Greek debt no longer a technical problem
The EU has approached the Greek debt problem as a technical one up until now. Greek governments used to share that perspective. No more. Alexis Tsipras and his Radical Coalition of the Left (Syriza) puts politics front and center. Why? Because the purely mathematical approach of debt dynamics turned out to be a disaster. The unemployment increased around 50 percent, while the ratio of public debt to GDP increased from 120 percent to more than 170 percent. It was a bitter failure.
Allow me to start by explaining the debt dynamics. Italian economists are the best in their academic analysis of this subject. That comes from years of experience in their country’s rising government debt.
Debt dynamics are all about how to lessen the burden of government debt on the economy. The key term there is “ratio.” The debt ratio – that is the ratio of debt to GDP – rises with high interest rates and the primary budget deficit. Plainly speaking, that means the government spends more borrowed money while keeping the cost of borrowing low inside its own country. The ratio declines with inflation, growth and a primary budget surplus. In theory, it is a simple and sound mechanism, a neat mathematical formula. Governments can control the debt ratio through fiscal spending: Tighten your belt, expect a decline in interest rates and hope for growth. From Athens’ point of view, austerity was pain without an end in sight. Europe should have realized that if the patient is not responding to your treatment, you need to change your approach. They did not and Greek voters went out to get a second opinion.
That is how I understand Tsipras’ idea of a European Debt Conference. Recall that the 1919 Paris Peace Conference burdened Germany with an inordinate economic punishment at the end of World War I, and thus paved the way to the Third Reich. The 1953 London Conference led to today’s prosperous Germany. There, it was agreed that German annual payments should not exceed 15 percent of German exports. Greece is not paying war reparations, but rather repaying the credit that elevated it from a middle income, to high income country. How did that happen? The EU relaxed the borrowing constraints for Greece as it was preparing to join; and once it was a member, there was no mechanism for individual country adjustment within the EU. The northern banks financed Greece’s Europeanization.
Debt dynamics matter if you are planning on paying them back. But you can also look for other options. In 2001, I recall we analyzed the impact of refusing to honor the then very high Turkish debt. Some 95 percent of the debt was held by Turkish residents, which meant that not paying that back would have destroyed people’s credit standing. That, in turn, would have constrained their spending for a long time to come. We decided against that option because it would have made the recovery process more difficult. Look at Greek debt today. Some 60 percent of it is to Euro area banks, half those being German. The problem does not lie with debtors as it did with us, but rather with the creditors.
Remember that Alexander Hamilton’s fiscal plan led to the establishment of the United States of America. After the American War of Independence, Hamilton combined the states’ debt at the hands of a central treasury, thus indebting them to the federal government, rather than directly to their creditors. The debtors’ union created a fiscal bond and thus a powerful central government was formed. Can it be done again?