Thursday, April 26, 2012

Euro-Crisis: Welfarism solution or problem.

To thrive, euro nations must cut welfare state
Apr 24, 2012
by Fredrik Erixon

Most criticism of government profligacy in Europe lately has focused on the obvious sinners, such as Greece. When it comes to overspending on social welfare though, Europe has no angels.

Even the "good" Scandinavians and governments that appeared to be in sound fiscal shape in 2008, but were then undone by unsustainable private-sector debts, were spending too much and will have to restructure.

The only question is whether this will be done gradually, or via shock therapy.

Take the four countries at the epicentre of the euro-area crisis: Greece, Ireland, Portugal and Spain. They are in many ways different but they have three important characteristics in common.

First, total debt in these countries expanded rapidly throughout the past decade - either because of increased government borrowing (Greece and Portugal) or through a rapid build-up of private debt (Ireland and Spain). Second, they all ran substantial current-account deficits in the years before the crisis. Third, government spending in those nations grew at remarkably high rates.

In Greece and Spain, nominal spending by the state increased 50 per cent to 55 per cent in the five years before the crisis started, according to my calculations based on government data. In Portugal, public expenditure rose 35 per cent; in Ireland, almost 75 per cent.


Clearly, the welfare-state expansion in Greece and Portugal was part of the reason these two countries ended up as clients of Europe's bailout mechanisms. But Ireland and Spain had problems with the rapid expansion of the state too.

A big part of rising affluence during the boom years was generated by escalating real-estate bubbles which caused private debt to soar. They boosted the construction sectors and, more generally, pushed domestic consumption to the point where Spain had to borrow as much as 8 per cent of gross domestic product (GDP) every year to finance its current account deficit.

Like other bubbles, they spearheaded economic growth, which allowed governments to expand the state rapidly.

That growth vanished and gold turned to sand. Simply put, the bubble-fuelled prosperity wasn't sustainable. A record of solid fiscal surpluses was quickly turned into high structural deficits. Spain, for instance, entered 2008 with a budget surplus of slightly more than 2 per cent and ended 2009 with a structural deficit of 9 per cent.


This has been a familiar story during the crisis. Yet surprisingly few people in Europe have bothered to understand the role that the welfare state played in creating it.

Take as an illustration the average Spanish pensioner. Until recently, he received a state pension that was more than 80 per cent of the average salary of current earners. So when the economy was growing strongly, salaries and, therefore, pensions did too. That might not be a problem if wages (and pensions) were to fall again when the economy shrank - but that doesn't usually happen.

Instead, the pension bill tends to remain at the same elevated levels even as economic growth and government revenue fall, creating an unaffordable ratchet effect.

Europe's crisis economies will now have to radically reduce their welfare states. State spending in Spain will have to shrink by at least a quarter; Greece should count itself lucky if the cut is less than a half of the pre-crisis expenditure level.


The worse news is that this is likely to be only the first round of welfare-state corrections. The next decade will usher Europe into the age of ageing, when inevitably the cost of pensions will rise and providing healthcare for the elderly will be an even bigger cost driver.

This demographic shift will be felt everywhere, including in the Nordic group of countries that has been saved from the worst effects of the sovereign-debt crisis.

Germany, for example, still has an underfunded pension system. One study has projected that on current population- and spending-growth trends, healthcare expenditure would account for 15 per cent of Germany's GDP by 2025 and almost 26 per cent by 2050.

Europe's social systems will look very different 20 years from now. They will still be around, but benefit programmes will be far less generous and a greater part of social security will be organised privately. Welfare services, like healthcare, will be exposed to competition and, to a much greater degree, paid for out of pocket or by private insurance.

The big divide in Europe won't be between North and South or left and right. It will be between countries that diligently manage the transition away from the universal welfare state that has come to define the European social model and countries that will be forced by events to change the hard way. BLOOMBERG

Fredrik Erixon is director of the European Centre for International Political Economy, a research group in Brussels.


