“What Next, EU?”
By Dr. Rudolf Pozgay, courtesy of the Austrian Economics Center
The amount of economic and social challenges that the European Union has faced to date have given rise to the idea that EU reform is required. An example of such efforts is Juncker’s “White book” with five possible reform scenarios, as well as the resolution of the European Parliament from 16 February 2017 on improving the functioning of the EU. What both of these efforts have in common is that they are trying to reform institutions that are irreformable in the current state of political elites. On the other hand, it must be clearly stated that the EU would be a great organization in the sense of a community of free nations and nationalities living in Europe, provided that the functioning of individual countries as well as the current EU concept were not based on bad, amoral principles.
What bad, unethical principles are we talking about? In essence, there are two complex and interrelated problem areas.
The first problem area is related to the system of governance in individual EU member countries. Following World War I, most countries in Europe turned to political institutions based on representative democracy. This development is not at all encouraging. Democracy has already been highlighted as a bad form of government by Aristotle in his work, and developments so far prove him right. Within the functioning of representative democracies, citizens are important for politicians only during election time. During that time, rival political elites promise the moon to voters. At the same time, there is not much difference between right-wing and left-wing political elites. It is always about some form of benefits and promises for voters. Potential voters are most sensitive to social benefits and in the process of their development, European countries have gradually transformed themselves into social states.
It is characteristic for the social state to take responsibility and care for the lives of a substantial part of the population. However, in life, nothing is free, and the obtained social benefits have associated costs. As election campaigns, in order to secure votes, led to increases in social benefits and government engagement in correcting the so-called mistakes of the invisible hand (subsidies, stimulating demand, regulation, etc.), the financing of such actions required obtaining an increasing amount of funds from productive parts of the society by means of taxes and levies. Tax and levy increases, however, also have their limits. When the state collects on taxes and levies more than half of the income of citizens (which has long been a reality in European countries), citizens’ dissatisfaction starts to threaten political elites. That is why governments have to a large extent started addressing the problem of lack of finances by deficit government budgets. As a result, there is ever-increasing debt, which in turn means society and current generations are being financed at the expense of future generations.
On the other hand, the expansion of the social state, as the state increasingly affects the lives of people, leads to family degradation and the restriction of human freedom. In essence, the state has through its actions eliminated the three-generation household family – the family, which in the past was able to take care of both the upbringing of children and taking care of old family members. However, increasing the tax and levy burden meant that one family member-provider was not enough to feed the whole family. Families were forced to employ two main family members. Thanks to the social state, we are witnessing the decline of the family with all the associated social negatives.
Developments have reached such a stage that the social state is confronted with an inability to resolve issues that it has taken into its competence from a family-based society. This concerns in particular the financial entitlements of the social and pension system, which contribute significantly to expenditure. Particular attention should be paid to the pension system, which is based in most EU countries on an absurd Bismarckian system of intergenerational solidarity. It is worth mentioning that Bismarck introduced this system in 1889 not for social but political reasons.
The unsettling situation of social states in the EU can also be seen from EU statistics (Eurostat). If one hundred years ago an average of 8 to 13% of European GDP funded state expenditure, it is now almost half of GDP: 44.8% in 2017 for the EU28. But such an amount is not enough to cover the expenditures of states that are constantly indebted at the expense of future generations. The EU28 in 2017 spent € 150 billion more than they collected, under threat of punishment, from their citizens and companies on taxes and levies. At the same time, large expenditure items are linked to the non-productive sphere. Social expenditure amounted to more than 45% of expenditure in 2017. At present, contributions to the social system (including the pension system) are not sufficient to cover social spending. In 2017, social spending in the EU28 was up by € 1125 billion compared with social earnings, and therefore had to be subsidized from tax revenues. The situation will become even worse due to unfavorable demographic trends. The share of citizens over 65 will increase to around 28% of the total population in Europe by 2050, an increase of about 75% compared to the current figure. Another significant item of budget expenditure are salaries and wages of public administration employees, which account for over 21% of the EU28 expenditure. The expansion of the social state is also illustrated by the fact that the appropriations for social spending in the EU28 have increased by more than 34% over the last ten years (2007 to 2017), with GDP growing by only 19% over the same period.
