The Greek default death spiral

Public debts in Southern Europe only grew in 2011, and they were already unsustainable in 2010. Worse, the interest rates these countries have to pay on their debts has grown as all the long-term rolled-over debt held by these countries now carries a 7% upwards interest rate.

Greece is the worst affected, with a government debt to GDP ratio of about 160% and getting worse. It is clearly now on the other part of the Laffer curve and further tax increases will not lead to more tax revenue, but less tax revenue. Whilst for other countries, an ECB bailout is the most likely scenario, Greece is on a collision course with an official default that it can no longer turn away from. No one seriously believes the Greeks are going to pay their loans back. Greece is drifting irrevocably into the situation whereby it will officially default and simply not be able to pay the wages of its civil servants, the pensions of its elderly, and have Greek banks collapsing around them as well, unless the ECB bails them out completely, which now seems unlikely. Re-introducing a Greek currency would mainly add huge capital flight to the woes and solve nothing in the short run. It really is looking rather bleak for Greece at the moment, whether it manages to trick the rest of Europe into another stay of execution or not.

Here, I want to point to particularly interesting political processes that have locked Greece into a default death spiral: political paralysis, civil service paralysis, and population paralysis. And at the heart of them are the special interest groups that dominate Greece.

What do I mean by special interest groups and their hold on Greek society? Iannis Carras wrote a hilarious and informative piece on how it works in Greece. Iannis relates the story of how a particular set of rent-seekers conspired to divert water from Western Greece to Thessaly by means of large construction projects. Diverting this water via large dams and reservoirs was done against the wishes of local residents, against EU planning rules, and against the ruling of the Greek high court judging it to be illegal. How did the rent-seekers get round this? They nominally broke the project of water diversion from one region to another into several smaller ones and simply kept going. And what drove this project? European cotton subsidies! Cotton is very thirsty and so water was diverted to the area more suited for cotton. Who drove it? Construction companies, Thessaly major farmers, and Greek politicians, all happily flaunting Greek law. Worse, it turned many a Greek politician and former farmer into a pure rent-seeker. And once they got into that game, they kept going. A favourite means of extorting money out of their own government is now for Greek farmers to simply block the roads until someone gives them money!

Other examples abound. Greece is now full of museums, ports, and roads which no-one uses, paid by the European Union and spawning groups of entrepreneurs everywhere whose main income in life comes from lobbying either the EU or any other major institution. Indeed, in a quite cruel illustration of the increased power of vested interests in these times, Carras notes that the only real reforms being implemented in Greece are all in favour of the construction industry. The most recent such example is the removal of environmental obstacles to build houses, effectively allowing large-scale theft of government natural reserve land by private companies,  which in turn makes a mockery of the intended sale of that same government land. A sale which was hoped to reduce the government deficit!

Iannis Carras’s sobering conclusion is that ‘EU aid has strengthened the position of intermediaries and rent-seeking elements in the Greek economy.’

Then the issue of paralysis, whereby the main thing to say at the outset is that paralysis mattered because it prevented structural reforms from happening.

Importantly, structural reforms could have tilted the balance of whether default was inevitable, but it has turned out to be impossible to legislate and enact structural reforms. By structural reforms, I mean tackling tax evasion, opening the economy up by means of labour market reform, and dismantling the legal apparatus supporting strong special interest groups that paralyse the professional service sectors and the civil service. Such structural reform was needed to get economic growth going, has been advocated by virtually all intelligent observers inside and outside of Greece, and initially would have involved pretty simple off-the-shelf legislation. Yet, it has not been done and it now clearly wont be done, even though the consequence is a disaster for the country.

The first and probably most important lock-in process is the civil service: the need for quick spending cuts meant that the public sector had to reduce in size and freeze wages. What do you think happens inside the ministries when this occurs? That the lesser-paid remaining employees are going to do their utmost for their country by devising and enacting radical reform legislation, or that those who remain will be the weaker ones who couldn’t get decent jobs elsewhere and whose principle worry is not to rock the boat and retain their job? The right answer is the latter.

As a result of this paralysis of the civil service, the sheer capacity for structural reform has been strongly eroded, as was nicely illustrated in this excellent piece on the impossibility of reforms. Greece, and to some extent also Spain and Italy, is now less able to legislate and support structural reform than 2 years ago. All that remains is austerity packages, which are technically easy: bit less money here, slight increase in tax rate there. Nothing new has to be set up or thought through.

The second lock-in effect is a gradual paralysis of the political system. At the start, when it became clear to the elites of Greece that they were looking at a major loss of status for their country if they kept going as before, the political elite had a kind of ‘we must stop this’ mentality. This moment came about 2 years ago for Greece.

Yet, just as more recently in Italy, Greek politicians forgot the crucial lesson of Machiavelli about reforms that go against vested interests: you need to implement them with lightning speed whilst the political will is there.

What Machiavelli warned his audience about happened in Greece: by being too slow, they alerted all those who would lose from reform, which cemented opposition to them. As a result, Greek politicians have basically done nothing in the last year and Greece is in complete political paralysis with no-one daring to offend the rent-seekers.

It is instructive to think a step deeper and ask why Greek politicians see it in their best interest to do nothing. The major political reality in Greece is the anger of voters who see their standard of living go down with plummeting housing prices, increased unemployment and decreased welfare, and who blame whomever is in charge, whatever they did or are trying to do about the problem. Such voters might want the country to avoid the shame of a default, but that sentiment is dwarfed by blind anger towards anything associated with the loss they are having to endure.

Interestingly, this public sentiment has only strengthened the hand of the special interest groups: when faced with high uncertainty, workers became more militant within their unions; major corporations increased their attention to political lobbying to make sure they wouldn’t lose out; the professions mobilised such that the legislation favouring them was safeguarded; etc. Since the early pain fell on the politically weakest, i.e. those not organised in special interest groups, the relative power of the problem groups has only increased within politics, the civil service, and the world of work. It is now only via the popular vote that there is potential mileage for a politician in advocating real change, but the popular vote is uncertain and easily swayed by the relentless media lobbying of the special interest groups. Hence, as a calculating Greek politician, not implementing any real reform and blaming the foreigners is an optimal strategy.

