Spoilt West invites its own decline

By Peter Hartcher, Published The Straits Times, 14 Jun 2012

IT IS easy and natural to think of the woes of the West's main powers as an economic problem. Because that's the way it is presented to us. And it is economic - at least, superficially. But if you take a step back, what we are really living through is the decline of the West.

It's not just about Spain's debts and Europe's currency, or even just about Europe. It's not just about Washington's deficits and the US recession, or even just about the United States.

These are the symptoms and the locations of a common dysfunction, not driven by some remote economic force but by people and politics. That dysfunction is very human, very normal and very simple. The central driver in the decline of the West is indulgence.

This indulgence has worked through three channels.

First is government spending. In country after country, political leaders have indulged their electorates and powerful special interests. They gave in to demands and pressures and expectations. They spent money they didn't have. Everyone wants more handouts and bigger subsidies but no one wants to pay more taxes. Political leaders are supposed to manage these conflicting pressures in the national interest. They did not. The deficits began and didn't stop. They piled up.

The main powers of the Western bloc, since World War II at least, have included not just western Europe and the US but also Japan. All three of these huge economies have been guilty of extravagant spending and inadequate taxing.

The pensioners and public servants of Greece have had a lot of bad press in the last year or two for their indulgence. They have been roundly abused for expecting too much in welfare payments and retirement benefits and for not paying enough tax.

And it's true there has been quite a bit of wasteful middle class welfare and ill-disciplined social welfare paid to the voters of many euro zone countries. But most of the governments of Europe have also wantonly indulged powerful special interests.

Farmers, for example. Almost half the European Union's annual budget - 47 per cent - is spent on subsidies to farmers. The Common Agricultural Policy props up hopelessly uncompetitive farmers who should have gone out of business.

But they are a powerful and organised political force, so they get paid for being uncompetitive. This is a weakness shared by Japan and the US, too, though not as extravagantly.

The most famous American subsidisation of a special interest is its wasteful spending on military programmes. In the early 2000s, the US accounted for only 5 per cent of world population but just under half of all global military spending. Another way of putting it is that the US spent almost as much on defence as the other 190 countries of the world put together.

Japan's special fetish has long been construction spending. Not just since the tsunami, but for decades before that.

In 2003, for instance, it spent 40 per cent of the national budget on construction in what was already one of the world's most over-built countries.

One reason was the fact that, for a long time, the construction sector kicked back a share of the money to the politicians who decided the spending.

Under the reign of one former top figure in the long-ruling Liberal Democratic Party, Mr Shin Kanemaru, it was a fixed 2 per cent cash kickback on contracts awarded - a huge pay-off.

The second channel through which indulgence was exercised was the central banks. Central banks in Japan, then the US and Europe, made money too cheap for too long. It was an indulgence. But it was a fatal one.

Central banks were granted independence from politicians for an excellent reason - most people love low interest rates and politicians love giving people what they want.

But if you keep rates too low for too long, it pushes up prices and creates terrible problems.

Until the 1980s, excess money went into the price of consumer goods and you got inflation breakouts.

But from the 1980s onwards, something changed. Excess money started flowing into the price of assets instead - shares and real estate, in particular.

The Japanese let this happen in the 1980s and when the 'bubble economy' popped, it went into a slump from which it is still recovering.

The US - telling itself it was special and different and better and, in any case, it had the genius, Mr Alan Greenspan - made exactly the same mistake. It got the same result.

Why did it do it? Mr Greenspan, as Mr Jim Grant of Grant's Interest Rate Observer sagely said, was a better politician than he was a central banker. He kept the great American party going and became a national hero for doing it, even though it was intoxicated on cheap money, until it came to its inevitable end.

The third channel was the banking sector and the high-rolling investment banks in particular. Politicians and regulators in the US, mainly, but also in Europe, indulged the fantastic profitability and the generous political donations of the investment banks.

Under cover of the ideology of the free market and its supposedly miraculous ability to reach perfect equilibrium, they created new and virulent ways of profiteering from the great gushers of cheap money flowing from the central banks. Sub-prime mortgage lending was one.

Of course, when it all crashed, the political leaders had to bail out the banks. And that was expensive. The cost was added to the towering public debts that the politicians had already accumulated. And so the cycle feeds itself anew.

By last year, the average public debt of the euro zone nations was 82 per cent of the size of their total gross domestic product, far above the permitted maximum of 60 per cent. In the US, the figure was 103 per cent. In Japan it was 230 per cent.

As these great Western powers grew richer, they grew flabbier and more indulgent to the point of collapse.

It's a very old story in the history of civilisations, told anew in our time.

The writer is the international editor of the Sydney Morning Herald, where this article first appeared.