Monday, June 29, 2015

It's the Pensions, Stupid.

On July 5, writes John Fund, "the Greek people will be asked to make a choice: either 'surrender' and give in to cuts in pensions and higher taxes or refuse and perhaps be forced to exit the euro and go back to a depreciated drachma as their national currency."

The Greek people are of one mind on all this. About 80 percent of them want to stay in the Euro; and about 80 percent of them are opposed to "austerity" spending cuts and tax increases.

So the Greeks aren't much different from Americans. We Americans all demand our entitlements and benefits but we don't want to pay for them.

Here's Cliff Taylor in the Irish Times talking about the difference between the Irish "austerity" and the Greek "austerity." Both countries did a pretty good job of "in terms of cutting borrowing" but to reduce debt you need high growth.
The problem is that Greece never got momentum moving firmly in the right direction; it never got around the corner. As the crisis took hold, its debt level shot up, reaching more than 170 per cent of GDP. Reducing such a high debt level requires high growth (along with a bit of inflation) and a big surplus on the government’s annual budget, excluding debt costs.
This ought to be obvious. You can't have a flourishing, prosperous nation state unless you have economic growth.

Ireland, on the other hand, started the crisis with very low national debt, so it was able to get "around the corner" and resume growth in 2012.

Of course, you can't really have high growth if you are burdening your economy with e.g. Obamacare.

So let us try and understand the problem of the modern administrative welfare state.

The problem is really very simple. The whole idea is to tax the country up to the limit that is politically possible, and distribute the revenue in entitlements and subsidies. Usually, however, the government borrows a little to sweeten the pot a little. Since this works pretty well in normal times everybody is happy.

But the truth is that when you get into debt you are making a bet against the future that cannot go wrong. You must have the income to make your payments; otherwise you get into a world of hurt.

This is obvious in personal finances. People that mortgage themselves up to the hilt get wiped out if they lose a job.

The same thing applies to administrative welfare states. When there's a recession or a crash they must continue to pay their normal entitlements to pensioners plus their free health care and free education, but must also increase their welfare expenditures substantially to take care of all the people thrown out of work. All this on reduced revenues because of the recession. This wouldn't matter if, say, the government was collected and spending about 10% of GDP. But at 40% of GDP you can't really afford a recession, because you already are paying entitlements to tons of people to do nothing. Now you need to bail out the banks and also pay the unemployed.

The solution is pretty simple: privatize all pensions, privatize health care and education. No more "defined benefit" pensions. Then the state can weather a crash and a depression by borrowing. No problem.

But of course no modern state is going to do that because every state that ever was has maintained itself by paying pensions to its supporters.

Either way, for nations and for individuals, don't ever forget that when you contract a debt you are making a bet that you'll repay before the downside hits. Because the downside for a debtor means that you get wiped out.

The thing to watch in the Greek crisis is how the bank depositors get screwed. In Argentina in 2002 they wiped out the depositors, and in Cyprus they gave them a haircut. The buzz-word is "bail-in."

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