Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday 30 July 2015

The wheels on the bus

I have an image in my mind. Its a bus running downhill, and its brakes have failed. There are four men in the front cab. The two men in the middle are both trying to control the steering wheel to keep the bus on the road. The man to their right has control of the accelerator, and is pushing on the gas hoping this will crash the bus to the right. The fourth man to their left controls nothing, but as his pleas to stop pressing the accelerator fall on deaf ears, he begins to wonder whether it would be better for the passengers to grab the wheel and crash the bus to the left. The three other drivers do not agree on very much, except that it is all the fault of the guy on the left, and now appear to be thinking about throwing him off. As the bus hurtles downhill swerving from side to side, its passengers are battered, some injured, and a few are jumping off.

I do not need to explain the symbolism. I tried to change the image to explain why the man on the right refuses to stop pressing on the accelerator of growing primary surpluses, but gave up because the real reason is that he wants to crash the bus anyway. (The argument that the Eurozone’s rules do not allow debt write-offs is just nonsense.) Otherwise I think the image works well. The two men in the centre represent Tsipras and maybe Hollande. Hollande is saying that if only you would let me have the wheel (‘structural reform’) all would be well, but in truth the main reason the passengers are being injured (unemployment and welfare cuts) or are jumping (migration) is the speed of the bus.

The central question is whether the men in the middle are delusional. By keeping the Greek economy on the road that is the Eurozone are they only going to prolong the agony with the same inevitable crash which is Grexit?

There is only one reason for optimism that I can see, although it assumes yet further reductions in Greek living standards. The hill the bus is travelling along will begin to flatten out and the road might even start to rise as Greece becomes more competitive in terms of price. I outlined here why that has not yet boosted the Greek economy to the extent it has in Ireland, but if unemployment remains at or above 25% Greece should get even more competitive. Instability and unwise Troika interventions may delay the process, but eventually the tourists will come. The Eurozone does contain a natural correction mechanism: it is just slow and painful.

If this does eventually lead to sustained growth in Greece, it does not excuse what has gone before: recoveries do not justify recessions, and government profligacy does not have to imply a 25% fall in GDP! However this correction mechanism is not bound to succeed, if it is countered by another dynamic, which is one that has been and continues to be imposed by the Troika. That dynamic is austerity chasing primary surpluses when that austerity makes the economy shrink. Macromodels would probably tell us which dynamic will win out, but they will not factor in a deterioration in the financial position of banks (already not good as Frances Coppola points out) as the economy stagnates, and the deteriorating social and political situation that austerity brings.

So the eventual outcome still depends on the decisions of the Troika. It always has of course. The truth that their apologists find so uncomfortable is that the Troika has been in charge of the economy since 2010, and therefore is responsible for the mess we are now in. The idea that all would be well if only Greece had undertaken every item of structural reform they specified (and a lot was done) is just silly. Now it appears as if it is all the fault of the former Greek finance minister, because he dressed funny, or kept wanting to talk about economics, or did some contingency planning - it is so absurd you couldn’t make it up.

One ray of hope offered by Anatole Kaletsky is that now “ritual humiliation” has been achieved, the Troika will be more forgiving. I wish he was right, but this argument fails to account for the German finance minister who clearly believes that exit is the best option. He wants the bus to crash for the sake of the other cars on the road. An optimistic view would be that the shock [1] of what was done to Greece a few weeks ago will bring others to their senses, and Schäuble’s influence on the Eurogroup (and strangely the IMF) will decrease. I fear the larger truth is that the non-German bloc in the Eurozone does not have an alternative economic vision to offer (although it clearly exists), and will never face Germany down.

[1] Link added 31/07


  1. Does this post mean that you think Grexit would be worst for Greece?

    It's obviously true that further euro support would be better for Greece. If Europe waive the debt away and let Greece run a 3-4% budget deficit for a few years, I am certain things would get much better for Greece living standards. It might even not cost that much to other European countries... But it implies running a pretty large risk of seeing even less money out of Greece for European countries I think. Given the current displayed solidarity I doubt Grexit would be worse. It would achieve debt restructuring and solve the competitiveness issue in one go...

    I personally think only one member to the troika is really culpable: the ECB. Monetary policy has been totally inappropriate for the entire Euro area for a long time and it's only now getting more appropriate. The damage caused to most Euro countries vastly exceeds the total damage inflicted to Greece as well...

    My opinion is that the Euro is a mistake. Germany should leave as the least disruptive break-up scenario and the rest of the Euro area will have a more appropriate currency area... A united states of Europe is clearly not in the cards at the moment: it has no democratic mandate.

    1. «If Europe waive the debt away and let Greece run a 3-4% budget deficit for a few years, »

      The greek government was (according to official government statistics) running a deficit of 15-20% a year for several years around 2008, and an equivalent trade deficit, both financed by "solidarity" from (mostly french) banks.

      Defaulting would make that "solidarity" permanent and payable by french, german, italian, spanish, polish, slovakian, dutch, bulgarian, etc. taxpayers. It would also remove the need for Greece to pay a much reduced interest on that debt: the IMF says that currently:

      «Cash interest payments on Greek debt last year amounted to 6 billion euros (3.2% of GDP)»

      Plus this year repayments of principal of around 10-15 billion euros are due, and similarly for a long time.

