Will the Fiscal Crisis Create an Opening to Shrink the Burden of the State?

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This is a transcription of the Dan Mitchell’s talk at the ISIL 2013 World Conference.
Transcription edited by Kenli S.

I don’t have a good t-shirt to hold up, but I did think to throw some humor into my presentation. So before I jump into what’s happening with fiscal policy, this is the challenge that we all face as libertarians.

At the top left is what republicans think we are, the middle top is what democrats think we are, and the top right is what the media thinks we are. Our friends, they’re at the lower left. We think of ourselves as freedom fighters. Then of course what we really do every day is we shake our heads and think how government is screwing everything up.

So that sort of is a good lead in to talking about fiscal policy because I’m going to show how government is messing things up. Primarily because the poorly designed entitlement programs—not that there’s such a thing as a well-designed entitlement program—mixed with demographics is creating fiscal chaos and unfortunately politicians usually never address the problem, at least in a productive way, until you’re already in the middle of a crisis.

I want to show some numbers first from the BIS, the OECD, and the IMF. This first chart (and we’re using France as the first example because in the Bank for International Settlements study they were the ones that had the legend in it) and the red line is basically government left on autopilot, the green and the blue lines are what happens if you do medium level adjustment or significant adjustment in terms of age related government spending.

This is debt as a share of GDP. Now, government debt is not what we should worry about, government spending is what we should worry about regardless of how it is financed, but this is the way the BIS did the study. Really the way you should think about this is that this is a measure of the unfunded liability of government spending commitments that can’t be met.

You see that France is going to go to 400% of GDP. Greece got in trouble at 113% of GDP. Spain and Portugal got in trouble at about 60 to 70 to 80% of GDP. France is not going to get to 400% of GDP; they’ll have their Greek style fiscal crisis first.

Here is Germany 300% of GDP if they leave policy on autopilot. Greece 400% GDP, of course they’ve already hit their fiscal crisis. Here is Ireland 300% of GDP, they were actually making a lot of progress back in the eighties and nineties and in the early part of last decade when government was under control; but then, they did bail out of the housing bubble with lots of big mistakes.

Here is Italy, I’m actually surprised that Italy is in better shape than some of these other countries, at only 250% of GDP. I suspect it will be worse than that when the final numbers come out.

The Netherlands are far worse than Italy, 400% of GDP. Japan, if any of you are rich and you hold assets that are Japanese denominated, get rid of them as quickly as you can. Here is Portugal, 300% of GDP. Spain 300% of GDP.

UK, you always hear these stories about, oh, Anglo-Saxon capitalism. Nonsense. The UK is in worse shape than every single continental European economy in terms of the long run burden of government spending.

And then, I’m ashamed to say, the US is not far behind the UK and both of us are only worse than Japan. We’re at 450% of GDP. That’s what the Bank for International Settlements estimates.

Let’s look at what the OECD estimates, it’s just one slide we are going to look at here, but it basically shows the immediate change in fiscal policy as a share of GDP beginning in year, one in every year, into the future, in order to stabilize that at 50% of GDP. Again they looked at debt, but they really should be looking at spending, but the debt really is a proxy for spending.

Interestingly, the US is the third worst country on the list. You see Switzerland is down as one of the more stable countries. But actually Italy, Portugal, and Greece are all in much better shape in the long run than the US. The US baby boom population is really going to create a huge nightmare for the US. We are not in trouble as quickly as Europe but we are going to be in deeper trouble than Europe, if we leave everything unchanged.

So basically, countries in the Western world are either in fiscal crisis already or they are heading in that direction, with very, very few exceptions, Switzerland, perhaps being one of them. Sweden actually surprised me as being reasonably stable in the long run, because they have done some interesting reforms.

Let’s look at an IMF chart here. I like the IMF chart, it’s far too complicated to read, but basically, on the vertical axis it shows how much government spending is going to increase. They’re actually looking at government spending. Kudos to them. That’s the vertical axis. The horizontal axis is how much you have to change policy immediately to affect the long run, so you don’t want to be in the top right quadrant.

You’ll notice, of course, that the US is the farthest in the top right quadrant and when I show American politicians this type of data, they’re shocked because American politicians have this very naïve view that; ‘Oh, no, we’re in good shape, we’re not Europe, somehow we’re different, somehow we’re better.’

