Speech delivered to the CIS Big Ideas Forum 2010 (Sydney), 2 August 2010
There is no doubt that Europe is living through ‘interesting times’ – this is, of course, a curse, not a blessing.
The last year has been challenging for Europe: Greece nearly defaulted; Spain’s banking system is in trouble; Britain’s budget deficit has ballooned; and cracks have emerged in Europe’s common currency.
And yet, what we have seen so far may only be the beginning of a prolonged period of pain for Europe. It is possible, and may even be likely, that Europe will never recover from the financial crisis.
I know this sounds utterly pessimistic and so this may surprise you coming from a German.
We Germans of course have a reputation of being optimistic, uncomplicated and forward-looking.
No, hang on. I must have got that mixed up.
The Germans really enjoy indulging in visions of imminent Armageddon, looming disaster and the end of the world. There is a good reason why the English language had to import the wonderful German word Weltschmerz, which literally means ‘world-pain’ or ‘world-weariness’.
Oh Weltschmerz! Nobody does it better than the Germans! Forget German engineering, Vorsprung durch Technik or even German beer. If you want to sum up Germany’s national character in just one word, it would have to be Weltschmerz.
The doom and gloom is programmed into the German DNA. In what other language could you scramble words together that contain six consonants in a row?
Well, actually the Germans even manage eight consonants one after the other. And that happens to be just another word symptomatic for the German mindset: Angstschweiß – a combination of Angst (anxiety) and Schweiß (sweat).
I think in English you would simply call this ‘cold sweat’, but it has none of connotations of emotional torture as our beloved Angstschweiß.
Being German thus means inhabiting a world characterized by Weltschmerz and Angstschweiß – it’s not a particularly appealing place, I can tell you.
In my next life, I think would like to be Italian or Spanish instead. Of course, life would still be miserable, but it wouldn’t nearly depress me as much. As they say in Italy: Alla fortuna bisogna lasciar sempre una finestra aperta. – You should always leave a window open to fortune.
The Germans would never leave any windows open for fear it might rain in.
I would probably even settle for being Dutch instead of German. In many ways, the Dutch are, of course, just like the Germans – but at least nobody hates them.
Since I cannot change my German nature too easily, I am afraid you will have to endure my boundless pessimism tonight. So back to the topic: The future of Europe. Or actually, let’s be a bit more blunt: The end of Europe.
A sober look at the facts and figures of Europe today is enough to understand why there is ample reason for pessimism, even if you are not German.
It is well known that European countries are heavily indebted. It is less obvious by how much. Most of the time we are talking about debt, we are not presented with the full picture. The discussion is usually constrained to just the official, headline data for public indebtedness. These figures are scary enough but they are just the tip of the iceberg.
Let’s look at the United Kingdom, for example. A few days ago, the Office for National Statistics released a working paper under the seemingly harmless title Wider Measures of Public Sector Debt – A Broader Approach to the Public Sector Balance Sheet. They probably made it sound so dull because the content is anything but.
The official figure for the United Kingdom’s public sector net debt stands at £903 billion – or 62 percent of its GDP. However, once you consider Britain’s hidden burdens, the numbers change dramatically.
After adding the government’s exposure to RBS and Lloyds Banking Group, the unfunded public sector pension schemes and the equally unfunded state pensions, various off-balance sheet obligations from private finance initiatives and nuclear decommissioning liabilities – and not forgetting miscellaneous guarantees and contingent obligations – the total exposure comes to somewhere between £3.7 and £4.8 trillion – that is between 254 and 330 percent of British GDP.
These figures are closer to the truth about public sector debt in the United Kingdom … although they are coming out of a government agency. Unfortunately, they still do not adequately reflect the state of public indebtedness. The reason is Europe’s worsening age structure.
In a research paper published last year, economists from Munich’s CESifo Institute calculated that the UK had explicit and implicit liabilities of 547 percent of GDP. The report was however based on 2004 data. A few things in the world of finance have, of course, happened since, so the real figure should be significantly higher today. How much higher is anyone’s guess. But whether it is 600 or 700 percent of GDP does not really alter the big picture. If it were a private company, the United Kingdom would be bankrupt.
I apologise to our British friends – sorry Frank! – for singling out the United Kingdom. Actually, I could have taken almost any other European country. The issues are remarkably similar in all their economies. The levels of public debt have reached staggering dimensions.
