Where are we heading to …? (Part 1: to be a saint or a fool ?)

I was asked by my children, if the states are borrowing so much more then we (as family) do, that they cannot get credit. Instinctively I would have answered “yes”. But before answering, I put down a few numbers, just to be sure.

Here there are the numbers:
Western Europe has a GDP per head varying between 32.000 and 38.000 US $ at 2009 PPP (source: The World in figures 2012, by the Economist).

The average price paid by a home buyer in Western Europe is between 150.000 and 180.000 US $ 2009 PPP.
Consequently home buyers gets a mortgage, whose principal varies from a minimum of 450% to a maximum of 560% of their yearly income.

So why cannot states borrow money on the markets, if they have a   GDP / Debt   ratio varying between 70% to 200% ?

The answer is easy but not obvious.
Would a bank borrow 150.000 US $ to a family father that plans to spend the money as follows (source Eurostat):
5% capital investment
10% for food and other items
13% for healthcare
15% for other services
23% for house keeping personnel
39% for supporting old family members
5% interest expenditure


In fact an average family that asks for a mortgage, spends (data aggregation from Eurostat, 2005)
10% in capital investment (House)
25% in food and other goods (furnishing, wear,
11% in services (communication, utilities, recreation, culture, education, hotels restaurants)
9% in transportation (car and public transportation)
2% healthcare
8% interests
35% taxes (OECD average 2009: but taxation can grow to more then 50% of GDP in some states, like France)

It means, that 68% of the disposable income of a family goes to the purchase of goods. About 33% of purchases of a family are on durable goods (house, car, furniture, white goods, TV, computers, etc.), compared to 5% of the state expenditure.

In 1910 the state was spending 12,5% of GDP and devoting (as a normal family today) about 30% of its expenditure to the purchase of durable goods (infrastructure).  Today the state spends an average of 45,6% of GDP and devotes just 11% to the build up of infrastructure (source Public Spending in the 20th Century). A global perspective, by Vito Tanzi (IMF) & Ludger Schuknecht (ECB), Cambridge University Press 2000.

The state has the expenditure pattern of a tramp, that consumes almost 90% of what it earns.  Tramps do not have access to credit. Eventually poor people have, if there is the concrete perspective of a significant increase in their earnings or if, like in micro finance, credit spoors investment and consequently earnings.

I would say that the difference between a tramp and a poor person, is that the latter is poor but is striving to improve its status, the former is poor (mostly) because of its attitude.

I would say, that it has become obvious in the (bond) markets, that a paradigmatic shift has to happen: in the last 100 years the amount of money collected by the state in absolute and in relative terms, has been increasing relentlessly. This is going to change for three main reasons:

1)     it is difficult to imagine that states may have a share of GDP bigger then 50%, so there is not much room to increase the state’s share of the pie.  In fact it is recommended by several economists, that taxation stays under 35%. So the GDP share of the state will likely to shrink, some day;

2)     productivity increase in OECD countries is slowing down, not only because of conjuncture. So the growth in personal income and in general wealth is slowing down;

3)     the dependability ratio in the OECD will change dramatically in the next 30 years: in 2035 we will have 117,6 dependent persons for 100 working persons. Today it is 79.6 on 100. Than means that there will be an increase of about 50% in the coming 30 years (source OECD population statistics 2006) .  If nothing changes, in 2030 no less then 60% of state expenditure will be on welfare. To cover that, the average taxation/contribution has to exceed 60% by no less the 10%.

So the answer to my children was:

No, the state is borrowing much less then a family with a mortgage. But it is plainly evident that its spending pattern is unsustainable. Less then 10% of the money borrowed goes into increasing its infrastructure (assets), most the rest is passed over to needy people. Who would help the needing, with borrowed money ?

A saint … or a fool.

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