No, it’s just a matter of timing and the demographics and when all these things are happening. In other words, what’s happening in Greece? What’s happening in Italy, and Ireland, and Spain, and all these other countries? It’s going to spread all throughout the world.

So the question then becomes for us, if we want to try to save the world and create some sort of libertarian future, instead of a statist future, is there a way we can take advantage of this?

In other words; how do we stop this from being the future with a bunch of interest groups, in effect, killing their host animal? I mean if you’re a parasite, you shouldn’t want to kill your host animal. If you’re a dog, I mean, if you’re a flea it’s not good for you if the dog you are on dies. That’s what this great Chuck Asay cartoon is getting across.

Really we have two hypotheses we want to look at, and Naomi Klein a left-winger, she has a horrifying vision that economic crisis leads to free markets and she of course hates that concept, because she’s on the left. Robert Higgs, one of us, also has a horrifying scenario, he wrote, “Crisis and Leviathan” and he thinks chaos leads to more statism.

So who is right? Even though we philosophically agree with Robert Higgs, all of us of course hope that Naomi Klein is right and you’ll wind up with crisis leading to free markets. Well, there is some evidence on both sides. In the US every time we see crisis, whether Great Depression or war, the government gets bigger, and the State gets more powerful, but with your varying degrees of accuracy you can say that crisis in Chile, or perhaps in the former Soviet bloc actually led to some reforms that were pro liberalization.

Looking forward into the future and looking at the fiscal crisis in the Western world, which of these two theories do we think is going to be more accurate? In other words, are we going to see good policy? Will politicians run out of all the bad options, so they have no choice but to do some good options?

Well let’s look at some of the evidence. If you look at the European Union data and look at annual government spending levels, you know; don’t pay attention to projections and the way politicians say, ‘oh we cut spending’ simply because it grew by 4% instead of 8%. Look at the actual annual spending levels to see what’s really happening and some nations have been forced to cut spending.

In the last few years, Greece, Spain, and Italy among others have actually cut spending, that is a sign of progress. They never would have done that if somehow they had gotten unlimited bailouts. Yes, the IMF, the European Central Bank they are getting some bailouts, but they are being forced slowly but surely to begin to reign in some other expenditures, that’s the good news.

The bad news is that they‘ve raised taxes even more, so they’re stifling the private sector and the private sector isn’t able to use these freed up resources that are no longer being diverted to excessive government spending.

Even if they weren’t raising the taxes you’d have another issue you have to worry about: Can you put toothpaste back in the tube in terms of teaching people? Or can people relearn, self-reliance, work ethic, and entrepreneurship?

These are forms of social capital. Economists talk about human capital, that’s your education, your skills, they talk about physical capital, that’s machines, that’s factories, but there is something else very, very important for a functioning market economy; and that’s social capital and that’s things like work ethics, spirit of independence, self-reliance, and so on and so forth.

The problem is that a lot of European economies when you look at international polling data on issues such as “Is it government’s job to provide you housing, a home, a job, etc, etc.?”, in a lot of European economies you have very strong majorities where people think it’s the government’s obligation or responsibility to those things. So even if they run out of money and there is no way to do those things, will people suddenly realize they have to do those things themselves. That’s why I’m actually worried.

If you are an economist, a good economist that is, you learn to never make a prediction, but I’m going to go ahead and break that rule. I will not be surprised if countries like Greece are not democracies within 10 years.

Now of course as libertarians we care about freedom not democracy, but it’s not even that they are going to lose democracy and become like Singapore. They’re going to lose democracy and just become more statist, if that’s even possible.

I have two cartoons here that an Italian intern from Cato drew. That was the one great contribution she did during her internship. This is how the welfare state begins. I don’t know if it’ll be true in other countries, but if you’ll look at the debate and the Congressional record for every single welfare program in the US, Social Security, AFDC, Food Stamps, Medicare, Medicaid, the politicians always sell it the same way! There’s going to be a lot of us contributing a little to help a few hard luck cases.

It’s sort of like if all of us in this room were society and we said hey, let’s all chip in a couple of dollars because Christian broke his leg. And we’re all good people and that’s the spirit, and then voluntarily, we’d all chip in a few dollars and help him get his leg fixed.

