Greece and Trust

Nick Rowe pulls me up on a point that I didn’t make in my account of what should have happened to Greece after 2010. I argued that some external body (e.g. IMF) should lend sufficient money for Greece to be able to achieve primary surplus (taxes less non-interest government spending) gradually, thereby avoiding unnecessary unemployment. Gradual adjustment is required because the improvement in competitiveness required to achieve ‘full employment’ with a primary surplus cannot happen overnight because of price rigidity.

Nick’s point is that for this to happen, the external body has to have a degree of trust in Greece: trust that it will not take the money and at some stage default on this new loan. This trust may be particularly problematic if Greece had defaulted on its original debt, which I think it should have done. This, after all, is one reason why Greece would not be able to get such finance from the markets.

This is what the IMF is for. Governments are more reluctant to upset the international community, and so defaults on IMF loans are rare. As Ken Rogoff writes: “Although some countries have gone into arrears, almost all have eventually repaid the IMF: the actual realized historical default rate is virtually nil.”

But does this help explain why other Eurozone countries keep going on about how Greece has lost their trust? I think the answer is a clear no. In fact I would go further: I think this talk of lost trust is largely spin. The issue of trust might have explained the total amount the Troika lent from 2010 to 2012. However, as I have said often, the mistake was not that the total sum lent to Greece was insufficient, but that far too much of it went to bail out Greece’s private sector creditors, and too little went to ease the transition to primary surplus. (The mistake is hardly ever acknowledged by the Troika’s supporters. Martin Sandbu discusses the - misguided - reasons for that mistake. [0])

The reason the Troika give for lack of trust is that Greece has repeatedly ‘failed to deliver’ on the various conditions that the Troika imposed in exchange for its loans. The Troika has tried to micromanage Greece to such an extent that there will always be ‘structural reforms’ that were not implemented, and it is very difficult to aggregate structural reforms. However this is exactly what the OECD tries to do in this document, and if I read Figure 1.2 (first panel) correctly, Greece has implemented more reform from 2011 to 2014 than any other country. [1] We can more easily quantify austerity, and here it is clear that Greece has implemented almost twice as much austerity as any other country. [4] The narrative about failing to deliver is just an attempt to disguise the fact that the Troika has largely run the Greek economy for the last five years and is therefore responsible for the results. [3]

You could argue with much more justification that the failure of trust has been on the Troika’s side. Greece was told that the austerity demanded of it would have just a small impact on growth and unemployment, and the Troika were completely wrong. They were then told if they only implemented all these structural reforms, things would come good, and they have not. You could reasonably say that the election of Syriza resulted from a realisation in Greece that the trust they had placed in the Troika was misguided.

Given these failures by the Troika, a reasonable response to the election of Syriza would have been to acknowledge past mistakes, and enter genuine negotiations. [2] After all, as Martin Sandbu points out in a separate piece, a pause in austerity in 2014 had allowed growth to return, and because Greece had achieved primary surplus new loans were only required to repay old loans. But it is now pretty clear that large parts of the Troika never had any real wish to reach an agreement. Over the last few months we were told (and the media dutifully repeated) that the lack of any agreement was because the ‘irresponsible adolescents’ of Syriza did not know how to negotiate and kept changing their minds. We now know that this was yet more spin to hide the truth that large parts of the Troika wanted Grexit.

The lesson of the last few months, and particularly the last few days, is not that Greece failed to gain the trust of the Troika. It is that creditors can be stupidly cruel, and when those creditors control your currency there is very little the debtor can do about it. 

 

[0] Greece was prevented from defaulting because of fears of contagion of one kind or another, which meant that Greece was taking on a burden for the sake of the rest of the Eurozone. The right response to these fears was OMT, and direct assistance to private banks, as Ashoka Mody explains clearly here. But given that this was not done, what should have then happened is that once that fear had passed, the debt should have been written off. But politicians cannot admit to what they did, so the debt that was once owed to private creditors and is now owed to the Troika remains non-negotiable.

 

[1] The Troika can also speak with forked tongues on this issue: see Mean Squared Errors here (HT MT).

[2] I am often told that the Troika had to stand firm because of a moral hazard problem: if Greek debts were written down, other countries would want the same. But the moral hazard argument has to be used proportionately. Crashing an economy to avoid others asking for debt reductions is the equivalent of the practice in 18th century England of hanging pickpockets.

[3] I am sometimes asked why I focus on the failures of the Troika rather than the mistakes of Syriza. The answer is straightforward - it is Troika policy that is the major influence on what happens in Greece. And when the Troika gives Greece’s leaders the choice between two different disasters, it seems rather strange to focus on the behaviour of Greece’s leaders.

[4] Postscript: Peter Doyle suggests that, all things considered, Greece overachieved on fiscal adjustment     

The Stupid Cruelty of the Creditor

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

	2010	2011	2012	2013	2014
Government Consumption Growth %	-8.7	-5.2	-5.9	-7.1	-4.0
Underlying Primary Surplus (% GDP)	-3.6	1.3	4.2	6.5	7.6
Output Growth %	-4.9	-7.1	-6.3	-4.5	-1.3
Unemployment %	12.5	17.7	23.6	26.7	27.2

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.