A long-winded, angry, reply to Krugman

One feels a little naughty, perhaps even insolent when disagreeing with Paul Krugman. He did, after all, educate our economic thinking for the last fifteen years.

His NYT oped “What ails Europe?”, however, while a solid analysis as usual, leaves aside a part of the story that hasn’t been told. Krugman notes that there are several examples of countries with large welfare states that have not gotten themselves into trouble. He mentions Sweden, in fact, and he also comments that, of the GIPSI countries (formerly known as PIGS), only Italy is in the top five. Indeed, but then again Sweden is no Greece, and it is no Cyprus (if I should better use my own country as an example).

This argument is a bit like saying that having a high-fuel consumption car is not a very big problem. After all, a Volvo will get you places in exchange for the gas it guzzles. GIPSIs, however, are more like gas-guzzling Ladas: They guzzle, but they do little besides.

Large welfare states are not that big of an issue, as long as the state is efficient. And, while an American may be forgiven for keeping the discussion on state efficiency on a theoretical “markets-are-better-than-states” level, the experience in our GIPSIs is, in fact, rather painful. Romney’s unserious musings aside, welfare states are not in themselves a bad idea. But when social transfers are directed towards those who pay the highest political rents, rather than those who actually need these payments, then you don’t “buy” social cohesion with your spending; you buy deadweight losses. Big ones.

This is why the “German” discourse is also partly correct over this. Excessive deficits in a country that can attract investors like, say the UK or the US, is one thing. Excessive deficits in a Greece or an Italy, however, raises a justifiable question over debt service. And this is because of the «welfare state» -or a twisted version of it: The issue at hand here is that GIPSIs have used their welfare state as a guise for increased political rent seeking payments. Take potato growers in Cyprus.

Year after year, as long as anyone can remember, they get hit with frost and hail. Nobody wondered if their crop fits their weather; instead, they’ll run each year to the government for compensation because their families are starving. And successive governments cough up the money each season. This may be Cyprus, and the example is a relatively cheap one. But this is, I think, a good illustration of how messed up GIPSI sates are. This is on the verge of corruption.

When we, in these countries, go up in arms about our welfare state, it’s a completely different discourse from the American debate. We do believe in social pensions. We believe in more equitable distribution of wealth.

...NOT because of a strong euro...

And we believe in a safety net. But we are mad at our politicians who have mastered a way of logging in their rent-seeking spending as social policy: We have dozens of state monopolies, many of them are still alive on the sole argument that they don’t want to sack workers.We even give cost-of-living allowances to state workers in the top 10% of national income because this is their “hard-won workers’ right”. Now, the monetary story that Krugman tells does hold water, as always.

But, really, Greece was never strictly speaking competitive,, to begin with.  State spending, at around 40-46% in these countries, does not represent «welfare spending» but rent -seeking. This rent-seeking translates into the state vacuuming up liquidity from the market and driving borrowing costs up. In the meantime, contracts, resources and labor are driven to state-fed enterprises, twisting the market. More simply put, they are like a giant hammer over the «invisible hand», which, severely injured, can’t really work.

If there is a monetary policy story here, it’s not only currency overvaluation, but also the monetary side of crowding out.

And, on top of that, one has to take into account the soft budget constraints that ruin productivity in our countries: The welfare state is defined to mean that business failure on a scale beyond the minute, is forbidden. The state will step in, subsidize, bail out, pay compensations.

This is done on our taxes, and, ultimately, on our national debt. And, again, our countries, for many reasons, some of which are reasonable, are not so attractive for investors.

For “welfare reasons”, we pay state workers allowances for showing up to work, for being on time and for working 38 hours a week. We even pay student allowances, Easter allowances (!) and maternity allowances irrespectively of personal income levels. And, in or bloated civil service, we pay 14 salaries a year and allow retirement as young as 55 because “you shouldn’t work till you die”. And, on top of that, let’s not forget that investment, product improvement and higher productivity was also discouraged during the good times. On top of that, this skewed, twisted definition of the “welfare state” was used to mean that collective agreements rule the day. Never mind that they it’s done in the GIPSIs, has destroyed incentives for the good workers, while guaranteeing the income and promotion of the mediocre ones.

All these exploitations of the welfare state by rent-seeking politicians, have destroyed our productivity and our competitiveness. More so, I would argue, than euro appreciation has.

And, reading, Krugman’s article, I felt that this has to be said. Because –look at Greece- in the end, its decent, hard working, honest folk that pay.

Forgive me for being so long-winded. But there is anger here. Anger at our politicians, and anger at ourselves for putting up with this madness.

Even today (in fact, today more than ever) the welfare state is proving itself to be a superb mechanism for managing social cohesion, industrial peace and a society more just than the one I saw for seven years in the US. Romney’s argument is not very serious. But, then again, we are no Sweden.

And currency appreciation aside, we have bigger problems, ones that we imposed on ourselves by insisting on voting for these people, again and again. And, if the US has a lesson to draw from the GIPSIs (and I do include Cyprus and Malta in them), it’s this: Americans have already had their narrow escape. They’d be very lucky to make it twice. Vote for whomever you want. But think ahead first.