Matthew Melchiorre

Post image for Selfishness Underlies the Shutdown, At Home and Abroad

Americans aren’t the only ones talking about government shutdown this week. Former Italian Prime Minister Silvio Berlusconi almost collapsed Italy’s government on Wednesday by threatening to pull his party’s support for the current left-right coalition government. Fortunately, he eventually relented. At their core, petty selfishness drives both President Obama and Berlusconi’s actions.

The former, by defending his signature healthcare law at any cost, hopes to preserve his spot in the history textbooks. The latter will pull out all the stops to prevent his expulsion from the Italian Senate—after a tax fraud conviction this summer–that would signal an end to his longtime pursuit for political glory.

I elaborate on their similar motives to gum up the political works in my recent op-ed in Forbes.

Obama won’t negotiate on the health law because it is the centerpiece of his domestic “legacy,” hoping to be immortalized alongside Democratic heroes like FDR and LBJ, who stuck to their guns in advancing their big-government vision for America. Public opinion be damned, Americans will learn to like it later.


Meanwhile, Berlusconi is on a hunt for glory, having portraying himself as an action hero poised to rescue Italy from the “edge of abyss.” And he doesn’t want to lose that moment in the sun, much as Obama doesn’t want to lose his “legacy.”

Berlusconi and his deputies threatened to collapse Italy’s government over petty self-interest. Instead of material gain, Obama promises his deputies a place in history alongside himself. By refusing to even negotiate with Republicans over aspects of the health law that are unpopular among businesses, individuals, and their own supporters, Obama and Congressional Democrats, driven by the same motives as their Italian counterparts, created a government shutdown.

How many more days must pass before Obama and his Democrats realize that self-serving stubbornness is not a governing style?

Read the whole article in Forbes here.

Post image for Europe’s Continued Stagnation Is Not Surprising, Given Lack of Reform

The Guardian reports that Italy’s record-long economic slump has continued for another quarter. This isn’t much of a surprise given Prime Minister Enrico Letta’s continued refusal to countenance necessary structural reform, especially as it pertains to changing the country’s wildly outdated labor laws that have proven politically impossible to change.

On a broader scale, today’s news is a microcosm for the rest of Europe. As long as countries push off necessary reform to the fundamental structure of their economies—meaning the creation of business-friendly regulatory environments, structural budget cuts, and improved enforcement of property rights—they will continue to stagnate and face financing constraints from international markets. In my new report, The True Story of European Austerity, I point out the surprising lack of budgetary change in most of Europe and explore the differing economic results between countries that have not pursued fiscal responsibility and the handful of those that have.

At the end of the day, entrepreneurs and investors must ask themselves: Do I feel confident taking risks in this environment? Given the increasing regulatory burden from Brussels—exemplified most recently by implementation of the Financial Transactions Tax to discourage high-frequency trading—and little hope for the aforementioned fundamental change, the answer seems to increasingly be a resounding “No.”

European officials ought to change their tune. In an earlier post summarizing first-hand data analysis, I found lower borrowing costs associated with higher levels of economic freedom among European countries. Investment chases freer economies.

How many more quarters of stagnant growth will it take for European leaders to realize this? Well…who is John Galt?

Mark Gongloff, a writer for the Huffington Post, claims to show “The Complete Failure of Austerity, In 1 Chart.” Wow! Either he has found the magic set of data points that every economist has spent years looking for or he has terribly oversimplified the data we’ve all seen before into a contrived series that supports his narrative.

I’m always wary of research claiming to have found the economic unicorn, so I have serious doubts about the former. There are two fundamental problems with Gongloff’s analysis.

First, his main example of austerity’s supposed failure is the economic stagnation of the United Kingdom since Chancellor of the Exchequer George Osborne announced fiscal consolidation in 2010. But Gongloff focuses on what Osborne said and not what he actually did. If Gongloff, along with his journalist colleagues who make the same mistake almost every time they utter the word “austerity,” had taken the time to glance at the U.K.’s budget data, he would have found that our Atlantic neighbors have actually increased spending and taxes since “austerity” began. As I point out in my country-by-country report on austerity, The True Story of European Austerity: Cutting Taxes and Spending Leads to Renewed Growth, this is not unique to the U.K. The economic woes of Britain and Western Europe stem from a lack of austerity, not a dearth.