The Greek politicians were not alone in being too slow to reform: the Italians are making the same mistake. Italy just in the last 2 months shows how this goes: Mario Monti was explicitly appointed as a technocrat to do what needed to be done. To his lasting shame, he wasted his first salvo in December 2012 on a simple austerity package without any structural reform. By now, the major unions and interest groups have organised against him.

Monti’s latest round of reform is a good illustration of what he now does. In grandiose media style, he promised 5000 more pharmacies, 500 more notaries, and what looks like no more than a few hundred extra taxi licenses. This is really nothing more than symbolism: Italy needs millions of jobs, not a few thousands! Worse, Monti made a big point out of extending bakery opening hours to Sundays, which is peanuts in the scheme of things. Hence the story there so far is no real reform whilst minor reform is puffed up to be the real thing, and meanwhile it’s getting late and Monti’s political backing in parliament is slipping.

To be fair, other European politicians also were not quick enough in realizing long-run realities. Some 18 months ago, when informed observers already knew that Greece could never pay back its debt, what did the Northern European leaders do? They pretended vociferously that Greece would not default, that ‘Europe would stand behind Greece’, and they exposed their own banks and countries much more to a Greek default by direct loans to the Greek government and to support the buying up of Greek bonds by the ECB. This policy, which is the height of folly in hindsight, only made sense at the time within the logic of a political elite that had no idea what was going on and that bought into its own rhetoric of Greek competency. And the parliaments all approved this!

A final fascinating aspect of the Greek death spiral is the return to full posturing once it became clear to the senior politicians that a default was inevitable because the road to structural reforms was political suicide.

Greece, quite incredibly, in January 2012 had a PM who was openly threatening Eurozone leaders that Greece would pull out of the Euro if he didnt get more bailout funds. This is much like a thief threatening to no longer enter your house if you don’t send him more of your valuables! The cheek of the man has to be admired, but the cold political calculator should drily note that such posturing is entirely for domestic consumption and a clear indication that the PM is preparing his country for a ‘blame the foreigners’ story, even though in reality these foreigners have propped up the Greek government by well over 200 billion Euro in loans in recent years!

In Italy too, the PM is adopting posturing mode. The minister of finance and the PM both announced that they want the markets to ‘recognise’ Italian efforts. You might as well demand of the weather to recognise your need for summer! Merkel, astonishingly, echoed their voices.

Indeed, the Italian government now and then resembles pantomime-mode when it comes to reforms. The PM, Mario Monti, has announced ‘rolling reforms’, sector by sector, one sector per month. He is just these weeks going to ‘talk to the unions’ about labour market reforms. This is so counter to Machiavelli’s prescript of swift and unexpected reforms that it is almost laughable. It is like Jason in the Friday 13th movies saying to all his intended victims ‘I am coming to get you….. in 6 months time!’. The act keeps the handouts coming from the ECB and the rest of Europe, but we will see how long it works without real reform. So far, Northern Europeans seem to be buying it, just as they did with Greece….

 

79 thoughts on “The Greek default death spiral

  1. Paul, dramatic action of the type you advocate is precisely what the parliamentary systems of these countries are designed to frustrate. They have structurally weak governments because of their historic experience of structurally strong ones. There was, after all, at least one Italian government that could carry out such “reforms” at will. Plus of course Greece itself had such a CIA-installed government in your and my lifetime (and people wonder why the Greeks are so paranoid about foreign interference …). Neither experience was a happy one.

    But in talking about debt dynamics people really are missing some important points. Government debt of 160% need not be unsustainable, or even especially onerous. Its the lack of confidence in future growth prospects (ie expectations of a poor FUTURE tax base) that drives up those interest rates. And 7% interest on a 160% of GDP debt when your economy is shrinking is a very different thing from (say) 3% on 160% of GDP with growth of 3%. But why is the Greek economy shrinking? Why, its because they have this massive debt burden …

    Certainly the very-long-entrenched Greek and Italian habits of rent-seeking reduces their GDP. But its the GROWTH, not the level, of GDP that matters here and Greece and Italy have both grown well in the recent past with exactly the same rentseekers. Do not confuse macroeconomics and microeconomics.

  2. I must say that as a non-economist I don’t really get this. If I dare, it would appear to me that economic conventional wisdom is roughly as follows:

    1) In order to reduce deficits (and continue to finance them) the economy needs to grow at at least about the borrowing rate
    2) in principle governments should spend to promote growth
    3) governments can’t tax to fund the spending because this would be contractionary and thus would lower growth (also most of these countries are pretty highly taxed already)
    4) thus governments must borrow to fund the spending
    5) see pt 1, and in order to keep down rates to a level where they don’t blow the deficit out of the water irrespective of growth governments need to be able to convince markets that they are actually going to repay their loans

    Greece and Italy and Portugal (at least) are all screwed here because they can’t do 5 but there is no other way around 3 and 4. Their ability to do 5 appears largely divorced from growth, markets appear (rightly) convinced that these countries are simply unable to generate the cashflows required to repay their debt and thus are demanding higher (albeit still artificially low thanks to ECB) yield to compensate for the additional perceived risk.

    But isn’t there an absolutely blindingly obvious way around 3 and 4, across most of the West but nowhere more than Italy and Greece: structural reform???

    But none or very little of the commentary appears to make much of this, the likes of Krugman/Soros/Roubini all just seem to think that the ECB should step in and circumvent number 5 instead and then, usually mentioned as an aside, get on with that structural reform stuff.

    Those guys aren’t utterly stupid so what am I missing?

