Germany’s Foolish Idea

by Mario Rizzo  

An elementary lesson of economics is this: If the benefits of an action accrue to the agent but many of the associated costs can be shifted to another party, there will too many such actions. 

Consider now Greece. Its welfare state is out of control. The effects of this fiscal problem threaten its bond ratings. It is in violation of the fiscal rules of the European Union.  At the same time, the value of the euro is threatened. The German government is thinking seriously of bailing out the Greeks with debt guarantees to avoid contagion effects.  

So now the problem of moral hazard raises its ugly head. The power of precedent is such that if Greece is bailed out, what incentive is there for other countries to restrain the growth of their expenditures?  

I do not believe that even if Greece defaults on its bonds that the contagion effects would be intolerable. But the main problem is that the unsustainable welfare states in Europe and the United States are, well, unsustainable.  

People like to deny reality when it is unpleasant. This is not just a problem of bad leadership. It is a problem that goes to the heart of the fantasy world the typical voter lives in. But reality bites. Let’s see how it does so in the next few years.

In the meanwhile, we can hope that the German government comes to its senses.

16 thoughts on “Germany’s Foolish Idea

  1. If strong nations, like Germany, bail out weak nations, like Greece, then credit markets will eventually run on the debt of the strong nations. As Niall Ferguson notes in the FT, it is a fiscal crisis of the Western world.

    The same issue is playing out in the US, albeit to a lesser degree, with fiscally impaired states like CA, and their backer, the federal government.

  2. We kind of expected it to happen. But Mario is completely right. One must say, that at least it is going to be loans and not a absolutely free lunch. I wonder if this will also lead to crowding out 🙂 in Germany. I do not think Germans are happy about it.

  3. Does this mean that countries are too big to fail? You might say the government is too big to fail but the real issue is government spending relative to revenue. Perhaps it is a matter of the level of the government’s outstanding sovereign debt. But Greece is a relatively small economy and the its debt, in terms of the absolute amount, is small by other countries’ standards.

  4. Chidem,

    I do not think it is a matter of ‘too big to fail.’ They fear a wave of speculation against the other member states that are in trouble such as Spain, Ireland, Portugal and maybe Italy. If this would be the case, the euro area is in danger. A break down of the curreny would certainly be a problem. These are their arguments and I am not even saying they are bad.

    However, the problem is that Merkel forwarded this kind of solution without any idea or commitment on how to monitor the Greek government and enforce stabilization of the budget. Yes, they will have to report. But where is the sanction for Greece. Interest rates on the loans will only be a sanction if they really pay them back. France already favors bailing out via payments. Even though Angela Merkel made sure that there won’t be payments right away. I am pretty sure that this will pave the way to bailing them out. The incentive for Greece is to not make it by themselves and wait for some money.

    Moreover, if Germany and France decide to pay some of the debt and let us say Ireland follows. Then they may not be able to bail Ireland ( outeven less so Spain or Portugal), because the budget in Germany and France is everything but solid. This may even reinforce negative expectations against the euro area. Therefore, what is really needed is a way to monitor their plans to save. These countries have to change their policies.

  5. Andreas,
    The only such enforcement that we know of is the one used by the IMF, which makes its loans conditional on belt-tightening policies. And even then, people tend to resist and get off the prescribed program as soon as possible. In this situation, where as you say, there are fears of contagion to other parts of the EU and pressure on the euro, there is no real threat of the money not coming–so there is no leverage for policy change.

  6. Things are what they are. If the entire euro-zone is out of fiscal balance, then it is just a matter of time before the euro loses value. Why try to patch it all up with moral hazard inducing loan guarantees? Then what you get is an even worse case of fiscal imbalance shortly down the road. The speculators are the one thing keeping Europe even loosely connected to reality. It is really time to reform the welfare states.

  7. “You might say the government is too big to fail but the real issue is government spending relative to revenue.”