Second, Gongloff picks out a few select European countries to showcase austerity’s ineffectiveness at reducing government debt burden. His failure to take into account all European countries aside, he uses a meaningless (and unfortunately overused) statistic to measure each country’s debt burden: total government debt/GDP. That is, sovereign principal debt as a proportion of the whole economy’s assets. Unless he wants to posit as useful assumptions in analyzing debt sustainability: 1) 100 percent expropriation of everyone’s assets, and 2) the non-existence of debt financing, he should instead compare government’s required payments against its means of payment: interest payments vs. revenues. Using Eurostat data, I’ve crunched the numbers below.

In countries that actually cut spending and taxes, quarterly government interest payments as a proportion of revenues—measured with a median value in order to parse out temporary volatility— increased on average by 2.6 percent during each quarter since austerity’s implementation. In countries that carried out what Gongloff implicitly advocates: increasing spending and taxes, this figure was 4.7 percent. Cutting the size of government, it turns out, actually slows the increase in public debt burden on government finances.

Does this post close the book on the austerity debate? Of course not. But it sheds light on the absurdity of arguments claiming to have proved or disproved austerity’s effectiveness in a few paragraphs and one chart.

We hear frequently that financial markets thrive on irrational fears. That they are wrong to be wary of unreformed economies and that central banks are right to quell high sovereign borrowing rates with newly printed money.

This is an especially popular line of argument regarding the Euro Crisis, as European political leaders, EU officials, and academics tout it regularly. Paul De Gauwe of the London School of Economics and Yuemei Ji of the University of Leuven authored one of the prominent studies supporting this claim. But their methodology suffers from oversimplistic metrics for how markets view economic health and security of investment—termed “fundamentals” in financial lingo.

De Grauwe and Ji test the “market irrationality” hypothesis in two ways. First, they posit that if bond spreads decrease in response to European Central Bank (ECB) President Mario Draghi’s June 2012 announcement to do “whatever it takes” to maintain the euro, then ECB money printing can manage the Euro Crisis, which is a product of irrationally fearful markets, according to the “conventional wisdom.” An OLS regression of 10-year government bond spread changes since Draghi’s announcement upon initial bond spreads finds that spreads have indeed decreased.

Second, De Grauwe and Ji assess how markets respond to economic fundamentals by regressing country debt/GDP ratios on bond spread change since Q2 2012. They hypothesize that a positive relationship (spreads decreasing as debt burdens increase) would support the argument that market fears over European turmoil are irrational.  This is indeed the relationship that they find. Thus, De Grauwe and Ji conclude that Euro Crisis market jitters are irrational.

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Despite its frequent use through the media and in political debate, few journalists and politicians actually use the term “austerity” correctly. But Cypriot Finance Minister Harris Georgiades does.

In an interview with The Wall Street Journal this month, he refused to label Cyprus’s budget adjustments to date as “austerity.”

I won’t call what we’re doing austerity, it’s fiscal consolidation,” he said. “Austerity is to spend less than what you have and we’re still spending more.

To most people, this is simple common sense. But to spendthrift politicians and drama-hungry journalists, this does not compute. Any cut, regardless if it results in a decrease of total spending or not, constitutes “austerity” to then be demonized. The sequester, whose tiny economic effect belied its massive political doom saying, is a prime example of this here in the U.S.

Georgiades is right on the money, as I point out in my new study, The True Story of European Austerity: Cutting Taxes and Spending Leads to Renewed Growth. Not only has Cyprus not implemented austerity, but neither have most other European countries. And only four have actually decreased spending and taxation below pre-austerity levels: Bulgaria, Ireland, Latvia, and Lithuania.

This group of countries also had the highest rate of economic growth than any other group of European countries carrying out an alternative form of “austerity.” And here, Georgiades gets it right again (though he brands himself as a heretic among Krugman-ites and Europe’s Keynesian elite in doing so): “Much public spending in Southern European economies, including Cyprus’s, has a negative effect on growth because it crowds out the private sector.”

European leaders are starting to catch on. Austerity unburdens the economy to grow. But austerity must entail real cuts, not more modest budget growth disingenuously touted as skinning government to the bone.

Cries throughout the media of “savage austerity” notwithstanding, only a handful of European countries have actually implemented austerity in the true sense of the term: reducing both public spending and taxation. On the other hand, most countries in Europe have either been following the exact opposite path—increasing spending and taxation—or have been implementing some combination of the two.

