Attacks on the welfare state are misguided and will only worsen things

It seems that the fiscal austerity agenda is morphing into what is probably the real underlying strategy – to demolish or seriously compromise government welfare spending and income security provisions where it benefits individuals. In a Bloomberg Op Ed today (April , 2012) – To Thrive, Euro Countries Must Cut Welfare State – we learn that Europe is “overspending on social welfare” and that benefit programs have to far less generous into the future. This resonates with the foolish intervention overnight from the Australian conservative Treasury spokesperson (one Joe Hockey) who claimed that when they regain power next year (which they will given how hopeless the Labor government has been) they will dismantle our income support system to save the government from running out of money. On the one hand, the level of ignorance about macroeconomic matters displayed by these commentators is stunning. On the other hand, one could easily assume they know exactly what the story is but are choosing to mislead their audiences because if they disclosed their true agenda they might not get the same support. Either way, the attack on the welfare state is misguided and will only worsen the long-run prospects of us all.

The Bloomberg Op Ed was written by one Fredrik Erixon from the European Centre for International Political Economy, which claims it is an “independent and non-profit policy research think tank dedicated to trade policy and other international economic policy issues of importance to Europe”.

Further investigation reveals that it gets is “its base-funding from the Free Enterprise Foundation in Sweden and welcomes financial support from individuals, foundations and other organisations sharing our ideas in favour of an open world economic order based on voluntary exchange and free trade”.

In other words, it is not an “independent” research organisation but a front for free trade and anti-state viewpoints.

The Opposition treasury spokesperson, Joe Hockey is prone to making ridiculous statements which we typically ignore but this time he was embarrassing our nation in London. He gave a speech to some conservative policymakers in Britain’s chancellor of the exchequer George Osborne – The End of the Age of Entitlement. There is no transcript of the Speech available but he gave a lengthy interview to the ABC Lateline program last night – We have bred entitlement: Hockey.

The claims by both Erixon and Hockey reflect a stunning ignorance of macroeconomics and the choices available to government and the sources of macroeconomic problems under different monetary systems.

Hockey was talking about Australia where the government issues our own currency and floats it freely on international markets. In other words, it has full control over its fiscal and monetary policy as a fully sovereign government and despite all the institutional machinery it has erected to cover its deficits $-for-$ with debt-issuance into the private bond market it is never intrinsically revenue constrained.

EMU member states are clearly revenue-constrained in their spending given that they surrendered their currency sovereignty and chose to work with a foreign currency. So their ability to even meet the fluctuations in non-government spending that occur (the current crisis being an extreme example) and maintain stable economic growth is highly constrained.

However, the solution for them is not to start hacking into the standard of living of their societies because they operate within a deeply flawed monetary system that almost ensure austerity has to be the norm. Rather, they should dismantle their monetary system and restore currency sovereignty.

Then they will line up with Australia and other sovereign nations and face the real problem of welfare provision and income support – inequality and productivity.

Neither of these issues are broached by our would-be “welfare cutting” commentators (Erixon and Hockey).

Hockey was asked in his extended Lateline interview last night: “What do you mean exactly when you say the age of entitlement is over”. He replied:

Well, with an ageing population and an entitlement system that has seen extraordinary largesse built up over the last 50 years, Western communities, Western societies are going to have to make some very hard and unpopular decisions to wind back the involvement of the state in people’s lives.

Now, when you look at Europe in particular and France in particular, nearly 30 per cent of GDP is going towards public welfare and health care and pension costs.

That compares with other countries in Europe which are between 20 and 30 per cent. Australia is at 16 per cent, Korea at about 10 per cent. So, obviously the age of entitlement is coming to an end because governments are running out of money and the debt is now crippling governments.

At that point you realise several things but the most important is that Hockey doesn’t understand any macroeconomics. He is the shadow treasury spokesperson and was a lawyer before entering parliament.

First, as noted above we cannot compare the EMU nations with Australia (or the US or any fiat-issuing state).

Second, the Australian government can never run out of money (where money is defined in this context as the capacity to buy goods and services offered for sale in Australian dollars. It is impossible for the Australian government to run out of that capacity given that it issues the currency.

