one aspect, however, Dahrendorf's analysis was spot-on. By the end of the 20th century, the once colourful political spectrum had shrunk to a single spot. Political parties may have still called themselves conservative, Christian democrat, liberal or green but in effect they were just different shades of social democrat. A Christian Democrat was just a social democrat who went to church on Sundays; a Greens supporter was a social democrat who recycled their rubbish to perfection; and a Liberal was a social democrat who liked to talk about freedom when it suited them.

In Europe's political practice, conservatives and social democrats have become virtually indistinguishable. It probably takes a microscope and a PhD in political science to detect the great ideological differences between Tony Blair and David Cameron, or Gerhard Schroeder and Angela Merkel. In reality, there are no differences because they are all varying shades of social democrats.

There are at least two good reasons Europe's political systems have converged on the social democratic Centre. One is the fallout from the collapse of Soviet communism. The other is the practical constraint: the need to win elections.

When communism collapsed in eastern Europe and the Berlin Wall fell in 1989, many observers concluded that this marked the triumph of the Western model. Indeed it did. The state-run economies of the East could not keep pace with the mixed economies of the West.

But instead of celebrating the victories of the market economy over planning, Europe's more conservative parties were left strangely weakened by these events.

Perhaps they naively believed that history had indeed reached its end state, as Francis Fukuyama famously opined. The result was a certain smugness on the part of the political Right, who assumed that the big ideological confrontations were a thing of the past now that Western liberalism had won the battle of the ideology. This was naive because the demise of the Soviet Union in no way diminished the aspirations of the Western social democrats to reform society according to their values.

While the Left was thus busy entrenching the welfare state, the Right made the mistake of not realising that history had never stopped. The demise of the threat of communism made the liberals and conservatives forget what they stood for because they had lost the main threat they once were united against.

The second reason for the convergence of Europe's political system on the social-democratic centre was that it is here that elections are being lost and won in modern mass democracies. To win a majority of the voters, no politician can afford to move too far from this Centre. And when a large group of the population receives a large part of its income from or through the state, it is no surprise that the political system reinforces this dependence through elections. Consequently, dependence on the state tends to enlarge the state's activities through time.

Economists have long analysed this phenomenon. Anthony Downs explained it in great detail in his treatise An Economic Theory of Democracy, first published in 1957. He contended that in modern democracies, political parties tried to target the so-called "median voter". By moving closer to the political centre, left-wing parties could win over some right-leaning voters and vice versa. As a result, left and right parties became more like each other with each election because they were both after the support of the "median voter".

What sounds very game-theoretical has been Europe's practical experience. Blair's New Labour was an attempt to shift the old Labour Party to the Centre. In the same way, Cameron's repositioning of the Conservative Party only had one goal: to win back the voters in the Centre who had previously been lured over by Blair. No wonder die-hard traditionalists in both parties were equally irritated: old-school Labour supporters because Labour sounded too much like the Tories, and old-fashioned conservatives because Cameron styled himself as the "heir to Blair". But that was precisely the point of the exercise.

In mixed economies with their large welfare states, the drive to the Centre has made economic reforms all but impossible. Unless circumstances are as dire as after Britain's 1978-79 "Winter of Discontent" that brought Margaret Thatcher to power, elections can no longer be won by promising radical change.

Merkel had to learn this lesson the hard way. In the 2005 German general election, she ran on a ticket of fundamental free-market reforms. As opposition leader, she promised a complete overhaul of the health system and a fundamental simplification of the complex tax system. One of her key advisers even wondered publicly whether Germany should move towards flat taxes by abolishing the myriad tax breaks that Germans had become used to.

On election day, Merkel was punished for so much courage. In an election thought to be unlosable for the opposition, her party only narrowly won more votes than the social democrats, with whom she was forced to enter into a grand coalition. Merkel learned her lesson and has not talked about anything that remotely looks like an economic reform.

