In the middle ages those who could not afford to pay their debts were sent to prison by their creditors. An efficient solution to the moral hazard problem? Hardly, because the chances that the debtor could earn some money to repay something to the creditor from a prison cell were not high. So countries gradually developed rather more civilised bankruptcy laws, like Chapter 11 in the US.
Yet we are seeing the equivalent of these medieval practices in Europe at the moment. Arguably the harm being inflicted on the people of Greece by its creditors is even more cruel, and more stupid. More cruel, because the harm is being done to those totally innocent of the original contract - children indeed, as Karl Smith notes. More stupid, because those doing the damage cannot see what they are doing, either by refusing to open an economics textbook, or believing that they somehow know better.
Just look at these numbers, from the latest OECD economic outlook.
The Greek Macroeconomic Disaster
Consumption Growth %
Underlying Primary Surplus (% GDP)
Output Growth %
Why is this happening? Because the Eurozone governments that foolishly bailed out Greece after the crisis first developed in 2010/11 want all their money back. (I discuss this in more detail here.)
But surely, you may say, those who lent money to the Greek government are entitled to have their money back (with interest). No one was forcing the Greek government to accept these loans, and the conditions that go with them. The creditors are justified in doing everything they can to pressure the Greeks to repay their debts, including threatening Greece with expulsion from the Eurozone. The fact that this is causing great human suffering and misery is just one of those unfortunate things, and perhaps a necessary lesson to make others think more carefully before electing governments that secretly run up unsustainable debts.
If that is what you think, then I would suggest this view is the moral equivalent of locking debtors up in prison. It is also as stupid, because the damage being done to the Greek economy and its politics is making the scale of the eventual default greater than if some debt relief was allowed now. A fiscal contraction of this scale, in a country with no independent monetary policy, was bound to do this much damage. Any macro textbook tells you that. Those who believe that reducing one component of demand just changes its mix rather than its overall level display an ignorance which in this case is close to criminal.
But, you may say, the Greek economy has become uncompetitive, and wages need to fall if the economy wants to stay part of the Eurozone. There is no escaping macroeconomic pain. True some deflation was necessary, but deflation on this scale is totally wasteful, and the immense harm it is doing is therefore avoidable. Once again, very simple macroeconomics tells you this. And, as Ryan Avent is the most recent to point out, the core of the Eurozone is making this competitiveness correction as difficult to achieve as possible. You might say that this chaos is required to achieve necessary structural reform. I seem to remember someone else once had a similar idea, which they called perpetual revolution.
Unfortunately this would not be the first time creditors have laid waste cities in an effort to recover debts, as Peter Frankopan has reminded us. But it need not be like this. Let me end by quoting Robert Kuttner, from a review of David Graeber’s book ‘Debt: the First 5000 years’.
[The Allies] wrote off 93 percent of the Nazi-era debt and postponed collection of other debts for nearly half a century. So Germany, whose debt-to-GDP ratio in 1939 was 675 percent, had a debt load of about 12 percent in the early 1950s—far less than that of the victorious Allies—helping to produce postwar Germany’s economic miracle.
The lesson from the 1920s had been learnt. Whether this was done out of self interest, because a vibrant post-war Germany benefited everyone, or compassion, I do not know. But whichever it was, the creditors of the Eurozone could use some of that wisdom right now.