How Richer States Finance Poorer Ones

Uwe E. Reinhardt is an economics professor at Princeton.

From time to time I attend symposiums on the euro crisis. I find the topic fascinating in its own right, and it also provides therapeutic relief from the dreariness of health policy in the United States. In comparison with international banking and finance, the American health sector is functioning rather well.

Today’s Economist

Perspectives from expert contributors.

The discourse on the euro crisis is dominated by experts who come from the world of finance; these experts seek a solution in “financial stability.” To them, that means shielding major international banks from the fate of Lehman Brothers, however recklessly these banks may have mismanaged their loan portfolios.

Furthermore, it means that interest rates on sovereign debt should be kept artificially low, lest they push the already deeply indebted peripheral nations of Europe — Greece, Italy, Spain, Portugal and Ireland — even further into the debt trap that their public or private sectors had busily built for them during the last decade, abetted by reckless bankers inside the countries and abroad.

To achieve this “financial stability,” a standby pool of money between 1 trillion and 2 trillion euros is said to be needed now to prop up the price of the risky sovereign of the periphery and thus to keep interest on it lower than it would otherwise be.

Naturally, assembling that pool of funds from other nations — notably Germany — is a major political challenge.

From their discussions, one gains the impression that finance experts view “financial stability” almost as an end in itself rather than a means to an end. After all, money is not a real resource. It merely is the terrestrial analogue of the Force by which Jedi knights in the “Star Wars” films could move real things with their minds. On Earth, money merely moves real resources — sometimes through the souls and votes of politicians, as my fellow blogger Simon Johnson has noted — much as magnetic force can move paper clips.

Viewed from the perspective of the real economy, then, “financial stability” has become code for sizable and long-term transfers of real resources from the hitherto better-managed, more productive and internationally more competitive European economies to the heavily indebted countries in the euro club. The latter will ultimately have to be forgiven much of the debt they will have accumulated.

It would not be amiss to call these transfers welfare payments.

Now, it can be and has been asserted that the designated donor countries — again, notably Germany — owe these transfers to the peripheral countries.

By this thesis, the donor countries have benefited from more than a decade of European currency union, which effectively enhanced their international price-competitiveness vis-à-vis the peripheral countries relative to the old system of national currencies. At least one economist went so far as to call Germany “the vampire squid of Europe.”

Be that as it may, persuading the citizenry of the donor countries of this thesis — and the sustained transfers of real wealth that it requires — is a major political challenge, which many Americans and their news media routinely seem to underestimate.

All of which must make an American wonder how we have been able to flourish in a currency union — the United States dollar zone — so well and for so long.

Here we have three advantages not yet achieved by Europeans, if ever they can achieve them.

First, we have a high degree of fiscal integration in this country that goes along with its elected central government. That federal government can directly tax citizens in the states.

Second, the constitutions of most of the states require balanced operating budgets (as distinct from capital budgets, which properly tend to be debt-financed). While clever accountants and governors can always find ways around this stricture at the margins — by booking some operating expenditures as capital expenditures — the budget constraints do help to enforce fiscal discipline at the state level.

Third, and most important, we have found a number of camouflaged vehicles through which we can indirectly make sizable transfers of real wealth among the states, without exciting the citizenry by booking them as explicit transfers.

Chief among these are Medicaid and Medicare, as Bruce Vladeck notes in his classic paper, “The Political Economy of Medicare.” There is also vast military spending, along with sundry other federal programs directing federal money to the states.

The table below, based on data regularly assembled by the nonpartisan Tax Foundation, convey a feel for the direction of these transfers. The data clearly identify donor and recipient states.

Source: Tax Foundation

Readers contemplating the table will discover in it a certain paradox — that those residents who most often denounce big government and call for sharp cuts in government spending often benefit themselves from such spending or live in regions that receive significant government support. This was also noted by the Tax Foundation. In presenting the data in the form of a geographic map, the foundation wryly observes:

As you can see from the map, states that get the “worst deal” — that is, have the lowest ratio of federal spending to taxes paid — are generally high-income states either on the coasts or with robust urban areas (such as Illinois and Minnesota). Perhaps not coincidentally, these “donor” states also tend to vote for Democrat candidates in national elections. Similarly, many states that get the “best deal” are lower-income states in the Midwest and South with expansive rural areas that tend to vote Republican.

In an illuminating article, “Even Critics of Safety Net Increasingly Depend on It,” Binyamin Appelbaum and Robert Gebeloff of The New York Times note this as well. The article comes with interactive charts and video clips of interviews with residents of the heartland. I encourage readers of this blog to spend some time with that article.

Of particular interest in that article is an interactive map that shows the incidence of government benefits by county, in total and broken down by type of program. One can click on a county to discover the amount of transfer income per capita in the county and the fraction of the county’s income represented by transfer payments. It appears that there are quite a few Greeces within the American borders.

One wonders, though, what would happen to the economies of the “best deal” states in the chart above, and in the “best deal” counties in the interactive map, if the federal government carried out the drastic spending cuts of which there is so much talk in this election campaign season.

The ensuing austerity might be no more welcome here than it is in Europe.

Source & Image : New York Times