Chapter 5 A Tale of Three Crises
There are a lot of rational (tax) ideas out there, there are a lot of ways you could build something from scratch that would look roughly like the society we have now, but would work better, would be smoother and fairer and all that. And of course, these things are proposed in politics […] and then they cannot be done. Then our system prevents them from happening or garbels them in such a way that they look supremely ugly, once they are created […]. This is a machine for creating disillusionment with government, cynicism, Tea-Partyism, and over time, this is our county, our democracy eating itself alive. […] And that’s why I get a little discouraged sometimes.
5.1 A Crippled Mixed economy
In the preceding , I have tried to shed some light on the in much of the current oecd-world (, p. ). The puzzle is now a little clearer:
In spite of unprecendented prosperity, late oecd welfare states are less efficient, equitable and sustainable than they could be, because they fall short of an (, p. ). Among the institutions of the mixed economy, especially, because it is by far the most effective and efficient tool for government to improve upon, or redistribute market outcomes (, p. ).
Equipped with a deficient mixed economy and suboptimal taxation, democracies are forced to make unnecessarily unattractive trade-offs between efficiency, equity and sustainability, eroding their output legitimacy. At the same time, the legitimacy of democratic inputs may be undermined by a widening gap between the complexity of an advanced (mixed) economy and the simplifying tendencies of electoral democracy. Potentially, pluralist democracy may, in part, have fallen victim to the tightly concentrated special interest that late capitalism offers, especially in the field of taxation.
Taken together, such diminished legitimacy in outputs and inputs, may help explain widely reported dissatisfaction with democratic performance (but not institutions) (for example, Dalton 2004) and contribute to the apparent mismatch between popular opinion and the governing abstractions of the mixed economy.
Net of such constrained welfare and confused democracy, material and political equality would suffer. A deficient mixed economy and suboptimal taxation would corrode the social contract, by which democratic government should have some ability to redistribute the fruits of non-zero-sum games borne by the free exchange of state-protected property rights (compare Crouch 2004). Offered only unattractive choices, and thoroughly confused about the abstractions of the mixed economy, citizens would be increasingly impotent under the social contract. One suspects, especially poor and poorly educated citizens would be effectively disenfranchised from the social contract.
5.2 Possible Better Worlds
5.3 Better Taxation
In the following (p. ) and (p. ), I show that under liberal-pragmatic axioms and orthodox ontology (, p. ), we could have vastly and .
Among doable taxes, a potentially supplemented by a , and/or appears to offer more attractive trade-offs between equity, efficiency and sustainability than the current tax mixes dominated by , and (see , p. ).
5.4 Better Democracy
Among doable forms of democratic rule, deliberative democracy (for example, Cohen 1989) appears both more promising and demanding than pluralism.
Deliberation promotes egalitarian, inclusive, well-reasoned and civic-minded discussions for (possibly) consensual political decision-making. Its normative theory draws heavily on Habermas (1984)‘concept of communicative action and Rawls (1971)’ “Theory of Justice” as fairness. Where pluralism encourages the representation of particular interest, deliberative democracy demands alternative conceptions of the common good (Cohen 1989, 18). Where pluralism aggregates given, pre-social preferences, deliberative democracy is all about forming preferences. Where pluralism assumes individual voter error to balance out, when errors are random (Page and Shapiro 1993; Surowiecki 2004), deliberative democracy insists on perfecting the deliberators understandings (see , p. ).
Deliberative democracy offers more attractive trade-offs between participation, enlightened understanding and political equality (Fishkin 2009) (, p. ) and promises to alleviate some of the public choice contradictions of pluralism (for example, de Condorcet 1785; Arrow 1950) (, p. ). It also transcends the impoverished, and dubious ontology of pluralism (homo economicus!), and opens legitimate rule to feminist or even virtue ethics.
5.4.1 Crisis of Equality
Again, not an empirical claim per se, but it seems worth nothing that as per a priori logic, there may be runaway dynamics of inequality, for which we might have no possible counteracting tax institution. pperhaps, we don’t actually want to use that institution, or only to a limited amount, because its costs are too high, or the boons of overall growth are too great, but whatever, it’d be nice to have it available to the sovereign.
A complete empirical test of the governing dynamics of inequality is beyond the scope of this thesis.110 Here are some tentative statistics which support the thesis of self-reinforcing inequality.
According to the US Survey of Consumer Finances (SCF) the range between the lowest and highest sextile (!) of median before-tax family income has risen from $145,000 in 1989 to $170,000 in 2004 (Bucks, Kennickell, and Moore 2006). During the same period, the mean gap between the outer sextiles has increased from roughly $245,000 to $295,000 (ibid.). The mean income gap for extreme quartiles of education of head of household has increased from $80,000 $115,000 (ibid.). While the median net worth is reported to to be roughly $90,000 in 2004, the respective mean is around $450,000. The median (mean) range between the outer quintiles (!) of net worth has increased from $1,000,000 (around $1,800,000) in 1989 to above $1,400,000 ($3,000,000) in 2004. Interestingly, even the median (mean) gap between the topmost quintiles has increased from $600,000 ($1,500,000) to $900,000 (above $2,500,00).111
In Germany, a similar trend is discernible. From 1998 to 2006, the Gini coefficients112 in real gross wages (not incomes!)113 continuously rose from 0.407 to 0.453 (Bundesregierung der Bundesrepublik Deutschland 2006, 14). Interestingly, even the range between the topmost deciles in share of all gross wages rose from 9.8 to 10.6 (Grabka et al. 2007, 64). For all gross (net) incomes the Gini coefficient rose (roughly continuously) from 0.465 (0.261) to 0.520 (0.316) (2007, 82). The Gini of wealth distribution rose continuously from 0.745 in 2002 to 0.795 in 2007 (2007, 138).
In sum, inequality seems to be increasing over time, in labor and capital income, and in wealth. Distributions of income and wealth are, in fact, decidedly non-normal, but starkly positively skewed as evidenced by the ever diverging medians and means. These tentative statistics then support the central tenet of self-reinforcing governing dynamics of inequality.
5.5 Bad Tax
“Things in tax are bad today.”
— Edward J. McCaffery (2005, 893)
5.6 Deliberation and Democracy
Why does deliberating taxation matter for democracy?
A dysfunctional mixed economy without good taxes may produce illegitimate outputs, and, in so far as it disturbs the state-market balance of the mixed economy, violates output congruence of a democracy (compare Zürn 2000, 190). Yet, even if experts could agree on a tax — such as a promising, post-paid, cash-flow based pct — the tradeoffs involved in choosing or calibrating a tax regime are irreducibly political. For example, experts cannot positively inquire whether economic “growth”114 is in itself virtuous, which inter-subjective aggregation would be utility-maximizing, what deontological rights owners have or which human relationships should be governed by prices or command at all — even if they could agree on any of those alternative ethics.
These metaphysical conundrums are reflected in very concrete, technocratic issues in taxation. Likewise, experts cannot justify the axioms on which their (economic) analyses rest: whether, and under which institutional circumstances we are homines oeconomici, cannot be exhaustively answered from observation, because nature provides no intelligible moral messages on what kind of man we should be (Gould 1982, 43). This ontological stance matters for tax, too: for an expert to model a general equilibrium is to invoke, as well as to make, a homo economicus.
Of all conceivable institutions to resolve these disagreements, deliberative — not aggregative, not pluralist, not participatory — democracy offers the greatest normative appeal, because these disagreements raise, in Habermas (1984)’s words, competing validity claims, in need of argumentative redemption, as in: is “growth” comprehensible, who truly bears a cit, is homo economicus right, and are social insurance employer co-payments truthful? I illustrate further more, and less valid claims on taxation.
Liberal democracy, born out of the hope that material inequality and political autonomy can be reconciled, especially, rests on deliberation, because if anywhere, it is in taxation that money and power may have replaced language to govern meaning and action (Habermas 1971). In fact, if you wanted to hide some process of (re)producing inequality anywhere, you could hardly find a better place than the intricacies of (income) taxation (consider, for example “tax planning 101” in McCaffery (2005, 888)).
Instead of communicative action (Habermas 1984), what emerges today from citizens, their legislatures and public spheres, may be more “analytic muddle of tax” (McCaffery 2005, 862). The beliefs held and issues considered in the public (for example, Caplan 2007), appear to bear little resemblance to the abstractions suggested by economists (for example, Harberger 1974). People seem to ignore fundamental choices in tax (for example, McCaffery and Hines 2010), and may fall for inconsequential alternatives (for example, Sausgruber and Tyran 2011), possibly even err systematically against their own material interest — if they are on the lower economic rungs (for a German example, Kemmerling 2009). Here, too, (input) congruence of democratic rule may be violated if and to the extent that people are confused about policy choices (compare Zürn 2000, 90).