      So you are asking not only for 3-4% of GDP of forgone interest payments plus 4-6% of GDP of forgone debt repayments, but also a continuation of the 2-3% of GDP that is given to Greece as net fiscal transfer, no-strings-attached, from the other EU countries, and 3-4% of government deficit financing, also no-strings-attached. But actually the greek government has already cashed in via securitization many years of those 2-3% net transfers, so they would need to be given again.

      In effect you are asking for the EU and eurozone countries whose financial systems Greece would have just blown up to give Greece no-strings-attached new net fiscal transfer of around 7-10% of GDP indefinitely, let's say 9%.

      But this would boost greek GDP only to the level it had in mid-2012 when Greece was in "deep austerity" *compared to 2008*, as indeed it had a government deficit of only 9% of GDP, compared to the 15% of GDP of 2008.

      if one assumes 2008-2009 as the baseline, as SimonWL astutely does, then any level of government deficit of less than 15% of GDP (note well "of GDP", not of government spending) is going to cause "austerity", never mind a cruelly low level of just 9% of GDP.

      «I am certain things would get much better for Greece living standards.»

      Greece in 2014 had a somewhat higher GDP-per-person at PPP relative to the EU average than it had in 2000-2001 when greek living standard were considered quite high: 78% in 2001, 90% in 2008, 83% in 2013.

      But consider the case of Bulgaria and Romania: their GDP-per-person in nominal terms in 2014 was 25% of the greek value, which was 75% of the value (at constant prices) it had in 2008.

      If greek citizens are entitled to the living standards they had in 2008, which were not even at the EU average, and therefore to be able to run an anti-austerity government (and trade) deficit of 15-20% of the GDP they had in 2008, shouldn't the bulgarians and romanians entitled to the same living standards?

      Isn't therefore the argument that the bulgarians and romanian governments are running such vicious demand-suppressing "austerity" policies that the demand of their citizens is cut by that austerity to to 20% or 25% of its potential level?

      Shouldn't then the bulgarian and romanian governments stop their absurdly excessive "austerity" policies and run deficits of 75-80% of the level of GDP Greece had in 2008?

      Or are the greeks entitled to the lifestyles that are given to them by a government deficit of 20-25% of their 2008 GDP, but the bulgarians and romanians aren't?

  2. This analogy reminded of a scene from the hilarious 1981 movie Airplane. The plane is in danger and a right wing blowhard on a talk show says, "They bought their tickets, they new what they were getting into._.I say, let em crash!"

    That's Schable on Greece. I think there are technical solutions proposed here and elsewhere that could work. But honestly, I see virtually no evidence the core wants Greece to survive . They must be an object lesson.

    Vengeful creditors often harm themselves. See Versailles , Sachs had a good article on this. Throw a man in debtor's prison and he can't repay.

    But the disturbing thing is political and moral. Empathy and solidarity are on the wane in Europe. In the US the Republicans are 17 clown for prez, many of whom are sociopaths.

    I thought we were better.

    1. My reaction as well. Blame the Republican Supreme Court, Citizens United and money in politics for the 17 member clown show for the Republican primary. They all are getting the money to run from investors. Another symptom of inequality.

    2. We were better and then came Nixon and Reagan.

  3. Re the alleged horrors of Grexit, how come Greece wasn’t doing too badly last time it used the Drachma instead of the Euro, i.e. prior to 2000?

    Second, there is big obstacle in the way of more generous treatment of Greece: it’s called “democracy”. I.e. German and other core country voters just don’t want to continue pouring money into Greece.

    1. Ralph, core euro area country voters would thus choose democratically to write down the assets they hold on Greece. It is their right, it effectively means no more cash going to Greece, hence no more debt servicing or amortization by Greece and flowing to the core. Core country voters would thereby pull the plug on their own Greek assets.

    2. Patrick, I imagine a significant proportion of voters in core countries have now concluded that more help for Greece amounts to throwing good money after bad, i.e. that further help is pointless. If that’s true, the core country creditors do not lose anything by cutting off further assistance.

      Having said that, Grexit does not necessarily mean Greece does not at some point repay its debts, though eventual repayment would doubtless be far in the future. It’s up to Greece what it does. If it DOES DEFAULT it will be excluded from capital markets for five or ten years, so it has an incentive to repay debts eventually.

    3. That's inaccurate. Defaulting nations are not excluded for that long. Capital markets are too greedy.

      "Another ideological weapon of the creditors is the idea that financial markets will automatically punish countries that default. But neither historical evidence nor logic support that claim – if anything, a country that has removed a pile of unserviceable debt is a much better credit risk going forward. Debt is only a constraint on governments because there are political agencies enforcing it, either local elites who want the debt-servicing-required outcome anyway, or embargo, or gunboats."

    4. Ralph, you say that "core country" voters no longer wish to continue throwing money into Greece; however, with a new programme, that's exactly what they would continue to do... In reality, I don't think the "ordinary" voter has any idea of what the issues are; even economists can't agree on what is necessary ;) , so the ordinary voter, who is no economist, can only get a very general impression, through the mass media, with all the limits or distorsions of the info going through their filters.

