After watching for two years the tragic-comic Greek drama, the vicious downward spiral sucking a country into a black hole despite one futile effort after another to "rescue" it, many European governments are telling themselves (though staunchly denying it to the world): "There, but for the grace of God, go I". Softened up by this awful example, 25 of the 27 member states of the European Union [EU] have agreed to conclude treaties with one another to observe the golden rule of a balanced budget allowing only a minute deficit, and to adopt the domestic legislation, including a constitutional amendment if necessary, to implement it. True to form, Great Britain and the Czech Republic begged to be excused (which prevented the radical move of putting the Golden Rule directly into the EU treaties). The passage of the Golden Rule through 25 legislatures is hardly assured, but even the intention of making it the established European fiscal standard merits a look at its logical foundations.
There is a set of fairly universal rules of conduct that comes about spontaneously as a matter of by and large everybody behaving in his or her best interest by treating others the way they wish others to treat them. A rational person will refrain from stealing the property of others in the expectation of others not stealing his, rather than he and the others all stealing from each other. Technically, these rules are conventions which are adhered to out of self-interest and by and large enforced by the threat of retaliation.
Beyond these conventions of right conduct, there are particular occasions to undertake acts in self-denial. They involve the suppression of what Hume called a "passion" in favour of some less palpable and more distant interest that on consideration seems superior, but whose dominance must be reinforced by some explicit undertaking. Such undertakings follow one of three modes:
The Contract. You promise to provide a good or a service of value to another party if he or she promises to provide value in exchange. If the performance of the two promises is simultaneous, you get what you value as and when you give what you value less, while if you do not give, you do not get. There is no conflict between interest and "passion". However, if the other party performs first, you have got what you wanted, and it takes a measure of self-denial to perform your part of the bargain. Contract is the instrument of such self-denial. It is enforced by retaliation, the "shadow of the future" (if you default on this contract, you will have trouble finding parties to contract with you in the future), or by a formal judiciary process. Thus, a contract binds you to do what in certain circumstances you would rather not do.
The Unilateral Promise. You promise to another party, or indeed to the world at large, to do something or conduct yourself in a certain manner without your fulfillment of the promise being conditional on some quid pro quo. Legal doctrine is very firm in holding that this is not a contract. The Geneva Convention on war and prisoners of war is such a promise, as is your word to your wife that you will do the washing up three days a week forever. Such promises are not enforceable except informally by the risk of retaliation and the loss of reputation, a risk contingent on circumstances and not always high.
The Vow. The vow is a promise of self-denial given to yourself that you will not yield to certain "passions", e.g. will not gamble, smoke, drink to excess or take drugs. Enforcement is more problematical than for the unilateral promise. If you do not honour your vow, you may lose reputation and self-respect, but the force of these deterrents is seldom overwhelming. Above all, they might not penetrate the thick skin of the state at all. Thomas Schelling with admirable conciseness called a constitution "a vow" by the state. In its constitution, the latter promises to make certain kinds of social choices and not to make other kinds, for example regarding fiscal policy, the manner of treating judges or more generally, the rules it will apply in the making of decisions about the freedoms and resources of its subjects. If it violates an article of this vow, the enforcement problem is paradoxical: how clear is the picture of the state both intimidating the judges and protecting their independence, or vowing fiscal rectitude while borrowing up to ten per cent of the national product year in year out, whether it rains or shines? How plausible is the idea of the state punishing itself if it transgresses the limits it has set to limit the exercise of its power?—limits that classical liberals still fondly believe to act as a barrier to protect individuals from the encroachment of collective choice.
In 1955 The Economist published a satirical essay, "Parkinson's Law," by Cyril N. Parkinson. The tongue-in-cheek essay spoofed work activity and coined the eponymous "Parkinson's Law," summarized as: Work expands to fill the time available. Some subsequent readers have taken off further on the joking concept, suggesting that political activity expands to the funds available. Perhaps there is some truth underlying every joke.
A political Parkinson's Law lays it down that "Entitlement spending expands to push the budget deficit to the limit just short of bankruptcy". It expands driven by electoral rivalry, and for the same reason it is very hard, sometimes politically suicidal, to shrink it. This law plays a part in the choice of a government's "lifestyle":
1. Spend-and-borrow. This has been the predominant type of Western-style democracies in the last three or four decades. Notable exceptions were Canada and Sweden, both having succeeded in reversing the expansion of their welfare state without too much political drama, and Germany, where Chancellor Gerhard Schroeder (1998-2005) pushed through a labour market reform which set the German economy, sluggish like much of the rest of Europe prior to his reforms, on a vigorous upward course that cost him his political life. Elsewhere, spend-and-borrow continued to predominate until 2008 when every government got a big fright, but nevertheless continued with this policy because the momentum was hard to stop and the fraught years after 2008 did not seem the best time to change direction.