It might choose to erect all sorts of stupid hurdles that force it to borrow before it spends and the such. But intrinsically it cannot run out of money if it chooses to use its sovereign currency-issuing capacity.

Third, the only nations that are being “crippled” by their debt holdings are those that have no currency sovereignty. And it is not the debt that is doing the damage but the need to fund on-going spending at a time that tax revenue growth is so weak given the collapse in real economic growth. That is the problem.

Even in those nations, the ECB (which is, in effect, the currency sovereign) could easily end the “financial” crisis by ensuring it funds all deficits. Then the member states could focus on growth and re-build their tax revenue.

Hockey was then asked (in the Australian context) – “which entitlements would you like to see reduced or gotten rid of?”. He replied (evading the question):

… we need to be ever-vigilant. We need to compare ourselves with our Asian neighbours where the entitlements programs of the state are far less than they are in Australia …

Western nations are in financial trouble and they’re in financial trouble because like a bad parent, over the years they have always said to voters, “You can have what you want,” and sooner or later it comes to an end when the burden of debt starts to cripple their economies.

The interviewer should have asked him to specify which Western nations were “in financial trouble”. That would have allowed him to probe Hockey’s understanding (or lack of it) of the way the design of the monetary system limits or otherwise the capacity of the government to conduct its fiscal affairs.

He could then have asked Hockey to explain exactly how a sovereign issuing government such as Australia is like a currency-using household (the “bad parent”) – the former always having the capacity to spend irrespective while the latter always is revenue-constrained and has to fund their spending.

He could then have pushed Hockey to identify the different sustainability paths for public deficits and private deficits. The former is always sustainable as long as the nominal spending growth is able to be absorbed by the real capacity of the economy to produce. The latter is prone to unsustainability and the recent crisis has demonstrated that.

He could have then quizzed Hockey about the crisis and its causes – too much private debt following the greedy and criminal behaviour of the financial sector.

But he didn’t.

Hockey then avoided detailing which “welfare” programs he would cut or eliminate – “I’m not going to get into cherry-picking Australian initiatives from London”

He was then asked whether “an entitlement” generalised to the massive corporate welfare that the Australian government provides business (diesel and fuel rebates; and a raft of other welfare payments not to mention the bank guarantees). Hockey, predictability ran a mile:

Well they need to be looked at on a case-by-case basis, but the two that I think you’ve identified relate to business and business investment. The great criticism of Spain at the moment is that the fiscal consolidation program in Spain involves reducing any incentive and support for business and not taking a hard look at the welfare entitlements of the people. And this is the very interesting paradox at the moment.

The United States is focusing everything on stirring up its private sector economy to get growth back and it’s giving way on fiscal policy, it’s letting fiscal policy run. But in Europe, it’s the opposite. They’re focusing on fiscal policy and they’re totally ignoring attempts to try and shore up the private sector.

So one of them’s got to be wrong over the next few years and it’s going to have a profound impact.

So corporate welfare is fine for the conservatives as you would expect. The bank bailouts, the handouts to the top-end-of-town were fine and none of the deficit terrorists said much about them. But as soon as the government offers a pittance to the workforce – perhaps via unemployment support – there is a scream that the government will run out of money.

The hypocrisy is staggering.

Further, I wonder whether Hockey has really studied the public finance data before he made his comparison between the US and Europe. The former is trying to impose fiscal austerity onto its economy but its dysfunctional Congress is militating against their own desires – which makes the US a lucky country (that is, its politicians are too incompetent to actually get what they want) and that is the reason the US is still growing.

In Europe, growth has stalled and is now contracting exactly because the EU elites are focusing on fiscal austerity rather than growth. You cannot get growth by undermining spending. By not supporting aggregate demand the member states are ensuring that the recovery in private sector sentiment will be a drawn out process.

The rest of the interview was appalling. I do not have time today to fully consider Erixon’s Op Ed. It was equally flawed.

The entire premise that a currency-issuing government can run out of money is flawed. The claim that governments have to cut income support entitlements and run budget surpluses, which are construed as being equivalent to accumulation funds that a private citizen might enjoy is flawed.

The flawed chain of logic begins with the erroneous claim that if accumulated surpluses are allegedly “stored away” then this will help government deal with increased public expenditure demands that may accompany an ageing population with growing income support needs.