The amoral relationship of the ruling elite of the social states to future generations can be illustrated by the evolution of debt. Government debt of the EU28 increased by 68% in the last 10 years and at the end of 2017 reached € 12.5 billion.
The results of the development of the social state so far are a gradual economic as well as moral decline. Why is that so? In representative democracies, democratic elections are used to justify taxing those who are productive in favor of the unproductive ones. The result of taxation is the distribution of taxpayer’s money for the benefit of political parties, their supporters and potential voters. Various social packages in effect lead to the expansion of the non-productive part of society. This reduces the overall production capacity of society. The high tax and levy burden, together with an unfavorable business environment, results in a gradual decline of the former middle class, which on the other hand is confronted with an increase in the wealth of unproductive political elites and a small group of their supporters.
With the rising dependency of citizens on the social state, the cost of political elites also increases in persuading citizens to vote. Playing for election results is increasingly driven by rich individuals as well as wealthy companies that provide political elites with campaign funds, including mass media support. Political elites thus become dependent on a small group of society’s richest members. As a result, the proclaimed democracy has actually turned into an oligarchic system of governance, with a prevalent financial oligarchy. An integral part of such a system of governance is corruption at practically all levels of public administration.
Another economic downside of generous social policies is that they are, by their nature, going against habits of saving, thereby preventing the creation and growth of real capital as a necessary condition for economic development.
Moreover, representative democracies lead political elites to centralist power aspirations. Centralization is a means for unproductive political elites to strengthen their position in society. It is worth noting that a significant part of intellectual elites, whose existence is linked to resources gained by the political elites from the productive sphere, are in great support of these political elites. Centralization is only justified in solving crisis situations of socio-economic significance (e.g., major natural disasters, war, conflict). Otherwise, centralized governments slow down the way to prosperity because they erode autonomy, initiative, association with and sense of belonging to the local community.
The Brussels bureaucracy, including top EU institutions and bodies, is the concentrated expression of the downsides of centralization in governance. To illustrate the incompetence of the EU institutions, it is enough to revisit the fate of the Lisbon Strategy. Early in 2000, senior representatives of states and governments agreed in Lisbon on an ambitious goal to make the EU the most competitive and dynamic knowledge-based economy in the world by 2010, capable of sustainable growth with more jobs and greater social cohesion. Despite the efforts made by the EU institutions, it was clear after a few years that the inflated targets could not be fulfilled and therefore the Lisbon Strategy was corrected first in 2005 and later in 2010 as well, when the European Council adopted the Europe 2020 Strategy. It is clear already now that the objectives of this strategy will not be met, especially in such sensitive areas as youth unemployment and the poverty level in EU countries. Why is that so? Paradoxically, the EU institutions, in all of their (lack of) wisdom, create and enforce measures (regulation, fiscal and monetary instruments) that, in their effects on economic operators, create barriers to achieving the stated goals. Instead of significant reductions in tax and tax burdens on businesses and residents, the elimination of bureaucratic regulations, the abolition of subsidies and incentives of all kinds, the elimination of the promotion of moral hazard and a number of other phenomena impeding the free development of creative forces, we are witnessing opposite tendencies. Such an approach by the EU institutions leads to bankruptcy instead of prosperity.
Special mention should be made concerning the moral aspect of the conduct of the EU institutions. European leaders are often accustomed to defending European values as part of the defense of their actions. These are defined in Article 2 of the Treaty of Lisbon, which states:
The Union is founded on the values of respect for human dignity, freedom, democracy, equality, the rule of law and respect for human rights, including the rights of persons belonging to minorities. These values are common to the Member States in a society in which pluralism, nondiscrimination, tolerance, justice, solidarity and equality between women and men prevail.
In reality, however, EU citizens are confronted with extortion, self-righteousness, double standards, corruption, wastefulness of European taxpayers’ resources, or failure to comply with their own rules and treaties by EU institutions and bodies and their representatives.
The second set of problems is related to the existing financial system. The financial system in all EU countries operates on principles that are incompatible with the smooth functioning of the market. These principles are:
- fiat money;
- fractional banking supported by central banks;
- central banks.
