The Welfare State as an Underlying Cause of Spain's Debt Crisis

The ongoing crisis that so dramatically hit Spain in 2008 was at least in part caused by the countercyclical monetary policy the Federal Reserve and the European Central Bank applied in the first years of the new century. Their artificially low interest rates must in part be responsible for the excessive leveraging in banks, businesses, and households. Their unwarranted use of monetary policy to foster growth has recoiled on them with a vengeance. Now central bankers and their political masters find that they cannot perform as expected. A constant feature of financial crises in the past two centuries, as Reinhart and Rogoff (2010) have noted, is that, when banks collapse, companies fail, and families go insolvent they all turn to the central bank and the government to bail them out. The authorities usually Fred it difficult to answer those anguished calls even when they have the power to print money, so that devaluations and write-offs ensue. But matters are made worse when a constant undertow of unfunded social spending makes efforts to change the course of the economy toward safer waters practically impossible. This is what happened in Spain. A housing bubble expanded by artificially depressed interest rates burst when the returns on overvalued assets became too low to attract new investors. As the Spanish government, lacking the power to print money, moved to act as lender-of-last-resort to the financial sector, it discovered that it did not have the funds and could not borrow them, because it was incapacitated by a financial bubble of its own--an uncontrolled entitlement policy. A doubly severe sovereign debt crisis hit the economy. It is now obvious that the social policies of most European nations and those of the United States are financially unsustainable. Welfare states are not suffering from a temporary liquidity problem but from structural insolvency. Since voters will not accept large cuts in entitlements, the only way to maintain those entitlements seems to be to raise taxes and Social Security contributions. But those higher exactions constrain growth and compound the inability to finance social policies. This leaves only one remedy at hand: the hope that inflation will in the end reduce the burden of public debt. This silent acceptance of hidden default through inflation is only one of the moral consequences of the continuous expansion of entitlements. Women use repeated pregnancies to extend their reliance on welfare. Men elude responsibility for their offspring. Families shift the burden of educating their children onto the state. People do not save for health care or pensions. Governments react to unemployment by increasing the minimum wage. Rent seekers decry competition, especially from the poor. All this puts democratic politicians in an impossible situation: they ought to tell the voters about the depth and probable default of the unfunded obligations of the welfare state; they should warn of the corruption of social mores caused by the expectation of entitlements; and they should at least think of new institutional arrangements making it possible to attend to the needy without destroying individual self-government. Meanwhile, the problems of the welfare state refuse to go away. Spain's Debt Problem To state the obvious, the sovereign debt problem of Spain is a large and continuous budget deficit feeding into its accumulated debt. The growth of the debt made Financing it more and more expensive, as borrowers demanded larger risk premia. Fiscal consolidation has not yet corrected the drift (see Figure 1). The net increase in debt in 2013 is expected to be 48 billion [euro] ($61.5 billion) and the gross issue of public debt 207.2 billion [euro] ($267.3 billion). These are large sums compared with Spain's GDP of 1.05 trillion [euro] ($1.37 trillion). I mention the gross figure because the refinancing of maturing debt must be covered, and the new paper may have to be issued at a higher interest rate if confidence falters--that is, at higher spreads than the old debt it replaces. …