All entries for Friday 30 April 2010
April 30, 2010
Greece at the mercy of "the markets." Hundreds of thousands faced with job cuts, lower salaries, and longer to work until retirement. It's hard not to feel sorry.
Equally, it's easy to understand the wrath of many Greeks: why should foreign bond holders have such power over the domestic policies of a sovereign state? Why should they accept the diktats of the IMF?
There is a simple answer. For many years, the Greek government spent far more than it raised in taxes. Why? It was the easiest way to buy votes. The problem was that the Greek government could not do it without the cooperation of others: those willing and able to lend it it.
Some of these were Greek financial institutions such as pension funds. But 80% of the Greek debt is held abroad, much of it with German and French banks. But these have walked away, taking the ball with them.
Now that the markets have called an end to the game, those who want to stand up for the entitlements of the Greek workers have to ask where the money will come from. Here are the options:
- Continue to borrow on the market -- but who will lend? The Greek debt is already at or beyond the margin of sustainability (on which more below). It is not an attractive prospect.
- If not borrow, then take. One option for the Greek government is to take from the lenders that previously enabled the years of pleasure and are now causing the pain. Taking without permision is normally called taxation. In this case it is called default. For Greece, default is all the easier because most of the lenders are abroad; they do not vote and are unlikely to throw rocks. Unilateral default has one problem: you can only do it once. After that, there is the same problem as before: if the voters want the Greek government to spend more than it raises in taxes, they must borrow. But who will lend?
- If neither borrow nor default, then print money. For most sovereign states, printing money would fix several things at once. The new money would cover the budget deficit. Then there would be inflation, but inflation would erode the real value of the debt. After that there would be a disaster, but hey ... But Greece cannot go down this road, even if it wants to. When it joined the euro, Greece gave away the right to print its own money.
- If neither borrow, nor default, nor print money, then ... raise taxes and cut spending, because there is nothing else that can be done.
These are Greece's options. In fact, the conditions that the EU and the IMF are "imposing" on Greece -- to raise taxes and cut spending -- are just what Greece must to do anyway, because there are no other choices that don't end in disaster.
Even that might not be enough. Government revenues are currently around one third Greece's GDP. If the debt heads for 140% of GDP and then stops, and must be refinanced at 10%, it follows that in future taxation must transfer 14% of GDP annually to bondholders in interest payments, and these alone will use up around 40% of Greece's limited tax capacity. Moreover, around 80% of Greek debt is held abroad, so those interest payments must shift more than a tenth of Greek GDP abroad each year -- just to cover the service on the debt, not to reduce it. The currrent EU-IMF bailout assumes that Greece's problem is liquidity. But what if it is solvency?
In that case, the future still holds the possibility of default. Given more time there will perhaps be an organized, agreed default. A rescheduling of repayments agreed with Greece's creditors will not kill Greece's credit ratings for ever, provided Greece adheres to the conditions imposed upon it.
One way of thinking about the Greek government yesterday, if not today, is that it stood at the centre of a web of obligations: legal obligations to bondholders, moral obligations to public sector employees and pensioners, and political obligations to voters. What the world has found, adding these up, is that they total far more than Greece's available resources. Something must give.
Greece holds one card, and it is an important one. If Greece goes down, so do its foreign bondholders. The German government has faced the choice between bailing out Greece and bailing out its own banks. It is interesting, and not inevitable, that the German administration has chosen in favour of Greece rather than to let Greece go and pick up its own pieces afterwards. This illustrates two things: the importance of politics, and the well known saying widely attributed to Keynes: "If I owe you a pound, I have a problem, but if I owe you a million, the problem is yours."
In all modesty, how far from Greece are we? Expectations of the British government, and what it can do for lenders, employees, the young, the old, the sick, and voters at large, have also become overstretched. Like Greece, the UK has a government that overspends, with a budget deficit of similar size relative to GDP. As in Greece, public spending is much more important to the UK economy than it should be. Even before the crisis, its importance was rising steadily; public spending accounted for nearly half of the entire increase in GDP over the period of the Blair-Brown government from 1997 to 2007. Since the start of the crisis, the growth of public spending has accelerated. Right now, public spending amounts to more than half of the UK's GDP.
In some other important ways, we are much better placed than Greece. Our aggregate debt is smaller relative to GDP, with less need for near-term refinancing. More significantly, the UK has a much greater fiscal capacity than Greece, with better coverage of tax raising institutions and less avoidance. We will be able to raise the taxes we need to finance the debt we have. And we will raise them, for another important reason: more of our debt is held at home, so lenders are also voters.
Finally, and crucially, we are not part of the eurozone. That matters, not because it will let us print money, but because it will let us recover from fiscal adjustment. The coming squeeze on spending and tax increases will put a cramp on jobs and demand from the public sector, but further depreciation against the euro and dollar will eventually rebalance the economy, allowing exports and private spending to take its place.
If there is a parallel with Greece it is not in the national picture but the regional one. For the UK as a whole, the ratio of government spending to GDP is currently a little over one half. For Ireland, Wales, and the Northeast it is between 60 and 70 percent. These regions are not only hugely dependent on public subsidies but they have no chance of renewed competitiveness through currency depreciation because, like Greece, they belong to a currency union -- in their case, the United Kingdom. What keeps them going is an unconditional year-on-year bailout from central government revenues.
My vote is not yet decided, but these are some of the reasons why I am taking seriously what the conservatives have to say about the economy today. Darling called the first phase of the crisis far more astutely than Osborne, and labour deserves credit for that. I am not convinced that more of the same will take us into a recovery.