The fiat money system, money not backed by any commodity, began at the beginning of the last century, and was fully in place after 1971 when the US dollar was completely decoupled from gold. The fiat money system, which also includes the euro, allows, essentially without restrictions, for the manipulation of the monetary supply in the economy. At the same time, the fiat money system enables governments to finance their expenses through borrowing: banks buy government bonds which then serve as collateral for banks to obtain cash liquidity from the central bank.
Fractional banking is a banking system that allows banks to use their clients’ funds that have been deposited with the bank on a current (i.e. not a fixed term deposit) account. In terms of bank regulation, banks are required to hold only a part – a “fraction” (mandatory minimum reserves) – of the money deposited by clients. Currently, the EU’s minimum reserve ratio is 1%. In theory, at the required minimum reserve level, it is possible to generate a 99-fold amount of the originally deposited funds. Available funds (deposits plus money generated on the basis of the multiplier effect) are used by banks to provide loans to businesses and citizens as well as to finance governments via buying government bonds.
Fractional banking is problematic both in legal terms as well as in terms of Jean-Baptiste Say’s law of markets. In Say’s view, money is only a temporary medium of exchange: “Money performs but a momentary function in this double exchange; and when the transaction is finally closed, it will always be found that one kind of commodity has been exchanged for another.” The fractional banking system allows the generation of funds not covered by any goods and consequently to mislead the market participants into believing that they are exchanging goods for goods. In fact, goods are being exchanged for nothing, which is then reflected in the deficiency of goods.
Central banks are supposed to serve as institutions providing currency stability and, at the same time, as the institution of last resort to rescue banks. Central banks are responsible for the monetary policy in the country, ensuring money issuance and influencing the economy through manipulation of the central interest rate. Interest rate manipulations result in increased investment into large amounts of projects that would not be profitable under normal circumstances. The result of such interest rate manipulations, which is complemented by government interventions, are economic cycles with all their negative manifestations.
Central banks also fail to fulfill one of their basic and proclaimed tasks, which is to ensure the stability of the currency. Statistics show that central banks are not able to take on this major role. The biggest negative action of central banks is the issuance of money not covered by goods. The ECB is not an exception as evidenced by the growth of the monetary aggregate M1, which has doubled over the last ten years. The result of such actions is price inflation and thus depreciation of savings. In essence, this is a hidden form of taxation, for which the poorest are paying the most. People are being robbed the fruits of their labor by inflation, as the purchasing power of money is declining. The euro has lost about a third of its purchasing power over its short existence. However, such developments are in agreement with Article 127 of the Treaty of Lisbon, which states that price stability is the primary objective of the ECB. Only because of people’s lack of understanding of money related issues can central banks declare policies of targeted inflation in contradiction with their mission.
Central banks play an additional negative role in the economy and that is acting as the ultimate liquidity-providing institutions for commercial banks. Such a function of central banks promotes moral hazard in the behavior of commercial banks, which are therefore more likely to accept excessive risks. An exemplary case of the anti-social approach of the ECB and EU’s political elites was the resolution of the debt crisis of the PIIGS countries, where large French and German banks were at risk, because they held bonds of these countries. The solution consisted of borrowing “cheap” ECB money from the eurozone banks and creating the European Financial Stability Facility that European taxpayers funded in order to “solidarily” help troubled PIIGS countries to avert problems with government debt repayment and thus the insolvency of vulnerable banks. The fact that such a solution was not in accordance with Article 125 of the Treaty of Lisbon, which states that each country is itself responsible for its management, was only insignificant to the European political elites.
The ECB also actively assists banks in improving the structure of their assets, since 2015 massively buying securities (mostly government bonds) from banks. The result is, other than the increase in ECB’s assets – the figure for the end of 2017 was close to € 4.5 billion, or around 40% of the euro area’s GDP – the above-mentioned money supply growth and the resulting inflation.
Sadly, Henry Ford’s statement still holds true today: “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” With the current situation in Europe it does not at all look like a revolution is coming.