  4. Simon, you say that Greece will eventually recover, even under austerity, as tourists will come back. That might be so, if Tunisia and Egypt remain unsure, if infrastructure remains of good quality, if Greeks still welcome rich Germans (and Belgians); if Golden Dawn or the Military have not taken over the country by then... Working in Brussels and being a Belgian citizen, I clearly see that inasmuch as Belgium is part of the "German bloc" under the current Flemish nationalistic-dominated government, Begium (via its Finance minister) has absolutely no sympathy for Greece... its austerity all the way!

  5. Is your image an appropriate one? Greece is a bus that was fuelled by credit. Without fuel you are in danger to to run downhill backwards. The breaks don't work. The steering committee looks into the wrong direction because they are in the front of the bus. With enough grit in the gears the bus stops and doesn't move back or forwards. Luckily, people find a (gr-) exit and will have saved their lives. The drivers are sued because they had driven the bus while being stoned by credit.

    1. " does not excuse what has gone before: recoveries do not justify recessions, and government profligacy does not have to imply a 25% fall in GDP! "

    2. But recoveries based on non-sustainable finance are always followed by recessions. Macro 101.

    3. «Without fuel you are in danger to to run downhill backwards»

      The other 18 EU governments (the famous "Troika" is just a front for those countries) have provided immense, very generous subsidies to Greece since 2009-2010 (in addition to the "voluntary" PSI haircut), in order to achieve a soft landing and prevent a run downhill backwards.

      The greek economy has achieved in 2010-2014 a very soft landing to the same level of GDP it has in 2000-2001, according to official statistics. To achieve that has taken a lot of money and has been of enormous value to the greek economy.

      I have read some bloggers and other "authorities" state that avoiding a formal default has been of no value to Greece and all the support that the other 18 eurozone countries (given via the ECB, IMF, and the EU commission's vehicles) have given to it has been worthless, and that the "soft landing" has been pointless too.

      Some have even argued that it would have been much better to formally default, blowing up the french financial system and large part of the german one as final "goodbye" to Greece's partners in the EU, and then exit the eurozone and the EU and become "monetarily sovereign" again, becoming able to borrow again to sustain large government deficits to finance a demand-led recovery.

  6. I wonder what will happen to Podemos as they are poised to win in the December election.

    Also I believe the ECB's ongoing QE will help as a second- or third best solution, but it won't be enough to lift Europe.

    It does look like Schauble wants to kick Greece, which would ultimately help Greece, but then the next go around, they'll just pick on the next weakest link and humiliate them.

  7. The usual vacuous remarks without any constructive plan, based on comical assumptions.

    I have been asking on this blog and others a very, very simple question:

    * What is the plan in which greek GDP surges back, *without* net transfers of 20-25% of GDP to Greece, in 4-6 years, by 20-25% to its level of 2008-2009?

    Our blogger is a professional macroeconomist, and perhaps he can come up with that plan.

    If he cannot come up with that plan talk like:

    «the Troika has been in charge of the economy since 2010, and therefore is responsible for the mess we are now in»

    is just handwaving, and it seems to me disingenuous, misleading handwaving too, as it what happened before 2010 did not matter at all, when instead it matters a great deal, because it was 10 years of massive once-only asset sales boosting spending well beyond Greece's ability to produce that it wants to consume.

    In the UK and other countries there is a saying: the day after every national soccer team match millions think that they would have been better team managers...

  8. It seems that Schauble has offered Greece an assisted and orderly way out with perhaps even a debt haircut. I can't understand why Greece would not at least consider such a proposal given the current creditor plan offers even tougher austerity and a marked reduction in political and economic sovereignty. Why would any state be wanting to remain in the EZ given what Schauble intends to foist on the rest of the EZ - a strict fiscal union under German command. You would have to be bonkers. Probably some E100b +/- has left Greece and could be the source of funds to finance economic growth post an exit with a devalued domestic currency. It would give the owners of offshore stashed Greek funds a windfall - c'est la vie. I would bet the rest of Europe (Merkel for sure) would be content they remain in the EU to stop them sliding too far east.


  9. I wonder if the usual suspects may liken the accelerator operator as those in favour of fiscal stimulus, the drivers as George and Dave - and maybe Daniel Hannan asking for further breaking.

  10. A collapse of 25% in real gdp is related to a collapse in Greek potential gdp. So I agree with you it is not sure Greece will come back to growth if austerity follows also after a gdp collapse. It could be interesting to analyze the positive influence that a gdp collapse has on people. It is easy to observe it after a war or a natural catastrophe. On the contrary a 25 collapse in gdp is not immidietly related to a distruption sentiment, it needs some time to bring it. So the question is how much time does Greece need to reach a distruption sentiment among people?

    A follower

  11. Modern models were built to explain periods of mild economic fluctuations, a period known as the Great Moderation, and while the models provided very good policy advice in that setting they had little to offer in response to major economic downturns.


Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time. In addition, I cannot publish comments with links to websites because it takes too much time to check whether these sites are legitimate.