  3. Virtue and good economics are not the same thing. There is a solution tot he European crisis, as people like Krugman have pointed out. Step 1 would probably be getting rid of Merkel, and that may actually happen in the not too distant future. Step 2 would ve getting rid of the entire pain caucus.

    What lies behind this trans-Atlantic policy paralysis? I’m increasingly convinced that it’s a response to interest-group pressure. Consciously or not, policy makers are catering almost exclusively to the interests of rentiers — those who derive lots of income from assets, who lent large sums of money in the past, often unwisely, but are now being protected from loss at everyone else’s expense.

    Of course, that’s not the way what I call the Pain Caucus makes its case. Instead, the argument against helping the unemployed is framed in terms of economic risks: Do anything to create jobs and interest rates will soar, runaway inflation will break out, and so on. But these risks keep not materializing. Interest rates remain near historic lows, while inflation outside the price of oil — which is determined by world markets and events, not U.S. policy — remains low.

    Merkel and the other EU leaders should just accept what is obvious. Greece cannot pay its debts. Greek interest groups and rentseekers played a large part in creating this mess. So did the international banks. Goldman-Sachs actually constructed the fraudulent instruments by which the Creek state concealed its indebtedness. Imposing all costs on the Greek people and none on the local or international rentiers is simply not going to happen.

    There is no obvious reason why the EU should defend the interests of creditors and absolutely no-one else, but that is effectively the Merkel policy. An alternative policy would stop confusing economics and virtue and do what is necessary to refloat the sinking economies.

  4. Alan, the banks have already suffered rather large losses.

    But that aside, how do you propose that the international rentiers be attacked? Bills of attainder perhaps?

    If you didn’t realise, Greek’s main creditor is basically the ECB and German banks. Does that give you an ‘obvious reason’ for Merkel’s actions?

    Also, there was once a Republic called Weimar. It experienced hyperinflation and it was a very sorry tale indeed. You might think it is stupid, but in the real world that is also called an obvious reason for the ECB/Merkel’s actions.

  5. DD,

    sure,growth would make even 160% debt sustainable, but that is what all the fuss about structural form is addressing. Greece is not reforming in a way that gives anyone confidence in its future economy. Its new patent levels are almost zero, good young Greeks are leaving, there is general paralysis of the education sector, the coast of the Mediterranean is already saturated with second-houses for the rich Northern Europeans so there is not much realistic mileage there, etc. Greece is simply in free-fall at the moment.

    Patrick,

    yes, Keynesian logic does apply to some extent, but its the rigidities and rent-seeking of these economies that prevent long-term growth. That has almost nothing to do with spending levels and everything to do with regulation. The Keynesian lens is simply not very useful when it comes to rent-seeking and structural reforms.

    Alan,

    I would not take Krugman too seriously when it comes to things that happen outside of the US. People in his position simply don’t have the time or background knowledge to really get on top of what is happening in Europe so what they say is mainly for internal US consumption.

  6. Paul,

    It would be nice then to know what superior background knowledge and time you have that give a better insight than Krugman.

    Sure Structural reform is very helpful toward gaining growth however I would like to know on what basis you believe such microeconomics policies will outweigh the macroeconomic policies.
    Patrick,

    It wasn’t hyperinflation that proved disastrous to the Weimar republic. It was the deflationary depression policies of Bruning. Without these stupid policies we would have never heard of a person named Hitler.

  7. Paul

    Even if Krugman’s understanding stops at beaches of Atlantic City he is by no means alone. Der Spiegel today called for a Greek bankruptcy. Joseph Stiglitz argues that the cosnequences of a bankruptcy may well be no worse than the deat by a thousand cuts that is happening now and offers a possible explanation for EU policy that turns on corrupt conduct, but by the inetrnational banks:

    There are three explanations for the ECB’s position, none of which speaks well for the institution and its regulatory and supervisory conduct. The first explanation is that the banks have not, in fact, bought insurance, and some have taken speculative positions. The second is that the ECB knows that the financial system lacks transparency – and knows that investors are aware that they cannot gauge the impact of an involuntary default, which could cause credit markets to freeze, reprising the aftermath of Lehman Brothers’ collapse in September 2008. Finally, the ECB may be trying to protect the few banks that have written the insurance.

    None of these explanations is an adequate excuse for the ECB’s opposition to deep involuntary restructuring of Greece’s debt. The ECB should have insisted on more transparency – indeed, that should have been one of the main lessons of 2008. Regulators should not have allowed the banks to speculate as they did; if anything, they should have required them to buy insurance – and then insisted on restructuring in a way that ensured that the insurance paid off.

    What this is about is creditors shifting risk for loans that should never have been made from their shareholders to the public sector. The best analogy from rrecent history is Russia where the same dreary shock therapy drivel was going to lead the Russian economy into a brave new world. Sadly it turned out to be an authoritarian regime with as much corruption as before.

    @Patrick

    Germany has forgotten its own history. The Weimar hyperinflation ended in 1925. The Nazis were a small marginal party. The massive expansion in Nazi support at elections dates from 1929 onwards when Germany followed the Merkozy prescription in responding to the Great Depression.

  8. Alan,

    of course Greece has to go officially bankrupt, if only to help re-set the expectations of its population. The question is how to let it go bankrupt: does the ECB bail out the other banks in Europe that would also fold if Greece no longer pays back its loans; is there a program of direct assistance to the poorest in Greece so that internal unrest is kept to a minimum, etc.

    Russia’s transition was a very complicated case. The notion that anyone there was in charge who was administering shock-therapy and who could have done differently is simply untrue. If ever there was a slow slide into a disaster it was there. Its easy to want to blame the Jeffrey Sachs of this world for naive advice, but the Russians are no idiots and what they implemented had political-economy reasons of its own. As Sachs would be the first to tell you, they didn’t implement his advise in the way he envisaged it.