5.6.1 The Good Old Days
5.7 Misunderstanding Tax
5.8 A Vicious Cycle
These two crises — an ineffective and/or inefficient welfare state and a confused democracy — may partly reinforce one another into one perfect storm of societal reaction by stealth:
The two issues, the crisis of egalitarian politics and the trivialization of democracy, are not necessarily the same. Egalitarians might say that they do not care how manipulative of democracy a government is, provided it divides society’s wealth and power more evenly. A conservative democrat will point out that improving the quality of political debate need not necessarily result in more redistributive policies. But at certain crucial points, the two issues do intersect . My central contentions are that while the forms of democracy remain fully in place — and today in some respects are actually strengthened — politics and governments are increasingly slipping back into the control of privileged elites in the manner characteristic of pre-democratic times; and that one major consequence of this process is the growing impotence of egalitarian causes. — Colin Crouch (2004, 6)
5.9 Critique of the Literature
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Welfare regimes are, as (Esping-Andersen 1990) has said, systems of stratification in themselves, and they have been, from the very beginning socialist demands in the 19th century more than epiphenomenal income replacement. They are tools to socialize the costs of painful, but welfare-enhancing (???) economic transformations as well as individual hardship and serve as engines to redistribute this very welfare as the legislator wishes. The indeed quintessential and highly political question for globalization and welfare entrenchment is then, whether the state can still (or ever could) socialize and redistribute as it wants, with no limitations resulting from the behavior of other states. Welfare state sustainability then has to be pitted not against past or current performance, but against a hypothetically desired welfare regime under global trade with global redistribution, both within and between countries. In game theoretic terms, to gauge how badly welfare-depressing defection is, you first have to calculate the payoff for mutual cooperation. In the global context, this certainly requires quite a bit of political imagination, something that political scientists, it appears, like to shy away from. Even leaving normative considerations aside, in this case, academic rigor alone requires such exercise.
If welfare states can be well or poorly designed mixed economies, achieving different outcomes, we should also judge its prospects by comparing actual or evolving regimes to such hypothetical, but possible and desirable configurations. That is a very different question than testing whether welfare states en- or retrench, let alone its spurious correlates of income replacement (Swank 2005) or even spending (Kleinman 2002, 24), and a question that would deeply unsettle Pangloss. As Offe (2003) reminds us:
“The mode in which welfare state institutions change can be explicit reform and retrenchment. But it can also be inconspicuous and gradual decay. For instance, people may defect from public health and pension systems, trade unions see themselves forced into single-employer concessions bargaining, workers resort to unprotected forms of pseudo self-employment in order to avoid social security dues, if not to illegal (”black“) forms of employment.”
— Offe (2003, 364)
Genschel (2005), too, reminds us of what Pangloss would rather have us forget: “The effect \[of globalization\] is not so much to force change upon the tax \[and thereby, welfare\] state as to reduce its freedom to change." (2005, 53). This is why political scientists such as (Pierson 2001, 1996) that assume institutional constraints (for example, veto points, Tsebelis (2002)) to only work to prevent retrenchment, are wrong: the very same constraints that may prevent or delay nominal cuts will also make it harder for welfare states to adapt to, rather than just to recede in the face of changing economic and demographic circumstance. Nondecision does not”generally favor the welfare state" (Pierson 1996, 174). While the welfare state might nominally have retrenched only “cautiously” (Pierson 1996, 174), the ground underneath it has shifted, leading to a much graver de-facto change of positions: it can no longer expand or react, relies on unsustainable deficits or real dissavings and must make do with growing inequality, and sometimes, structural unemployment, non of which Pierson (1996) even mentions.
To shake off Pangloss, and see clearly the demise of the welfare state, we must ask three new questions, that so far, much of the retrenchment literature has shirked:
What, given a hypothetical, intact mixed economy, would welfare states be capable of, if their democratic sovereigns wanted it? This is a question that, absent natural experiments on the matter, cannot be subjected to straightforward positive test, because precisely such a hypothetical, intact mixed economy does not exist. Still, we must compare actual to hypothetical regimes, to find out just how constrained actual welfare states may, or may not be, by whichever second-order process we subsequently propose.
What is the highest possible trade-off between equity and efficiency that an intact mixed economy can offer their democratic sovereigns? As I have argued in the above, better-designed mixed economies face less harsh — or even no — trade-offs between equity and efficiency than worse-designed mixed economies. The price for an additional increment of equity in efficiency (or vice versa) not only varies at the margin,115 but it also varies depending on the set-up of the mixed economy. For example, a highly progressive tax on consumption may allow same or greater equity at a much lower price than a compressed tax on labor income.116 More broadly, Ganssmann (2010) has proclaimed the Scandinavian welfare state as the “winner” to achieve higher levels of both equity and efficiency (2010, 343).
Amongst these higher trade-offs between equity and efficiency, there may, additionally, be local optima of equity-efficiency mixes, complemented by quite distinct institutional constraints and — somewhat related — path dependencies, ranging as wide as educational systems and industrial relations.
I have here mostly ignored these Varieties of Capitalism (Hall and Soskice 2001)117 They, too, are important detail. They strongly suggest that there may not be one universal mixed economy design, but that quite different designs might coexist and specialize. Still, also within each of these varieties, there are again different trade-offs between equity and efficiency. Interestingly, the institutions that Hall and Soskice (2001) identified as markers of cmes and lmes do not mention variants of tax, social insurance or any of the other key welfare state institutions. While cmes may correlate with, and are often conflated with Bismarckian welfare states, there is nothing about cmes that would make them necessarily rely on, for example, labor income-backed social insurance. Of course, the variant of capitalism will be reflected in the nitty-gritty of welfare state institutions: for example, the statuses originally maintained by Bismarck are, arguably, related to the categorical groups that cme educational systems create, or cme industrial relations are organized around. This institutional spill-over notwithstanding, I would hypothesize, that cmes and lmes might be able to achieve equally high trade-offs between equity and efficiency, even if the institutional implementation may vary: for example, cmes might continue to sport extensive job protection, while lmes will allow quick “hire and fire”, potentially complemented by generous unemployment benefits (as in “flexicurity”). Allocative results, either way, may be very similar, which is my point here.
Even carefully crafted positive research into changing welfare states currently looks, at best, at cross-sectional or longitudinal variation in social transfers as a percentage of output (for example, Ravenhill 2005, 249). This is much better scholarship than the naysayers who like to look only at absolute spending or income replacement, but still, it does not tell us how good a trade-off we are getting.
To gauge the level of trade-off between equity and efficiency available to democratic sovereigns, the retrenchment debate has to look at allocative results, not at transfer flows, that is, at inequality (for example, Gini-coefficients) and growth (preferably measures more comprehensive than gdp).
Out of logical necessity, if nothing else, welfare state retrenchment, inequality and growth are one question. The compartmentalization of these into different academic areas allows not, as one would hope, greater theoretical clarity but instead confuses and waters-down concepts. If “welfare” is to mean anything, surely, it must be the ability of states to alter allocative results, and to do so at a minimum, or democratically acceptable price in efficiency.
Consider the alternative research designs, that currently predominate. If income replacement stays the same (Swank 2005), but, realistically, incomes become more unequal and states more indebted, is that evidence of a non-retrenched welfare state? If transfer volumes rise absolutely, or stay constant relative to output (Ravenhill 2005), but, realistically, ever more people rely on ever smaller transfers, all paid for the labor-incomes of an already squeezed middle class, is that evidence of a non-retrenched welfare state? Surely, just external validity requires more extensive operationalizations. The best, theory-driven operationalization of a non-retrenched, welfare state is the intact mixed economy.
How well does the welfare state work as an entire system of production and distribution, that is, as a mixed economy? This is a very different question from those based on a traditional, more limited definition of the welfare.
Offe (2003), for instance, takes pains to remind readers that welfare states have nothing to do “with equality of outcomes’, neither normatively nor positively”, that “the guiding principle of principle (…) is the security and protection of workers, not equality” (2003, 450). This is a historically accurate definition, but it is no longer an externally valid conceptualization of welfare states, if the term is to be more than an empty hull devoid of positive reality and economic possibility. “Welfare states as worker protection” is not mece any more. By this definition, an economy, or rather, sectors thereof would be classified as a “welfare state”, in which poorly qualified workers are nominally protected, but either structurally unemployed because their gross wages are higher than their productivity, or live in working poverty, ever unable to participate in the riches of the wider economy. To the people working in cleaning or security in Germany today, such a definition would not have a lot of face validity. The labor market for poorly qualified workers in Germany is then, at the same time, evidence of a welfare state and evidence of a non-welfare state. Conversely, by the traditional definition, an economy, or rather a sector thereof with no nominal protection, but generally high compensation and little economic hardship, would be classified as a non-welfare state. For example, freelancers in management consulting, earning handsome but unsteady labor (!) incomes, but equipped with enough assets to weather rainy days, surely do not enjoy welfare state protection. Still, at face validity, they also do not exactly suffer from Manchester style laissez-faire. Under the traditional definition, they reality is neither welfare-state, nor non-welfare state.
