Bob Carr wrote a strange post advancing the conservative canard that the Euro crisis is a crisis of the welfare state, caused by high taxes and/or welfare spending as a proportion of GDP. He’s wrong.

The problem starts with the title of his post: “Eurozone v Australia: Why We Beat Them”. The idea seems to be that Europe’s woes and our comparative fiscal and economic strength means we have “won”. This is a mercantilist fallacy banished by Smith and Ricardo centuries ago. Europe’s weakness harms us. We would be better off if Europe’s economy was growing strongly. Countries do not compete with each other in this way; trade is not a zero-sum game.

The rest of the post amounts to an assertion that Australian governments are in good fiscal shape (with low a debt-to-GDP ratio and moderate bond yields) because our government occupies a small share of the economy, due to means-targeting of welfare. This is the story that conservatives are trying to tell about the sovereign debt crisis: that European countries tax & spend too much, and that the bond markets have finally stopped the party.

Carr suggests that our relatively low social spending “has made it possible for Australian State and Federal governments to pursue policies of debt retirement”. It’s a strange argument. The ability to pay down debt is obviously a function of both spending and taxes; if government spending accounted for 40% of the economy, but taxes accounted for 41%, there would be a budget surplus and the stock of debt would decline. If spending was tightly means tested, accounting for only 25% of GDP, but taxes were light and accounted for 24%, the budget would be in deficit and the stock of debt would grow.

If Carr’s explanation of the crisis were correct, we’d expect to see higher bond yields in countries with higher tax-to-GDP ratios. We don’t. Sweden’s taxes account for around 47% of its GDP, yet last time I checked it could borrow funds at 1.62%. Ireland has around the same tax-to-GDP ratio as Australia, yet the yield on its bonds is over 8%. The two charts below (the first with Greece, the second without) tell the tale. If Carr’s story was true – that the size of the public sector is the main cause of the Euro crisis – then we’d expect to see the dots in these charts sloping upwards from the bottom left to the top-right. In other words, the bigger the government (as a proportion of the economy), the bigger the bond yield.

Tax-to-GDP ratio and bond yields in OECD countries

Tax-to-GDP ratio and bond yields in OECD countries (excluding Greece)

The Carr story just isn’t there in the data.

What if we just look at social expenditure? The story is the same: there are high-spending countries that are in trouble (Italy, Portugal) and high-spending countries that aren’t in trouble (Denmark, Finland). There are low spending countries that are struggling (Ireland) and some that aren’t (Australia).

Public social expenditure and bond yields in the OECD

Public social expenditure and bond yields in the OECD (excluding Greece)

If we set aside the bond yields and just look at the stock of government debt, it’s difficult to find evidence for the story Carr’s trying to tell. Japan taxes at about the same level as us, but has far, far more debt. Norway taxes a lot more, but its debt ratio is also low. Italy’s tax ratio is about the same as Norway’s, but its stock of government debt is huge.

The European sovereign debt crisis is about a currency area that encompasses too many diverse regions, with too little fiscal integration and weak oversight. It’s about a central bank that is reluctant (or unable, depending on your point of view) to play the role of lender of last resort. In the case of Greece, yes, it’s about a government that spent too much, taxed too little, and fiddled its books to hide its deficit. But look at Ireland: it’s a low-tax, low-spending country that was held up as a paragon of fiscal virtue by conservatives before 2007. George Osborne declared Ireland to be “a shining example of the art of the possible in long-term economic policymaking.”

The crisis is not about the welfare state. I can’t understand Carr’s motivation in suggesting otherwise.

NOTE: The bond yields data are from Trading Economics. The other data are from OECD Stat. The countries included are the 27 OECD nations for which Trading Economics has information about bond yields. I’ve used the most recent OECD data available.

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