Is Life After the Welfare State Possible?

My paper for the Institutional Research conference in Boston Sept 2-4 has been accepted and published by the Journal of Insurance and Financial Management. Here is the abstract:

Recent macroeconomic trends primarily but not exclusively in Europe suggest that the welfare state is not conducive to growth and prosperity. European welfare-state economies have experienced a longterm decline in GDP growth, private consumption and domestic absorption; and a long-term increase in unemployment. Macroeconomic data suggest a correlation between the expansion of the welfare state and the decline in economic growth. Given that the welfare state is antithetical to growth and prosperity, is it possible to reform it away? This paper develops a framework for this question, identifying strict conditions under which welfare state retrenchment or termination is possible.

Productivity and the Welfare State

Recently the problem of declining productivity in the U.S. economy has made front pages. On June 1 U.S. News reported:

The U.S. economy is sick, and analysts aren't entirely sure where the ailment came from or how they should go about treating it. What is certain, though, is that domestic productivity gains have ground to a halt, and even the most senior Federal Reserve official is now worried about where the economy can reasonably go from here. "We have a lot of jobs being created in the face of not much output growth. Unfortunately, that means that productivity growth, which is the growth in output per worker [per hour worked], is very slow," Fed Chair Janet Yellen said recently during a speech at Harvard University. "Since productivity growth ultimately determines the pace of improvement in living standards for society as a whole, that's a serious and negative development."

Structural Consequences of the Welfare State

Last week I wrote about the Sovietization of money, explaining how the obsession with various kinds of quantitative easing is slowly destroying our monetary system. My point was not based in hawkish monetarist theory, nor in Austrian theory of intertemporal interest rates. No, it was simply a conclusion based on common-sense macroeconomics and liquidity theory as developed by, among others, John Maynard Keynes and Arthur Okun.

Today, let me elaborate on this point. The reason why we have irresponsibly easy monetary policies from all the world's major central banks is simple: government spending. Almost every industrialized economy is struggling with budget deficits, and the reason is invariably the welfare state. For a good 40 years now the Western economies have experienced slow growth and persistent budget deficits. In fact, deficits are so pervasive today that they have become a third form of funding government, as permanent as taxes and fees. 

This is of course bad for many reasons, one being the inescapable correlation between deficits and GDP growth. Take a look at this chart over the U.S. economy and the balance of the federal budget (columns represent five-year annual averages):

The Sovietization of Money

On August 5 the Wall Street Journal reported (p. C1 print edition):

Central banks have a new favorite tool for boosting lackluster growth: corporate-debt purchases. Two months after the European Central bank started buying corporate bonds, the Bank of England announced Thursday that it would adopt a similar strategy. ... The move, investors and analysts say, is likely to drive down borrowing costs even further around the globe for large companies already benefiting from ultralow interest rates. 

This program comes on the heels of the ECB's Public Sector Purchase Program (PSPP), a European version of the Federal Reserve's much-criticized Quantitative Easing. The PSPP, in turn, comes on the heels of the ECB's 2014 treasury bond buyback guarantee, where the bank promised to purchase any amount of bonds issued by any euro-zone government.

The Price for Bad Economic Forecasting

Last winter I met with one of America's better known governors, a man whom I think has the qualities to become a good president. When I introduced myself as an economist he said:

"You know why God made economists? To make astrologers look good!"

The first time I heard that joke I was in graduate school. It was told to me by a political scientist, whose discipline is of unknown academic origin and merit. Therefore, back then, almost 20 years ago, I was a bit annoyed at the joke. Not so when Governor X told it to me. In fact, I am the first to admit that the profession of economics has gone awry and marginalized itself from much of the current political and public policy world.