Offe (2003) might, asked about the plight of German cleaners, point to a leak in the “Keynesian” roof of full employment, protecting the lower storeys of welfare states. Today, full employment is only a necessary, but not a sufficient condition for an intact roof. In fact, full employment might always have been merely necessary, and we were just lucky that in the past, all other necessary conditions were mostly met. To stay in Offe (2003)’s elegant metaphor, the welfare state house is facing much harsher weather. For example, severe crosswinds of rising income inequality (for example, winner-take-all, efficiency wages) diverging factor returns (for example, Stolper-Samuelson trade), threaten to further drive apart the different economic strata making up the house, threatening to tilt the building. In addition, international tax competition, but also home-made dysfunctions are eating away at some of the load-bearing walls, putting enormous stress on the few remaining walls and the (already struggling) people making it up. If all we care about in this house is whether the roof is still tight against cyclical unemployment, the structure will not stand much longer. If the house of the welfare state is to survive the throes of economic transformation, it needs strong cross-beams, to re-balance the load of its stories. These cross-beams are progressive redistribution, and we measure their solidity by looking at overall inequality. Today, if not always, the ability of a mixed economy to efficiently curb runaway inequality is the sine qua non of welfare states, too.
This is not new to (Offe 2003), who also includes “monetary, fiscal, trade and economic policies” in the roof (2003, 543). However, he seems to neglect that consequently, the different stories of welfare protection cannot be organized (financed) irrespective of overall inequality: if, for example, the fiscal shingles are to remain intact, the protection schemes must charge those most who can best afford it and in a way that will least affect them.118
Surely, Pangloss would already despair over (Offe 2003)’s insistence on a full-employment protecting roof. But with inequality, we can and should ask him an even harder question that might reveal his unreasonable optimism in starker colors.
In addition to these functional reasons, there are normative and empirical reasons to demand of welfare states worthy of the label to, at least, be able to curb inequality. Normatively, it seems questionable to constrain the surely emancipative agenda that once endowed welfare states to worker protection. That’s quite little to ask of Pangloss. Empirically, we know that people care about relative differences in access to resources (Frank 2005a), that they suffer from relative inequality (Wilkinson and Pickett 2009). If we are welfare state researchers and, as humanists, care about the human outcomes of institutions, maybe more than evident at Bismarck’s time, today inequality is that relevant outcome, even if and to the extent that absolute material security is achieved.
To do meaningful second-order, sociological or political science work on the welfare state, you first have to do some first-order, economic work, if nothing else, because it lets us talk about welfare as if people mattered:
“In the first instance, we are interested in the welfare state because we are interested in human welfare.”
— Haggard and Kaufman (2009, 236)
5.10 Why it Matters: The Welfare State as Mixed Economy
At this point, a reader may ask: why would all, or even any of this, matter to the welfare state?
Materially possible and normatively desirable welfare states are, and must be thought of as, well-designed mixed economies, for at least three reasons:
Engaging Complexity. In a welfare state, (p. ). For example, a (p. ) and the (p. ).
To eradicate today, as Lord Beveridge promised 150 years ago, the five ‘Giant Evils’ of want, disease, ignorance, squalor and idleness, you have to anticipate this interplay of market and government and choose accordingly. The mixed economy provides us with a toolset to analyze the complexity of welfare states, including the dynamics presented here. For example, the mixed economy suggests we should always check the dwl (p. ) and (p. ) of any redistribution, a welfare state may undertake.
To answer the first-order question of welfare state design, as I have here tried to do, we need the abstractions of the mixed economy to know what is materially possible in a scarce world, filled with (at least some) homines oeconomici. For example, price controls may not be possible (without grave losses), but a well-designed, personal, almost arbitrarily progressive taxation is indeed possible in a closed economy.
Denaturalizing Market Allocations. When we consider welfare state programs in isolation from the markets which they supplant, we easily end up naturalizing whatever markets have allocated. In fact, any given market exchange which a welfare state may seek to correct, is already and always contingent on the institutions, dynamics and distributions under which it occured.
For example, rather than “fighting poverty” — as if that were an objective reality — welfare states must consider overall allocative dynamics (such as , p. ) and distributions (such as , p. ), and counteract them, as is seen fair. Markets do not make some people below an arbitrarily defined threshold “poor”, and leave others ok or even untouched. Instead, markets allocate incomes across the entire spectrum contingent on a host of institutions, dynamics and initial distributions. If government pursues a particular minimum standard of living for everyone, it might not only transfer income to those who fall below it, but may need to counteract those dynamics under which people slipped below the minimum standard in the first place.
Market allocations, in short, are — and should be — no less subject to enlightened, collective human choice than remedial welfare state programs: “Increasing dependency is no law of nature but the result of socio-economic changes, which in turn react to human intervention” (Esping-Andersen et al. 2002 x).
“\[...\] the importance of pushing the research on the \[Eastern European\] welfare state down the causal chain towards its social consequences. \[...\] \[A\]ny meaningful strategy of comparison of the welfare state must ultimately engage its consequences for a variety of outcomes, from poverty and inequality, to physical quality of life measures, to economic outcomes such as the efficiency of labour markets, competitiveness and even economic growth. In the first instance, we are interested in the welfare state because we are interested in human welfare.”
— Haggard and Kaufman (2009, 236)
The abstractions of the mixed economy I have summarized here synthesize a lot of what we need to know about the material, and therefore social consequences of a capitalist welfare state.
When we care about social consequences, the mixed economy suggests a great deal more to consider than just nominal welfare programs. For example, welfare states should not only provide social insurance, but also redress failing (p. ) and (p. ).
When we care about social consequences, the mixed economy also implies that not all welfare programs are created equal. For example, welfare states interventions should (p. ) and use (p. ).
When we care about social consequences, the mixed economy suggests that governments and markets are better at different things, and it ties welfare state interventions to specific justifications. For example, welfare states should nationalize or regulate utility markets if and to the extent that they are (p. ), but there is no reason to (as Germany presently does) redistribute within (p. ), who was supposed to only save the risk pool from (p. ). Caring about social consequences also means to leave markets alone, if they will likely serve material human need best.
When we care about social consequences, the mixed economy reveals that efficiency and equity are not always opposed, but often go hand in hand.
Inefficient is Inequitable. Titmuss (1974) urged welfare states not to exclusively concentrate on poverty relief because such “residual services (…) often become poor services for poor people” (1974, 134). This intuition is supported by the abstractions of the mixed economy: as the rich are forced or allowed to take the inefficient — but for them, affordable — exit route from government provision, a retrenched welfare state will offer only inferior provision, or none at all, to those too poor to exit.
This problem is particularly acute in health or disability insurance: as the rich and healthy exit the risk pool, coverage becomes ever more expensive, driving even more people out until it (p. ).
Similar distributive effects occur in a wider class of market failures, too. For example, a failed (p. ) of global climate or local public safety will not only be wastefully inefficient, but it will also hit hardest the poorest regions and people, who can least afford substitutes, such as building a levee or hiring private protection.
Inequitable is Inefficient. On the other hand, the abstractions of the mixed economy also imply that sometimes, slicing the pie unequally, will also make it smaller: “(…) there is a very good argument that equality of opportunities and life chances is becoming sine qua non for efficiency as well” (Esping-Andersen et al. 2002 ix).
For example, people may not be able to align the when collateral is not widely available (p. ), and overly taxing low and middle (labor) incomes may contribute to (p. ).
To answer the first-order question of welfare state design, as I have here tried to do, we need the abstractions of the mixed economy to know what is normatively desirable in a scarce world, filled with (at least some) homines oeconomici.
126.96.36.199 Higher Equilibria.
The first-order conflict about the best, possible welfare state is about the trade-offs, contradictions and uncertainties of the mixed economy explained in the above. My aim here was not to resolve that conflict: we may not know for sure, let alone agree on what the best welfare state looks like (even though I offered some well-informed hunches). A mixed economy can — in principle and for my purposes here — make arbitrary trade-offs between equity and efficiency, presence and future, or any of the other dimensions of human material need.
But given any preference set for these (sometimes!) competing goals, there are still more and less efficient institutional configurations for the mixed economy. More efficient, in this broadest sense, means that these configurations achieve more on all goals. These preferable mixed economies will still trade off preferred goals for less preferred goals, but the trade-off will be less harsh. For example, a nit may achieve the same, if not more equity than a minimum wage, but at much lower cost in growth, or unemployment. Of course, you still have to break eggs for the proverbial omelette, just fewer of them.
The competing goals of human material need, in other words, are not always in a pure and immutable zero-sum relation, where, for example, one increment more in equity means one less in efficiency, one more in present consumption one less in future consumption. Depending on the institutional design, these conversion rates will differ: sometimes, for example, one increment in equity will cost only a half-increment in efficiency. Alternative mixed economies, more often than not, are a positive or — equivalently — negative sum proposition.
Just entering the preferences between purposely competing goals does not yield a single configured mixed economy, but many different blends of command and exchange production and distribution. Again, we may not know or agree what the globally optimal configuration is, given our preferences, but checking and of a mixed economy, we can know better from worse configurations, or local optima.
A better welfare state is that mixed economy which elegantly combines and components to , , , and . That is, a welfare state that offers one of the higher possible trade-offs of growth, individual security, equality, saving and convergence. It does so without effectively borrowing from the future through , or hidden, but .