There will never be a squeeze on “taxpayers’ funds” because the taxpayers do not fund “anything”. The concept of the taxpayer funding government spending is misleading. Taxes are paid by debiting accounts of the member commercial banks accounts whereas spending occurs by crediting the same. The notion that “debited funds” have some further use is not applicable.

When taxes are levied the revenue does not go anywhere. The flow of funds is accounted for, but accounting for a surplus that is merely a discretionary net contraction of private liquidity by government does not change the capacity of government to inject future liquidity at any time it chooses.

The standard government intertemporal budget constraint analysis that deficits lead to future tax burdens is ridiculous. The idea that unless policies are adjusted now (that is, governments start running surpluses and cutting welfare entitlements), the current generation of taxpayers will impose a higher tax burden on the next generation is deeply flawed.

The government budget constraint is not a “bridge” that spans the generations in some restrictive manner. Each generation is free to select the tax burden it endures. Taxing and spending transfer real resources from the private to the public domain. Each generation is free to select how much they want to transfer via political decisions mediated through political processes.

Each generation is free to choose how much income support they offer their disadvantaged citizens.

When modern monetary theorists argue that there is no financial constraint on federal government spending they are not, as if often erroneously claimed, saying that government should therefore not be concerned with the size of its deficit.

Modern Monetary Theory (MMT) does not advocate unlimited deficits. Rather, the size of the deficit (surplus) will be market determined by the desired net saving of the non-government sector.

If the goals of the economy are full employment with price level stability then the task is to make sure that government spending is exactly at the level that is neither inflationary or deflationary.

This insight puts the idea of sustainability of government finances into a different light. The emphasis on forward planning that has been at the heart of the ageing population debate is sound. We do need to meet the real challenges that will be posed by these demographic shifts.

But if governments continue to try to run budget surpluses to reduce public debt then that strategy will ensure that further deterioration in non-government savings will occur until aggregate demand decreases sufficiently to slow the economy down and raise the output gap.

The real issue about welfare entitlements is ignored by the conservatives who construct the problem in terms of the financial capacity of the government.

Not once is this question asked: Will there be enough real goods and services available for sale to absorb the spending demands of the populations in the future. se projected expenditures?

If the answer is yes then there is no policy problem – the national government will be able to afford the projected demands on its spending and the income support provided (in $A) will be commensurate with growing real living standards.

In other words, under this scenario, the distribution of real goods and services between welfare provision and the rest will be determined politically,

The rising dependency ratios do matter but it is future productivity and inequality that matter. The conservatives think the dependency ratio is important because it will push governments into insolvency. The logic used is typically based on false notions of the government budget constraint.

So a rising dependency ratio suggests that there will be a reduced tax base and hence an increasing fiscal crisis given that public spending is alleged to rise as the ratio rises as well.

So if the ratio of economically inactive rises compared to economically active, then the economically active will have to pay much higher taxes to support the increased spending. So an increasing dependency ratio is meant to blow the deficit out and lead to escalating debt.

These myths have also encouraged the rise of the financial planning industry and private superannuation funds which blew up during the recent crisis losing millions for older workers and retirees.

The conservative policy recommendations are that people have to work longer despite this being very biased against the lower-skilled workers who physically are unable to work hard into later life. Additionally, welfare entitlements have to be withdrawn.

We can reject this logic out of hand (except in the EMU) for the reasons noted above.

A rising “effective dependency ratio” (that is, the ratio of economically active workers to inactive persons, where activity is defined in relation to paid work) matters because it tells us how many workers are producing real goods and services relative to the non-productive workers who also consume the output.

A properly calculated dependency ratio recognises that not everyone of working age (15-64 or whatever) are actually producing. There are many people in this age group who are also “dependent”. For example, full-time students, house parents, sick or disabled, the hidden unemployed, early retirees, and the unemployed and underemployed. The latter two groups are typically excluded from mainstream dependency ratio calculations.

By imposing fiscal austerity onto economies, the neo-liberals push the dependency ratio up well beyond what the underlying population demographics might produce. In other words, the neo-liberals actually undermine the future by damaging the present.

