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Economic troubles & the decline of social democracy

August 5, 2011

The most surprising thing about the economic troubles around the world is that they are considered surprising. The economic story is actually quite simple — western governments around the world have been consistently spending more than they have, and just hoping that continued economic growth would save them. The very obvious problem with this approach is that when debt gets too high while you have an economic slowdown, then the government faces a budget crisis. Then you have Greece getting bailed out and America extending their government credit card from $14.3 to $17.7 trillion.

But that’s only the start. Bailing out the Greek government does not solve the underlying problem of excessive European debt. And going into more debt does not solve the underlying problem of excessive American debt. These problems are currently being delayed, but not solved.

Some people are hoping that the solution will come from strong economic growth once again boosting tax revenue and making the debt look smaller as a percentage of GDP. With a bit of debt restructuring, and a bit of reform at the edges, maybe a bit of inflation, and a bit of luck, the western world may be able to come out of this crisis and muddle forward for a few more decades. But even under that optimistic scenario, the western world is in decline. The reason is that while we grapple with the current crisis, the western world is continuing with the underlying policies that are causing the trouble — the welfare state and regulatory state.

The welfare state (including the dole, pensions, public health, public education) is self-perpetuating, leading to greater dependency which requires greater welfare, and creating a political dynamic that requires ever more handouts. Add to this the demographic issue of an aging population requiring more pensions and government health care and you have a recipe for ever-growing government spending. The welfare state has grown enormously throughout the western world (under both sides of politics) and despite the fact that we continue to get richer, more and more people are becoming reliant on the government. Under current policies, the Australian government will go bankrupt in about 40-50 years… and Australia is actually in the best position of any western country.

For a while, this ever-growing government can be paid for through higher taxes and a growing economy. This is where the problems of the regulatory state kick in.

For many people, businesses are dangerous and need to be controlled, while politicians & bureaucrats can be trusted and should be doing the controlling. The problem with this is that it necessarily increases the costs of doing business and creates barriers to entry. In each case, the defender of big government will insist that their specific regulation (OH&S, labour law, consumer protection, fair trading, protectionism etc) is only a minor cost and is super-important… but when you add up all these minor costs you slowly suffocate the free economy.

With a light tax burden and minimal regulation, business will thrive and the economy will move forward. With a bit more tax and a bit more regulation, some businesses will suffer but we will still see economic growth. But as the tax burden continues to increase (to pay for the ever-growing welfare state) and as the regulations continue to build (6000+ pages of federal legislation passed every year in Australia) then productivity suffers. That means lower growth, a less dynamic economy, and slower recover from downturns.

The logical consequence from this is that at some point in the future the western world will face long-term economic stagnation and a permanent budget crisis… with the welfare generation demanding their hand-outs from a bankrupt government. The failure of social democracy.

But not yet.

There are still a number of ways that this could play out. The best-case scenario is that a couple of western economies abandon the social-democratic agenda of welfare & regulation and return to the ideas of free-market liberalism. The free-market isn’t perfect, but it is progressive, constantly evolving, full of opportunities and (most importantly) sustainable. The worst-case scenario is that the current crisis represents the collapse of the west. A more likely middle ground is that the western world pulls through the next few years with some minor reforms and then continues its slow sleep-walk towards stagnation and decline.

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