This view of the welfare state differs markedly from other perspectives:
- Full Employment or Growth.
A popular variant on the purposive trade-off between equity and efficiency, is that between the policy goals of full employment or growth, sometimes supported by “demand-” or “supply-side” economics. Offe (2003, 2003, 453) finds a similar controversy about how to best keep up the full employment “roof” over the metaphorical Keynesian welfare state house, protecting the lower floors: market liberals (or supply-siders) want to deregulate so that growth leads to more employment and social democrats (and, sometimes, demand-siders) want to sustain welfare state protection so that more employment stimulates growth.
These contenders both once had a (somewhat overstated) point, but as market failures grew and monetary policy improved, they are now both increasingly wrong.
Market liberals are wrong because not all deregulation, or any amount of it, will stimulate growth, and conversely, not all redistribution or other intervention will depress growth. The abstractions of the mixed economy suggest that sometimes, command production is more (p. ).
Social democrats, or more accurately, demand-siders are wrong because, of course, in the long run, only supply determines prosperity, and the depressed aggregate demand they always seem to suspect is clearly defined as a monetary phenomenon and unlikely to persist for very long. If it occurs, monetary expansion and fiscal stimulus should smooth it out, but that does not make for a roof. Social democrats are also wrong to believe that all redistribution and regulation is cost-free: there are dwls.
The indicators of activity that both market liberals and social democrats usually obsess about — gdp and full employment respectively — are both emphatically not related to greater (p. ). And so, they both sometimes fall for (p. ) and ignore (p. ).
So how can we rescue full employment? By not fighting this last war, for at least two reasons.
Pushing macroeconomic policy to full employment risks overheating the economy and building up inflationary pressure.
More fundamentally, full employment no longer is (if it ever was) a necessary, let alone sufficient factor for anything we might consider socially desirable outcomes for a welfare state. Full employment in itself cannot, as the house metaphor suggests, provide any shelter for depleted , lemon-market , let alone address intertemporal failures or bubbles, to name just a few. More dearly to social democrats, full employment will also be increasingly unable to — as the proponents of power resources had hoped — level the playing field between capital and labor, simply because some of the major inequities no longer are between capital and labor, but also within labor incomes as (p. ). Even if the “reserve army of the unemployed” is fully activated, the resulting upward pressures on low (or all) wages will be no match for the governing dynamics of inequality enveloping the postindustrial economy (such as Baumol’s cost disease).
Full employment, and (properly defined) growth are still desirable — because they are an efficient outcome — but neither serves as a powerful instrument to reduce poverty or economic insecurity: “Promoting labour market participation is no substitute for income redistribution and the fight against poverty: more work does not necessarily mean less poverty” (Esping-Andersen et al. 2002 ix). Offe (2003)’s metaphorical house of the Keynesian welfare state, in other words, does not need a few new shingles, but an altogether new roof.
That new roof is the ability of the mixed economy to redistribute, efficiently and progressively as the democratic sovereign wishes. With that ability, welfare states can subsidize any (however small) minimal labor market income to any desired minimum standard of living (for example, through a nit), and can provide any level of social protection desired without counterproductively burdening low incomes (for example, by paying social insurance out of general tax revenue). Progressive redistribution could, if desired, dampen or counteract any existing income dynamic, including markets. Offe (2003) may be right that the welfare state did not “have much to do with ‘equality of outcomes’”, but that does not make it tenable or desirable today (2003, 450). If you are serious about even just “security and protection of workers, not equality” (ibid.) you have to care about inequality and redistribution, at least a little. Without it, you will not have the resources to guarantee even such minimal, unequal outcomes for workers. I further develop this argument in my critique of the literature (p. ).
still serves well to distinguish different welfare states (Esping-Andersen 1990), but it, too, is no strategy for a possible and desirable mixed economy. Of course, welfare states may still “decommodify” (or subsidize) health care, education and replace (or insure) the incomes of the sick, disabled, old and unemployed, but such programs may be better described in the language of the mixed economy: as specific market interventions and redistribution.
The difference is not merely semantic, but at least three substantial misunderstandings easily follow from this choice of terminology:
Decommodification suggests — misleadingly — that welfare states could take some aspects of life, and some people off the market. But, because command and exchange modes of production and distribution always interact, that cannot be done.
For example, decommodification of disability income is easily misconstrued to mean that disability would no longer be affected by the market, and that markets would no longer be affected by disability. That is not so. When welfare states support the disabled, they not only exempt them — as intended — from earning a market income, but they may also make it cheaper, and therefore more likely for labor markets to produce, say, burn-out, depression or back pain.
Thinking in the abstractions of the mixed economy helps us to avoid such pitfalls. In this case, we know that insurance of risks is prone to moral hazard, and that (Pigouvian) co-payments can save the commons of a prudent risk-pool. We can, if desired, slap a Pigouvian tax on risky or strenuous employment and activities, to make sure it is more costly, and is avoided.
Decommodification easily morphs from description to prescription, as for example, when income replacement becomes a measure for welfare state re- or entrenchment. Caring about outcomes, there is nothing inherently desirable or essential about decommodification, for four reasons:
To decommodify someone out of the market also means to exit someone out of the central institution, that aside from providing the substituted material sustenance, mediates much human cooperation, generates self-worth to many and allows people to shape the world around them, however marginally. Instead, we should “enable all citizens to participate in the mainstream of social and economic life” (Esping-Andersen et al. 2002 ix).
Complete decommodification is a last resort response to hardship. Mixed economies have several alternative, and less intrusive, approaches to, for example long-term unemployment. Instead of generous, universal and unconditional — and therefore decommodifying — benefits, a mixed economy may subsidize low market wages with a continuous and regressive nit.
The availability of a specific tool, may not much matter to the desirability of a welfare regimes: social outcomes do.
Decommodification, conceptually, if not always in reality, is ignorant of potential welfare losses, as some person is provided, or some activity done under command instead of exchange — without a respective, justifying market dysfunction. Thinking instead, in the abstractions of the mixed economy, always ties a market intervention to a particular market failure or broader dysfunction, and considers the potential welfare losses.
Decommodification is both radical as a prescribed tool (exit the market) and strictly limited in its reach (only a set of included people or activities). To be sure, sometimes a complete move to (entitled) command provision and distribution may be necessary or desirable. Likewise, a democratic sovereign may choose to only care a lot about some market outcomes — and decommodify them —, and not care about others at all. But there is no reason that all welfare states should do so, let alone that we carve this specific vision of a social compact into our conceptual toolbox.
188.8.131.52 It follows:
for a better welfare state to strike any such optimal balance, even given arbitrary preferences, it needs an intact set of (p. ), (p. ) and (p. ) of a mixed economy.
Of these, tax is the elephant in the room: it is by far the most versatile, precise and powerful tool of command production and distribution in the mixed economy.
None of this is a merely abstract or academic concern. Much lies this balance of command and exchange: everything we materially value, and with that, a great deal of the life chances of us all depends on an intact mixed economy.
This is also not a revolutionary project. It does not ask for a new man, but it accepts, and timidly merely reforms homo economicus, the civilized version of our selfish demons. It does not ask for a new institution, it carefully compromises existing ways of exchange and command. The mixed economy, by any historical standard, is not a radical proposition.
This much, I hope, is widely agreeable.
“Taxes are the price we pay for a civilized society.”
— Oliver Wendell Holmes, Jr. (1904), Washington, DC
Taxation in the eu, for the most part, remains an exclusive competence for ms. Under the acquis, only indirect taxes (VAT) are harmonized — at ineffective, minimal levels — with very limited cooperation in other fields (for example, European Commission (2009), Bratton and McCahery (2001)). Per its treaties, the eu can harmonise only indirect, always proportional taxes — such as vat — and only by unanimous decision of the Council on proposals by the Commission (Article 113, Treaty of Lisbon, 2009 / Article 93, Treaty Establishing the European Economic Community, 1957). Union members do not even fully cooperate in collecting existing, national taxes: instead of full reporting of all incomes, some incomes (for example, dividends) and some countries (for example, Luxembourg) are exempted and instead levy a proportional, much lower withholding tax. It is, in short, no exaggeration to say that the eu has no fiscal institutions or even coordination to speak of.
In the eu, there is no match between the scope of economic activity — the union-wide common market — and the scope of taxation.
With no union-level taxation, what does this mismatch do to ms-level taxes? As the abstractions of the mixed economy suggest, tax competition results. For example, (Genschel, Kemmerling, and Seils 2009) find that tax competition is different and greater within the eu than outside of it, and that it accelerates with time and enlargement. eu tax competition is a pd, where states (strictly) dominantly prefer low taxes over high taxes and (Nash) equilibriate in suboptimal, mutual low taxation () on ).
If, and to the extent that such a race-to-the-bottom is at play in the eu, it will affect both levels and schedules of national taxation.
Straightforwardly, ms will be strictly limited in the overall level of taxation they can sustain. Governments will no longer be free to set a level of taxation, or, equivalently, determine the command-exchange components of the mixed economy. In some cases, tax levels may even fall, as has been shown for cit rates (Piatkowski and Jarmuzek 2008).