When we in Australia hear about the European debt crisis, we often fail to realise that the debt issue is not limited just to Greece. Or Spain. Or Ireland. Or Italy. Or Portugal. The acronym for the most indebted countries is getting longer. First it was PIGS with a single I. Then they realised they had forgotten Ireland, and it became PIIGS with a double I. But if you actually wanted to create an acronym for all the European countries with serious debt problems, it would soon become an alphabet soup. Unless you abbreviated it with just two letters: E U.
Even Germany, the reluctant saviour of the eurozone, the lender of last resort to the rest of the continent, is in dire straits. Germany’s debt burden has already reached 1.8 trillion Euros, or 76 percent of German GDP. But again, these official figures exclude pensions and other liabilities. The true figure is not far from the British debt level.
Germany’s supposed economic strength should also be questioned. In 45 out of 50 US states GDP per capita is higher than in Germany. The best thing you can say about Germany is that in the land of the blind which is Europe, the one-eyed man, Germany, is king. A closer inspection shows Germany to be neither particularly strong nor healthy.
Now all of these figures are frightening. They should be enough to rob any European of his sleep. And yet the real scale of the impending disaster can only be understood if we put public debt levels into the context of Europe’s changing demography.
Europe has experienced periods of high debt loads in the past … and recovered. Europe’s public debt after World War II was about as high as it is today. So should we be worried? Yes. Because between then and now are two important differences.
The first difference is obvious: The post 1945 debt burdens had been caused largely by a single event, the Second World War. Today’s debt burdens, on the other hand, have a much more structural character. Far from being created by a single tragic event, they are the result of decades of economic mismanagement. Europeans have become used to living beyond their means, comfortably cushioned from all of life’s ills by overgenerous welfare states. The only way they could afford this was by piling up enormous amounts of debt – and hoping that their children and grandchildren would eventually pay for it.
Which leads me to the second difference between then and now: The post-War debt levels may have been high, but so were economic growth rates. Growth was driven by a young, hungry population that went on rebuilding the continent from the ashes.
Today, you would have to look hard to find young, hungry Europeans. And if you found them, they would not be living in Europe but as expats in America, Asia or indeed Australia. The welfare state has sedated the entrepreneurial spirit in Europe. It’s no wonder that there is no European equivalent to Shanghai, Bollywood, or Google. But beyond that, the lack of young Europeans is a simple matter of numbers.
In all European countries, birth rates have been below the replacement level for more than 40 years. It was a development that demographers watched unfold with horror – but no one (least of all the political class) heeded their warnings. Now that the baby boomers are about to retire, the scale of the demographic problem is becoming clear.
Here are just a few projections. The working age population of most European countries is shrinking. By 2020, France will lose 5.5 percent of its working age inhabitants; Sweden will lose 6 percent; and the Czech Republic 8.3 percent.
Or look at it another way. Pension cost as a share of Luxembourg’s GDP was 8.7 percent in 2007. By 2035, it will reach 17 percent. In Belgium it will rise from 10 to 14 percent over the same period; in Greece it will go from 12 to 19 percent. All these are official forecasts from the European Union’s Ageing Report, so they probably err on the optimistic side.
We should also consider the extent to which Europe’s population will shrink. The United Nations estimates that the continent could lose about 68 million people by 2060. Germany alone will drop from 82 million inhabitants today to somewhere between 65 and 70 million. By then, there will be as many people in Germany over the age of 80 as there will be people under the age of 20.
It does not require any fantasy to imagine what this demographic change means for the continent’s growth prospects. It’s hard to generate growth with a shrinking population. It is near impossible if the remaining population also gets much older. Sooner rather than later, Europe’s demographic decline will lead to negative economic trend growth.
Combine these prospects with Europe’s incredibly large public debt, and you will see that for Europe there is no easy, realistic way out. I predict that in the coming decades, we will either see a series of sovereign defaults or accelerating inflation in Europe. Indeed, we may see both.
What we have witnessed over the past twelve months in Europe was but a taste of the pain that is yet to come. Europe’s economic model, based on a debt-addicted welfare state and unsustainable population developments, is finished.
For us in this part of the world, there are obvious lessons to learn about the toxic long-term effects of the welfare state on society … about the necessity of population policy … about the sweet poison of public debt.
In many ways, Australia today reminds me of Europe in the first decades of the post-war period. We are full of optimism … our population is growing … our economy is booming.
But make the wrong choices about the size of government now, ignore the challenge of population ageing, gloss over temporary problems with public deficits, and just a few decades later, we will end up like Europe – under different stars, but with the same destiny.