The conservative remedies miss the point overall. It is not a financial crisis that beckons but a real one. Are we really saying that there will not be enough real resources available to provide aged-care at an increasing level? That is never the statement made. The worry is always that public outlays will rise because more real resources will be required “in the public sector” than previously.

But as long as these real resources are available there will be no problem. In this context, the type of policy strategy that is being driven by these myths will probably undermine the future productivity and provision of real goods and services in the future.

It is clear that the goal should be to maintain efficient and effective medical care systems, sophisticated income support schemes and efficient public service delivery generally.

With less producers and more consumers the problem becomes a productivity one. Productivity growth comes from a number of interconnected factors.

First-class public education and health systems to support human capital development; strong funding for research and development; and high levels of activity (utilising all potential labour).

The neo-liberal solution for the future – fiscal austerity – which attempts to tackle the problems of the future by cutting spending now – will actually undermine the achievement of a high productivity future.

Maximising employment and output in each period is a necessary condition for long-term growth. The mainstream fiscal austerity approach is full of contradictions.

On the one hand, the the emphasis in mainstream is that to lift labour force participation we have to better utilise older workers (which is sound logic) but then they exhort governments to impose damaging fiscal austerity which reduces job opportunities for older workers and forces them onto the unemployment scrap heap.

Worse still is their treatment of the future workforce. With teenage unemployment rates up around 50 per cent in some nations and approaching that in other nations – the consequence of a deliberate act by governments to impose fiscal austerity – the policy choices are dramatically undermining the capacity of the economies to achieve high productivity in the future when it will be needed.

Anything that has a positive impact on the dependency ratio is desirable and the best thing for that is ensuring that there is a job available for all those who desire to work.

Further encouraging increased casualisation and allowing underemployment to rise is not a sensible strategy for the future. The incentive to invest in one’s human capital is reduced if people expect to have part-time work opportunities increasingly made available to them.

For sovereign currency-issuing nations these issues are about political choices rather than government finances. The ability of government to provide necessary goods and services to the non-government sector, in particular, those goods that the private sector may under-provide is independent of government finance.

Any attempt to link the two via fiscal policy “discipline:, will not increase per capita GDP growth in the longer term. The reality is that fiscal drag that accompanies such “discipline” reduces growth in aggregate demand and private disposable incomes, which can be measured by the foregone output that results.

For EMU nations and other nations that surrender their currency-issuing sovereignty, the problem lies in that surrender. The solution lies in restoring currency sovereignty.

Clearly budget surpluses help control inflation because they act as a deflationary force relying on sustained excess capacity and unemployment to keep prices under control. This type of fiscal “discipline” is also claimed to increase national savings but this equals reduced non-government savings, which arguably is the relevant measure to focus upon.

There are those that will argue that if welfare entitlements continue to rise in nominal terms then even if the government is not financially constrained, the impact will be that nominal spending will outstrip the real capacity of the economy to absorb it and inflation will result. In other words, governments will have to cut public and/or private nominal spending to arrest the inflation.

There is truth in that claim. Clearly, nominal spending growth should keep pace with the real productive capacity of the economy. Choices have to be made between competing claimants on the real output when it comes to policy decisions.

For example, the politics of the day might deem it preferable to maintain generous (whatever that means) welfare entitlements and cut military spending, to keep nominal spending growth and real capacity in balance. There is no necessity to cut income support therefore.

This introduces another related but separate consideration.

The other consideration aside from productivity is inequality. The welfare cutting lobby all operate as if the distribution of national income (between broad classes) and the personal income distribution (among individual units) are appropriate.

There was an interesting article (pre-crisis) written by Financial Times economist Martin Wolf (February 13, 2007) – Why America will need some elements of a welfare state – where he discussed a speech by the US Federal Reserve Chairman Ben Bernanke (February 6, 2007) – The Level and Distribution of Economic Well-Being.

Remember this was all pre-crisis discussion.

Martin Wolf was investigating the “rising inequality in high-income countries” and implicated “globalisation” (openness of trade) as a factor.

In the Bernanke speech we learned of three principles that should govern policy:

That economic opportunity should be as widely distributed and as equal as possible; that economic outcomes need not be equal but should be linked to the contributions each person makes to the economy; and that people should receive some insurance against the most adverse economic outcomes, especially those arising from events largely outside the person’s control.

