Saturday, February 07, 2015

Not In His Vocabulary


The financial world is waiting for the other shoe to drop in Greece. It's a sure bet that Greece's creditors are biting their fingernails. But, Joseph Stiglitz writes, there is a way out of this problem. It's worked before -- just as austerity has failed before -- many times:

Austerity had failed repeatedly, from its early use under U.S. President Herbert Hoover, which turned the stock-market crash into the Great Depression, to the IMF "programs" imposed on East Asia and Latin America in recent decades. And yet when Greece got into trouble, it was tried again.

Greece largely succeeded in following the dictate set by the "troika" (the European Commission the ECB, and the IMF): it converted a primary budget deficit into a primary surplus. But the contraction in government spending has been predictably devastating: 25 per cent unemployment, a 22 per cent fall in GDP since 2009, and a 35 per cent increase in the debt-to-GDP ratio. And now, with the anti-austerity Syriza party's overwhelming election victory, Greek voters have declared that they have had enough.

Not only has it failed in Greece. It's also failed in Spain:

First, let us be clear: Greece could be blamed for its troubles if it were the only country where the troika's medicine failed miserably. But Spain had a surplus and a low debt ratio before the crisis, and it, too, is in depression. What is needed is not structural reform within Greece and Spain so much as structural reform of the eurozone's design and a fundamental rethinking of the policy frameworks that have resulted in the monetary union's spectacularly bad performance.

The reason for the failure lies less with those who borrow money and more with those who lend it:

Given the amount of distress brought about by excessive debt, one might well ask why individuals and countries have repeatedly put themselves into this situation. After all, such debts are contracts -- that is, voluntary agreements -- so creditors are just as responsible for them as debtors. In fact, creditors arguably are more responsible: typically, they are sophisticated financial institutions, whereas borrowers frequently are far less attuned to market vicissitudes and the risks associated with different contractual arrangements. Indeed, we know that US banks actually preyed on their borrowers, taking advantage of their lack of financial sophistication.

It's wiser, Stiglitz believes, for creditors to forgive those debts:

Every (advanced) country has realized that making capitalism work requires giving individuals a fresh start. The debtors' prisons of the 19th century were a failure -- inhumane and not exactly helping to ensure repayment. What did help was to provide better incentives for good lending, by making creditors more responsible for the consequences of their decisions.

The classic example is Germany --  Europe's economic powerhouse. The debt burden which the allies placed on Germany after the World War I was one of the causes of World War II. At the end of the second war, leaders were determined not to make the same mistake:

Seventy years ago, at the end of World II, the Allies recognized that Germany must be given a fresh start. They understood that Hitler's rise had much to do with the unemployment (not the inflation) that resulted from imposing more debt on Germany at the end of World War I. The Allies did not take into account the foolishness with which the debts had been accumulated or talk about the costs that Germany had imposed on others. Instead, they not only forgave the debts; they actually provided aid, and the Allied troops stationed in Germany provided a further fiscal stimulus.

When companies go bankrupt, creditors swap debt for equity. Stiglitz suggests that the same remedy be followed in Europe:

The analogous approach for Greece is to convert its current bonds into GDP-linked bonds. If Greece does well, its creditors will receive more of their money; if it does not, they will get less. Both sides would then have a powerful incentive to pursue pro-growth policies.

Don't expect the Harper government to endorse this solution. After the G20 summit in Toronto, our prime minister -- masquerading as world statesman -- went to Greece and advised George Papandreou to apply the austerity brakes -- hard. We have seen the results of his advice.

Harper stands four square for punishment. But forgiveness isn't in his vocabulary.


The Mound of Sound said...

Do we have leaders today capable of the "grand bargain" Owen? Merkel appears to be holding the reins even as she struggles to hold Greece to its obligations while not allowing the EU to fracture. They're desperately afraid that Greece, Spain, Italy and possibly Ireland too will follow Iceland's model.

This is a vexing problem that requires statesmanship and it's hard to identify where that's to be found.

Owen Gray said...

It appears, Mound, that statesmanship is another word which has disappeared from our leaders' vocabulary.