Then somebody would come up with a bad idea. Hey, why don’t we all chip in a couple of dollars ahead of time so if we’ll pool the money, we’ll have some Administrator, called the Government, run it and that way if someone breaks their leg the money will already be there, so we don’t have to run a bake sale to get Christian’s leg fixed?

Well, that’s how the Welfare State begins. But what happens over time both as politicians learn they can do this as a vote buying exercise and as people learn how to maneuver and manipulate the system for their own advantage, then the number of people riding in the wagon, all of a sudden it becomes a party bus and you have a reversal of the ratios. Instead of lots and lots of people pulling the wagon and very few people riding in the wagon, it’s just the other way around.

That is a picture of what greets us today between the number of people who are getting welfare and disability benefits, the amount of Government employees and the amount of people on Government pensions, and if you’re in a hazardous profession like hairdressing you’d retire as early as age 48 in Greece. So in effect, this is the erosion of social capital and how do you fix that?

Well, here is where I think there’s a tiny bit of optimism, not for every country perhaps, but I think we’re going to see a divergence in the western world between some countries that get it and some countries that don’t. The ones that don’t may very well lose democracy. But I think what we are seeing is that the fiscal crisis is having a very sobering impact both on elite and ordinary people.

There is widespread agreement that dramatic change is needed. I mean when you have these sorts of establishment international bureaucracies that normally lean somewhat to the left, like the IMF and the OECD and the BIF putting out these reports saying that everything is completely unsustainable and that change is needed, that’s I think a remarkable thing.

Now of course the OECD, the IMF, they’re always very quick to recommend higher taxes, but I think even that option is going to begin to come to an end. Why? Because you can only squeeze so much blood out of a stone. It was remarkable, just last year the IMF actually put out a report saying that Greece is probably past the revenue maximizing stage on the Laffer curve.

What’s the Laffer curve? The Laffer curve is simply the notion that at some point when taxes get so high; that if you raise taxes even more, you wind up losing revenue. We’ve seen anecdotal and empirical evidence about the Laffer curve from all around the world, but for the IMF to actually write a paper saying that Greece is past the stage where higher taxes will result in less revenue, that’s rather remarkable.

If I go back to the other slide here for a second, what’s the bottom bullet point say? When all other options are exhausted politicians “may” no will, could, possibly, fingers crossed, do the right thing. It “may” actually happen. So if they know they can’t spend more, and they know they can’t raise revenue anymore, I think that there’s at least in some countries a pretty good chance we’re going to see some good reform.

We’re actually seeing that in the U.S. House of Representatives. Christian mentioned this dark secret from my past that I actually worked for a politician, at one point, Senator Packwood of Oregon. He wasn’t a strong free market, small government, conservative, or libertarian or anything like that. Although, privately he would say that he wanted much smaller government, but ‘oh the voters of Oregon were too left-wing’, so he had to make all these bad votes.

But, he told me something once that really stuck with me because I think he accurately captured the motives of some of these politicians. There was an amendment on the floor of the Senate about defunding government subsidies for the Arts. And this became a big issue back in 1989. It became a big issue because it turned out that the government was funding a bunch of pornography and so some of the conservatives said ‘we’ll just use this as an excuse just to get rid of government funding for the Arts’.

I was trying to convince the Senator to vote for this amendment because the government shouldn’t be funding the Arts. And he said, “Dan, if I knew that my vote would actually be the vote that put it over the finish line and that the Arts would actually be defunded, I would vote for it. But you’re asking me to cast a symbolic vote and then I’ll go back to work again and all these women on all the local Arts councils who are put there because their husbands are big political contributors, they’ll all yell at me. And I’ll get all these editorials criticizing me for being a Philistine because I don’t want the Arts being funded. Now I’ll be willing to put up with two weeks or a month of bad press and complaining if I’m actually voting to change policy, but if all I’m doing is casting a symbolic vote, why bother?”

Now, whether Senator Packwood would ultimately if had been presented with an opportunity to be the fiftieth vote to get rid of government funding for the Arts, I have no idea, but having been talking to politicians for thirty years now, I think that actually does reflect how many of them think.