Moreover, and more importantly, competition will also alter the base composition of taxation. To avoid large dwls, as they should, governments will turn to bases that are relatively price inelastic, that is, economic transactions that cannot be altered to escape taxation. eu integration opens up a lot of new escape routes, especially for newly mobile capital, and, to a lesser extent, high-skilled labor: they can relocate their economic activity to wherever the tax burden will be lowest. This causes welfare-depressing distortions in the high-tax economy: rather than face a now voluntary tax, these pareto-optimizing exchanges will not be made at all, and instead happen elsewhere. For example, a rich entrepreneur otherwise willing to open a new factory in high income-tax Germany, may, faced with the new alternative of building the same facility in a low-tax location, forego his original plan. Germany unambiguously looses welfare, both because the investment is not made, and also because it does not even generate any fiscal revenue.
Faced with these dynamics, governments will, again rightly so, shift their taxation to bases that are less prone to dwls, or equivalently, bases that are relatively less mobile. Relatively less mobile bases in the eu will be consumption and labor incomes, because consumers and workers cannot easily do their shopping and working in another country.
Other — partly dysfunctional — taxes traditionally used to raise revenue for mixed economies will be rolled back or falter altogether. This applies especially to — anyway defunct — national cits that large corporations can often evade easily, in part because nailing down the locale of any particular increment of income of a multinational firm will always be conceptually difficult. For example, the German holding of Deutsche Bank AG can easily reassign a particular income stream to a Luxembourg-based subsidiary, arguing that a crucial business process occurred there. Tax administrations will always, and necessarily, be unable to argue where any particular value was created (Ganghof (2006), Ganghof and Genschel (n.d.), Ganghof and Genschel (2007, 5)). Similarly, higher brackets of progressive pit will also cause large dwls or, more likely and wisely, disappear, as high-income individuals change residence or citizenship, offshore their income-generation to other countries, or at least shelter it in foreign corporations no longer affected by high, backstop cits. For example, a rich German entrepreneur can establish a new holding in Ireland to buy up his German-based firm, and have it retain most if not all of the earnings, effectively escaping german income taxation.
If and to the extent that Pigouvian taxes, or even fees fall on mobile bases, these will also either cause excessive market distortions, or, more likely, disappear. For example, a German steel producer may, (hypothetically!) faced with the German ecotax, relocate to Poland, avoiding the higher energy price, without, as the Pigouvian tax intended, raising the price of steel. Overall energy intensity will remain the same, steel production will simply fall below equilibrium levels in Germany.
Crucially, by shifting the base, eu ms will also alter the schedule of their tax regimes. By relying more on taxing labor incomes, schedules will become more regressive: most large incomes in developed capitalist economies are not labor, but capital incomes. By relying more on (pre-paid) consumption and other indirect taxes, schedules will become regressive or — at best — proportional: even if rich people, just as others, eventually spend all their income, they will only pay the same percentage in vat or similar taxes. If union member governments wish to avoid, as they should, excessive dwls they will have to sacrifice progressivity in tax. The already impaired, but lone vestige of progression, the pit together with its ugly, but necessary backstop,119 the cit will either disappear altogether, or, largely equivalent, depress their schedules and degenerate into effective labor income taxes, with, at best, some residual but proportional taxation of capital.
What kind of an economic reality results from this open, but heterogeneous eu, with unbounded trade, mis-configured currency union and rampant tax competition? It is, and must be, a deeply dysfunctional design, boxing the European household in unattractive policy dilemmas, wasting its communal resources, ever building new imbalances, harboring new crises, and, ultimately, fracture the social contract.
Straightforwardly, the strictly limited revenues of eu ms confine them to structural underfunding, or at least, constrain the command-exchange that mixed economies are otherwise free to make (p. ). By subjecting taxes to competition, any increment in more command production and distribution must be bought at an increasing price in lost economic activity, or dwl.
In this scenario, governments rebalance their Haig-Simons identities — as they always must — by cutting public consumption or dissaving out of their wealth. This can take many, but entirely equivalent forms. For example, governments can save on public goods, such as road maintenance, or it can reduce transfer payments, such as welfare benefits. It can also dig into its savings, and take on new debt, or, let infrastructure fall into disrepair.
Here, too, government is faced with unattractive choices: to either cut public spending to suboptimal levels, to go into debt or to otherwise dissave.
The neoliberal agenda promised that if states cut their spending, at least their economies would greater economic growth. Under a dysfunctional mixed economy, that is not necessarily so. In the eu, mixed economies cannot have the cake and eat it, they cannot even do one of the two. Instead, its welfare states are faced with a twin crisis that is mutually reinforcing: one of structural unemployment, and one of structural underfunding, as illustrated in (p. ).
Structural underfunding, aside from causing (p. ), in the long run may also diminish the kind of public and common goods that drive future economic growth, such as basic research or infrastructure, and especially, education. Over the long haul, structurally underfunded states will ill-equip workers for a global marketplace, and leave them with comparatively poor labor productivities.
In addition, structurally underfunded governments are increasingly unable to transfer low- and middle-income workers, or, at least, exempt them from taxation. In particular, the greater tax burden on immobile labor, and the constrained progressivity of tax under competition will make it even harder for workers to make ends meet at any given market income. They have to pay more — not less — to the state, or, misleadingly named “social insurance” and keep even less for their personal consumption.
As a result, at least some workers will be relatively unproductive and face high taxes on their already low or middle market incomes. If and to the extent that eu welfare states maintain some minimum socially acceptable living standard, either through a minimum wage, or, equivalently, welfare transfers, these low and some middle income earners will find it increasingly difficult to earn enough on the market to meet this standard. Any — already diminished — income will be further depressed by a tax wedge driven between the gross and net disposable incomes. Both in a minimum wage, and a welfare transfer regime, those workers with productivities too low to make the minimum income on the market will exit the market, and collect welfare instead — not out of laziness, but out of necessity.
The ensuing structural unemployment, in turn, reinforces the structural underfunding of the mixed economy government. First, it creates greater needs for transfers, putting further strain on public transfers. Secondly, it also depresses growth, and in the long run, diverges the economy from its long-term growth path, as segments of the labor force lie needlessly idle.
Alternatively, of course, governments can lower effective price floors by cutting welfare benefits, minimum wages or by raising work requirements. By lowering minimally acceptable social standards — frequently euphemised as “structural realignments” or “labor market flexibility” — states will have to abandon central welfare tenets and create and accept, once again, widespread working poverty. That is, eu welfare states can brake the vicious cycle of underfunding and unemployment if they cease to be welfare states, a configuration that (Streeck and Mertens 2010) have aptly called a “permanent austerity regime”.
Governments of dysfunctional mixed economies, here, as always, are faced only with equally unattractive options: to either save social standards at the price of structural unemployment and depressed growth, or to abandon them and risk widespread working poverty.
This dual crises, and the uneasy choices it forces, will only be exacerbated in a modern and open economy. Modern economies already produce highly unequal returns, as winners take all and, equivalently, Baumols cost disease looms. A modern economy will, by its very structure tend to produce people whose productivities are much lower than the overall productivity of their host countries. Trade, migration and capital mobility add even more pressure. As countries specialize even more according to their factor endowments (think: Romanian Nokia, German Management Consulting), remaining, relatively scarce factors (think: unskilled laborer in Germany) may find their market wages fall even further below the respective socially acceptable minimum income. Especially rich states may then be forced to redistribute income to these individuals, but find themselves unable to raise the necessary revenues (progressively) without further reducing their competitiveness.
Lacking any union-level fiscal institutions and marred by tax competition between the ms, the eu mixed economy lacks effective tools to redistribute market outcomes. Both within and/or between member states, rampant inequality will remain unchecked, or even further widen.
At home, the mixed economy has lost its ability to dampen (possibly accelerating) winner-take-all dynamics, and to compensate the losers from trade and economic transformation.120 The great U-turn back towards more inequality, in Europe as elsewhere in the oecd is well under way (Alderson and Nielsen 2002). As tax competition both erodes the base and depresses the progressivity of taxation, market allocations, increasingly, are final. Moreover, structural underfunding and associated public squalor will also hit hardest the lower and middle income earners, further widening the divide in living standards. Rich people can afford to exit from public provision, for example by paying doctors out of pocket, by sending their children to private schools or even walling their gardens and gating their communities. Lower and middle income earners have no such exit option, but are stuck with decrepit public provision.
