Clueless Financial Advisers, Greek Swimming Pools and the Death Spiral of the Welfare State

May 11, 2010

This weekend I was listening for a few minutes to Ric Edelman, a financial adviser, that has a Saturday program on a local AM station. He had the most ridiculous explanation of the Greek financial crisis I have ever heard: the Greek government is insolvent because Greeks don’t want to pay taxes. He cited as an example that there is a tax on swimming pools and only a small fraction of all pool owners report their pools and pay taxes on them. (You can listen to Edelman’s idiotic statement here. Fast forward to ten minutes in the podcast.)

Beware of muddled thinkers like Ric Edelman. Too many “financial advisers” are trying to give investment advice while clinging to leftist explanations of economic policies. How can you trust someone that doesn’t grasp the impact of government policies on people’s incentives and the productivity of the economy?

Edelman has no clue about what ails European welfare states like Greece. The problem is not that people seek to avoid the heavy tax burden imposed by their government. That is actually a healthy reaction that keeps more money in productive sectors of the economy.

The cause of the financial crisis is not people avoiding excessive taxation. Rather Greece got to where it is because of a bloated welfare state where people retire in their fifties and too many people are employed at bloated salaries in unproductive government jobs.

For a more sober explanation of Greece and why it matters read Robert Samuelson’s column “The Welfare State’s Death Spiral:”

What we’re seeing in Greece is the death spiral of the welfare state. This isn’t Greece’s problem alone, and that’s why its crisis has rattled global stock markets and threatens economic recovery. Virtually every advanced nation, including the United States, faces the same prospect. Aging populations have been promised huge health and retirement benefits, which countries haven’t fully covered with taxes. The reckoning has arrived in Greece, but it awaits most wealthy societies.

Americans dislike the term “welfare state” and substitute the bland word “entitlements.” The vocabulary doesn’t alter the reality. Countries cannot overspend and overborrow forever. By delaying hard decisions about spending and taxes, governments maneuver themselves into a cul de sac.

Once the welfare state is in place, it almost impossible to reverse it.

The welfare state’s death spiral is this: Almost anything governments might do with their budgets threatens to make matters worse by slowing the economy or triggering a recession. By allowing deficits to balloon, they risk a financial crisis as investors one day — no one knows when — doubt governments’ ability to service their debts and, as with Greece, refuse to lend except at exorbitant rates. Cutting welfare benefits or raising taxes all would, at least temporarily, weaken the economy. Perversely, that would make paying the remaining benefits harder.

Greece illustrates the bind. To gain loans from other European countries and the International Monetary Fund, it embraced budget austerity. Average pension benefits will be cut 11 percent; wages for government workers will be cut 14 percent; the basic rate for the value added tax will rise from 21 percent to 23 percent. These measures will plunge Greece into a deep recession. In 2009, unemployment was about 9 percent; some economists expect it to peak near 19 percent.

If only a few countries faced these problems, the solution would be easy. Unlucky countries would trim budgets and resume growth by exporting to healthier nations. But developed countries represent about half the world economy; most have overcommitted welfare states. They might defuse the dangers by gradually trimming future benefits in a way that reassured financial markets. In practice, they haven’t done that; indeed, President Obama’s health program expands benefits. What happens if all these countries are thrust into Greece’s situation? One answer — another worldwide economic collapse — explains why dawdling is so risky.

Read Samuelson’s full article here.

America is still at an earlier stage of the welfare state’s death spiral than European countries. We still have good options. See Congressman Paul Ryan’s Roadmap for America’s Future for a realistic plan to avoid financial Armageddon before the only option is draconian cuts to people’s standard of living.

But if we don’t stop the Obama administration’s continued expansion of government in 2010 and kick Obama out of the White House in 2012, time will run out for us and our economic collapse will make Greece’s crisis seem mild by comparison.

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