In 1930, with the Great Depression in its early stages and British unemployment already around 15 percent, John Maynard Keynes wrote an essay about the economic glory to come. He wanted, he said, “to disembarrass myself of short views and take wings in the future,” and his conclusion was that “the economic problem may be solved, or be at least within sight of solution, within a hundred years.” Indeed, he argued, the economic problem would turn out to be trivial in comparison with the “permanent problem,” which was how to occupy all the leisure that prosperity would bring: how to “cultivate into a fuller perfection, the art of life itself.”
As bizarre as it seemed with banks failing all around, Keynes believed that, while there would be turbulence along the way, living standards would soar to unimagined heights thanks simply to the power of compounding applied to historic rates of growth. As it turned out, Keynes was right. In the United States, average real disposable income per person—the purchasing power of the money that’s yours to spend or save—tripled between 1960 and 2009.
Keynes asserted that while the “struggle for subsistence” had been the “most pressing problem . . . not only of the human race, but of the whole of the biological kingdom from the beginnings of life in its most primitive forms,” humans, or at least humans of developed nations, had cracked the code. In his new book on global prosperity, The Rational Optimist, Matt Ridley presents a graph of world GDP per capita in constant dollars that consists of a line that runs roughly horizontally from the year 1 to about 1850, then rises almost vertically to today. The success, Ridley concluded, came through “exchange, specialization, and the invention it has called forth.” Like Keynes, he was merely restating Adam Smith’s insight of 1776—that free enterprise and free trade bring wealth that continuously renews itself through a virtuous cycle of what Ridley calls “everybody working for everybody else,” rather than acting as one’s own butcher, brewer, and baker.
So far, so good. In fact, very good. But what does happen after the economic problem has been solved, as it has been in such places as the United States, Japan, and Europe? Italians, for example, are six times richer now than their grandparents were in 1950. For many Europeans, satiety has been achieved, and therein has arisen a new problem, one not anticipated by Keynes.
Prosperity, it seems, can bring sloth, which in turn disrupts the virtuous cycle, though not immediately. There is a period, which I believe we are in right now, where the disruption is not apparent, where it can be obscured through government monetary and fiscal manipulation. But eventually, a simple rule will prevail: you can’t live well if you don’t work.
It is hardly surprising that work produces well-being, and if work diminishes, then well-being, even in the most advanced economy, will slow down, stop, or shift into reverse gear. “Decadence,” with its connotations of self-indulgence and decline, is not too strong a word for the response we have seen to economic success, especially in much of Europe, over the past few decades.
In 2004, the year he won the Nobel Prize, Edward Prescott, an economist at the Federal Reserve Bank of Minneapolis, published a paper titled “Why Do Americans Work So Much More than Europeans?” The data were stunning. Prescott found that the average output per adult between 1993 and 1996 in the United States was 75 percent greater than in Italy, 49 percent greater than in the United Kingdom, and 35 percent greater than in France and Germany. “Most of the differences in output,” he wrote, were “accounted for by differences in hours worked per person and not by differences in productivity.”
In other words, Americans don’t work any more efficiently than Germans; we just work a lot more. Not only do we work longer hours each week and take fewer vacations; we also work more years of our lives, and a higher proportion of our adults are working. In 2007, for example, American men, on average, retired at age 64.6, while Frenchmen retired at just 58.7 and Austrians at 58.9. That same year, 72 percent of Americans, aged 15 to 64, were in the workforce, compared with 59 percent of Italians and 64 percent of French.
Prescott showed that these differences are of fairly recent origin. During the period from 1970 to 1974, Europeans—including the French, Germans, and British—generally worked more than Americans. At that time, however, Europeans were less productive than Americans, so their overall output per person was about the same as it was in 1993-96: around one-third below the U.S. level. So, as Europeans became more efficient (producing more goods and services per hour of work), they cut back on their hours, choosing leisure over work. And the gap has widened. By the time Prescott won his Nobel Prize, Americans were working 50 percent more than the French.
The result is that Americans produce and earn considerably more than Europeans. In the U.S. we make $47,000, compared with $36,000 in Germany and the UK, and $34,000 in France.1 In fact, as the Michigan State economist Mark Perry points out on his blog, Carpe Diem, citizens of America’s poorest state, Mississippi, have a higher GDP per capita than Italians, and Alabamans surpass Germans, French, and Belgians.
In his paper, Prescott fingered the culprit: high taxes. “The surprising finding,” he wrote, “is that this marginal tax rate [difference between Europe and the U.S.] accounts for the predominance of differences at points in time and the large change in relative labor supply over time.” Taxation rates on the next euro of income became so high that people were discouraged from working—especially with the enticements of early retirement.
But this explanation is incomplete. Why are taxes so high in Europe? Certainly not to maintain a strong defense but rather to pour money into a welfare state that provides lavish support to retirees, perennial students, and others who aren’t working. In other words, Europeans have chosen to have workers support non-workers in their leisure. This is a social choice to which voters are, of course, entitled, and a choice that seemed deserved and even prudent given the achievement of the economic success that Keynes had predicted back in 1930.
Paul Krugman, who would later win a Nobel Prize himself and serves as cheerleader for Euro-economics, wrote five years ago that
Americans are doing a lot of strutting these days, but a head-to-head comparison between the economies of the United States and Europe—France, in particular—shows that the big difference is in priorities, not performance. We’re talking about two highly productive societies that have made a different tradeoff. . . . And there’s a lot to be said for the French choice.