This is why I think it’s very interesting and very important that for three years in a row, the House of Representatives have voted for the Paul Ryan budget that contains, not in a libertarian fantasy world entitlement reform; but nonetheless, genuinely meaningful, structural reform to both the Medicare and the Medicaid programs for non-Americans.

Medicare is our Government run healthcare for old people and Medicaid is our Government run healthcare for poor people, they are two of the three biggest programs in the budget and over time they will be the two biggest programs in the budget because healthcare is what’s driving America, huge long term fiscal unfunded liabilities.

What makes this interesting is the House of Representatives has done this for three years in a row, knowing there was no chance that the Democratic Senate was going to pass the legislation and knowing that there was no chance the Obama White House would approve the legislation. So in effect they were voting to dramatically change entitlement programs, even though they knew all they were doing was making themselves susceptible to a campaign commercial that says they want to push Grandma off the cliff. And there actually were commercials in the U.S. saying that the people voting for the Ryan budget were basically in favor of killing old people.

Yet they managed to get re-elected and they’ve done it three years in a row and I think the only reason they’ve done it, the only reason they’ve done it is because of what we’re seeing in Europe right now. When I go in and I talk to these guys and I show them this data, I think we’re actually seeing patriotism in the legitimate proper sense, people wanted to do the right thing for their country for the right reason.

Does that mean that these politicians have reformed, does that mean that they are perfect? No! Many of these Republican politicians that voted for the Ryan budget were the same politicians who voted for the giant expansion of government during the Bush years. And even today they’ll vote for things like export, import bank expansions and things like that.

So it’s not as if we’ve solved the problem, but because of what’s been happening in Europe because of the just the evidence that nobody can deny about fiscal crisis, I think we are in a situation where politicians can be convinced to do the right thing, especially if people like us are making all the right noises about the problem being government spending, about the need for the structural reform, because a lot of politicians in a lot of countries their idea of entitlement reform is just means testing and price fixing which of course don’t actually solve any of the long term problems.

That actually gives me some reason for optimism and maybe, just maybe, if someone like Rand Paul wound up in the White House with the right constellation of forces in the House and Senate, we might actually see genuine reform in the United States far beyond what we got in the Reagan years.

There are signs of hope elsewhere. Switzerland back in 2002, I think it was the voters of Switzerland, by I think by 85% voted for something called the debt brake. And the debt brake even though it has, I prefer the focus on government spending; not on debt, the way that the debt brake actually works is it basically says government spending can’t grow faster than population plus inflation, unless of course you somehow increase taxes to allow the trend line of government to grow. But it’s very difficult to raise taxes in Switzerland especially with voter referendum.

So the Swiss debt brake put Switzerland in a very good position, government spending has fallen by a couple of percents of GDP while at the same time in the rest of Europe it’s been skyrocketing up. I didn’t mention it on the slide, but the Baltic countries, Estonia, Lithuania and Latvia, they actually cut spending and when I say cut spending I talk about genuine cuts in spending. They spent less in 2009 than they did in 2008 and they spent less in 2010 than they did in 2009. They’re now growing and yes, they had a few tax increases, but they’re controlling spending in the Baltic countries compared to the rest of the Club Med countries, the Spain’s, the Italy’s, the Greece’s of the world. They’re overwhelming focused on controlling spending in the Baltic countries, not on tax increases.

The Nordic Nations. People are surprised to learn that you have in Social Security, Personal Retirement Accounts in Sweden. You have school choice in Sweden. They’ve actually made some modest steps about restraining spending and cutting tax rates, even in the Nordic countries.

There are good signs in Eastern Europe although I am very disappointed that Slovakia and the Czech Republic got rid of their flat taxes, but there are still flat taxes in a lot of other countries. Even Germany is being semi-sensible about controlling the growth rate of spending. I’m not optimistic in the long-run for them, but nonetheless; they’re at least being a ‘don’t statist’ as opposed to a ‘reckless statist’.


Let me just close up by saying what should be done in a very obvious way. When I say what should be done, obviously it’s very easy for all of us as libertarians to say well government at most should be 2 or 3% of GDP, because for much of Western history, government spending was less than 10% of GDP. All through the Golden Century between the end of the Napoleonic wars and World War l, government in the western world was a very tiny fraction of economic output. So it’s very easy for us to say, well let’s go down to that level and then of course we argue amongst ourselves whether we could get it down to zero.

