All entries for Friday 24 June 2011
June 24, 2011
Writing about web page http://www.ft.com/cms/s/0/4dfcca24-9e46-11e0-8e61-00144feabdc0.html
On the plane back from Moscow, I read Martin Gilman's No Precedent, No Plan: Inside Russia's 1998 Default (MIT Press, 2010). Gilman was the IMF's man on the spot during the Russian debt crisis of August 1998.
I flew into Moscow a few days after that crisis broke. Business life seemed to be paralysed. Many people that I met were panicked or in despair. But in retrospect, Gilman points out, this was the start of Russia's sustained recovery from the economic collapse that accompanied the breakup of the Soviet Union.
The crisis itself was very ugly. The disarray in Russia's public finances had built up over years, with persistent overspending, repeated failures to generate taxes, and the high inflation and high interest rates that resulted. In the private sector, Russian banks borrowed in dollars at low interest rates and bought up high-interest ruble bonds. In the crisis, the exchange rate plunged by a third, resulting in widespread bank insolvencies.
Gilman recounts the fear that Russia would turn away from a market economy and economic integration to ultra-nationalism and autarkic controls. In fact, there was no tragedy. At a lower exchange rate, the Russian economy regained international competitiveness and embarked on a decade of rapid growth that just about doubled real incomes.
As I read the story of Russia's crisis thirteen years ago, I was caught up in the parallels with Greece today. There are very important differences, of course. Greece is much smaller, with 11 million people to Russia's 140 million. Greeks are far richer on average, with $16,000 per head (at 1990 prices) compared with $5,000 per head for Russians in 1994. (And Greece doesn't have huge armed forces armed with nuclear weapons.) Surely, Greece's problems today should be more manageable than Russia's then.
In fact, Greece's crisis is similar to Russia's -- at best. When you add up all the political and financial claims on the economy, they exceed the resources available by an unsustainable margin. In Greece, people expected the public sector to guarantee jobs. They expected free services and benefits. They expected to retire early on fat pensions. They expected all this without paying taxes. The result was a growing debt, which had to be serviced. The government expected to be able to service the debt by borrowing more, so debt rose more rapidly. This was fine as long as interest rates were low, and as long as they could get away with misreporting what they were up to.
Now the only solution is to cut back on some or all claims on the economy. But whose, specifically? If Greece is not to default on the public debt at some point, there must be a huge fiscal adjustment. Back in February, the Financial Times put the tightening at somewhere between 8 and 22 percent of GDP -- and that was just to stabilize the debt, not reduce it. Greek living standards must fall by an unrealistically large amount. in fact, as Mervyn King reiterated today, Greece is insolvent. Default would at least allow Greece to transfer some pain to bondholders -- but domestic reform and retrenchment are still necessary, because who will lend to a defaulting government to cover its deficit?
In Greece now, as in Russia then, pain is inevitable but there is no prospect of agreement on how the pain should be distributed. Every group in the population -- the rich, the poor, the farmers, the business sector, the bankers, the public employees, the students, the pensioners -- looks for a way to pass the parcel onto others. The government does not have the authority to stop the game.
Moreover, much Greek debt is held abroad, so European bondholders, many of them French and German bankers, and increasingly the European Central Bank, are in the game too. The French and Germans are playing pass the parcel with the ECB; the British certainly don't want the parcel; as fast as the others pass it back to Greece, the Greeks hand it over again.
It is in everybody's interest to solve the Greek crisis quickly, but it is in nobody's interest to accept the role of victim. This must go on as long as at least one special interest inside or outside the country expects to gain by blocking a solution. Resistance will stop only when things are so bad that no one can any longer hope to derive a one-sided benefit from further delay.
In another respect, Greece's problem is worse than Russia's. The Russians could devalue. Devaluation of the ruble restored competitiveness and also cut incomes -- everyone's incomes -- by pushing up import prices. This put an end to argument over who should suffer the pain. Moreover, the pain was short-lived because recovery followed. Greece cannot copy this while it remains in the Euro zone. In fact, the only way of restoring Greek competitiveness is to wait while Greek wages and prices fall -- but this will not only take years; it would have the further highly unwanted side effect of further increasing the real burden of Greek debt.
Much good advice is being dispensed in the financial media about how to handle Greece's problems in an orderly, even optimal way. An orderly solution would mean several things at once: an agreed recheduling or restructuring of Greek obligations that decides how the pain is shared between Greece and external debtors; a fiscal programme that decides how the domestic adjustment is shared between taxes and spending, and between the various claimants on the Greek government; and a long term programme to liberalize Greek wages and prices and restore competitiveness.
There is nothing in the economic history of Russia or any other country to suggest that there can be an orderly solution for Greece. If an orderly solution was possible now, the problem would never have reached this point. Rather, it is more or less certain that the Greek crisis will break while everyone is unprepared, and it will work out in a chaotic, unplanned way, with unforeseeable consequences for Europe. For, without an exit from the Euro, the Greeks have no prospect of the rapid recovery that Russia made. An orderly exit from the Euro: what are the chances of that?
The Russian financial crisis came to a head in August 1998, unexpectedly, when many government officials, bankers, and IMF staffers were on vacation. As you pack your bags this summer, think about it.
P.S. I sincerely hope to be wrong.