Robert Samuelson tells readers today:
"the economies of many European countries are no longer strong enough to support their welfare states."
This would be more obviously true if Europe seemed to be suffering from a problem of excess demand. That would be a story in which government spending on the welfare state was driving up interest rates and crowding out private investment and consumption.
Nowhere in Europe do we see anything that resembles this story. Instead we see an economic collapse that resulted from the decision by incompetent central bankers (none of whom lost their jobs) to ignore the growth of dangerous asset bubbles across the continent. When these bubbles burst, there was no source of demand to replace the demand generated by the bubble.
Folks who understand economics know that it is difficult for the private economy to quickly replace large amounts of demand. For example, in Spain the construction and consumption demand generated by the housing bubble likely exceeded 10 percent of GDP. There is no mechanism that will cause the private economy to quickly generate 10 percent worth of GDP of additional demand, even if we are very nice to the job creators.
This left the government as the only source of demand for the economy. In the longer term the euro zone countries might see additional investment demand as capital shifts to new sectors and in principle increased net exports. In the case of the peripheral euro zone countries like Spain, most of this increase will come from reduced imports from core countries. However the short-term need for government spending leads to large budget deficits.
None of this tells us anything about the excesses of welfare states. While every welfare state can use reforms, like every non-welfare state, there is nothing about this story that tells us the welfare states are excessive. And, it is worth noting that the countries with the most generous welfare states in Europe are doing relatively well.
While Samuelson wants readers to believe that there is no alternative to cutting back welfare states as he tells us that Germany isn't strong enough to rescue the peripheral countries, he ignores the obvious route through which the peripheral countries could be saved. If Germany allowed the European Central Bank (ECB) to guarantee the debt of Spain and other debt troubled countries it would quickly reduce their interest burden to a sustainable level. The ECB would also have to foster higher rates of inflation in Germany and other core countries to restore the competitiveness of the peripheral countries.
In fact, this path is necessary regardless of whether or not the peripheral countries cut back their welfare states. The peripheral countries have huge trade deficits with the core countries. This will not change even if they sharply reduce the size of their welfare states.
Samuelson's welfare-state-cutting crusade is like telling someone who spends $1000 a month more than they earn every month to lose 20 pounds. Regardless of whether or not the person is in fact 20 pounds overweight, the weight loss is not going to affect their bank balance.
With Samuelson's story, the key problem is that the peripheral countries have large trade deficits with Germany. This can only be addressed by Germany running a higher inflation rate than the peripheral countries for a period of time. (This will primarily affect the import side for the peripheral countries, not exports to Germany, which bizarrely is Samuelson's focus.) Whether or not these countries pare back their welfare states is really beside the point.
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