Between ms, too, inequality will remain unchecked, as member and union level governments have no instruments to alter distributive dynamics of trade, that may — or may not — lead to fast convergence of productivities, and related, living standards. What is worse, the poorer mixed economies are especially constrained: at low productivities, they can least afford to burden mobile capital, and other mobile, high-earning factors, such as professionals with any, let alone progressive taxation. With open borders, but without coordinated tax or union-level transfers, these poorer ms currently can only take the hard, unmitigated route to economic convergence: they tax mostly (low-productivity) labor, proportionally if not regressively, and at low overall public spending levels (for example, Dauderstädt 2008, 88:267). By contrast, in the higher-productivity, rich ms, corporatist arrangements, strong trade unions and substantial, if increasingly dysfunctional welfare regimes can still eek out pockets with sometimes generous welfare provision: in always capital-intensive, often high-value add and sometimes oligopolistic — not commodity —production, these economies can, at least in some sectors, afford welfare. For example, a Bavarian specialist engine builder with high capital and relatively low labor inputs and maybe a handful competitors on the world market, may, faced with strong unions, accept above-equilibrium, possibly efficiency wages. Not so in Romanian manufacturing: Producing low-margin commodities, with little capital but hundreds of competitors and easy access, firms have to compete tooth-and-nail on labor costs. And so, ms may not only fail to converge as quickly, or as closely as they could, or hoped to, but the very conditions for economic development will diverge widely. The rich, high-productivity ms can still, if inefficiently and incompletely, dampen and distribute the pain of whichever economic shock hits or transformation sets in. In the poor, low-productivity East and South, it will be bare-bones laisséz-faire capitalisms.121
In the eu, Kuznet’s and Keynes’ grand hopes, that welfare would — and should — always follow growth, are dashed (as cited in (Galbraith 2002, 22). If they have any choice at all, it is a very unattractive one for the governments of the union: they can either stay in the common market and reap the gains from trade and abandon all or some welfare, or they can exit the union, stall economic integration, save their welfare regimes and retreat to autarky and recession.
5.12.4 Imbalances and Crises
The problem is all inside your head, she said to me,
You can’t pay back 200 percent of GDP,
You have to negotiate, if you want your country free,
There must be 50 ways to leave your lender.
You really don’t want the IMF to intrude,
Furthermore, they’ll force austerity for the interest that’s accrued,
Imagine your middle class, subsisting on cat food,
There must be 50 ways to leave your lender.
Fifty ways to leave your lender.
You just stretch out the loan, Joan,
Cut the creditors’ hair, Claire,
Or boost GDP, Lee,
Just listen to me.
Print more money, honey.
No need to pay back, Jack!
Structure a default, Walt.
And get yourself free.
— Planet Money / National Public Radio, 2012
Democratic governments, firms and households alike will be under great strain from the underfunding, unemployment and inequality that a dysfunctional mixed economy creates. They may take on any possibility to temporarily relief the pressure they are under, even if it will not solve, or even exacerbate the situation in the long run: here, too, humans and the institutions they man, suffer from time inconsistency.
In modern financial capitalism and complex societies, there are some powerful painkillers to numb the effects of a dysfunctional mixed economies. As painkillers go, they treat the symptoms, not the disease, and have serious side effects. And so it is with the macroeconomic temptations in the eu: as powerful drugs, they seemingly let economies transcend their material means, spread euphoria and frenzy. Only their cure is, ultimately, delusional, their treatment addictive. While under the charm of such chimerical boom and prosperity, economies keep building pressures and imbalances, that, one day, will unload in financial shocks and systemic crises, that, if sufficiently large, can disturb or bring down entire markets. After this kind of ecstasy always comes a day of reckoning, with a catastrophic hangover.
Just when an economy is in such drug-enduced delusion, and living beyond its long-term growth path is, as always in uncertain markets, hard to tell. National balance of payments accounts provide as in (p. ) an intuitive, if rough-and-dirty first indication. Between economies, too, an identity akin to Haig-Simons and the conservation of matter, holds: for any good or service that leaves the country, there must ultimately be imports of equal value, or, a change in ownership of foreign assets, that is, the promise of future imports of goods and services. Conversely, any import must be matched by exports of equal value or it will be offset in foreign ownership of domestic assets, that is, claims against future domestic production. As all the most important economic abstractions, this one is simple: balance of payments accounts are double-entry bookkeeping, only at the economy level.
The components of balance of payments accounts, as the Haig-Simons identity, break down over households, firms and governments. For example, in a fictions German account, households can import olive, or firms can import particle filters as semi-manufactured inputs, or governments can import commuter trains for public transportation (, p. ). In these accounts too, positions of one owner are offset by positions of other owners in the same economy. For example, German household exports of home-made cuckoo clocks can be offset by said firm imports of particle filters in a roundabout way, when clockmakers buy French-particle-equipped German cars, or following some other chain of exchanges. Positions also offset across the equality sign. For example, German household imports of olive oil may be offset by government issues of German bonds to Greek oil producers, with the government channeling the revenue to oil-consuming welfare recipients, or through a myriad of other transfers.
Balance of Payment accounts are easily misunderstood or oversold, for a four reasons:
Trade deficits and surpluses between any pair of countries are frequently reported, but meaningless and entirely unproblematic, just as shoppers need not worry about a trade deficit with the local supermarket. Trade deficits — as consumer debt — are potentially worrying only if they are net of all exchanges with all trading partners.
Conversely, balance of payments accounts do not apply only between countries, as is easily assumed, but is, in fact a meaningful and true identity between any group of market participants and the rest of their trading partners, all the way down from nations to households. For example, a trade deficit may also arise between laggard regions, impoverished demographics or even generations, and the rest of an economy, with much the same possible problems.
In the short term, even such trade deficits may not be problematic, but, in fact, help to stabilize economies from exogenous shocks.
Even in the medium and long run, persistent trade deficits may be ok if and to the extent that the resultant capital inflows can reasonably be expected to currently, or in the future, earn whichever factor income was promised. For example, emerging economies may well experience persistent trade deficits for some time, while machinery is imported to equip the workforce, if and to the extent that the resulting, now capital-deepened production pays off as expected.
Still, balance of payments accounts are an immensely enlightening abstraction, without which trading mixed economies cannot be well understood:
Trade deficits are not a sufficient, but still a necessary condition for building macroeconomic imbalances. Not every trade deficit will betray an economy living beyond its means, but every economy artificially held above its long-term growth path by said financial drugs will leave a grave trade deficit in its wake.
The balance of payments identity shows, as Keynes argued forcefully, if somewhat ineffectively at the Bretton-Woods conference in 1944, that these macroeconomic imbalances know no one culprit. The loaded language notwithstanding, both deficit and surplus economies are, equally, at fault. One parties excessive imports are another parties dumping exports. To get to equilibrium, where imports equal exports, either of the two parties, or both, must change its prices. To pride oneself, as German leaders frequently do, in being an export champion — but not an import champion — is but a mindless return to the folly of beggar-thy-neighbor, and, before that, mercantilism.
Financial flows always track flows of tangible goods and services, as well as vice versa.
It does not much matter who — households, firms or government — in an economy creates the trade deficit. Only the deficit net of all economic actors in a given region matters.
How, then, do we know the acceptable trade deficits, from the unsustainable ones? We look at the offsetting changes in the capital account, and check whether these are intertemporally efficient, or whether they were enabled by failed markets. In the eu, as in any other mixed economy, we must beware of these smoke and mirrors, that only forestall and worsen the inevitable day of reckoning: credit bubbles, asset bubbles, inflationary pressure, and nominally invisible, but real dissavings.
- Credit Bubbles & Default.
Trade deficits can precipitate in capital inflow, as new foreign-held debt. To receive their extra imports, deficit economies issue different forms of IOUs, including government bonds, corporate debt and household credit, sometimes backed by physical collateral, as in a mortgage.
If the sum of these debts, is sound, so is the trade deficit. If debts, sour, or were overly optimist to begin with, the trade deficits cannot stand. Consider the two scenarios:
The loans are performing as long as, if, and to the extent that whichever projects they financed generate sufficient earnings to pay back interest and principal. For example, if the extra, imported surplus production the IOUs enabled were transformed into a competitive factory that now churns out export merchandise, the loan can be paid be back out of these exports and revenues.
In the bop, the initial trade deficit is first offset by the loaned capital inflow, which later flows out again as the loan amortizes, offset by foreign factor payments and exports of the produced merchandise. In effect, the loan has, as efficient credit should, inter-temporally balanced past trade deficits with future trade surpluses and/or foreign payments. It matters little whether, and in which proportion the amortization on the capital account is offset by either foreign payments or equivalent actual exports, and whether the factory’s merchandise is actually for export or domestic consumption. In the balance of all economic transformations and exchanges, successful factories and other projects can always honor their loans without curtailing the living standard of the population. Interest, and maybe even collateral, are paid back out of extra production that would not have otherwise occurred. We need not worry about this kind of trade deficit: because it moves everyone closer to the long-term growth path, is an inter-temporal Pareto, or at least Kaldor-Hicks optimization.
The loan goes bad as soon as, if, and to the extent that whichever projects they financed do not generate sufficient earnings to pay back interest and principal. For example, if the factory is not competitive, or — more to the european point — no one needs or can afford the airports, malls and mansions into which the extra imports were coagulated, there are no revenues or exports to pay back the loan. In the extreme, but conceptually similar and now plausible case, the extra imports were not meaningfully coagulated into capital at all, but were simply consumed away at present.
Come the day of inevitable reckoning, the deficit economies have two choices:
If the loan in question carries effective recourse, the deficit economy has to return the loaned capital in other, material ways. As when a leasing company repossesses a car on which payment the lessee has fallen behind, deficit countries must return the surplus production in some form. For example, the deficit economy may ship back the foreign-financed machinery in the project, or, more likely, return the same amount of surplus production transformed into some other good or service.
