Sunday, December 05, 2010

How Welfare States operate financially

This is a comment I posted over at Armed and Dangerous, which sums up my thoughts on how social democracies in Europe tend to work financially:

The idea behind running those states is that debt is not a problem for that states, because of two mechanisms:

a) Inflation actually reduces government debt (of course, this is on the back of their citizens, which will have to deal with losing wealth). And thus they can use it to limit their debt.

b) Growth is important, because the size of the yearly growth of the GDP is also an indicator to the rise in tax revenue.

In a "perfect" world, so their assumption, growth will outpace inflation and thus provide a safe way to reduce debt and yet have no pressure to actually get a balanced budget and thus make necessary cuts the government. Every one, however, who has witnessed more than a few years of world-wide politics knows at least several issues that are totally destroy this thinking. First, it is a static analysis, that doesn't include changes in laws, regulation and taxes and second it does assume that it is possible to target inflation and to know the actual "inflation" of the moment. Both ideas are highly uncertain, because measurements are indirect and prone to meddling.

If we look at the European welfare states in the last 50 years growth went down, expenditures went up (and so grew the debt) and inflation stayed high, which are primarily the symptoms that caused those nations to fall during a crisis.

At the moment I just try to get hold of all the data on GDP, Inflation and Rise in national debt via the ESTAT (European Statistics Department). Then I will reserve final judgment on my theory =)

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