May 14, 2016

Macroeconomics and the Welfare State, Part 2

The welfare state intrudes on people's ability and desire to provide for themselves. Its intrusion comes in three different forms: by providing work-free income; by regulating individual and corporate activity; and by excessive taxation.

According to assorted reliable data sources (Eurostat, Bureau of Economic Analysis, Office of Management and Budget, Bureau of the Census) total government spending equals 40 percent of GDP in the United States and 48 percent in the euro zone. These are frighteningly large numbers, especially for the U.S. economy which historically has been saved from Europe's excessively burdensome government. 

As I demonstrated in my 2014 book on the European crisis, when government consumes about 40 percent of GDP a long-term shift occurs in the economy. So long as government stays below the 40-percent mark (approximately; we are talking about macro variables and causalities here) the private sector can still cope with the burden of government. It can accommodate and adjust for the tax burden and still maintain a moderate rate of growth and job creation. 

When government grows in excess of 40 percent the private sector loses its ability to adapt and continue to grow. Government has simply become too burdensome; private-sector activity stagnates and new business investments migrate to lower-tax jurisdictions. This breaking-point is visible in GDP data, with a downshift in growth below three percent per year. Most European welfare states went through this downshift in the 1980s and 1990s.

The United States appears to have reached that point after the turn of the Millennium, though there was inconclusive evidence of it until the unimpressive recovery from the Great Recession. This is the first recovery for the U.S. economy without three-percent growth, and with less-than-perfect credit for the federal government. 

I will return to the credit-rating issue later. For now, let us stay focused on the problem with sluggish growth. Despite its poor performance, as I explained in Part 1 of this article, the U.S. economy is still stronger than the euro zone. The reason is that our welfare state has not yet quelled private-sector economic activity to the same extent as it has in Europe. Our main economic activity is private consumption, just as it should be in a healthy, well-functioning economy. In fact, over the past 15 years private consumption has increased as share of our GDP, now being close to 70 percent; by contrast, in the euro zone the share of GDP used for private consumption is declining, slowly moving toward 50 percent:

Source: Bureau of Economic Analysis; Eurostat.

Since the U.S. economy is dominated by private consumption, its growth is driven by the domestic, long-term variables that drive household spending. The European economy, on the other hand, needs to supplement domestically driven growth with growth from foreign markets - also known as exports. In fact, over the past five years euro-zone GDP has grown by an annual rate of 0.59 percent, on average. Private consumption has grown more slowly: 0.12 percent.

Exports, on the other hand, have expanded by 4.1 percent. This means that while consumption was growing more slowly than GDP, exports outgrew GDP at almost seven to one.

The significant growth-rate differences explain why exports is a steadily rising share of euro-zone GDP:
Source: Bureau of Economic Analysis; Eurostat.

By contrast, the same growth numbers for the U.S. economy:

GDP 2.04 percent;
Private consumption 2.25 percent;
Exports 3.53 percent.

Here, exports also grew faster than GDP, but only by 1.74 to 1. Notably, private consumption also grew faster than GDP; the lower rate for the sum total of the economy is due to contractionary fiscal policy: U.S. government consumption contracted, at -1.54 percent per year, in 2011-2015.

European government spending expanded at a lowly 0.39 percent per year; still an expansion and not far behind GDP.

The bottom line, then:

1. The larger government grows, the more it intrudes on the private sector;
2. Claiming 48 percent of the economy, government in the euro zone is weighing down the private sector to the point where its only way to cope with the burden is to stagnate, even contract;
3. Government in the U.S. economy has just reached 40 percent, the breaking point where the private sector goes from coping and adapting to the burden of government to stagnating and contracting under it. 

No comments:

Post a Comment