This is the hard way of rebalancing the bop: the inevitable, promised outflow of capital on the capital account (reflecting net changes in the ownership of, but not generation of, assets) can be balanced only with an often painful trade surplus, because there are no factor incomes to be otherwise offset on the current account, reflecting a nation’s income. Either way, a failed investment enforces a later, and often painful trade surplus to return principal and return.
Alternatively, if and to the extent that debtor economies (can) forego recourse and exert sovereignty vis-a-vis creditor economies, they (partially) default on their commitments and simply refuse to return the coagulated surplus production. In that case, creditors are stuck with their claim. By fiat, the original loans become full, or partial transfers from the debtor to the creditor economies. Here as always, the two sides of the bop identity cancel out: the original trade deficit is matched by a later, ex-post, enforced, foreign payment in the form of debt forgiveness, haircut or default.
No matter the choice, this kind of trade deficit is never an optimization, but an unavoidable redistribution, either from surplus future to deficit present if and to the extent that debtors pay, or from creditors to debtors, if and to the extent that debtors default.
Crucially, it matters very little who in the deficit economy — households, firms or government — initially took on debt. These non-performing loans will redistribute from future to present, or creditor to debtor no matter who signed them. In many cases, government will be forced to act as the lender of last resort and take on, or guarantee all the bad loans, both to counteract adverse selection and, often to save an exposed banking system from systemic crash. Even if and to the extent that government, or, equivalently, future taxpayers, can avoid to take on the bad loans, the redistribution is merely concentrated on whoever remains nominal debtor. Domestic policy can force only some people — ideally those responsible — to repay, but, short of default — another redistribution — it cannot void the need to repay. Here, as always, something akin to economic conservation of matter reigns: when credit bubbles burst, someone will have to pay back the future, either some debtors, all taxpayers, some creditors, or any combination thereof.
In addition to these mere inter-temporal distributions, credit bubbles and associated mass defaults or austerity, of course, also waste economic welfare, because of the turmoil they harbor, not to mention the hardship they imply. As the business cycle fluctuates wildly in such crises, the economy diverts from the long-term growth path, leaving resources either depressively idle, or manically scarce.
Credit bubbles are a market failure that may plague any economy — not just the eu — but the european, defunct mixed economy is particular prone to them, for at least three reasons:
The eu, until at least 2012, exercised most macroprudential oversight and otherwise mostly regulated financial markets at the ms level. Here, even the regulatory arm of the mixed economy was impaired, and regulations might have been arbitraged to suboptimal levels.
Monetary policy drives bank lending. The ecb, because it can set only one monetary policy, was unable to react to credit bubbles in individual markets or regions, such as Spain or Greece.
Equivalently, if there were in the emu, or ever hoped to meet the its nominal convergence criteria, deficit and credit-crazed ms also could not devalue their currency through monetary interventions.
- Asset Bubbles & Crashes.
Broadly similar, and often concomitant to credit bubbles, asset bubbles can also fuel trade deficits. As some assets in the deficit economy are persistently overvalued, foreign investors buy up these domestic assets, offsetting the trade deficit on the current account with a capital inflow on the capital account. Real estate, stock or some other asset that did not previously exist, or belonged to domestic investors, changes hand to foreign investors, expecting an ex-post unreasonable return. Come the day of reckoning, asset prices plunge, and much the same process sets in as when credit bubbles burst, only in asset bubbles, the default incidence is on the foreign investor, because she will usually, if not always, have taken risk-bearing equity in the asset.
Asset bubbles, too, are a redistribution from a future day of reckoning to a manic present, and, in that future, a redistribution from foreign investors to the domestic economy. In addition, asset bubbles also waste welfare: when they burst, they spiral downwards, often cause grave systemic risk and generally divert the economy from the long-term growth path.
Asset bubbles, too, are a universally looming market failure, but the eu is particularly vulnerable, again, because of likely regulatory arbitrage and ill-fitting monetary responses to local business cycles.
- Monetary Expansion & Inflation
Overly expansive monetary policy can also enable unsustainable trade deficits. In this scenario, central banks simply inject more fiat money into the economy to offset the current account deficit with a Potemkin inflow of capital. Fiat money, of course, never creates capital, and if, when and to the extent that this bluff is called, inflation ensues: money supply and demand equilibrate at new, higher price levels.
This problem is widespread in the emu with asynchronous business cycles, a single interest rate target and no transferred stimulus to speak of. In those regions where a low interest rate pumped too much money into the economy, as now appears to have been the case in Ireland, Spain, Portugal and Greece preceding the 2008ff crisis, loose money silently credit and asset bubbles, and might have already built yet-to appear inflationary expectations.
Inflation, here, as always, wastes resources and redistributes arbitrarily. The middle class and older people, with frequently nominal denominated assets (pensions), but real denominated liabilities (rents) will be particularly vulnerable to whichever level of inflation this crisis might, eventually, bring.
Inflation, too, as the other temporary diversions from the long-term growth path, redistributes from the future to the present. Even inflation does not spiral to double-digits or more, any additional increment in medium-term inflation and expectations is costly, as disinflating to previous levels is painful and often causes prolonged unemployment.
- Dissaving & Depletion
Trivially, economies can also go into unsustainable trade deficits by real dissaving. Instead of, say, selling shares in domestic companies, the deficit economy can just burn more of strictly limited fossil carbon, diminishing its real, if not its nominal assets.
Because such real assets, including an economies infrastructure, demography, environment or CO2e levels as unresolved commons have no defined ownership rights, they do not nominally show up in the capital account of an economy. Whatever this assets are transformed into, however, may well show up as an export in the current account. For example, a deficit economy can dig into its coal and iron ore resources, transform them, and export them as steel, offsetting other imports. Because the dissaving in natural resources is not usually recored, and thus triggers no change in the capital account, the steel export revenue will erroneously be attributed as a domestic income in full, when in truth, much of the revenue comes from dissaved domestic assets, that ought to be recorded on the capital account.
Such dissavings — by definition — redistribute from the future to the present. As dissaving most easily and nominally invisible occurs out of vulnerable commons, it also wastes the welfare of some of our most precious, communal resources. If, when and to the extent that they are depleted to sustain trade deficits, we may never or only at great cost be able to restore them.
I cannot marshall evidence here to show how each of these dynamics caused the 2008ff Euro, let alone the broader sovereign debt crisis. Nor can anyone, in 2012, reliably predict which of imbalances may yet turn out to be unsustainable, and why. What I do claim here is that whatever the actual imbalances and crises of the embattled emu and eu are, or will be, they will, underneath it all, follow these scripts. Using some economic imagination, these are imbalances and resulting periodic crises we would expect to plague any such internally open, but dysfunctional mixed economy.
While this european mixed economy may be of its own kind, the market failures that enable these imbalances and trigger the resulting crises are in no way sui generis. The herding and information externalities that inflate asset and credit bubbles, the systemic chain-reactions that loom on large defaults and the tragic commons depleted by real dissavings are the kind of market failures that plague all real-existing capitalism. As such, they must be meet the appropriate regulatory, fiscal, and — to a lesser extent — monetary responses. Similarly, loose money tempts governments of all market economies, not just — in fact, probably, least of all — in the eu. It, too, must everywhere be curtailed by policy: a constitutionally-enshrined monetary governance, preferably a robustly independent central bank, bound to a well-defined goal. Because as dangerous drugs endemic to capitalism, these problems are not European problems, they also do not require a European solution.
Still, the deficient european acquis exacerbates the imbalances and crises looming everywhere, in at least three ways ((echoed by Bordo, Markiewicz, and Jonung 2011, 25)):
Without a monetary union or nominal convergence criteria thereto, trading economies can intervene in their exchange rate, or, at least, let their currencies depreciate freely. As adjustment mechanisms, none is as fast as currency devaluation to get out of trade deficits. In an instant, imports become more expensive and exports become cheaper, ideally, until import and exports equilibrate at the free exchange rate. Alternative — and ultimately equivalent — domestic readjustment of (higher) prices and (lower) wages often takes longer, maybe too long to avert a bop crisis.
Discretionary exchange rate interventions are difficult to get right, and easily deteriorate into competitive devaluation, or beggar-thy-neighbor by a fancy name. Freely fluctuating exchange rates, in turn, are costly as the second theory of optimal currency areas reminds us, and they, too, might be the result of herding or otherwise failing global currency markets.
As drug addiction therapies goes, the methadone of devaluation is, at best, a mixed blessing.
And still, it is a prescription, the european economy has to do without, no matter the indication. Within the emu, everyone in the eu who ever wants to join, currencies cannot fluctuate. To readjust, member economies can only hope their wages will not be too downwardly sticky.
Creditors and debtors alike will anticipate the systemic risk and spillovers that the monetary union bestows on all its members. They know that other members too, would suffer from defaults or, related, emu-exit, and, therefore, will likely bail them out. With systemic default risk as a union-level commons, but decisions in individuals, firms and, at best, ms-hands, credit everywhere, but particularly in the high-risk economies, will be too loose.
