The current crisis through defects of representation

Originally published in Italian on www.lettotralerighe.it; August 17, 2011(direct link to post: http://lettotralerighe.blogspot.com/2011/08/fattori-determinanti-dellattuale-crisi.html)
One would probably expect from an economist a number of analyses of current market conditions with many graphs and tables.

Those are coming (in fact they are already done) but at the moment I think it is more relevant to clarify two important factors which, in combination, have taken the current European situation to a point which will be difficult to disentangle without a radical change in mentality.

The motto of American colonists during the War of Independence was  ‘no taxation without representation’. Americans were not complaining, as many believe, because for high tax rates. Indeed, they were paying much less than English citizens. They wanted, instead, to elect representatives in Westminster: not in a local parliament but that of the motherland. The English refusal brought to the War of Independence.

Many other wars and revolutions have happened because those who paid most into the system could not take the most important decisions, either because they were kept out of the decision-making process altogether or because they were a minority with respect to those segments of society that they were in fact supporting.

What does this have to do with the current situation in Europe?

Well, there are two defects of representation which could undermine the social equilibrium, as they have already done so with the economy.

The first defect is common with most of the developed world, and is linked to universal suffrage. In a world which is growing older, young generations which produce the most part of wealth are a minority with respect to older generations which receive the most from the State. The result is a growth of entitlements. Clearly, in order to maintain and grow the level of entitlements, which for the most part benefit the elderly, it is necessary to increase the income of the State. This can be done by increasing taxes or issuing government debt. The rise in debt levels has been the consequence of political parties searching for votes among a populace growing progressively older.

Increasing debt today, however, inevitably means having to raise taxes tomorrow if borrowed money is used to pay for entitlements and growth of the state apparatus handing those over, instead of being invested in projects which could increase wealth.

This is the main reason debt in several Stated has grown exponentially after WWII (I past times governments were contracting debt mainly to wage wars). This analysis owes much to those by Niall Ferguson, especially those contained in ‘The cash nexus’ and ‘The ascent of money’. A more typically Italian sort of entitlement is represented by various advantages owned by state-owned or politics-friendly monopolists and oligopolists. This is also a privilege of which few take advantage at the expense of everybody.

The second defect of representation is instead typical of Europe, where important decisions are more and more taken in Brussels and then ratified at national level, while electors chose mainly national and local governments. In fact, if it is true that the European Parliament is elected, it is also true that the Commission (more and more a Government) is not elected directly, but nominated using also criteria of national interest. In a power vacuum during the crisis, then, the European Central Bank had to make important decisions more than once, as political decision mechanisms in Europe are cumbersome and ill fit for crises which require immediate response. Obviously the ECB is not an elected body.

The latter defect of representation is creating frustration towards Europe within a growing portion of the public opinion in the Old Continent.

There are ways to overcome the two defect which we saw before without radical solutions such as a reduction of suffrage, but with very strong political implications.

In order to solve the generational problem, the introduction of a budget clause is needed. This, however, cannot be limited to balancing the budget, as could be done by introducing new taxes. In fact, new taxes reduce growth while maintaining entitlements, essentially penalizing the young. The clause that is needed is that a generation cannot leave more debt that it has found (as said by Laurence Kotlikoff about USA: http://www.bloomberg.com/news/2011-08-03/generational-balance-not-budget-balance-laurence-kotlikoff.html). There are methods in economics that allow to measure these numbers: those methods revolve around the concept of Generational Accounting. The only way forward which is fair to everybody is to reduce entitlements and competition advantages, of which in the end only a minority takes advantage but everybody pays for. In Italy in particular the defect of representation of the young extends, for similar reasons, to Trade Union representation. CGIL, the main Italian Trade Union, reports (http://www.cgil.it/tesseramento/default.aspx) that in 2010 the percentage of pensioners with Union card was 52.1%. Furthermore, the category of active workers with the highest percentage of members was civil servants, with 7.1%. Essentially, almost 60% of all those with a Trade Union card are either receiving entitlements or working in the entitlement system. A way to resolve this defect of representation would be moving contract from nation to firm level. Encouraging steps in this direction have been taken recently. The above data could explain the strong resistance to change from Trade Unions.

To solve the second defect, if a European Union still is to exist, is to accelerate political integration, giving at the same time the possibility to citizens to elect a European government directly. What is needed, in other words, is a lessening of the national decision level and the emergence of European parties which can put forward coherent programmes for the whole Union.