Europe’s Long-Term Economic Woes—and America’s

Europe’s current economic crisis is being attributed to its having a common currency but no common fiscal authority. It’s as if the United States had no Treasury Department, and a state that had borrowed heavily from banks in other states got into serious financial trouble, like Greece. It could not reduce its debt burden by devaluing its currency (and thus repaying its debts to the banks in other states in cheaper dollars), which would have the further benefit of stimulating exports (by enabling the same amount of foreign currency to buy more U.S. products) and discouraging imports (because it would take more dollars to buy products denominated in a foreign currency). The state could not expect to receive any transfer payments from other states, and the federal government would not be authorized to transfer money to the state (remember that I’m assuming that the federal government has no Treasury Department). So the state probably would default on its bank debt (“restructure” the debt is the current euphemism), and this might bring down the banks that had made the loans that were now in default.

 

That is the current economic situation, with Greece taking the place of the defaulting state, and the European Union taking the place of the U.S. government, in my hypothetical example. And the situation will be resolved, one way or another. One way would be by a default, perhaps accompanied by a bailout of banks whose solvency is endangered by the default. Another way would be by Greece’s abandoning the euro in favor of its own currency, And a third way would be by fiscal measures (“austerity”) that would restore the government’s solvency.

 

The current European economic crisis is thus the product of an encounter between a defective institutional structure (a common currency but no common fiscal authority) and an overindebted member state of the supranational institution. These problems are solvable in a variety of ways, including by dropping the euro or creating an EU fiscal authority, comparable to our Treasury Department, as well as by a default or austerity measures. But the financial crisis is short term and tends to mask Europe’s longer-term economic problems, well discussed in a recent article in the New York Times: “Europeans Fear Crisis Threatens Liberal Benefits,” May 22, 2010, www.nytimes.com/2010/05/23/world/europe/23europe.html?pagewanted=1&hp.

 

The basic problem is often said to be the conjunction of an aging population, low birthrates, and extravagant social welfare benefits (mainly pensions, early retirement, and publicly subsidized health care). For example, these benefits consume 31 percent of the Gross Domestic Product of France—twice as much as such benefits consume of the U.S. GDP (these are 2005 figures). But I think we need to dig deeper for a satisfactory explanation.

 

It is true that improvements in health care (including nonmedical preventive measures such as diet and exercise) are increasing longevity, but they are also increasing (along with the decline in manual labor as a percentage of all work) the age at which people are no longer healthy or fit enough to work. And it is true that birthrates are very low in most of Europe, which increases the percentage of old people, but that of course is not because of some biological impairment of European fertility. Nor would low birthrates matter much if Europe were more welcoming than it is to immigration, because immigrants tend to be young.

 

The major cause of Europe’s long-run economic problems is political, though the political is in turn shaped by cultural factors, including historical memory; maybe the best way to describe the major cause of the problems is Europe’s “political culture.” Government has greater prestige in Europe than in the United States and (a related point) socialism retains substantial support in Europe; individualism, with related notions such as self-reliance, freedom to fail, entrepreneurship, the “self-made” man, and the Horatio Alger story do not grip the public imagination of many Europeans. Government in Europe employs a higher percentage of the working population and engages in more redistribution of income, resulting in high taxes to fund retirement at earlier ages than in the United States, generous pensions and family leave, unemployment benefits generous enough to discourage work, and medical care. Lavish redistribution of wealth in turn entails barriers to immigration, lest the social safety net become an immigration magnet. Unions are strong in Europe, and they push up wages and (worse) encourage featherbedding, short hours, and other inefficient practices. Unions of government workers are especially pernicious, as they reinforce the natural tendency of government to overpay its employees because they are voters as well as employees. A third of the Greek work force is government-employed, for example, and much of it appears to be both overpaid and underworked relative to employees in the private sector.

 

Because socialist policies reduce economic efficiency, European countries (with some exceptions, notably Germany) have difficulty competing in foreign markets with China, Indian, Brazil, and other rapidly growing economies, and so have difficulty maintaining a positive trade balance. And because tax rates in Europe are already very high, government deficits cannot easily be reduced by raising taxes. The aging of the population increases the demand for public spending, and the demand can be met only by increased borrowing, which is also necessary to close the gap between exports and imports.

 

European economic stagnation and public overindebtedness is in short mainly a political problem, resulting from a swollen and still rapidly expanding demand for government services. It is a political problem rooted in cultural factors summed up in the word “statism,” in contrast to American individualism, as designations of dominant political ideologies. This is an oversimplification but seems to me to get at the heart of the difference between European economies and the U.S. economy.

 

Many of the same economic pathologies that plague Europe plague us, but less seriously. We have an aging population, though it is due mainly to increasing longevity rather than to a low birthrate, for our birthrate is close to the replacement level and immigration brings us over the replacement level; there has been an ominous increase of late in hostility to immigration but this may be a byproduct of the economic crisis and so may pass when the crisis passes. Many of our public employees are overpaid and underworked, but only 8 percent of our labor force is employed by government (federal, state, and local), and this includes our military personnel (almost 1 percent of the labor force), who do not appear to be either overpaid or underworked. We have an alarming public debt, swollen by unfunded spending programs in both the Bush and Obama Administrations (the new health care reform is, realistically understood, unfunded) and by the decline in tax revenues as a result of the economic downturn. But as long as the U.S. dollar remains the dominant international reserve currency (which means that it is used in many transactions in which there is no U.S. party), the demand by foreign central banks for the dollar will remain very high and the resulting volume of U.S. money held abroad will enable us to continue borrowing abroad at low or at least moderate interest rates.

 

But if we continue running huge deficits, continue being unable politically either to cut spending significantly or raise taxes significantly, continue adding huge new spending progams, continue increasing the ratio of elderly to young, continue raising the minimum wage and promoting unionism, turn protectionist, resist immigration, and become even more deeply involved in military operations, we too may eventually go the way of Europe, even the way of Greece. Nowhere is it written that the United States can never decline.

Comments

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That is the current economic situation, with Greece taking the place of the defaulting state, and the European Union taking the place of the U.S. government, in my hypothetical example. And the situation will be resolved, one way or another. One way would be by a default, perhaps accompanied by a bailout of banks whose solvency is endangered by the default. Another way would be by Greece’s abandoning the euro in favor of its own currency, And a third way would be by fiscal measures (“austerity”) that would restore the government’s solvency.

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