    The Merkozy prescription and the reactions after 1929 are miles apart. Trade flows are not being hampered at all and the first reaction to 2008 was fiscal expansion. It is not very helpful to think about this crisis in simplistic Keyenesian versus classic or monetarist terms.

  9. Shock therapy does not necessarily take a domestic central authority. Russia was starved of international credits and pressed to privatisation at any cost. Putin turns out to have been the cost. And the thing is the EU authorities consistently deny that Greece will go bankrupt and announce that implementing each new summit communiqué will solve the problem. None have. None will.

  10. Alan, do you think that privatisation in Russia served strong domestic political interests quite well?

    As for EU summits never solving the problem, I think we are all in furious agreement that Greece is past the point where it must default. At which point it appears that you think it will be able to buck the ‘pain caucus’ and spend like it’s 2007…?

    I think that they will still need massive structural reform and substantial cuts in goverment spending, bankruptcy will merely give them some room to do that.

    So what’s so wrong about the pain caucus?

  11. alan,

    the Russian privitizations turned into an instrument for the former elite to give itself all the means of production. To blame outsiders for that large-scale theft is unfair.

  12. Patrick,

    the main problem of the pain caucus is that contractionary fiscal policy leads to economic contraction.

    This means the numerator increases and the denominator falls in Budget deficit as a % of GDP and public debt as a % of GDP ratios.

    This means one has to have some way of gaining growth. This is a simple task for most countries bar Greece.

    Paul seems to be implying that microeconomic reforms will outweigh present macroeconomic policy but has yet to show any evidence of that.

  13. JB,

    I prefer to put the onus of proof on you and then I shall judge whether I agree with it or not, rather than the other way round. After all, my post was not titled ‘Keyenesian versus micro-reform’ but was on Greece’s paralysis. It would be new to me to hear that Keyesianism is a useful lens for describing political lock-in effects! And of course structural reform is not the same as micro policy.

    Let’s hear your position on what Greece or Italy should do and we will see where we differ.

  14. You are a touch sensitive.

    I was not criticising you merely curious.

    I am by no means against micro-economic reform indeed I am a great believer in large reforms there.

    What I am interested in is where you see growth coming from that offsets the contractionary fiscal policy effects.

    As I said, and experience bears this out. the Austerity measures are making things worse in terms of the ratios.
    Incidentally Greece is entirely different to Italy.

    Italy neither manufactured figures nor followed fiscally profligate poicies before this current episode.

  15. JB,

    I agree that fiscal austerity is not good for Greece, but there is really not much the Greeks can do about that now, nor have they really had much of a choice in that regard for the last few years. Some Greek economists have argued for a stimulus coming from the EU via the structural funds, but for reasons clear in the post that is as much a part of the problem as it is the solution. There is an argument to be made that the North of Europe should run bigger deficits so that there is more to export for Greece (and the IMF is making that argument) but its hard to see that line getting up politically at this moment in the rest of Europe.

    Structural reform is essentially about getting the incentives right for people when it comes to investing in productive activities or in political rent-seeking. As such it is tangential to fiscal policy. Why do I think it matters how the incentives are aligned in a country? Communism versus capitalism.

    Where could growth in Greece come from? Always hard to tell. Traditionally it makes money out of things like basic processing, shipping, and transport. Tourism is actually doing well in Greece. Luxury cruise ships hence come to mind….

  16. john,

    Yes – remember, measures of economic activity are about just that: activity – Keynes described it as the velocity of money. Stimulus peps up velocity.

  17. Homer, it’s all very well to say greece needs to borrow more. Would you lend it to them? What evidence is there that further govt spending in greece would lead to economic growth in that country and a reform of the economy and tax base.

    The buggers are in a hole and I don’t think anyone’s found a way out yet.

    They don’t have much future without serious reform and they have to be dragged kicking and screaming to that reform. The rest of the E-zone should have binned them early and just got on with it.

    Other than saying austerity is bad, what exactly has Krugman suggested is the solution to the greek problem?

  18. @Patrick

    What is wrong with the pain caucus is that its policies do not work, except to preserve the sacred right of the creditor to extract dough from the debtor. The Greek crisis is in part a tale of naughty Greeks. It is also a tale of naughty lenders writing loans that were never going to perform, and in the case of Goldman-Sachs, of actual criminals assisting the Greek state to flaunt the EU stability pact with fraudulent financial instruments. And lastly it is a tale of the ECB and the northern European governments imposing a fiscal straightjacket that is shrinking the Greek economy faster than it is shrinking the Greek debt. The latest bright idea out of Merkozy is for the EU to impose a European budget commissioner on Greece to veto naughty departures from the plan.

  19. Paul,

    you seem to be missing the point.

    I do not believe anybody believes austerity wil lead to growth except maybe Merkel and Trichet. I have not found anybody who believes Greece can do anything else though fiscally given their ‘record’ and circumstances.

    They need something to promote growth over and above the fiscal program at present.

    You seemed to me implying a large scale microeconomic reform program would do so.

    This is what I queried. I thought you must have had some empirical evidence behind this.

    It appears you do not.

    Pedro,

    Krugman has simply states that austerity leads to worse outcomes in the budget deficit and government debt ratios in a slowing economy.

    He has also pointed out gaining competitiveness under one currency is very hard. the Irish solution has proved illusionary.

    I think it follows the solution to Greece is elsewhere i.e. outside the Euro

  20. Homer,

    there you go again! Onus of proof on others and you sit back and judge, not saying anything of interest.
    Distinction between communism and capitalism not good enough for you to be convinced that the structure of the economy matters? The Harz reforms in Germany not sufficiently proven to be effective for your taste? The de-regulation of the Swedish economy in the 90s? Indeed, the Thatcher reforms? The fact that both inside and outside of Greece the economists are clambering for structural reforms there? If you want some background literature on this, start here and follow the references: ec.europa.eu/europe2020/pdf/nrp/nrp_greece_en.pdf

    The question is not why I think structural reforms are the way to go. The question is what alternative you have to offer. None, it seems.