Well, not really. GDP per capita in the U.S., at purchasing-power parity, is 41 percent higher than in France. With their taxes and their labor regulations, the French and other Europeans have taken the leisure side of the tradeoff to an extreme.
France is not wealthy enough to retire. No nation is.
A financial crisis can pull the covers away to give us a clear look at what’s underneath, and the current crisis has exposed Europe as a fool’s paradise. “The fundamental cause of the financial crisis,” wrote the George Mason University economist Tyler Cowen on his blog, Marginal Revolution, “is people and institutions thinking they are more wealthy than they are.” An American homeowner who was armed with an appraisal saying that the value of her house had risen in three years from $700,000 to $1 million was able to borrow $300,000 against that increased wealth. The problem was that the increased wealth she borrowed against turned out to be illusory, to the chagrin of borrower and lender both.
The same with nations. Europe supported its welfare state with borrowed money, a practice that can be perfectly healthy as long as both welfare state and debt are modest and loans can be serviced by diligent workers. Europe, however, is not nearly as wealthy as it thought it was, or as wealthy as its national way of life indicated.
Take Greece. A perennially poor country with a history of fiscal irresponsibility that goes back to Dionysius of Syracuse in the 4th century b.c.e., Greece joined the European Union in 1981 and the eurozone—the continent’s monetary union—in 2001. Since the second event, especially, Greece has been behaving as if it were truly rich. The secret was borrowed money. At the end of 2009, the country had a public debt equivalent to 114 percent of its GDP. That’s on top of the 3 percent of GDP that the European Union contributes as direct aid each year. Meanwhile, Greece consistently violated the EU’s rules for minimum deficit and debt levels. The Greeks, however, lived better and better, with an official retirement age of just 58. Only three-fifths of adult Greeks under age 64 were in the work force.
What used to happen to nations living beyond their means is that they defaulted on their debt. “Greece’s default in 1826 shut it out of international capital markets for fifty-three consecutive years,” write Carmen Reinhart and Kenneth Rogoff in This Time It’s Different, their indispensable book on the history of financial crises. In fact, Greece has had five separate instances of default or rescheduling of its debt since that time; Germany, eight; Spain, 13; Portugal, six.
Default can impose needed fiscal discipline on a government. But in an age of financial magic and euro-solidarity, default for a European nation is not a burden that has to be borne—at least not yet. On the brink of not being able to pay its debts earlier this year, Greece was bailed out with $100 billion in loans from the 15 other eurozone countries and about $50 billion from the International Monetary Fund. This year, the Greek government will make interest payments amounting to 15 percent of GDP on its loans (the U.S. pays less than 3 percent). With Portugal and Spain and perhaps Italy heading for similar trouble, Europe announced it would guarantee debts up to $955 billion.
There are two problems with such bailouts. First, they do little or nothing to end the leisure-seeking practices, encouraged by high marginal tax rates and labor regulations, that led to the near-defaults in the first place. Greece may promise austerity as a condition for being saved, but don’t count on delivery. Second is the matter of moral hazard—the tendency of insurance against calamity to provide an incentive toward behavior that produces calamity.
I warned of the dangers of moral hazard during the current financial crisis in an article in this magazine last year, and, unfortunately, we are seeing those predictions being realized. Much pain was caused by the crisis, but much was mitigated as well by government policies that kept profligate banks and other businesses alive that should have disappeared—and, of course, Washington took the occasion of the crisis to increase the size of its own welfare state. What the eurozone nations have done in bailing out Greece and pre-bailing Portugal and the others is to introduce a heaping helping of moral hazard that may seem nourishing at first but that inevitably will cause severe indigestion, or worse.
The lesson of the Rinehart-Rogoff book, which looks across eight centuries, is that financial crises produce sovereign debt crises. The pattern is that nations take on massive amounts of extra debt to dampen the effects of the initial crisis. These high levels of debt reduce growth, thus diminishing expected tax revenues and raising welfare costs. The nearly inevitable result is default, restructuring (that is, telling creditors that they will have to accept, say, 20 cents on the dollar), or debasement (impossible for a eurozone country to accomplish unilaterally unless it drops out of the currency union). While these are nasty consequences, they teach important lessons to creditors and borrowers alike and, for a time at least, have a salutary effect. Even if Keynes’s “economic problem” has been solved, people have to keep working, but there is no reason they can’t cultivate the “art of life itself” at the very same time.
The paradise of leisure that Keynes predicted is impossible in stasis. To keep it going, a country has to keep growing. This is an important lesson for Americans as well. The Congressional Budget Office is predicting GDP increases of only 2.2 and 2.3 percent beginning the middle of this decade, compared with the 3.5 percent average for the quarter-century that began in 1983. With such anemic growth and with reasonable assumptions of spending and taxes, the CBO projects that America’s debt-to-GDP ratio will rise to 200 percent—triple its current level—by 2032.
While the United States is not Europe, many of our states clearly have aspirations in the same decadent direction. With high marginal tax rates and regulations that discourage work, California this year is running a deficit of $20 billion, and a recent study found that the pension shortfall for government workers is $500 billion. Investors were recently paying about $300,000 to buy credit default swaps—that is, an insurance policy—on each $10 million in California municipal bonds. That’s a rate 50 percent higher than on bonds issued by Kazakhstan. As a monetary union, the United States may face a decision similar to that of the eurozone nations: should the federal government bail out California? If it does, we will have entered a fool’s paradise on this side of the Atlantic as well.
1These numbers refer to per capita GDP, at purchasing-power parity (that is, with currencies adjusted for what they can actually buy.