The eu, in other, metaphorical words, is not only plagued by powerful and addictive drugs, but dealers and addicts alike can reasonably expect to be saved — as the should — if they overdose.
Lastly, and familiarly, the european mixed economy lacks the fiscal means to otherwise rebalance internal demand, that intact mixed economies use to mitigate regional imbalances, including public works, industrial policy, or even straightforward transfers.
The imbalances that have built up over the last years of European integration, and the crises in which they now seem to erupt, tell of the market failures of our capitalist economy. But they also betray the underlying dysfunctions and unfairness of an impotent mixed economy, that built these pressures in the first place. To bemoan only the market failure, and to seek to redress it is as naive as it is dishonest. Even worse, to simply wish away the crises, and to blame someone (“the banks”) — anyone (“’the markets”) for our misfortune, is to shoot the messenger, rather then to heed her warning.
In drug policy, if you are faced with a rampant substance abuse, you have to follow (Mills 1959), and sociologically re-imagine the saddening observation of an overdosed corpse: you have to ask how, and why, people socially turn to harmful drugs in the first place, and then, if you can, cure this anomie, whatever it may be. If you only wage a war on drugs, they will always win.
And so it is with the imbalances and crises facing the eu today: we have to use our economic imagination to explain how, and why, the european economies turned to delusional market failures in the first place, and, if we can, strengthen them to resist any siren call.
Our anomie, now, should be clear enough: it is the underfunding, unemployment and inequality left untouched by an impaired command arm, that slowly, but steadily, unravels the social contract of the mixed economy. Faced with such pressures, it is little wonder that individuals, firms, states and the household-writ-large they collectively make up turn to the sirens of delusional growth.
Boxed in, as it is, the dysfunctional mixed economy, and especially its poorer constituents, find ways to relieve such economic pressure somewhere, to postpone such austerity to somewhen and disguise such anomie somehow.
To now, as many do, deplore only the failing markets,122 to demonize investors or politicians is an act of exorcism. It was we, who made a Faustian bargain with these devils: to let them reign free, if only they could numb the economic pain. They obliged us. But no one, as Doctor Faustus, should be surprised if some day, there is hell to be paid.
5.13 An Old Deal
“We can’t start another new deal.”
“How about fighting for the old one \[...\]?”
— The West Wing (Season 5, Episode 5), created by Aaron Sorkin.
To insist on an intact mixed economy is not so innovative. The mixed economy is, in fact, a very old deal, prepared by the social reforms of Chancellor Bismarck, forged by Presidents Roosevelt and Truman, institutionalized by Lord Beveridge and, with miraculous success, reactivated in war-torn Germany, by Chancellors Adenauer and Erhardt. If there is such a thing as a European social model, or really, any capitalist social model, it is the mixed economy.
To insist on an intact mixed economy is also not radical. The mixed economy, is, at heart, a compromise of exchange and command, of market and state, of individual freedoms and duties, of efficiency and equity. The mixed economy hopes not for an end of history, nor harbors any overhaul of society: it makes amends with capitalism.
Tax — the cornerstone of the mixed economy — in particular, is a reformist, never a revolutionary project. Good taxation, especially of consumption, accepts private property as given, even legitimate and desirable, and merely adjusts the sticks and carrots that people reap for their personal enjoyment. Minimizing their dwl, good taxation maximizes the freedom of all market participants to do as they would absent the tax.
Today, Europe is reneging on this old deal. Without union-level taxation to speak of but with full factor and goods mobility, tax schedules are compressed and levels lowered. Without fiscal complements, the common currency allows imbalances and lets diverging business cycle fluctuate widely. Even regulation is yet incomplete, such as in labor market legislation, and is arbitraged away by competition.
On these institutions rides it all: that we can efficiently produce public good cancer research or preserve our environmental commons, that we can pool the risks of the healthy and the frail, that we can restore some fairness between market winners and losers, that our children will receive at least what we have received, and that our neighbors prosper, too. Tax especially, and together with regulatory and monetary institutions, are the social contract of modern capitalism.
European regional integration does not rewrite the social contract, but sins by blithely omitting much of passages on tax, monetary and regulatory policy. Absent them, the european polity is no longer free to choose between command and exchange, but — without explicit popular consent — defaults to ever more market, and ever more present consumption. Our household-writ-large now occupies a greatly constrained coordinate space (), boxed in by chronic underfunding, looming unemployment and rampant inequality, shaken by recurring imbalances and crises.
By its dysfunctional design, the european mixed economy yields ever more to markets while the other part of the mixed economy, the state, is on the retreat. Bereft of their old, flexible and capable social contracts, the acquis will, nay, already has — however fortuitously — remade european society in the neoliberal, consumerist image. “Neoliberalism” and “consumerism” are, in this case, not catch-all labels of disaffection, but I choose them with equal anger and care, and they apply precisely. The aquis is:
because, eviscerating the state, it morphs markets from one of several means, to inescapable reality or even ultimate end, neither of which it is, nor should be.
because, it cannot set a positive savings rate, and leaves austere members no choice but to loot real savings, and give into the temptations of bubbles. As a result, much of the resources of the communal household will be devoted to near-term consumption.123
Just how angelic the postwar mixed economy really was, I do not know.124 Still, relative to 19th century mass poverty (Marx and Engels 1848), 20th century “mob politics” (Crouch 2004, 158) and the spectre of 21st century neo-laissez-faire, the mixed economy, and the welfare state it has enabled, appears as singular achievements of the modern era. The economic institutions of Postwar Western Europe have brought about unseen prosperity and equity, all in relative peace and freedom.
That is an old deal worth fighting for.
5.14 Why Tax Matters to Democracy
“But who can say how much is endurable, or in what direction men will seek at last to escape from their misfortunes.”
— John Maynard Keynes (1936)
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The eu commission is quite explicit about this:
“The Single Market Review put (sic!) citizens, consumers and smes at the centre of policy-making.”
— European Commission (2008, 3)
One wonders, at least, why, in addition to citizens, consumers and some (though not other) firms are also mentioned, when, in a functioning market, the latter two should be served only as proxies of the ultimate beneficiary, the citizen.↩
To mention just a few red flags, it is unclear what costs Postwar prosperity extracted from others (dependence or world systems theory), we do know whether or how Western affluence can be repeated without the same gigantuan carbon footprint and we worry whether broad-based growth in value-add is but a historical episode (cost disease).↩
For example, László Kovács (2004), then Commissioner for Taxation and Customs asked that tax rates must be allowed to differ 6-8% simply to make up for the remote location of some markets.↩
Capital inflows will be particularly effective in relatively poor economies. As these economies, supposedly, still lie far below the golden rule of saving (Solow 1956), returns on capital will be much higher than in richer economies where further (near-Solowian) capital deepening faces diminishing returns (for example, Barro and Sala-i-Martin (1995) or ibid. 1992 as cited in (Beckfield 2009, 3).↩
Who knows? — Had they known about , and had they foreseen the coming wonders of electronic retail banking, they might have saved us all a lot of trouble.↩
For starters, desiderata are not (yet) comprehensively exhaustive and mutually exclusive (MECE). They are also not weighted.↩
A fully-fledged CBA would require ordinal, if not cardinal quantification of equity and efficiency. Quantifying the gains of the suggested superior tax choice, if possible at all, will be key to the further development of this project. For this, and other see further .↩
For this insight, I am indebted to Franziska Deutsch who first noted in 2011 that tax was an interesting case because it affected everyone, but most people knew little about it.↩
Ideational perspectives surely are important, and rationalist epistemologies not the only way to knowledge, but, as I explain in more detail in (p. ), first-order alternatives must be clarified first.↩
For this comparison, I am indebted to Maike Schulz, who — citing Eco — reminded me in 2013 that an ever elongating reading list need not be a bad thing.↩
For some social science that seems to physically placing “markets” in quotation marks, see, for example Beckert and Streeck (2012). In lieu of an economic, or social scientific explanation of failing or corrupted markets for sovereign debt, this rhetorical device works to distance the social scientist from these market messengers, as if their price signals were merely social constructs. There is, however, such a thing as objectively given, materially tangible, unsustainable debt that higher interest rates might merely communicate (Wihlborg, Willett, and Zhang 2010, 55). “Punctuation”, in any event, does not replace an explanation.↩
The eu commission is quite explicit about this:
“The Single Market Review put (sic!) citizens, consumers and smes at the centre of policy-making.”
— European Commission (2008, 3)
One wonders, at least, why, in addition to citizens, consumers and some (though not other) firms are also mentioned, when, in a functioning market, the latter two should be served only as proxies of the ultimate beneficiary, the citizen.↩
To mention just a few red flags, it is unclear what costs Postwar prosperity extracted from others (dependence or world systems theory), we do know whether or how Western affluence can be repeated without the same gigantuan carbon footprint and we worry whether broad-based growth in value-add is but a historical episode (cost disease).↩
…the reach of which was only recently discussed in the 2012 US Supreme Court ruling on the Affordable Care Act.↩