  21. Paul,

    The history of micro economic reform is that the growth comes much later than anticipated.

    Thatcher for example looked like being a one-termer until the Falklands happened.
    Growth in those years was quite tepid to say the least.

    Strong growth came later under Lawson.

    you might say the same about Australia and New Zealand in terms of impact.

    Perhaps you simply haven’t thought things through.

    what you are saying is very simplistic

  22. again no substance Homer, you are just Kibitzing. The lag between reforms and growth is well-researched, but a different topic.

  23. err no not if you are making the case this is where growth is going to come from.

    Also the Greeks are being told areas such as services which is a good thing) but hasn’t really happened here.

    I could accuse of having no substance. you will not for whatever reason give the support to your arguments.

    As I said I am curious however thus far no-one still knows your argument only your assertions

  24. @ Dan at 17
    Then in a society that is basicaly a rent seeker gangster society wont increasing velocity simply make the problem bigger ,quicker?

    The situation seems analogous to ecosystems were the top predators ( in this case the painful bite of failure) have been removed; Unsustainable unculled population growth of both prey animals and mesopredators, followed by population crash ,followed by destruction of carrying capacity , and inexorable long term degradation of both the environment and the ‘fitness’ of the surviving population.

    The only way to reverse this trend is to reintroduce top predators, be they mountain lions, dingos or very big monitor lizards

  25. John: yes, of course – can see the Sun headline now: ‘Rent seeker gangster society in political economy dysfunction shocker’.

    Pretty simple solution – tie the grants. ‘We’d like to give you x billion Euros. But we’ll audit you, and if you don’t employ this many people and build this much stuff, we’ll dump your bloodied carcass in the Aegean.’

  26. Dan, I think that was the German plan A. It wasn’t popular.

    John, the correct answer by analogy is to give the lower population sharper teeth. Typically this is done through regulation. Unfortunately Greece is where it is mainly due to a catastrophic inability to regulate properly.

    Homer, so we are left with you agreeing with Paul? You haven’t said anything which could be regarded as a coherent disagreement as far as anyone can discern.

  27. “Homer, so we are left with you agreeing with Paul? You haven’t said anything which could be regarded as a coherent disagreement as far as anyone can discern.”

    Each comment has been less coherent than the previous. I’m starting to worry about you Homer.

    Dan, tieing grants is one of the things being whinged about. But still, why should the krauts give them another pfennig? http://en.wikipedia.org/wiki/Escalation_of_commitment

  28. I haven’t said I am disagreeing with anyone.

    We know Austerity worsens Greece’s’ position visavis Budget deficits and debt.
    We know they cannot borrow more to kick start their economy.

    Paul first of all implies this stimulus to growth will come from microeconomic reform but then agrees with me that this will take time to permeate through the economy.

    I am asking how Greece will grow.

    The other major problem is improving its competitiveness. We thought Ireland had shown us that but now we find out it was a statistical illusion.
    How do they fix that up.

    I know the solution to both problems when Greece has its own currency but I cannot see an answer under the Euro.

  29. Dan, eventually a large group doing stupid things may change, when the stupidity is completely exhausted. The long run solution to their problem is increased productivity. The maintenance of their current systems and structures do not look like a path to increased productivity.

  30. “… when the stupidity is completely exhausted…”

    I refer that matter to Einstein.

    However, the long run solution to their problem is their problem, and it cannot be anyone else’s to decide.

  31. My feeling that this is not going to end well for Greece is growing stronger. As I see it the first problem is that you can’t leave the euro overnight – it normally takes a couple of years to establish a currency, and exiting a currency takes about the same length of time.

    If you are running a primary budget deficit (excluding interest payments), then as far as I see it default brings on the problems that you have been dealing with through the austerity package. If no one is willing to lend you money then your tax revenue and your spending have to coincide within a couple of months at least i.e. instant austerity.

    Of course if you have your own currency then you can print money (to pay public servants and pensioners), but if it takes a couple of years to establish a separate currency, then you have a period of all the costs and none of the benefits of default.

  32. As I read this – http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_12464_10/02/2012_427207 – the primary budget defict in Greece is now about 2.4% of GDP or about 5 billion euros. When you default you no longer pay interest payments currently 15 billion euros – so your fiscal position improves enormously. But you have to come up with 5 billion euros in tax increases or spending cuts to close your primary deficit. Given that the current sticking point is about 325 million euros – http://www.guardian.co.uk/world/2012/feb/10/greece-crisis-bailout-euro-default – I think Greece is better off not defaulting.

  33. Hi Peter,

    of course Greece itself is better off not defaulting. Quite apart from the fact that austerity is worse for them after a defulat, they are about to get 130 billion in further loans which is a huge incentive to promise whatever those putting up the money ask of them. Since no-one believes they can pay back whatever they promise is empty rhetoric and they can blame the foreigners for the pain of the austerity. It would be for internal political reasons that they would refuse the conditions put on this, and it has to be said that the added conditions are a loss of face for Greece.
    I doubt it would take years to reintroduce the currency, but I agree it takes a while and that lag would be a very painful one, which is why I in a previous post said no country would leave the euro. Yet, I have noticed in the betting markets the smart money being on an exit before the end of the year for Greece so I was even contemplating taking a bet (though the spreads are high and the market is thin).

  34. Yet, I have noticed in the betting markets the smart money being on an exit before the end of the year for Greece so I was even contemplating taking a bet (though the spreads are high and the market is thin).

    Hmm, thin markets with big spreads. I wonder if I shop around among the online bookies whether I’ll find some arbitrage opportunity here? That seems to have a lot better risk/return ratio than conventional financial investments at the moment.