As I explain in my new study, The True Story of European Austerity: Cutting Taxes and Spending Leads to Renewed Growth, carrying out real cuts leads to real growth. The table below shows average annual growth rates for groups of countries (with greater than four members) that have followed varying kinds of austerity policies.

Table 2

The group of countries that shrunk the size of its public sector from both the spending and revenue sides (group #1) had the highest average annual rate of growth, and it was the only group to maintain this rate above 2 percent—the standard for economic healthiness.

Unsurprisingly, leaving more money in the pockets of businessmen and enterprising individuals leads to greater prosperity than taking more of it away.

Read the whole study here.

In its annual country report released on Monday, the IMF turned up the heat on France for labor reform. The Washington-based lender called for a “powering up” of Hollande’s labor reforms to tackle the “significant rigidities hinder[ing] the economy’s capacity to grow and create jobs.”

Socialist President Francois Hollande, who has suffered since inauguration the largest fall in popularity of any French President in the past 50 years, has already been under considerable pressure from a citizenry fatigued from anemic and oftentimes negative economic growth and rising unemployment since 2008. Yet he still hasn’t delivered on reviving France’s flailing job market.

That’s because he’s too focused on devising government schemes, such as giving subsidies to small businesses who hire young people and retain older workers, to avoid making real changes to business-crushing labor regulations that have come to be entitlements within French society. Hollande’s changes to these laws thus far, in an attempt to draw attention away from his inaction on structural reform, are merely cosmetic, as I point out in a February CS Monitor article.

These reforms only increase flexibility during economic downturns, and they do nothing to change the employer’s fundamental and burdensome obligations to employees.

First, firms still cannot lay off workers to improve competitiveness when the business is healthy; they can only make economic dismissals to preserve competitiveness when already in financial straits. In France, it ought to be legal to fix small problems before they become big.

Second, businesses remain obligated to assist laid-off employees in finding other jobs and in retraining them for their new positions – a distinctly French phenomenon. For businesses with more than 1,000 employees, this limbo period before dismissal can last from four to nine months.

Third, reform merely reduces the period for laid-off employees to legally challenge their dismissal from five years to two. Some progress! Not only does 1 in every 4 French employees bring a case to court, but French labor courts are the least business-friendly in Europe, with employers losing 75 percent of cases, according to the Organisation for Economic Co-operation and Development.

The agreement also increases taxes and fees for hiring workers on temporary contracts. This hits businesses hard because 8 of every 10 new hires are on these contracts, according to French Labor Ministry estimates. This was a union demand to discourage the use of temporary work, which is a competitive threat to union-protected permanent contracts.

The reforms especially harm French youth, as more than half of those employed now jump from job to job under temporary contracts, according to Eurostat. Understandably, businesses don’t want to take the risk of hiring an employee they can’t dismiss later.

France needs to increase labor flexibility, not create government programs that add needless complexity to a labor market that is already difficult to navigate for businesses. Hollande is playing a losing game of charades. It’s time for him to roll up his sleeves and deal with the difficult political battle that real reform entails.

Spain’s central bank—operating within the European country with the highest rate of unemployment—just recommended to the government in Madrid a suspension of the minimum wage in certain industries. The bank wants to remove the law from being a “barrier” to hiring lesser skilled workers.

Say again? Our more left-leaning friends across the Atlantic just admitted that the minimum wage, a price floor for labor markets, creates unemployment. This simple economic logic is often denied by economists, pundits, and politicians in the U.S., and most recently by Barack Obama in pursuing his goal to increase the minimum wage to $9 per hour.

With more than half of all Spaniards under the age of 25 currently jobless, the welcome realization that minimum wage prices low-skilled and typically young workers out of lower-paid jobs they would gladly take comes at a high price.

Germans had this epiphany too at a time when they endured unemployment above that of their European peers. That’s why the Social Democratic government of the 2000s (yes, a bunch of center-left Europeans!) began implementing a “minijobs” program in 2003—as part of a larger package of labor liberalizations—for people who wanted to work a limited number of hours per week at a competitive and tax-free wage. Though Germany does not have an official minimum wage, most full-time wages are set through industry-level collective bargaining agreements, thereby creating the same price floor as a wage law. The minijob contract is exempt from these wage conditions.

