Struggling welfare state in EU is a stark warning
The question as to how European nations arrived at their present state of economic dysfunction is perhaps as important as what they should do to revive their sick economies. The factors which have driven Europe's crisis are deep seated, and cannot be resolved through monetary manipulation by central banks or the substitution of technocrats for popularly elected politicians.
Many economists have rightly cited the maintenance of the euro currency zone as an issue, which places the Greek tourism economy under the same monetary policy umbrella as manufacturing giant Germany. Allowing Greece and others to exit the eurozone is a sensible option, however, the exile of heavily indebted nations from the currency union will not resolve a crisis of excessive public spending that has spanned many years.
The share of general government expenditures to GDP for the original eurozone countries plus Greece averaged 52per cent last year, increasing by seven percentage points since 2007 as countries subsequently embraced big spending fiscal stimulus.
The historical data for the eurozone countries, where it is available, shows that the size of government increased dramatically since the late 19th century, when spending as a share of GDP was capped at about 10 to 15 per cent.
This spending growth was caused in large part by a transformational change in the scope of activities that governments took upon themselves, including publicly provided payments for unemployment, pensions, health care, housing and other social purposes.
Notwithstanding the exploits of Bismarck in Germany the welfare state was a largely unimaginable concept in Europe during the 1880s, as welfare state spending remained at below 1per cent of GDP.
By 2010 the landscape had changed with average expenditure on cash transfers and social benefits in kind within the original eurozone and Greece standing at 30 per cent of GDP, or over half of total general government spending. The welfare state in Europe and elsewhere has done much more than displace core public expenditures in areas such as defence, policing and justice.
From an economic perspective numerous studies show that larger welfare states impede private sector production and growth by distorting incentives to work and save.
The eurozone states also impose internationally uncompetitive tax regimes to finance welfare payments, worsening the burdens shouldered by those not reliant upon government handouts. Combined with population ageing, low fertility rates and large immigrant populations whose work prospects are hampered by slow jobs growth and labour market skill mismatches, the ingredients exist for a welfare state that generates significant fiscal and economic harm.
As much as the Europeans now find themselves trapped in this Catch 22 situation, it would be a mistake to think that Europeans themselves have not been long aware of the challenges of a growing welfare state.
Writing in the aftermath of World War II, German economist Wilhelm Ropke warned of the degeneration in social values, including self reliance, as governments cater for a growing array of perceived social needs throughout the community.
Ropke referred to the irony of the growing welfare state when individuals and families, with their unprecedented wealth levels, can now more effectively help themselves than at any other period in human history.
Similar sentiments were echoed by another German, Walter Hamm, who wrote in the early 1980s that ''equality must be paid for with great sacrifices of prosperity for the general public''. Hamm raised concerns over what he saw as a ''possible defect in parliamentary democracy,'' whereby politicians tried to secure votes by seducing the public with promises of ever increasing welfare payments.
As European riots poignantly demonstrate this argument can run both ways, since voters who become dependent upon government subsidies tend to strongly object to any plan to reduce their entitlements. While these and similar criticisms of the welfare state have proven to be prescient, they were not heeded as the ''social market economy'' compact entailed more welfare supplicants feeding off the taxes siphoned from the fiscally besieged productive classes.
A case can be made for the argument that Europe's struggle to contain its welfare state holds some lessons for us here in Australia.
While welfare state expenditure in Australia at 19per cent of GDP is significantly lower than the eurozone average, significant growth in spending has been nevertheless recorded since the 1970s.
To some extent this has been reflected in the working age share of welfare recipients rising from 13per cent to almost one third last year.
The integrity of our means-tested welfare state has also been fraying at the edges through the extension of family payments, child-care subsidies and other benefits to middle and upper classes.
The degree to which the Australian welfare state is subject to fiscal churn has been revealed by analysis showing that more than 40per cent of Australian families receive more in welfare payments than they pay in taxes. By creating the fiscal illusion that increasing welfare spending is somehow costless, the long-term risk is that we too will inherit a system that fails to assist the genuinely needy at reasonable cost.
As the current European situation attests, this prospect is something that is best avoided.