The European model

I try to be fair in my posts here. Since the beginning, I’m criticizing Greece’s public sector as profligate and overly large. Here comes the fairness part, but is this just a Greek problem? As it turns out, or more accurately as I see it, no, it is a pan-European problem or maybe a pan-EU problem, since public sectors for core Europe as just as large.

source: ECB

From the chart above we can see that general government expenditures are just as large as they are for Greece. This is the “European model” then, but there seems to be a crucial difference with Greece, here it appears that the social state is more than a euphemism. The following chart goes some way into proving this. Social payments and employees’ compensation account for 72% of total government revenue which means that there are additional benefits that the EU population enjoys. Before you say it, public investment is negligible as a % of GDP. Doesn’t this remind you of Greece a bit? Government funds channeled mostly to consumption. How long will Europe be able to be doing this for…?

source: ECB

Under the light of the now raging sovereign debt crisis I consider the next graph to be very important. Interest payments as a % of GDP decline over the years. It seems that our EU counterparts took advantage of the easy-money policy that the ECB administered and managed to secure a relatively low interest cost for their sovereign debt. But what will the figure be for 2010? And more importantly what will the figure be for the  years beyond that? I don't know, I'll let you do your own projections...

source: ECB, Hellenic Ministry of Finance

The combined Euro Area16 general government accounts show that during the past 15 years there was not a single year that a fiscal surplus was recorded. Are the Europeans as profligate and reckless in their spending as we Greeks are? 

source: ECB

Well, I don’t know what the average or median (pick your preferred measure) wage for public sector employees is in core European countries, but I have something tells me that it probably is on the generous side. 

But there is one factor at play here that is game changing, the fact that the European population seems to be aging. This is something that the EU countries cannot disregard. This is putting countries finances in strain. Why? Usually when people retire their spending capability declines, hence with a rapidly aging population Europeans are trying to save more to ensure a smooth transition into retirement and private final consumption remains relatively weak. This is were the government has to step in, in order to ensure that the overall standard of living does not decline (in line with employment due to weak final consumption etc.).

source: ECB

But is there an alternative? Could the private sector play the government’s role here? Well, I think not…

What I think should be done is that governments reduce overall public spending. It will be painful and it might bring some social strife but friction will be smaller now than it will be down the line. I believe that there is a certain stickiness in wages (more so in public sector wages) mostly when they have to be cut. It is just that the European population has to adjust to an lower overall standard of living which is more in line with the current economic reality. The fact that so many EU countries could face contagion during the sovereign crisis is proof that market participants view that large governments is not a problem confined to the periphery. I think that what’s going on now in the periphery maybe is the last wake-up call. I hope that I’m not wrong and that we are not actually beyond that point already…