4.Future developments in Europe
To summarize the effects of employing unethical principles in politics and economics, the current developments in the countries of Europe can be described in particular by the following unfavorable features:
- decline of the traditional three-generation household family;
- growth of unproductive working age population;
- inefficient use of an ever-increasing amount of money earned from the productive sphere;
- increasing levels of debt being passed on to future generations;
- a monetary system based on dishonest money;
- devaluation of products of labor due to steady decline in the purchasing power of money.
The reactions of the European political elite to the situation in Europe so far do not indicate that the elite would be keen to take action and tackle unethical practices in politics and economics. The political elite still believes that we are moving in a tunnel where, thanks to their efforts, at any moment a spark of light will appear at the end, signaling a bright future. In reality, however, Europe is at a dead-end. It is to be expected that the political elite will seek to address the situation by further integration in the form of centralization of fiscal policies, tax harmonization and even greater redistribution. As a result, the poor will be even poorer, and the rich (especially those linked to political and financial structures) will be even richer. Europe will become not a land of free people, but a country of (indebted) slaves. It is highly likely that radicalization will spread in Europe, also due to a senseless immigration policy, when hundreds of thousands of economic immigrants from Africa and Asia are arriving in Europe. These immigrants are not delivering any economic benefit; on the contrary, they represent an enormous burden on the already fragile social systems in the EU. The result will be an increase in social tensions that will lead to serious conflicts.
5.What would Europe need
To be clear, a turnaround towards prosperity is inevitably dependent on radical reforms related to restoration of moral aspects of the lives of individuals and society. This means implementing reforms based on the following principles:
- Restore the role and place of the traditional three-generation household family in the society;
- Base the relationship in society on natural law, according to which a person has the right to live, to own property and to express himself freely;
- Drastically reduce the role of governments, as the current development, based on the expansion of the functions of governments with a constant distortion of the market, brought most European countries into a state of economic, social and moral malaise;
- Let people take responsibility for their destiny again;
- Base the monetary system on sound money.
These principles are inherently in conflict with the current integrative approaches of European politicians. Such integrative approaches must be fundamentally rejected because they lead to a scenario of failure. Europe is a cluster of culturally and economically diverse countries in which further subsidization of lower performing economies by those that are more productive will lead to increased economic and social tensions. Centralization that interferes with its (unqualified) actions in the mutual cooperation of economic entities means wasting precious resources. In order to ensure prosperity in Europe, a completely opposite approach must be taken. Not centralization, but decentralization. We need not a centralized Europe, but a Europe of cooperative regions, including enhancing the status and role of regions and municipalities in coordinating the activities of citizens and businesses within their territory. Decentralization is an important prerequisite to enabling direct participation of citizens in decision-making processes in the region. It should be stressed that decentralization would be ineffective without a radical reduction of the role of the state.
From the nature of the problems typical for the EU countries, it is clear that a turnaround and ensuring the transition to a trajectory of prosperity would require, in line with the above principles, undertaking major reforms along the following lines:
- Address the co-operation of European countries only within the scope of the international agreement on the European Economic Area. In this context, to abolish all EU institutions and bodies, with the exception of the European Council as a coordinating body with resolutions having a recommendation character.
- Agree on a transformation program to move to gold-backed currencies and to change the rules of the banking system with the aim of eliminating fractional banking.
- Reduce the role of the state in European countries to that of ensuring the rule of law (justice), defense, security and foreign representation. Other existing state activities should be cancelled or transferred to the private sector.
- Financing of the aforementioned functions of the state should be funded by a per capita tax, which would also apply to legal entities. All other taxes should be cancelled, with the exception of a revised turnover tax, which will be temporarily left in effect to finance the phasing out of the current pension system. State-run pension systems, which are based on intergenerational solidarity, as well as the health insurance of pensioners, should be transformed to family savings systems with voluntary insurance.
- Rationalize public administration, and at the same time increase the role of local and regional authorities in coordinating activities of businesses and citizens within their territory.
- Transform political systems of countries into participatory democracies at the level of municipalities and regions.
Dr. Rudolf Pozgay is an independent consultant with over 35 years of experience and expertise in areas of economics, banking and e-commerce. He served for 10 years as CEO and Chairman of the Board of the Slovak National Clearing Centre, provider of interbank clearing services for banks in Slovakia.