So full employment; real wages rising in proportion with productivity and income support schemes to ensure that others are not left behind. Most income support recipients are receiving support as a result of “events largely outside … [their] … control” (for example, old age; unemployment, disability etc).

The neo-liberal era has been characterised by a deliberate violation of these principles and the situation is now worsening with fiscal austerity.

Full employment was largely abandoned; real wages growth has been suppressed and is well below productivity growth and income support provisions are under attack everywhere.

The result has been that there have been rather dramatic increases in wealth and income inequality over the last thirty years in most advanced nations.

Martin Wolf wrote:

Recent analyses suggest particularly large gains at the top of the income distribution. Also noteworthy has been the jump in the share of profits in gross domestic product since the 1980s …

He then asked what could be done about this and notes that:

… rising inequality causes declining equality of opportunity; and, second, it also makes losing a job costlier, more objectionable and so more resisted.

He also cites evidence that shows that “inter-generational mobility is smaller in the US and in the UK than in the Nordic countries and even Germany” because “the relative poverty of the parents is visited upon the educational achievements of their children” and so “rising inequality directly undermines the achievement of Mr Bernanke’s first principle”.

He says that governments should “create a system of support that does not destroy incentives” and that would require “at least two elements: greater funding of education for the disadvantaged … and universal health insurance. The left will also want higher minimum wages and generous subsidisation of low earnings”.

He concludes that “without more generous government-financed services, the US may be unable to maintain a dynamic, internationally open and socially mobile society”.

The same applies in Australia. Welfare cutting undermines mobility and potential. Survey evidence suggests the overwhelming majority of income support recipients desire to work (if they can). The best way to cut the welfare budget is to promote full employment.

Unfortunately, the conservatives want to undermine full employment by false claims about fiscal solvency and then attack the income support provided to the unemployment pool, that the austerity approach creates.

In the European context, they want to hang onto a monetary system that logically forces them to act in this way (as long as the ECB stays on the sidelines).

The general point, relating inequality back to the previous discussion, is that if the nation is hitting an inflation barrier then there is scope to redistribute spending capacity by selectively cutting back. While low-income earners and income support recipients have higher propensities to consume relative to those at the top end of the income distribution, the absolute spending capacity is what matters.

So instead of attacking welfare support, more progressive taxation policies could be used in this context. But that isn’t remotely what the conservatives are thinking about.

I was also doing some analysis today linking productivity growth to the level of income support provided (welfare provision). The preliminary findings (more in another blog) is that there is no consistent relationship. Some nations that provide extensive welfare safety nets also have very high productivity growth whereas other nations have less favourable productivity growth with the same welfare provision. The same can be said for those who provide less coherent welfare nets.

The conclusion is that high welfare support does not undermine productivity growth as a matter of course.

Conclusion

The idea that it is necessary for a sovereign government to stockpile financial resources to ensure it can provide services required for an ageing population in the years to come has no application. It is not only invalid to construct the problem as one being the subject of a financial constraint but even if such a stockpile was successfully stored away in a vault somewhere there would be still no guarantee that there would be available real resources in the future.

The claims that welfare entitlements will be unsustainable because governments will run out of money are equally flawed.

The best thing governments can do at any point in time is to ensure that incomes are maximised in the economy and a necessary condition for that is the achievement of full employment. This requires a vastly different approach to fiscal and monetary policy than is currently being practiced and proposed by the conservatives.

If there are sufficient real resources available in the future then their distribution between competing needs (income claimants) will become a political decision which economists have little to add.

Long-run productivity growth that is also environmentally sustainable will be the single most important determinant of sustaining real goods and services for the population in the future.

Principal determinants of long-term growth include the quality and quantity of capital (which increases productivity and allows for higher incomes to be paid) that workers operate with. Strong investment underpins capital formation and depends on the amount of real GDP that is privately saved and ploughed back into infrastructure and capital equipment.

Public investment is very significant in establishing complementary infrastructure upon which private investment can deliver returns. A policy environment that stimulates high levels of real capital formation in both the public and private sectors will engender strong economic growth.

Reducing inequality also can play an important role in keeping the claims on real resources commensurate with their availability.

That is enough for today!