According to the The Wall Street Journal, roughly two-thirds of minijob workers hold no other job—meaning that they would otherwise be unemployed. And one in every five working Germans has a minijob. As the Euro Area reported a record-high unemployment rate of 12.2 percent in April, German unemployment remained among the lowest in Europe, at 5.4 percent, and youth unemployment was similarly low, at 7.5 percent.

Labor flexibility creates jobs. Blanket regulation requiring higher wages creates unemployment. Spain and Germany found this out the hard way. With unemployment still stubbornly high at 7.5 percent, let’s hope America does not.

Does austerity kill? In a recent New York Times op-ed, David Stuckler and Sanjay Basu claim that fiscal austerity leads to a worsening of health outcomes, using higher suicide and disease rates across Southern Europe as their case-in-point. But there are problems with this formulation.

First, the authors make the mistake of linking fiscal austerity with less health spending.  Greece, Spain, and Italy chose to cut health spending even though there were better choices for cuts. And health spending didn’t put them into deep debt to begin with. Borrowing at cheap interest rates and spending it on pet projects and political patronage — which includes the welfare state, but not so much in health — put them in deep debt. Estonia swiftly and severely began to reduce the size of government in 2009, but it increased health spending during that period and suffered no health declines.

Second, Stuckler and Basu point to high unemployment and trimmed social services as the sources of increased depression and suicide in Southern Europe. But this is not an argument against austerity; it is an argument to make people less dependent on the social welfare system. In Southern Europe, labor markets are broken. That’s why the IMF gave each country a failing grade in labor market efficiency in 2010. In Italy, it’s illegal to fire employees for poor performance and difficult to dismiss them for outright negligence. Layoffs also are a long and expensive process. So,when recession comes, employers can’t hire at lower wages and don’t want to hire because of these factors — which makes matters even worse. Droves of Italians and Spaniards wouldn’t be dependent upon state welfare today if labor markets were more flexible. That’s why austerity should regard not just cutting spending and revenues, but also shrinking the regulatory state. Job protections,  a hidden cost of the welfare state, are the real killer.

The narrative with which the authors open their op-ed—in which an older Italian family commits suicide because Italy’s increasing the pension eligibility age forced the main breadwinner back into a workforce with meager opportunities—tells us to abandon not austerity but the level of commitment to current welfare-state policies. If businesses had more flexibility to hire and fire workers, if the implicit tax rate on labor wasn’t the highest in all of Europe, and if Italy’s court system was more efficient in resolving labor disputes, this family wouldn’t have been so reliant on receiving a state pension in the first place. Finding work would not have been such a hopeless proposition that it  ended in such tragedy.

Third, the authors bring up Estonia’s experience with poor health outcomes during its transition from communism but conveniently fail to mention its success with real austerity from 2009 to the present. After making deep cuts to both spending and revenues beginning in January 2009 (unlike any other country in the Euro Area), Estonia experienced positive economic growth by the third quarter of that year — more than 2 percent growth in 2010, and 7.6 percent growth in 2011. Unemployment began to decrease by the sixth quarter after austerity and is now below the Euro Area average. And most importantly to Stuckler and Basu, neither the change in the rate of suicides nor the change in the total death rate were statistically significant relative to Estonia’s previous 10 years. See my in-depth statistical report for more information:

Painting austerity as the grim reaper is more than a stretch. “Austerity” need not mean a reduction in health spending. And focusing on the short-term effects of trimming the welfare state ignores the long-term causes behind why some citizens’ lives depended so heavily upon it. Does austerity “kill”? It doesn’t have to.

Don’t let the optimism surrounding last month’s job numbers fool you. The unemployment rate’s decline from 7.6 percent in March to 7.5 percent in April is more statistical artifact than progress.  Like that of our Western European neighbors—and the U.K. in particular—the U.S. economy is stuck in a rut. Why? The answer is simple. Government profligacy overburdens the economy while propping up private inefficiencies, as I explain in Investors Business Daily.

Since 2008, Washington policymakers have been pacing around the doctor’s office too afraid to take the bitter but effective pill America needs: slash federal spending and end the U.S. Fed’s life support for zombie banks.

Economically stagnant Britain shows us where this continued procrastination leads. Instead of dashing after our tea-drinking transatlantic neighbors, American policymakers should look to Estonia, which took its austerity meds and quickly returned to prosperity.

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