  35. I just had another look. Willem Buiter from Citybank gives the same basic scenario as I do (default without exit) but now gives a 50% chance of Greek exit the next 18 months. The betting odds now reflects this same judgment: Greece unlikely to leave this year (about 35%), but heavy odds-on to leave by 2015.

  36. I am always amazed at where the ‘smart’ money is going.

    Quite coincidentally it is usualy going in the same direction as the writer’s thoughts.

    where is the ‘not so smart’ money going?

  37. tel,

    I couldnt agree more. The germans and the rest of the northern european are making a huge mistake by getting cought up in internal Greek politics. It will be bad for everyone, not least the greeks whose one succesful industry is European tourism.
    They should simply refuse to put up any more money and tell the greeks that it is their problem.
    The EU should prepare for a future in which defaults are more normal and primarily a problem for the individual countries, not the Eurozone. That means de-coupling the finance systems, not cross-lending even more.

  38. That means de-coupling the finance systems, not cross-lending even more.

    So Paul, you’re advocating less integration and by extension even less globalization?

    How would you arrange trade financing such as the L/C market in that environment?

  39. JC,

    yes, less financial integration in Europe in the sense of less loans between the European banks/governments. More financial integration in terms of rules, taxes, and regulations.
    None of this would have to affect trade flows. Incidentally, if you put in some effort into this you will find central bank reports that make the similar point that more loans to each other increases risks of system collapses, so its by no means a novel point.

  40. yes, less financial integration in Europe in the sense of less loans between the European banks/governments.

    Paul, if one attempts to minimize financial flows between the EU member states you’re basically calling for less integration. Period.

    More financial integration in terms of rules, taxes, and regulations.

    That’s sounds awfully like the French call for tax harmonization, which at the time really was a demand that Ireland raise corporate taxes to French levels. So tax competition between the member states is not a good thing?

    None of this would have to affect trade flows.

    Sure it would in so many ways that it would take too long to list them. Lets be aware of one thing here. The problems we saw in Europe is sovereign failure, which because of its structure led to a crisis.

    Incidentally, if you put in some effort into this you will find central bank reports that make the similar point that more loans to each other increases risks of system collapses, so its by no means a novel point.

    There’s nothing at all novel about loan risk raising system risk as it’s a tautology in a sense. I find it hard to understand how the 50 year call for more EU integration suddenly doesn’t mean financial integration as well. If Europeans are worried about their banking system etc. they should have paid more attention to the Stability Pact while ensuring member states were playing by the rules set forth. If they were (including Germany) they wouldn’t be in this mess.

    I find it really interesting how people are suggesting we should impose walls around national borders when globalization and financial integration has been an astonishing success.

    Sovereign failure in Europe doesn’t point to any failure other than governments borrowing to much, too weak to raise taxes to cover those costs and having an imperfect structure in the EU entity.

    Globalization in all facets has been an astounding success raising 100′s of millions of people out of poverty in the developing world and frankly a developed failed state such as Greece doesn’t even show on the radar in the whole scheme of things.

  41. JC,

    tax competition within a currency union is indeed not such a great thing. To understand what is being argued here, you should basically think of this as if we are looking at the states of the US: you dont want the other states to go bankrupt if California goes bankrupt, but you do want the same rules and taxes to prevent races to the bottom and barriers to financial transactions. As with the US, trade between states is not going to be hampered if the debts of the EU countries are had by banks and countries outside the EU.

    You are hence setting up a pure straw man in equating cross-debt holdings with globalization. Also, you should bear in mind that much of these European cross-debt holdings are artificial and arise because of interference with the system. In short, you should be arguing for my position against others who might truly disagree.

  42. The US does have tax competition within a currency union. There is a reason so many of the several US states are impoverishing themselves with a combination of tax cuts and corporate welfare and funding that policy by ever-greater service cutbacks. Oddly enough the states that are most politically conservative tend to have the feeblest economies.

    Merkel had a choice when this began.She could explain the advantages Germany gains from the currency union to her electorate and adopt serious measures to avert the Greek crisis, or she could keep climbing off the plane waving a piece of paper declaring ‘fiscal rectitude in our time’.

    The peripheral economies in the EU cannot adjust their currencies to manage their economies. Neither do they get the advantage of a transfer unions as do states like Alaska and (until recently) Western Australia.

  43. tax competition within a currency union is indeed not such a great thing. To understand what is being argued here, you should basically think of this as if we are looking at the states of the US: you dont want the other states to go bankrupt if California goes bankrupt, but you do want the same rules and taxes to prevent races to the bottom and barriers to financial transactions.

    Why would I want any rules unless I thought competition doesn’t work. California is going broke because of its own doing and no other state caused that. Michigan is a basket case because of it’s similar peculiarities. The same applies to Tasmania- our very own failed state. If all the other US states followed California and Michigan, or we followed Tasmania we/they would be just as broke. Tax competition, not the phony subsidized handouts to special cases that pretty much amount to graft, promotes efficiencies.

    As with the US, trade between states is not going to be hampered if the debts of the EU countries are had by banks and countries outside the EU.

    I don’t get your point. There are no financial restrictions in setting up banking operations or lending across state borders in the US. However the federal system works there because unlike Europe the Fed has the power to tamper with the money supply, whereas The ECB is very limited and in some ways is not a central bank at all in Fed sense.

    You are hence setting up a pure straw man in equating cross-debt holdings with globalization.

    Not at all. There’s no straw man in suggesting the globalization of the financial system and the globalization of the trade in goods and services go hand in hand. I can’t see how you could effectively promote globalization by hampering the financial system. You’d hobble it.

    Explain to me for instance how BHP or RIO would find comfort with letters of credit drawn by a Chinese bank for say a $100 million iron ore shipment? Keep in mind that you would have to apply to the Chinese courts to have the L/C discharged instead of Western banks.

