Dan Mitchell: European Fiscal Policy Week, Part II: The Right Response to Italy’s Fiscal Crisis

European Fiscal Policy Week, Part II: The Right Response to Italy’s Fiscal Crisis

I wrote yesterday to speculate about a possible fiscal crisis in Italy.

Today, here are my thoughts on why there should not be a bailout if/when a crisis occurs.

I have moral objections to bailouts, but let’s focus in this column on the practical impact.

And let’s start with this chart, which shows debt levels in Portugal, Italy, Greece, and Spain (the so-called PIGS) ever since the misguided bailout of Greece about a dozen years ago.

As you can see, OECD data reveals that there’s been no change in these poorly governed nations. They have continued to over-spend and accumulate ever-higher levels of debt.

This certainly seems like evidence of failure, in part because of Greece’s continued bad policy.

But I’m equally concerned about how other Mediterranean nations did not change their behavior.

So why did those nations accumulate more debt, even though they had an up-close look at Greece’s fiscal collapse?

I suspect they figured they could get bailouts, just like Greece. In other words, the IMF and otherscreated a system corrupted by moral hazard.

Defenders of bailouts assert that Greece was forced to engage in “austerity” as a condition of getting a bailout.

I have two problems with that argument.

  • First, notice how Greece’s debt has continued to go up. If that’s a success, I would hate to see an example of failure.
  • Second, the main effect of the so-called austerity is a much higher tax burden and a somewhat higher spending burden.

If there’s a bailout of Italy (or any other nation), I suspect we’ll see the same thing happen. Higher taxes, higher spending, and higher debt.

I’ll close by acknowledging that there are costs to my approach. If Italy is not given a bailout, the country may have a “disorderly default,” meaning the government simply stops honoring its commitments to pay bondholders.

That is bad for individual bondholders, but it also could hurt – or even bankrupt – financial institutions that foolishly decided to buy a lot of Italian government bonds.

But there should be consequences for imprudent choices. Especially if the alternative is bailouts that misallocate global capital and encourage further bad behavior.

The bottom line is that the long-run damage of bailouts is much greater than the long-run damage of defaults.

P.S. Just like it’s a bad idea to provide bailouts to national governments, it’s also a bad idea to provide bailouts to state governments. Or banks. Or student loan recipients.

Federal Spending by the Numbers

Uploaded by on Jun 10, 2010

http://blog.heritage.org/2010/06/10/new-video-federal-spending-by-the-numbers The Federal Government is addicted to spending. Watch this video from the Heritage Foundation to learn about the trouble we are in and where to find solutions.


Greece going broke before the USA? We got to control the entitlement mentality.

I wrote yesterday that the United Kingdom is doomed because there isn’t a political party with the vision or courage to restrain the welfare state.

At various points, I’ve also expressed pessimism about the future of France, Germany, Italy, Spain, Ireland, and even the United States.

Simply stated, almost all western nations suffer from the same toxic combination of dependency, demographic decline, and poorly structured entitlement programs.

But some nations are heading in the wrong direction more rapidly than others, and Greece is best example (perhaps I should say worst example?) of a country that is careening toward catastrophe.

It’s such a basket case that I’m not sure whether the politicians or the people deserve the lion’s share of the blame.

  •  The politicians deserve blame because they treat public office as a tool for self-enrichment and self-aggrandizement, largely by steering taxpayer money to friends, cronies, contributors, and supporters. Sometimes they do this in a search for votes. Sometimes in a search for cash.
  •  The people deserve blame because they view the state as a magical source of freebies and they see no economic or moral problem with using a coercive government to steal from fellow citizens. They realize the system is corrupt, which is why they seek to evade taxes, but that doesn’t stop them from trying to live at the expense of others.

In a best-case scenario, this type of dysfunctional system reduces prosperity. But when the number of people mooching off the state reaches a critical mass (as illustrated by these two cartoons), then you get societal meltdown.

Which is a good description of what’s happening in Greece.

And even when the government is on the verge of collapse and there’s pressure for reform, the political elite somehow figure out how to screw things up.

The latest example is the possible creation of “special economic zones.” When I first glanced at the story excerpted below, I thought this meant the Greek government was going to create something akin to “enterprise zones” featuring lower tax rates and less red tape.

Because I’m a supporter of the law applying equally to everybody, I’m not a big fan of such policies. I want to reduce the burden of government, of course, but I want that approach for entire countries, not just a handful of areas selected by politicians.

But at least the concept is good, right?

Not when Greek politicians are involved. They have taken the worst features of enterprise zones and combined them with the worst features of redistributionism. Here’s some of the story from Ekathimerini.

The government is paving the way for negotiations with the European Commission regarding the creation of special economic zones (SEZ) in Greece, Development Minister Costis Hatzidakis confirmed on Tuesday in Athens. …“SEZ will give a boost to the basis of the real economy,” said Hatzidakis, reiterating that the existing labor legislation will be fully respected. ..This forms part of the 10-point priority plan Hatzidakis announced yesterday aimed at boosting growth. Changes to the investment incentives law and the fast-track regulations will be completed within the next 15 days. The bill to be prepared will include subsidies of up to 80 percent for smaller companies… Public-private partnerships will be used for bolstering regional growth.

So the zones will keep all the bad labor laws, but provide big subsidies and create “public-private partnerships” (i.e., cronyism).

I hate to sound negative all the time, but that sounds precisely like the kind of nonsense that put Greece in a ditch to begin with.

To be fair, the article does talk about targeted tax relief and accelerated procedures for dealing with red tape. But that’s not exactly good news. Targeted tax cuts are a form of discrimination and they create an environment favorable to lobbying and corruption. And while it seems like good news to approve licenses more quickly, why not just get rid of bureaucratic hurdles? After all, this is the country (this is not a joke) that requires stool samples from entrepreneurs seeking to set up online companies.

It’s very hard to have any optimism after reading this type of story. Greece surely is an example of statism run amok, but let’s return to the point I made above about almost all other western nations heading in the same direction. Greece may be closest to the fiscal cliff, but the rest of us are driving in the same direction.

And if you think this is overheated rhetoric (yes, I’m prone to hyperbole), check out these dismal numbers from the Bank for International Settlements and the Organization for Economic Cooperation and Development.

P.S. The BIS and OECD numbers show that the United States is in worse shape – in the long run – than every European welfare state. I assume this is largely based on assumptions of health care spending rising more rapidly in America. The bad news is that this is a reasonable assumption (thanks to our third-party payer problem). The good news is that we can easily solve the problem with a combination of entitlement reform (which deals with a direct cause of third-party payer) and tax reform (which deals with an indirect cause of third-party payer).

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