The Collapse of the Entitlement State

The huge amounts of public spending that the entitlement spree entails are in turn at the root of the sovereign-debt crisis

By Fabio Rafael Fiallo

The redistributive reforms (or follies) of the 20th century were largely inspired by two leading economic thinkers: Karl Marx and John Maynard Keynes. Notwithstanding their ideological differences, they had one point in common: for both of them, income equalization serves to promote economic growth.

For Marx and his progeny, class struggle would lead to the demise of capitalism and to its replacement by a superior, egalitarian system (socialism) that would usher the human kind into a world characterized by the abundance of goods and services to be distributed according to each one's needs.

A similar correspondence between income equalization and economic efficiency formed part of Keynes' ideological paraphernalia. To combat recession, he argued, income should be redistributed among the poor - through hiring workers for public works. The rationale: the wealthy save more than the low-income classes, whereas what is needed at times of recession, Keynes added, is to reactivate aggregate demand (hence consumption) so as to induce firms to increase output and enlarge payroll.

The 20th century showed the limits, or rather, the failure, of both policy visions. Contrary to Marx's anticipation, the construction of the communist paradise turned out to be an economic fiasco and a political nightmare. Keynes' policy prescriptions, for their part, led to the "stagflation" debacle that nearly paralyzed the world economy in the 1970s.

In spite of such failures, the belief that income equalization enhances economic growth continues to pervade conventional wisdom. That belief lies behind the entitlement spree that advocates soaking the rich through taxation so as to give the State the means of promoting growth by reducing inequalities among social groups, regions and countries.

The idea has given birth to the welfare state, with its cohort of bloated bureaucracies and inefficient unemployment benefits, pay-as-you-go pension schemes and education and health services. The idea has, too, brought about a variety of aid programs involving the transfer of wealth from richer to poorer regions within a country as well as between countries.

The entitlement extravaganza is not alien to the cascade of crises that have shaken the world economy during the past few years.

It was indeed the entitlement mania that created the conditions for the subprime crisis of 2007. The origin of that crisis can be traced back to Jimmy Carter's Community Reinvestment Act (CRA), which, in order to facilitate access to housing, compelled banks to provide unwise lending to subprime clients. Alan Greenspan's low-interest-rate policy did the rest to engender the housing bubble that culminated in the 2007 crisis.

The huge amounts of public spending that the entitlement spree entails are in turn at the root of the sovereign-debt crisis that is crippling the financial health of countries of southern Europe.

Furthermore, to finance entitlements, taxes on firms operating in countries with a prodigal welfare state have been on the rise. The international competitiveness of affected firms is hampered accordingly. Hence the hollowing-out of industries, to the benefit of countries offering lower labor costs.

The income-equalizing splurge has bred secessionist forces in more than one European nation. The wealthy regions of the Netherlands, Italy and Spain, to mention just a few cases, are increasingly reluctant to cede, through taxes, the fruit of their efforts to profligate central-government bureaucracies or to poorer regions that do not stand out for their efficiency in managing the resources transferred to them.

In the same vein, the German population (which agreed to make considerable sacrifices with a view to recapturing international competitiveness) is calling into question the usefulness of providing financial rescue to countries where indispensable, supply-side policy reforms encounter the opposition of well-entrenched vested interests and, in some cases, where government institutions prove to be unable to effectively deal with graft.

The inefficiencies involved in inter-country transfers of funds have been present, too, in the so-called "development aid." Studies carried out separately by William Easterly and Dambisa Moyo neatly demonstrate that, rather than becoming an engine of growth, development aid has served to feed corruption, fund bloated bureaucracies and maintain uncompetitive industries in the Third World.

All these anomalies, disparate as they prima facie seem to be, stem from one single source: the profligacy, waste and misallocation of resources that the egalitarian, entitlement fever in its different forms brings about.

No one with an ounce of humaneness could possibly preach maintaining, or worse, exacerbating, social and regional inequalities. But when a model exhibits so many dysfunctions - as is the case of today's entitlements system - it is legitimate to call into question the validity thereof.

The time has come to dislodge the infatuation with entitlements from the center of economic policy-making and put in its place the pursuit of efficiency and economic growth through supply-side incentives and rewards.