On the contrary, she now talks and acts like the social democrats she once liked to castigate. In her latest U-turn, she supports universal minimum wages (she calls them "lower-wage limits").

The quest for the often welfare-dependent median voter has turned all parties across Europe into social democratic parties.

Elections in the past have been thinly disguised bidding wars between political operators that turned around the question of who could promise more to the present generation at the expense of generations to come. The bills for politicians' profligacy were shifted into the distant future. Europe's politicians became masters in the art of fiscal illusion, always making the costs of their programs appear smaller than they really were.

It is fair to say that European politicians not only managed to fool voters about the true nature of their fiscally unsound policies, but for a long time their reckless policies also escaped the attention of capital markets. Perhaps that was because deficit spending in Europe had been practised for so long that it was regarded as a perfectly normal state of affairs. In any case, Europeans were convinced that state bankruptcies could happen only to hapless Latin Americans or unsophisticated Southeast Asians, not to them.

As Europe's debt crisis now reveals, that was an arrogant mistake. Like everybody else, Europeans cannot escape the consequences of their actions forever. The day of reckoning for Europe's previously celebrated social model has come.

This is a rude awakening from the social democratic dreams across Europe, not just in Greece, Spain or Italy. Germany, the self-righteous and self-proclaimed anchor of stability, has an official debt ratio of 81 per cent of GDP, which is still higher than Spain's. And British politicians, who gleefully look down on the troubled eurozone, can only hope that the debt vigilantes do not turn their attention to Britain's budget deficit, which is just as bad as Greece's.

Europe is a continent run by a deeply statist social democratic elite. For decades, they have become used to only enjoying the proceeds of growth. And when that growth was no longer sufficient, they were quick to prop it up by going deep into debt.

In recent months, capital markets have finally - and not a day too late - made it clear to politicians that this is an unsustainable business model for Europe. What must happen next is the painful task of reining in public expenditure, cutting back the state, and freeing the economy so it can recover.

All these tasks are anathema to social democrats. Little wonder that European politicians are going cap in hand to the Chinese rather than tackling their own home-made problems. But whether they like it or not, for lack of any political alternatives, it will be up to Europe's social democrats of all parties to clean up the mess they have created.

SOURCE

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The impending collapse of Italy

By economic historian Martin Hutchinson

In the past decade, Italy under Silvio Berlusconi has been considerably better managed than was Lehman Brothers. Berlusconi and in particular his finance minister Giulio Tremonti have an excellent grasp of Italy’s weaknesses, and have tried within the constraints of the Italian political system to bring the country’s bloated spending under control, improve its abysmal tax compliance and, as a corollary, reduce its excessive burden of taxes. In consequence, the Berlusconi governments have at least stabilized Italy’s grossly excessive public debt, which had risen disgracefully from 30% of GDP in 1970 to 120% in 1995, but has been flat since then in spite of Italy’s deteriorating demographic profile. They have also accomplished a considerable amount in pension reform, but have not adequately reformed Italy’s corrupt public sector, its over-burden of regulation or its opaque and sluggish corporations.

The main criticism of the Berlusconi governments, which should really be directed at the leftist governments that intermingled with them, is that they have not prevented a substantial deterioration in Italy’s relative productivity against its Eurozone neighbors, which has gradually made Italian exports uncompetitive and widened its balance of payments deficit to 3.7% of GDP.

Italy’s problem is now a political one. Under Berlusconi it was mostly competently run and could hold its own internationally if only through the force of Berlusconi’s personality. As the market figured out in its negative second-day movement after Berlusconi’s departure, it is most unlikely that any Berlusconi successor will be anything like as good. Even if some figure from Berlusconi’s own party, such as Angelino Alfano, were to succeed him, he would have far less authority over the fractious center-right coalition and far less ability to keep the necessary budget-cutting reforms moving forward. A “technocrat” successor such as the much loved (by the EU bureaucracy) Mario Monti would be much worse; he would secure a large handout from his friends at the EU or the IMF, and would then waste the proceeds in government aggrandisement, making an eventual Italian bankruptcy 12-18 months down the road all the more painful. Since the market would quickly spot the road down which a Monti government was heading, it would withdraw support for Italian bonds within weeks, well before that inevitable destination had been reached.

