The wisdom of the governing elites

Greece And The Crisis Of The Governing Elite

By C. Kadlec

“Everyone wants to live at the expense of the state.  They forget that the state lives at the expense of everyone.” — Frederic Bastiat

Europe’s governing elite – and those who believe in the superiority of government in the management of the economy – is in crisis.   Their visions of a more just society and economic security are being shredded by the stark reality that the governments they run are running out of money.

The looming Greek default and the nascent financial crisis in Europe is a symptom of this crisis of the governing elite.  At risk is the background consensus that supported the expansion of government to the point that public spending now accounts for roughly half of all economic activity among the 17 nations in the eurozone.  A destruction of that consensus would imply a massive loss of power by the elites who for decades have declared that given the power, they could produce an economy with less risk and more fairness than free market capitalism.

The pending failure of the governing elites to deliver on their most basic promises is setting off alarm bells in Washington. Treasury Secretary Timothy Geithner, former Treasury Secretary Larry Summers, and World Bank President Robert Zoellick have admonished the Europeans to move forcefully to resolve the European debt crisis lest it threaten the already meager U.S. economic recovery.  Unsaid is the concern that Europe’s failure will tarnish America’s governing elite, providing additional energy to the Tea Party’s call for restoring limited, constitutional government in the U.S.

There is no one to blame for Europe’s debt crisis other than its political class. They are the ones who borrowed extravagantly with the pretense that good intentions trumped fiscal responsibility, who set the rules that require banks to hold zero capital against government debt, and who permitted the European Central Bank to buy billions of euros of that debt from banks.  That has endangering the euro itself, which has fallen 20% against gold since the beginning of the year, signaling that higher inflation and increased economic turmoil in the euro-zone may lie ahead.

In the absence of the next, 8 billion euro loan from its European partners and the IMF, the Greek government will soon simply run out of money to pay public sector wages and pensions. That reality last week triggered a run by dollar depositors on European banks with exposure to government debt prompting the U.S. Federal Reserve to make emergency loans to the European Central bank so it, in turn, could provide dollar liquidity to its member banks.

There appears to be no way out. The economic policies imposed on Greece by the governing elite have made things worse.  The combination of spending cuts and massive tax increases slammed the economy, which shrank 7% in 2010, and 5% in the year ending June 2011.  As a consequence, tax revenues last year fell by 2 billion euros, or 8.3%, instead of rising 3.3 billion euros to 27 billion euros. Social spending rose as unemployment jumped from around 9% to 16%, and the government’s debt became an even greater percentage of a now smaller GDP.

Italy, Portugal and Spain are headed down the same destructive path. Last week, Italy increased the value added tax a full percentage point to 21%. Portugal has increased its value added tax by 1 percentage point across all categories, while increasing the top marginal tax rate by 1.5% on top earners and by 2.5% on corporations. Spain just announced it would reinstate a wealth tax on approximately 160,000 taxpayers with more than 700,000 euros ($972,000) in declared assets in hopes of raising a little over a billion euros in revenue.

Awakened to Bastiat’s warning by these tax hikes, individuals are rioting in Athens and Rome, diving into the underground economy thereby starving the state of revenue, and rebelling at the polls.  All of this is especially galling to Germans, who can’t help but notice the fundamental unfairness of the welfare state writ large.  In reaction to German Chancellor Angela Merkel‘s support of the Greek bailouts, which effectively punish German taxpayers in favor of irresponsible governments in southern Europe, her party has been handed significant electoral defeats in 6 out of 7 state elections in the past year.

Finnish voters have prompted their government to require collateral in exchange for any additional loans to Greece, further complicating efforts to cobble together a package in time.

The governing class’s response is a call for yet more power through a centralized European government, or institutions that would be able to exert direct control over the budgets of the zone’s member states. Treasury Secretary Timothy Geithner’s advice is for the Europeans to borrow more money by permitting the existing European bailout fund to use leverage to increase its own lending capabilities.

Others call for Greece to withdraw from the euro so it can devalue its currency.  But a plummeting Greek currency would rapidly reduce the government’s revenue in terms of the euro, guaranteeing a massive default on its outstanding euro denominated debts.

All of these proposals are desperate measures designed to cover up the fundamental failure of the underlying political economic model, which assumes that those who govern can provide free goods and services to the population at large, lavish pensions for government employees, impose rigidities onto labor markets and otherwise achieve social goals through their management of the economy.  What we are now seeing is that good intentions are and never were sufficient.  That so-called “rights” to jobs, health care, housing and pensions require real resources that cannot be conjured out of nothing by a good speech or a government decree, but must be taken from those who produce in the private sector.

Yet, the taxes and other exactions used to take those resources have reduced economic activity and income so much that the private sector can no longer fund current government outlays.  Now that investors are less willing to lend money, a rapid, jarring adjustment in which expenditures are brought down into alignment with receipts seems unavoidable.

The promises broken during this adjustment will betray the fundamental belief by many in the wisdom of the governing elites and the benevolence of government. The result may be a new background consensus that recognizes the limits of what governments can do, and the cost of empowering them to do more.  Or, supported by mobs in the streets, the governing elite may declare a state of emergency and seize businesses and property, consuming capital in the name of the greater good.  Either way, the European experience is sure to influence the U.S. political debate swirling around 2012 presidential election.