Social model is Europe's solution, not its problem

Apr 24, 2012
by Paul Fourier

In the wake of the financial crisis, Europe's leaders are calling the continent's social model into question - it is "done", according to European Central Bank (ECB) President Mario Draghi. That's a travesty.

The crisis is, above all, financial. Yet governments aren't addressing the malfunctions that caused this problem. Instead, they are forcing ordinary people to pay and attacking the social systems that support them.

Take the example of Greece. The country is being pushed to accept an austerity plan of unprecedented severity, predicated on reducing public spending and slashing salaries, pensions and social systems in the most brutal way. This has forced the country into an economic, social and political crisis that will last for many years.

These policies are initiated not by Greeks but by European Union officials in Brussels, at the ECB in Frankfurt, or in London, where the British government continues to block proposed measures to fund a recovery, such as a Europe-wide tax on financial transactions.

These ideas are modelled on the austerity plans that were imposed on the countries of Latin America in the 1970s and '80s - and they are suicidal.


Labour unions in the European Trade Union Confederation take the opposite view of these choices. Union leaders believe austerity is pushing Europe - and many industrialised countries outside the region - into a recession, unemployment and poverty. Democracy, both political and social, has to be restored.

To start with, it is time to rethink the EU, which has become nothing more than a large market, without any consideration of social or fiscal harmonisation. The result has been to set Europe's citizens in competition with each other, as can be seen in the debate about how Germany has grown at the expense of its partners.

Wealth that is generated by the creation of a continent-wide market should benefit the citizens of the EU together. It should, above all, raise standards of living. But the effect has been the opposite.

As governments compete to attract companies by offering lower corporate tax rates and social contributions, the result has been to impoverish social systems and public finances and, therefore, workers and pensioners.


Priority has to be given to growth and employment, rather than pleasing the markets. We need new economic, social and monetary policies. We need to move towards a new distribution of wealth that favours income derived from labour over capital, wages and productive investments over financial investments and dividends.

Far from reducing the purchasing power of workers and retirees by undermining the pension and social-welfare systems, we need to boost these as a way of supporting internal growth that is much less dependent on external markets.

We need proactive employment policies that promote public-works projects and laws that discourage companies from cutting staff levels when profits are high.

All this is especially important for the young. Unemployment for the under-25s is now 23 per cent in France, more than 30 per cent in Greece and 50 per cent in Spain.

The argument so often put forward to justify reductions in labour costs - keeping companies competitive - doesn't stand up to scrutiny. What handicaps European businesses today is the lack of quality and innovation. To try to compete with Chinese businesses by lowering labour costs is a decoy. It does nothing but benefit short-term corporate profits, to the detriment of employees.

More of the wealth that companies produce should be used to increase salaries (with social-security payments), and to pay for training as well as research and development. Doing so would help companies to innovate and strengthen their position in the market.

Above all, we need to maintain employment in the public services, the quality of which benefits companies as well as individuals. Cutting public spending can only be done to the detriment of the very things that underpin the growth of large industrialised economies: Excellence in education, an effective health system and quality public services.


Social-protection systems based on solidarity between the generations, between men and women, rich and poor, have to endure in their current form. To attack them is to cast onto the mercy of the marketplace our ability to maintain our health, to safeguard our pensions and to raise our children in good conditions. Invariably, this produces two-speed protections and weakens the poorest.

Leaders on Europe's political right are refusing to question the economic model they have been supporting for decades. The financial crisis has shown that this model, based on deregulation, privatisation and reduction of the state's role, is exhausted, if not bankrupt.

Either by error or ideological stubbornness, Europe's current leaders are imposing the heaviest burden of reform on those who are least protected. If Europe's governments continue on this path, they risk tipping their countries into new crises and reinforcing the nationalism and xenophobia that's already becoming all too evident. BLOOMBERG

Paul Fourier is a member of the executive board of the Confederation Generale du Travail, one of France's largest labour-union groups.


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