    Also, you should bear in mind that much of these European cross-debt holdings are artificial and arise because of interference with the system.

    Which “cross-debt holdings” are you talking about? I’m discussing private banks. I don’t quite see the artificiality in BNP-Paribas having bank branches in Italy and providing competitive banking services to Italians when they were previously reliant on their inefficient monstrosities.

    In short, you should be arguing for my position against others who might truly disagree.

    I don’t understand why I would be.

    There is a reason so many of the several US states are impoverishing themselves with a combination of tax cuts and corporate welfare and funding that policy by ever-greater service cutbacks.

    Which ones. Texas for instance has been the prime job creator since the GFC.

    Alan

    Oddly enough the states that are most politically conservative tend to have the feeblest economies.

    Really these are poor impoverished states?

    Alaska
    Florida
    Nevada
    Texas
    Wyoming.

    Can you point to one single study that proves raising taxes increases national income, or in this case state income?

  44. Conrad

    We’re around the same size as continental US land wise give or take. I guess if we had 50 states you could find it easier to compare and contrast in terms of relative demographics etc.

    It does appear that the failed states like California, Illinois and New York have run out of runway this time. We shall see.

  45. JC

    Alaska us almost entirely dependent on federal funding for reasons beyond their control. They are in roughly the same fiscal state as the Northern Territory and that is unlikely to change in the near future.

    Your list of states, in terms of per capita income, ranks as follows:

    Alaska 2
    Florida 38
    Nevada 18
    Texas 25
    Wyoming 19

    I will take your list of states and raise you Alabama at 46, Mississippi at 50 and Arkansas and West Virginia at 48 and 49.

    California’s fiscal problems date from Proposition 13 and are compounded by a state constitution that until recently required a 2/3 vote for the budget and still requires a 2/3 vote for any revenue increase. The Republicans, who have not enjoyed a majority in either house of the state legislature since the early 90s, simply use the supermajority requirement to ensure continuing fiscal collapse.

  46. I left out Washington and New Hampshire, Alan. Who are they like, you think, perhaps New Guinea and it’s close neighbor Timor seeing to you Alaska is like NT and not say WA.

    California’s fiscal problems date from Proposition 13 and are compounded by a state constitution that until recently required a 2/3 vote for the budget and still requires a 2/3 vote for any revenue increase.

    So you’re saying they spent themselves into oblivion knowing full well they never had the tax receipts to be able to fund themselves. I would have thought that would make your argument look even worse.

    The Republicans, who have not enjoyed a majority in either house of the state legislature since the early 90s, simply use the supermajority requirement to ensure continuing fiscal collapse.

    Yep those pesky Republicans again are at fault, this time brainwashing the dumb electorate in not listening to the Democrats to spend more, who in turn ignore the state plebiscite, borrow to the hilt and send the state veering on bankruptcy.

    I will take your list of states and raise you Alabama at 46, Mississippi at 50 and Arkansas and West Virginia at 48 and 49.

    I wouldn’t if I were you. Each have a living standard higher than Germany’s. Your argument was previously about poor US states = no income tax. I notice it’s now morphed into ” I hate the GOP” sort of thing, which frankly is boring.

  47. Let’s see:

    Alaska’s appetite for federal dollars has always been voracious and is not confined to the stimulus. A study by Prof. Scott Goldsmith of the University of Alaska, Anchorage, noted that an “extraordinary increase” in federal spending drove the state’s pile-driver growth of the last 15 years.

    In 1996, federal spending in Alaska was 38 percent above the national average. Thanks to the late Republican Senator Ted Stevens, who was Senate appropriations chief for several years, and to the military, which keeps expanding its bases here, Alaska’s share now is 71 percent higher than the national average

    That bears a significant resemblance to the fiscal structure of the Northern Territory, it seems to me.

    I at no stage mentioned income tax. I said that there is a race to the bottom and the conservative states tend to under-perform economically.

  48. In 1996, federal spending in Alaska was 38 percent above the national average. Thanks to the late Republican Senator Ted Stevens,

    Remind me, who was president at the time and could have turned to the congress and said he wasn’t signing the spending bill unless that part was removed?

    If you vote for a spending bill you carry the responsibility, period, no matter if you’re a congressman or president.

    Why would Alaska have to resemble the NT which is up and growing despite the government spending you attest to. It could also resemble a broken milk crate like Tasmania too basically with it food bowl out.

    Alan, Doncha think this GOP gotcha thing is kinda boring.

  49. Alaska probably gets a pass, you can see it as the Federal Government compensating Alaska for not being allowed to exploit its natural resources.

    Paul, why isn’t tax competition in a monetary union a bad thing? I would hate to imagine an EU without tax competition!

    Harmonisation is different, and can extend very far before it comes to rates and specific allowances. The EU could implement its common consolidated company tax base and national countries could still provide their own rates of depreciation/amortisation, their own rates of tax, allow specific deductions for corporate equity, etc.

    That said even harmonisation is not always a good thing. Someone was making the point in today’s or yesterday’s fin that harmonisation of (I think it was) OH&S is not helpful if the harmonised rules are worse than the worst of the collection of rules they replaced.

  50. Patrick@59 – re. OH&S harmonisation, that’s a no-brainer hanging off a big if. To paraphrase, if everybody agreed to make things worse, they would be worse.

  51. patrick,

    short answer: you cant sustain a Tobin Tax in one country if you dont have it in another in the same currency union because the product being taxed can too easily avoid it.

  52. …you cant sustain a Tobin Tax in one country if you dont have it in another in the same currency union…

    Why does a currency union have anything to do with it? Suppose all transactions were done in gold, then you have a currency union. Doesn’t stop some jurisdictions from taxing the gold, if they have the power to do so.

    Besides, no national government can tax anyone other than their own citizens. National governments are a protection racket, so for example, Chinese citizens has no need of protection from the Australian government, so there’s no reason to pay for it either.

