A World in Turmoil? When economic and social factors are in conflict

The European Union once started as a peace project, now the path seems to lead towards deep conflict. An Essay by Wolfgang P. Warth

When analyzing Europe’s post-war history, we see Yugoslavia as a similar experiment, which failed and ended up in bloody war. We can consider Brexit as a first warning sign that the European Union is stumbling towards a final crisis, and we could see Turkey’s recent turning away from Europe as evidence for the fading of the European idea.

There seems to be a common pattern of divergence, characterized by a growing gap between rich and poor which has a tremendous impact on societies all over the world and on European society in particular. The growing perception of instability feeds into individuals’ fear of becoming victims of turbulent economic times. A sense of loss of control permeates all strata of society. A collective feeling of helplessness is a stringent consequence, with the lack of voters’ confidence in political leadership creating further uncertainty in the political process. Things have gotten complicated: The growing alienation between the European Union and Great Britain, the reorientation of Turkey, and the failure of Yugoslavia are but a few examples for the disintegration of the modern Europe.

Trying to determine the root causes for these changes, the discussion often ends up blaming capitalism: Marx ante portas. But capitalism, of course, represents the very nature of the economic order in Western societies: Their basic principle is the protection of capital, which is mainly in the possession of individuals, not of the state. The rise of capital was undoubtedly necessary to achieve the status of welfare the Western population is now enjoying. Capital is also a tool to enhance productivity. And therefore capital is the main reason why we have enough to eat, comfortable housing and well-functioning public transport systems in our cities. The belief, that all this capital should be under control of a state, burst some twenty-five years ago, when the USSR collapsed. Capital must be allocated individually and this principle makes the best use of it. So why is capitalism to be blamed for so many conflicts? If capitalism benefits the individual, then why not the society as a whole? Is it the utilization of capital that makes the difference? These questions have to be addressed!

Why is one person poor and another one rich? When we talk about capital, we have to distinguish between ‘human capital’ – the ability of an individual to maintain a certain living standard, and ‘real capital’, which is an instrument to improve the outcome of an individual’s work. Poor education, a lack of natural resources and real capital are the main factors that lead to poverty. Thus, it has to be a core interest of the state to improve human capital and to facilitate an equal access to education, in order to enable each and every individual to get the educational level wanted.

But the distribution of real capital follows another logic. Inequality is a result of different and productive individual skills that compete with each other. In fact, it is first and foremost attributable to a lack in qualification; and secondly, a lack of real capital when qualification alone is not sufficient to create a profit. But this mismatch cannot be adjusted by government intervention, for the simple reason that individuals are equipped with different intellectual skills and motivation. In order to prevent this gap in capital distribution from ever widening, governmental policy will promote capital accumulation by tax incentives with the poor in favor, i.e. the exemption of income below a certain level.

This policy could end up becoming a huge burden for the state. In Democracies, majorities are needed to govern. It doesn’t come as a surprise that lower and middle class citizens who favor top-down redistribution are more than happy to provide such majorities in their own favor. Tax increases hurting the upper classes are often the logical consequence. If the increase is too high, however the affluent will look for other domiciles and the benefits of the intended redistribution will not materialize. It is a hard job for a government, to balance the needs of the poor with interests of the rich.

An alternative would be to form a majority of the rich and the middle class with the intention to expropriate the poor. Such a strategy enhances conflicts within the society, since existential questions provoke riots. The only way to implement this strategy would mean to limit the portion of unskilled workers in society, since these cannot leave their domicile, lacking of money to pay the travel and to set up a new life elsewhere. Left to their own the devices, the discontented masses could attack the property of individuals and spread fear within the whole society. The cost of controlling such a conflict would initiate the majority to secure these “slaves“ economically and grant them a better life. The probability of success for such an endeavor must be zero.

In order to form majorities, there is need for new ideas. What if, for example, someone lends money to the state at a reasonably high interest? If there is a credit, politics will be shaped differently. Another idea would be to have banks that collect money and lend it to the state. They will convince certain individuals that government bonds could make them rich. Why? If this works, the rich will borrow money to the state and subsequently become richer.

Sometimes this could work, sometimes not, for the idea of credit and interest is entangled with crises. We have learnt that financial crises are mostly the result of an overdose of real estate financing. This can be explained easily: The time horizon of home financing usually amounts to at least thirty years. Within that period there can be a lot of external (economic) factors that might change. There could be something unforeseen happening in the future making the debtor as well as the bank suffer. When many suffer, this is called a crisis.