    Jeffrey Rogers Hummel wrote that, at least in America, there is an institutional limit on revenue raising (outlays/receipts as a percent of GDP). I would suspect this is the case with other nations too, although perhaps at a higher level in Europe where the populace is more comfortable with higher taxes. Does this mean that a large-scale default of Western nations like the US on treasuries is likely?

  8. “Things are what they are. If the entire euro-zone is out of fiscal balance, then it is just a matter of time before the euro loses value.”

    As the US have a high debt and a high deficit, there would not be any worries of lost in value in general. Actually a lot of countries would like to see the euro go down a bit to stimutate exports. However the ghost of state bankruptcy is around. This might bring about another crisis in Europe. This is what they try to prevent.

    The problem is that the guarantees are not formally conditioned on a strict savings plan that take care of the welfare state.


    you are right. It should be a program as the once the IMF usually has. I guess if they followed this kind of program, this would just be a guarantee and no financial support from the other members would be needed. However, there is no such thing.

  9. BTW, the so far best solution I read here is that of Jerry:

    They should form a sanction mechanism that means that in case of bankruptcy there will be an independent board that controls the budget. Then Greece is not independently run until the budget is balanced again. This is definitely something countries would not want.

    Alternatively, Greece shall feel free to exit the euro area, reintroduces the drachme, depreciate heavily and asks for IMF help.

  10. I totally agree with the economics of the post and of the comments, but there is a political problem which has gone unnoticed: Europe so far is not a nation-state, so that it is decentralized. A decentralized system (such as a market) works when incentives are aligned. Is the Euro at risk? Not necessarily.

    If power is centralized in the hands of the EU, probably controlled by Germany and France, and if it can impose sanctions on non-conforming states, the problem of the commons is solved. Monopoly is better than competition in these cases.

    The basic idea is: make everything a public good, then centralize power because decentralized decisionmaking doesn’t work in these conditions. It’s an investment in totalitarianism.

    Europeans will hail the new emperor as a saviour, once they will understand that moral hazard impedes the smooth working of the system as long as there are autonomous and sovereign states.

    That’s not good news for Greece, but it is too weak to protest, as the “inner front” is in the hands of demagogues. The same applies for the whole Mediterranean area.

    This is in perspective good for those who can hope to affect decisionmaking (mainly France and Germany): a fiscal crisis is a small price to pay to get an Empire, exactly like the Great Depression has helped the centralization and extension of power in the hands of Washington, despite the fact that it was Washington’s fault.

  11. Hmmm. Well aside from the fact that so far Greece has not actually borrowed any money from Germany, despite this statement of support, some of the arguments here seem to be a bit over the top regarding some of the facts on the ground. Most particularly is the claim that somehow Greece’s fiscal problems show that the “unsustainable welfare states in Europe and the US are…unustainable.”

    So, I did a little googling and found two sites with numbers on social or welfare or some such label per country as a percent of GDP. One in Wikipedia comes from the OECD, listing countries in order (I am not sure what all is in this). Of the 29 in the OECD, Denmark was tops at 29.2%, Greece was 10th at 24.3%. Of those higher than Greece, the only one in any near term fiscal danger is Italy at #9, 24.4%. At #6 is very fiscally sound Switzerland at 26.4%. The US is 26th at 14.8% (I think health care must not be being counted), with only Ireland, Mexico, and South Korea below it. Guess Mexico is sustainable.

    Another list was at Nationmaster, only listing sixteen countries. Greece was not on the list. There, Sweden was tops at 30.6, Italy was #6 at 25.3%, the US was 11th at 23.4%, New Zealand was 15th at 17.5, and Japan was 16th at 15.7% (with its national debt at nearly twice its GDP, how sustainable).

    What is left out of all this are such things as demographic trends, cost trends for social services, and willingness to tax themselves on the part of various countries. So, the US has much more favorable demographic trends than most of these, but we have horrendous medical care cost trends, not to mention a total phobia about paying taxes. These latter two do certainly provide a possible threat down the road for the US.