  53. Paul

    There was a Tobin tax of sorts operating in Victoria for years as a duty tax on all bank transfers… even those to ones own accounts and stock transactions that occurred here!

    Of course they can operate in one part of a currency union. Locality for transactions is important also for jurisdictional reasons. It all depends how low the tax actually is in terms of causing a shift. It’s a horrible tax, but that’s another thing entirely.

  54. It’ll put a minor damper on speculative/Ponzi financial transactions with high volumes making up for low margins, and no economic purpose other than enriching the people who conduct those transactions. Heaven forfend.

  55. Dan

    Why is a short-term speculative transaction worse than a long term speculative transaction? I don’t quite understand this distinction people make. Secondly why is timing of crucial importance in deciding to ping people with a tax.

    Here’s a case in point. In early December I had a one year or more time horizon that one particular stock (WNR)(as well a bundle of others) in the US refinery space would go from 12 bucks to 20. I bought this stock with this opinion and a number of what appeared to me to be perfectly decent underlying reasons why this stock and other refineries in the Cushing region would rise. We hit 19 in early Feb and I sold out at around 18.00 for a portion of them (50%), as I thought the horizon period had condensed and that it was over bought. Why is such a short term sale considered of less value than if I had held much longer? The underlying reasons were the same. What about capital gains taxes that I and others pay?

    How can you be so sure people make profits from short term trades? In fact they don’t, most people lose money. This is similar to the myth that short side traders make money, when in fact they were licking wounds for 20 years for the most part.

    Why is mobile capital considered a bad thing?

    Investment decisions have a time element of course, but what is also important is maximizing the rate of return and that means looking for new opportunities at times in periods of short duration.

    Countries defending the Tobin tax are the ones with the long term arrow pointing down, not up.

  56. JC:

    I didn’t say anything about timing. Insofar as the velocity corollary of volume goes: people trading more often would pay more tax as a function of velocity; this would reduce purely inflationary activity (eg. money markets) to the benefit of economically productive activity (or, if you prefer, more broadly economically productive activity underpinned by fundamentals).

    In the context of the example you gave, the difference between a Tobin tax of the magnitude most advocates (including me) propose, and no Tobin tax, would be imperceptible.

  57. As for mobile capital – it has good applications and deleterious applications. Again, a Tobin tax would put a damper on the latter while leaving the former essentially the same.

    Honestly I think your objection is to tax generally, not the Tobin tax specifically, which is just a small trasactions tax on people who can easily afford it.

  58. True, you didn’t allude to timing as having a relationship to the Tobin tax, but you did criticize short term capital flows as somehow being more evil than other forms.

    All taxes on capital are bad causing the economic growth tree to rot. The more you tax it the less there is. The less there is or the more is directed to consumption the more adverse impact it has on future living standards. You always want that long term arrow pointing upwards not down or even sideways.

  59. If the economic growth is fake/false/Pozi/an illusion/a mirage etc. you definitely do not want to encourage it. Quite the opposite.

    I know you believe that bubbles are only visible in hindsight but a) I disagree and b) even if you’re right, that’s not the same as saying, may as well let ‘er rip.

  60. Some people know the difference between hot money and money that feeds into investment.

    This being the case this is why long term capital is always encouraged whereas short term flows are not.

    Paul is correct. A Tobin tax whilst a theoretician’s delight is not a practical idea.
    It is very easy to avoid.

  61. Some people know the difference between hot money and money that feeds into investment.

    Do tell the difference Homes. Spend a couple of days thinking about it so it’s be mildly coherent. I’m happy to wait.

    This being the case this is why long term capital is always encouraged whereas short term flows are not.

    And you care because?

  62. That’s actually a decent come back for you, Homes.

    But answer the questions and while you’re there. What do you actually mean by “investment” the context you raised. Show a leg here and impress me for a change.

  63. a tobin tax is not a tax on money.

    It’s a tax on the movement of money, but I can’t see a whole lot of point in having money if you aren’t allowed to spend it. Admittedly, some people move their money faster than others (so the tax falls harder on some than others). For example, applying a small tax on buying and selling shares, derivatives, etc might be fairer than CGT. Some notable money movements are already heavily taxed (e.g. buying and selling land).

    Of course, once the foot gets in the door, the small tax becomes a big tax. Governments have spent many generations teaching people not to trust them.

    It’ll put a minor damper on speculative/Ponzi financial transactions with high volumes making up for low margins

    I dispute that looking at the velocity of transactions gives any information about Ponzi schemes. A successful Ponzi scheme should be long and slow, because that builds the sucker’s confidence. Madoff kept his going for twenty years, everyone thought it was bulletproof. Greece kept theirs going for ten years (earning themselves a coveted half-Madoff award).

    I also dispute that speculative transactions are necessarily bad, after all a speculator is merely someone who is attempting to predict the future, so why it is evil to do that? The most important job of our financial system is to collect information.

    For that matter, why are low margins bad? Every margin has the guy who is receiving it and also the guy who is paying it. If I want to buy something from overseas on my credit card, then I like the idea of keeping the overheads as low as possible.

  64. ‘I can’t see a whole lot of point in having money if you aren’t allowed to spend it.’

    False equivalence much?

    And I think policymakers are perfectly aware that a Tobin tax much higher than the low rate generally proposed at present would quickly begin to discourage productive investment.

    When I said ‘Ponzi’ I was actually referring to Minsky’s Ponzi stage, which are inflationary in nature, and not necessarily at all slow.

  65. Investment is this.

    No Homer. These are the categories of investment. People invest in an office building, capital equipment etc.

    The point is what sort of investment vehicles did they use? Did they use, debt, short term or long term or equity. And how about those that provide the funds for the investment indirectly by buying stock in an IPO or a rights issue. You’re suggesting you don’t want to see people in investing in the short term but you really don’t understand what it actually means.

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