Of course, if Italy had kept Berlusconi there would have been a clear solution to its problems; departure from the euro. Unlike Greece, whose currency parity needs to drop to a third or less of its current euro parity to be viable, Italy becomes competitive with a devaluation of no more than 20% or so. With a Berlusconi to keep public spending under control, an Italy devalued 20% could even service its public debt, since its average maturity is relatively long and any cost increase resulting from re-liraization could be easily absorbed over time.

More HERE

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Italy defaults on debt and sends lenders broke? So be it

By Adam Creighton, writing from a country that entered the GFC debt-free -- Australia

“Contracting debt will almost infallibly be abused in every government. It would scarcely be more imprudent to give a prodigal son a credit in every banker’s shop in London …” -- David Hume, Of Public Credit (1742)

The interesting question to ask about the European debt crisis is not what sort of bailout package will work, or which Italian or Greek government should oversee it. Economic forces will overwhelm any political theatrics.

The relevant question is how European countries were able to borrow so much in the first place. How did Italy end up with debts of 120% of GDP, or €1.9 trillion? How could Greece, a long-standing economic basket case, borrow as much as 150% of its GDP?

The answer seems to demonstrate either the gross stupidity or masterful sophistication of financial markets.

These countries, especially Greece, should not have been attractive to lenders. Greece had defaulted routinely on its debts since the early 19th century, and its finances (even the faked ones) were demonstrably shambolic right up to the beginning of the financial crisis in 2008.

Italy, still a geographic expression [As Metternich said] as much as a functioning political entity, riddled with corruption, had an excessive debt to GDP ratio of about 110% in 2001.

That governments will want to borrow excessively and wastefully is not a new revelation. David Hume knew that. But how could financial markets, awash with highly paid “risk managers” and apparently staffed with the most talented employees, shovel so much money at these nations?

Both countries were able to borrow almost as cheaply as Germany, a country with more evident fiscal fortitude, throughout the 2000s.

Sure, the advent of the euro had bound European countries more closely together, but that didn’t mean individual countries could no longer default. Indeed, the European Central Bank, the European Union and European politicians were emphatic that no bailouts would ever occur under any circumstances. Edmund Stoiber, a prominent German politician, reckoned bailouts to be as likely as famine in Bavaria.

That many banks and fund managers now face substantial losses on their loans to recalcitrant European countries may demonstrate their foolishness.

Or perhaps their brilliant perspicacity? Year after year lenders made a little bit extra profit on their loans to Greece and Italy. As for the risk, they might have realised that whatever European leaders said, Western governments had become so large, social democracy so rampant, and banks so large and interconnected that it would be impossible for any democratically politician to permit lenders to lose substantial sums on their loans.

And that is exactly what has happened. Indeed, private lenders have transferred vast swathes of their dodgy, multibillion dollar loans to public European institutions such as the European Central Bank, while politicians and the International Monetary Fund fall over themselves to protect lenders from losing money. At the same time, those lenders continue to clock up massive profits and pay absurd salaries to many of their staff.

It is a master stroke for private lenders; never in my lifetime have ordinary taxpayers been bilked so comprehensively and unwittingly.

More HERE

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The Big Lie of the late 20th century was that Nazism was Rightist. It was in fact typical of the Leftism of its day. It was only to the Right of Stalin's Communism. The very word "Nazi" is a German abbreviation for "National Socialist" (Nationalsozialist) and the full name of Hitler's political party (translated) was "The National Socialist German Workers' Party" (In German: Nationalsozialistische Deutsche Arbeiterpartei)

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