Therefore, a crisis must be seen as natural response to a practice of excessive money-lending. In the case of a house we talk about a running time of thirty years, when drawing on a credit. In the financing of states however, we talk about a very long period,  prone to end in crises, as proved in history.

Now let’s look at a credit’s impact on the debtor. If you use a credit voluntarily to finance a promising idea, which leads to a beneficial innovation, you will earn enough money to pay the creditor and a sizable portion will be yours. You, the creditor and society benefit from said innovation and will profit from your initiative. But there are also risks involved and your idea might not result in the expected outcome. As a result, you might come under pressure and, you might become dependent on your creditor. Possibly, the only choice you see is to cheat on him and on others. A deep clash will be the outcome. And too many clashes essentially harm society. A society endures credits only to a very small extent.

When we look at the credit period, state credit bears a high risk, as we have seen above. Lending stimulates the pursuit of an uncomfortable political path. First there is the promise to give money to the poor, after that comes the practice of borrowing money, which ends up in growing debt. The state becoming more dependent from its creditors will lack credibility and finally illiquidity is the consequence. If we assume that the state can be seen as insurance concept, comprising the whole society und securing its survival in critical times, this system has to build up reserves in order to fulfill its liabilities. These reserves will be used when a crisis occurs. In a modern world this refers to the ability to borrow money from abroad in order to get the necessary goods to guarantee the survival of the population. Credibility is an important asset. Strong states with an excellent economic performance have undisputed credibility, while a shortage signifies overstretch and is the antecedent of a failing society. Think only of what happened to Greece recently.

There is one lesson to be drawn from that: One cannot fight divergence with credit. Economic and social policy are appropriate tools, which the government has to use in a deliberate manner. If monetary policy seems to be a comfortable way to get the money needed to ensure welfare within a society, it turns out to be a dead end. Finally, there is the destruction of the monetary system and often the failure of the state. In distress a state can put borrowed money into the game, but only in case there is a clear will to realize a convergent policy which is backed by the society as a whole. The creditor must be aware of this. In the end it is better for a state to apply economic and social policies to close the gap between the rich and the poor and does not rely on borrowing money.

Only then it is possible for the state to protect its monetary system, to prevent inflation. If the welfare of a modern society is based on capital in private hands, then capital must be protected and this principle applies to money as well and demands stable money to be guaranteed.

Why has economic divergence become a driver of dividing the core regions and the periphery of the European Union? Two aspects are relevant: First of all, the transit from small private credit exposure in the periphery to excessive credit came too fast, changed the economic sector dramatically and enhanced economic risks. Secondly concerning fiscal matters traditional carelessness in deficit spending continued in a new environment that demanded self-commitment and that lower of rules to safeguard the monetary system. In the old environment the shock-absorbing capacity in a state with inflationary tradition could be found in self-insurance, mainly investing in private real estate, and a large shadow economy based on in cash bargaining. It is difficult to decide whether this kind of economic system emerges from a weak state or whether such an economic system results in a weak state. The private sector and the public sector alike are based on the assumption that credit will be an appropriate way to catch up swiftly with more advanced states and interest rates will remain low. But the consequences of such a bright future have not been translated into a new pattern of work and that means hard work, increasing savings and returning borrowed money.

The result is an ever-growing dependency on creditors and their rising impatience, which led to pressure on the state and the financial system, combined with the legitimization of decision-making processes in politics and endless discussions over sovereignty. During these discussions, which have not come to an end so far, the current state of the society became worse, because capital has been transferred to foreign and more stable political regions, the capital stock is shrinking, and productivity is reduced and the ability to compete with others is growing smaller. From an outside perspective, it was a bad idea to invest. But the withdrawal from the system is barely possible: There are people and a territory of geostrategic relevance.

So what must be done?

The European Monetary System has to be fixed in order to incentivize the turnaround from divergence within the European Union, separating the southern from the northern parts. These incentives must push the European member states to pursue policies that will reduce deficit spending and debt growth within narrow limitations and spur economic growth by the means of equity finance.

Now the new French government has set the objectives and in agreement on fundamentals with the German government these must be seen as a big step to secure the European Union: The reduction of public and private debt and the downsizing of macroeconomic imbalances are necessary prerequisites to strengthen the Union and will help to stabilize the monetary system.

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