    Many of those at the top of these lists (all those darned Nordic countries), look pretty good because they have better demographic trends than Japan or Germany, if not as good as the US, have been much better at keeping some costs in line, especially medical care, and have been willing to endure those oppressive high taxes (horrors! serfdom!).

    Regarding Greece itself (not to mention such next in line places such as Spain and Portugal), the problem is not the size of their welfare states, which is not all that out of line. The problem has been corrupt accounting and strong public sector unions, both in place for decades. Greece has had a long history of fiscal crises and was initially kept out of the Eurozone precisely because of that. They specifically engaged in fraudulent public accounting, which has now been admitted and corrected by the new Papandreou government. Thus, the immediate crisis arose when they admitted that their budget deficit was more like 13% of GDP rather than the 6-7% being claimed by the previous administration.

    So, sorry, this does not look like the headlights of some onrushing apocalypse of catastrophic collapse of welfare states, except for maybe those that lie about their accounting or fail to act to get their rising medical care costs under control or fail to stop cutting taxes every other year while they are fighting wars, and so on.

  12. Germany and France, in particular, won’t let the IMF help, monitor or pursue any sort of intervention in Greece because that would give the US, who controls the IMF, a say in eurozone economic policy – something they find embarrassing and politically unacceptable.

    The Western, and Eastern, European welfare states, while not an imminent apocalypse, are more or less unsustainable because of those negative demographic trends and because of the heavy cost they impose on growth given the modest projections for the future.

  13. Barkley,

    First, governments lie about the stats they have, as well as their accounting. And that’s when they have the stats. See Veronique de Rugy’s fantastic article in the March 2010 issue of Reason “Congress’ Phony Price Tags” about how America’s only native criminal class actually has a history of lying about projected costs of the various Big Dig projects, Medicare, the International Space Station, etc., etc.
    And I still fondly remember the time in 1990 when I told a census “worker” who came into my building to leave immediately, which he did. I don’t think the parasite got the correct number of people in the building.

    Medical care costs aren’t the only horrible trend in the U.S. antiSocial inSecurity is also a looming disaster, as are a few states, such as the Peoples’ Republic of California. The trend of the federal crookacracy’s debt level is also unsustainable, just as it was in WW II.

    What is “a total phobia about paying taxes” in the U.S. and how is it a threat to the U.S.? A threat to the Federal crookacracy, its lobbyists, “employees” and hangers’ on, maybe, but not to those of us folks who actually do productive work and pay taxes.
    Speaking of phobias, maybe the recent ballyhoed revision of the psychiatrists’ “disease” playbook should have included “total tax phobia.” I’ll email Dr. Szasz to find out what he thinks of this “disease.”

    Corrupt accounting and strong public sector unions are big problems, especially in Greece, but they are far from the only problems in Europe. High taxes are a drag on economic growth, innovation, and the formation of new businesses all over the continent, especailly in Scandanavia, as The Economist (a formerly classical liberal turned politically correct and far more statist publication) pointed out a couple years ago. Germany, which cut taxes a while ago, saw higher growth after doing saw. Ireland cut taxes and regulations in the 1980s and became the Celtic tiger as a result. Its recent problems have nothing to do with a smaller crookacracy and a lot to do with the State’s criminal money monopoly.
    (I love it when libsters decry monopolies, but neglect the worst monopoly of all, central banks.)
    Even The Economist this week in its leader “New Dangers for the World Economy” says that Eurpoe should have “a renewed focus on freeing trade, cutting spending rather than raising taxes and agreeing on new financial regulations.” Two out of three correct is a hall of fame batting average. The last should read “freeing money and banking from the monopolizing central bankers’ control of money.”

    And the U.S. needs to cut taxes and spending, institute free banking, and allow anyone to issue private money. This plus a private rule of law is all we need. When we get to anarchy plus the constable, then we can debate what to do with him.

  14. von Pepe is correct. I certainly consider strong public unions as part of the welfare state or, at least, the welfare-state mentality. But if you don’t like that, then I “amend” my statements to say welfare state plus strong public unions.

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