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….
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.
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?
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.
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.
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.
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.
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.
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:
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.
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.
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.
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?
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.
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.
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.
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.
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….
JB am no economist.
However Can stimulus measures work in a society were so much of economic activity is ,circular activity?
john,
Yes – remember, measures of economic activity are about just that: activity – Keynes described it as the velocity of money. Stimulus peps up velocity.
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?
@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.
So the idiot and fraudulent borrower should get let off then?
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
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.
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
again no substance Homer, you are just Kibitzing. The lag between reforms and growth is well-researched, but a different topic.
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
@ 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
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.’
(Simple in theory, anyhow.)
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.
“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
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.
They only have one choice, keep spiraling down till they hit the bottom.
And then?
“We’d like to give you x billion Euros. But we’ll audit you, … “
http://www.zerohedge.com/news/silent-anschluss-germany-formally-requests-greece-hand-over-its-fiscal-independence
Like that you mean?
Hasn’t actually worked yet. The panzer divisions ain’t what they used to be. I guess there’s a reason why we are quick to pull the forelock whenever the Yankees step into the room.
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.
“… 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.
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.
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.
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).
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.
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.
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?
This is why Germany cannot win in the situation.
http://www.joe.ie/news-politics/world-affairs/angela-merkel-depicted-as-a-nazi-on-cover-of-greek-newspaper-0020767-1
Their earlier bailout money received no appreciation whatsoever, and their attempt to impose limits on government spending produces outright hostility. I think it’s finally dawning on the Germans that walking away is their least-worst option.
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.
so the Germans originally didn’t have the smart money but now they do.
no wonder they are sauerkrauts!
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?
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.
Paul, if one attempts to minimize financial flows between the EU member states you’re basically calling for less integration. Period.
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?
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.
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.
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.
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.