I remember I used to be the left-winger in George Mason’s Economics Department. The other graduate students would yell at me when questioned the privatization of defense. They all thought I was a sadist.

Everyone else thinks I’m a crazy libertarian, so I like being in rooms like this because I feel sort of in the mainstream. But what is it that we actually need to do? Not our fantasy world, but what is the minimum that actually needs to happen to make progress? Well, that should be very simple: you restrain the growth of spending so that it grows slower than the private sector. That’s actually all that needs to happen to achieve success because what you’re doing if government is growing slower than the private sector; you have this virtuous cycle where the numerator and denominator of this government spending as a share of the GDP is going to improve.

And so while my friend Art Laffer is famous for the Laffer curve, I’m trying to make myself famous by something called Mitchell’s Golden Rule. And I’ve actually seen people starting to write about this, so my shameless efforts of self-promotion are starting to work!

This is very simple; the definition of good fiscal policy is that the private sector should grow faster than the government. That’s the glass half full way of saying it, and if you like the glass half empty approach, the government should grow slower than the private sector.

But basically it’s all about trend lines, the reason that Greece got in trouble is government for decades was growing faster than the private sector. Whereas if you look at Hong Kong and Singapore, it’s the other way around, or at least government isn’t growing faster than the private sector. They’ve been stable at about 15 to 20% of GDP for decades. But that’s really all that has to happen.

Yes, it would be great to cut government spending! But, when we’re talking with politicians, who of course are allergic to any kind notion of dramatic radical reform which is of course what makes the House of Representatives vote for the Ryan Budget, so noteworthy I think. But most politicians don’t want to do dramatic reforms even when they’re staring in the face of a potential fiscal crisis.

But if we can simply convince them to do something like the Swiss debt brake; put in some systems; some constraints so that government can’t grow faster than the private sector, what does that mean over time? That means over time if you have to go out for the mathematicians in the room, if you go out thousands of years and the Government is growing slower than the private sector you sooner or later thematically are going to reach 0% GDP.

Now we won’t be around to enjoy that and I’m not quite sure we could ever figure out some sort of Swiss debt brake that would make that enforceable, but nonetheless that’s actually all that has to happen. We’re not asking for libertarian perfection to avoid the fiscal crisis, we’re just asking them to do something very simple that millions of households and millions of businesses do all the time which is to reign in the growth of their spending to make sure it stays under the growth of private GDP because what is private GDP? Private GDP is your tax base and so if the spending is growing faster than your tax base it doesn’t matter how much you raise taxes, in the long run. It’s like a dog chasing its tail, it’s never going to work.

So where do we go? We have to first make sure we explain to people and educate people and this is very incumbent upon us because I run into libertarians and small government conservatives all the time and make those mistakes. We should never be talking about deficits and debts except to the extent we say those are one of the unhealthful consequences of big government and excessive spending. The problem is spending deficits, and debt and high taxes for that matter are symptoms.

So we have to figure out a way to bend down the cost curve of government that’s Mitchell’s Golden Rule, remember that phrase. And to do that though this is where we come back to this issue of social capital which is where I don’t think our side our movement spends enough time focusing on and thinking about. We have to convince people that liberty is better than dependency and that’s very difficult when people have been trained over decades to think of government; as we just talked about, as government as their Daddy that’s supposed to take care of them. I mean, getting people to figure out how to get a work ethic and entrepreneurship and self-reliance, that’s not that easy.

I put this slide in at the 20 minute mark so I could close with a little bit of humor. I have a bunch of libertarian humor on my blog and this I think is one of them because it’s actually anti-libertarian, but in a way that’s because we can be self-confident about our ideas. We can actually see ourselves in some of these different types of libertarians. And I picked out three that defined me pretty well. So it’s actually pretty good amusing humor.

I thank you very much for the chance to talk. Thank you, Christian.

For more info:

• Cato: www.cato.org
• Blog: www.danieljmitchell.wordpress.com
• Twitter: @danieljmitchell
• Videos: www.youtube.com/afq20

See more videos from the Lausanne Conference
This is a transcription of the Dan Mitchell’s talk at the ISIL 2013 World Conference.
Transcription edited by Kenli S.

Kenli Schoolland

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