2. Spend-and-tax. This is the rage that naturally follows when spend-and-borrow has been pushed to the limit and the rise in the national debt becomes really frightening. At this stage, governments scramble to shut tax loopholes and to raise taxes on the rich, on incomes from capital and enterprise—measures that pay political dividends but do too little to tackle the deficit. They also crank up value added taxes which are "anti-social," hitting the poor and the middle class, but which have a big enough effect on the deficit.
It is worth noting that spend-and-tax is the "lifestyle" that most easily satisfies the Golden Rule; the latter does not prohibit high spending provided taxes are set high enough for revenue fully to cover it. Most economists would condemn this way of satisfying the rule. However, in the short and medium term there may be no other way. The Golden Rule is partly a unilateral promise by which a country in the Eurozone seeks to reassure its fellow members in the zone that it will not upset the common currency applecart, and partly a vow to bite the bullet for its own good. As such, it has only very weak enforceability. Neither unilateral promise nor vow are easily enforceable. The idea that the European Union will somehow sanction a breach of the Golden Rule is wishful thinking by Berlin and grown ups do not take it seriously. Nevertheless, if against the odds the Golden Rule were adopted and by and large respected, it would be a force for good, because it would make governments and the electorates face the realities of scarce resources instead of the dream of cloud-cuckoo land, where the money is always there to back any measure that seems a good idea at the time.
3. Curb spending and raise taxes. In an extreme version, this is the shock therapy that must be adopted when the state finds itself in the danger zone where the national debt is nearing 90 per cent of the national income, let alone more, and the interest on the debt is about to rise sharply at the margin because successive tranches of it that fall due for renewal can only be refinanced at escalating rates. Britain in 2010 seemed to be going for such shock therapy. The therapy will only be accepted by the public when it is sufficiently frightened and interests groups ease up on the merry-go-round of protecting themselves at each other's expense. In its mild form, curbing spending by offsetting its basic propensity to rise, and gently intensifying the fiscal pressure along the lines of least resistance, is the fairly typical medium-term way of life of most states. It combines political survival with minimal economic growth.
4. Curb spending and reduce taxes. There is, if courage and a bit of luck lead to it, a possible path for the economy that converges toward the Golden Rule. Along this path, growth lifts revenues sufficiently for the rate of the deficit to be smaller than the rate of real growth plus the rate of inflation. National debt falls in total and falls even more as a proportion of national income; a virtuous cycle operates. Thanks to compound interest, the national debt as a share of national income shrinks faster than you would think, and finally a balance is reached where even a bit of bad luck, such as an adverse turn in the world economy, can be safely resisted. When the path of the economy reaches this benign stretch, we could say that beyond the Golden Rule, a Platinum Rule has been satisfied.
When most men and women need to make some effort to survive and to better themselves, there will be economic growth unless sufficient causes frustrate it. There is, in other words, a presumption of growth; it is not positive stimuli that are really needed to establish it as the normal state of affairs, but rather the removal of the obstacles we put in its way.
The unemployment rate in Spain has long been at least 20 per cent and currently it is 23 per cent. For under-25s, it is double that rate. The majority of the employed have legal job protection of such force, including judicial review of the "fairness" of dismissal, that employing someone on other than a short fixed-term contract is to give him lifetime ownership of the job. In France and Italy, the risk of hiring a person and having to live with him whether he is suitable or whether he is still needed, is only a little smaller. A French industrial company puts the average cost of dismissing an engineer at 100,000 euros. There is a 9.8 per cent unemployment rate in France and a six-figure vacancy for artisans and other skilled workers. The educational establishment loathes apprenticeships which "condemn" the young to manual labour and stop them from going to university. There are 100,000 apprentices in France and 600,000 in Germany. Germany has an export surplus of 170 billion euros, France an import surplus of 70 billion. The annual cost of complying with all regulations and doing the paperwork involved in the United States is estimated at $10,600 per employee. New banking regulations in Europe are forcing banks to starve perfectly sound small enterprises of working capital. And so on. Officious regulation and well-meaning but destructive income redistribution are the obstacles that keep growth below what it could otherwise be.
There is a rough-and-ready correlation between the weight of these obstructions and interferences—a heterogenous jumble that cannot be expressed as a single index number—and the share of national income pre-empted for purposes decided by the collectivity, such as the cost of running the state and the local authorities, entitlements and "social" insurance. In 2011, out of 100 euros of value the average Frenchman added to the national income, 57 were pre-empted by the state for these purposes, leaving him 43. This is too little to the point of being absurd. The individual may try to get out from under by borrowing from the next generation, i.e. vote for deficit financing. This could be prevented by sticking to the Golden Rule. But in either event growth would be stifled.
There is no indisputable level that would satisfy the Platinum Rule as well as the Golden one, but it is obvious that any marginal rise in the share left to individuals' own choice would have a positive marginal effect. The promised land may begin at 60 or more for the individual, 40 or less for collective choice. It would be reassuring to know that after the bitter experiences suffered since 2008, European states are on the path towards it.