Paul Krugman is at it again, defending the welfare state that is. In his recent column, titled “Legends of the Fail”, he claims that the welfare state is not the source of the crisis in Europe but rather countries with a large welfare state are doing better in the crisis.
Paul Krugman in his piece asserts that 1) The eurozone is going to fail, 2) the eurozone has raised interest rates on government bonds for participating countries and 3) the welfare state didn’t cause the crisis and cutting it won’t be a part of the solution.
Both the first claims are correct. It’s the third one I have an issue with. In this column, Krugman through his third claim displays a level of dishonesty unworthy of anyone who calls himself an economist. Basically what he is arguing is that many countries have bigger welfare states than Greece, and they’re not anywhere close to bankruptcy.
He brings up Sweden specifically as an example of a welfare state that is doing just fine. What he ignores of course is that Sweden through the financial crisis has done the exact opposite of what Krugman has recommended: We’ve slashed the welfare state, cut taxes and privatized government-owned companies. Our government debt is lower today than it was in 2006 – Krugman recommends that you should increase debt during recessions. Krugman’s own economic theories suggests that Sweden should be on the brink of depression, not Greece. Krugman isn’t just standing there with egg on his face; he’s got an entire poultry farm between his ears!
Next, Krugman brings up Ireland. I’ve been very bearish on the Irish economy, but even here Krugman gets it wrong. He correctly asserts that Ireland has went through with drastic austerity measures and yet its bond yield is higher than that of Italy (the latest basketcase in Europe). Ireland is paying an astounishing 8 % on its bonds (annually, on a ten-year bond), while Italy (which has done basically nothing to cut its deficit) is paying around 7 %.
What Krugman ignores is that before Ireland committed itself to serious austerity measures, bond yields were at 13 %! This was just a couple of months ago. Yields have collapsed due to the improving fiscal situation here in Ireland. While yields have dropped almost 40 % here, in Italy the picture is reversed. Yields have spiked as investors have realized no-one in Italy is serious about balancing the budget, while Ireland is on its way to be forgiven for its mistakes as Irish politicians show genuine regret and are doing their best to make things good again. I’m afraid it won’t be enough, but what is clear is that austerity is indeed working in Ireland.
Krugman does make a valid point; not having access to monetary policy leads to higher interest rates. Yet, the example he brings up (Japan) is not a very good one because one of the main reasons Japan is paying such a low yield on its debt is the fact that it survived a 10-year recession. If you can survive that without defaulting, investors figure, you can survive anything. However, because Japan does have a huge mountain of debt, they are very sensitive to a run on their bonds which could occur on any reason. Even a small, let’s say 0.5 % increase of the yield would be disastrous for Japan’s payback ability because the debt is so large compared to the tax revenue. If a 0.5 % increase were to happen, more investors may run from Japanese bonds, suddenly demanding much higher yields because they no longer think Japan is immune to default. Will that happen? I don’t know. Yet, the point is that Japan is a very special case and their debt level is not one that many countries could handle.
Krugman further ignores the psychology of the welfare state, which I’ve written about before: The lack of personal responsibility. We can particularly see this in Greece, where no-one feels it’s their responsibility to pay taxes. The entitlement syndrome doesn’t just go away because the growth does. Rather, there will be more people than before crying for the state to take care of them. When salaries fall, people always ask for the government to either strengthen labor market regulation (stopping employers from making necessary wage cuts) or increase welfare. Or, more commonly, both. That’s why, and this is a real paradox, we tend to regulate during the recession and deregulate during the boom, when it would make so much more sense to deregulate during the recession (to boost the economy) and regulate during the boom (to cool it off).
There is no nation so strong that it cannot be destroyed by people who think of themselves as not being ultimately responsible for their lives and well-being.
Ireland did a lot of screw-ups during the beginning of the recession. One of the biggest was a promise by the government not to cut public sector salaries (known as the Croke Park agreement). This is exactly what you’re supposed to be doing according to Krugmanian economics (I would call them keynesian, but in fairness Keynes was much smarter than Krugman). If wages fall, demand falls, prices drop, consumers postpone consumption etc. So why didn’t it work? Instead of writing academical science fiction, maybe Krugman should focus on trying to explain that. Ireland has only recently turned to real austerity measures, and only recently have the situation improved. Granted, part of it is definitely that they received a cut on the interest rate on their bailout last summer, but that doesn’t explain everything (Greece received the same cut, no improvement there).
Other than Sweden, Denmark is also doing just fine. But that’s because while Denmark has high taxes, in terms of labor market regulations they’re very conservative. Plus, Denmark’s got its own currency, as does Norway (which is another welfare state that is doing reasonably well), and like I said, I’m not denying that that’s a benefit when you’re borrowing money. Germany is a welfare state alright, but they are basically controlling the eurozone (together with France) and so they can control their own (and everyone else’s) monetary policy. Of all the downsides that comes with being in a currency union, Germany suffers from almost none of them but receives all the benefits, so no wonder they’re doing okay. Every case of a welfare state that is doing fine can be explained by other things than by saying that the welfare state is working. Krugman, being the dishonest pseudoscientist that he is, is of course not interested in analysing any other factors – he is an ideological crusader for the liberal cause, more than willing to ignore facts that doesn’t fit his worldview.
There are several reasons why you should cut the welfare state during recessions. One is to balance the budget and avoid deficits, which sucks up loanable funds that could have been used by the private sector and helped get the economy moving again. Another one has to do with incentives: If you’re in a recession, it’s almost inevitable that salaries will have to fall (temporarily, they’ll go back up in the next boom). In order to motivate people not to stay home and live on unemployment benefits, you have to cut unemployment benefits correspondingly to keep the incentive to work constant and avoid people slacking off. That’s somewhat theoretical, for sure, but none-the-less it deserves to be said. High unemployment benefits means a weak incentive to work.
Finally, a big problem in all the crisis countries in the Eurozone is corrupted governments. In Greece, this took the form of government officials forging deficit numbers and other statistics. In Ireland, it took the form of an unholy alliance between the government and the public sector unions, as well as the real estate developers and bankers. It’s not hard to see why a welfare state would become corrupt; power corrupts as we all know. And with all the power a welfare state has, corruption is more or less inevitable. Of course the welfare state is not the only source of corruption (there are loads of corrupt states with no welfare state whatsoever), but it should still be mentioned. It just isn’t as attractive to for example bribe politicians in a country where politicians don’t really have that much power to begin with.
The last ten years in Ireland saw run-away government spending, a massive expansion of the welfare state and as a consequence low or non-existant budget surpluses even during the boom. This left the country in a bad position for a rainy day, and so when the rainy day did come, the Irish economy got drenched. According to Paul Krugman, this isn’t even a part of the problem, but rather he implies further expanding the welfare state is part of the solution.
In conclusion, Krugman is right about the unsustainability of the Eurozone, and certainly you can’t balance the budget overnight – I’ve written about this – but Krugman keeps insisting that more spending and bigger deficits is somehow the solution, and as evidence for this, he brings up one country that is doing well but hasn’t followed his advice (Sweden) and one country that is doing better after they finally stopped following his advice (Ireland). Clearly he hopes that no-one is going to factcheck his claims, and sadly, most people won’t.
The intellectual dishonesty of the left continues. It’s time we start calling them out.
Thank you for reading.
John Gustavsson
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