What should Greece do?

by John Quiggin on February 16, 2010

There’s been a lot of discussion of the problems of Greek sovereign debt, its implications for the euro and so on. But I haven’t seen much discussion, from a standard national policy perspective, of what the Greek government should do in dealing with the simultaneous problems of an economic downturn and unsustainable debt (feel free to point me to good discussions).

The course of action being demanded by the bondholders and their advocates, as well as by the EU governments that are likely to bear the costs of a bailout is that of drastic retrenchment on the lines the IMF would normally advocate in cases of this kind. But that is obviously not a desirable policy response when considered in macroeconomic terms. I’m not well informed on the details of Greece’s budget problems, so I’m mostly going to make generic suggestions that are applicable to a case like this.

What Greece needs, if it can be delivered is a policy that will maintain its access to credit markets, while avoiding a drastic contraction in the short run. That requires a credible commitment that holders of Greek government bonds will be paid in full, or fairly close to it, a commitment that is inconsistent with sustained budget deficits.

The strategy that seems to be indicated is one that has the following main characteristics

* A sustained increase in the ratio of tax revenue to national income over time. That suggests a commitment to raise the VAT rate gradually over several years, with the extra revenue being hypothecated to debt service. On the income tax side, the most credible commitment to raise revenue in the long run is probably one of vigorous action against tax avoidance and evasion, benefitting from the efforts of the bigger European economies in this respect

* On the expenditure side, it’s likely that Greece, like most countries has unsustainable commitments on retirement incomes. A staged increase in retirement and pension ages, as has been done in Australia, is a reasonably credible way of constraining future growth in expenditure without too much adverse impact in the short run.

* Finally, there are the various non-conventional ways previous governments found to take on debt obligations, for example by mortgaging future income flows. Unlike the case of standard government bonds, there is no need to preserve access to this kind of borrowing in the future. On the contrary, action to ensure that no future government can borrow in this surreptitious fashion is highly desirable. So, these deals should be renegotiated to reduce the burden they impose, with the threat of repudiation/default in the absence of a satisfactory agreement. The prominent role of major Wall Street banks in organising these deals is a potential political asset here. An outcome in which Goldman Sachs gets stiffed, while bondholders in general are paid, would be an ideal way of softening the political pain associated with expenditure cuts and tax increases.

{ 56 comments }

1

ajay 02.16.10 at 12:56 pm

There’s also the issue of confidence in Greek honesty. Successive Greek governments, with the aid of (eg) Goldman Sachs, were using derivative deals to conceal the size of their debt, as well as just lying about it outright to Eurostat.
See here for example.
http://www.risk.net/risk-magazine/news/1591633/greek-woes-revive-seven-goldman-swap-story

Getting over that will need a lot of effort…

2

bert 02.16.10 at 1:30 pm

Such discussions of the national implications as I’ve read have tended to be overshadowed by the international context. It’s the distance between the various strongly held views that makes this such a volatile issue and such a massive big deal.

Otmar Issing: “This is a big chance – probably the last for Greece, and others – to adapt fully to a regime of stable money and solid public finances.”
Simon Johnson: “Ireland is already cutting hard … This is not an example of a “careful” solution—it is a nation in a financial death spiral.”

3

Tim Worstall 02.16.10 at 1:31 pm

I do love this conjunction I have to say:

“That requires a credible commitment that holders of Greek government bonds will be paid in full,”

“So, these deals should be renegotiated to reduce the burden they impose, with the threat of repudiation/default in the absence of a satisfactory agreement. The prominent role of major Wall Street banks in organising these deals is a potential political asset here. An outcome in which Goldman Sachs gets stiffed,”

As in, we’re going to reassure everyone that they’ll get paid by defaulting on someone?

Sure, I understand that no one really like Goldmans but come along now, you really think those loans/deals are still on Goldman’s books?

Your actual argument is “we’ll pay those deals but not the deals organised by these bastards”. And markets tend not to like such things for whenever there’s such political identification of “those bastards” everyone’s wondering who the next politician is going to call one.

4

bert 02.16.10 at 1:50 pm

I think in any case the focus on Goldman is a bit narrow.

Since Worstall has shown up, here’s some Quiggin-bait from the WSJ: “only supply-side reforms can restore economic growth and investor confidence in Greek debt.”
The author is Greek. And runs a hedge fund.
Frankly, the idea that Germany is going to have a problem selling its own debt is … counterintuitive.

5

ajay 02.16.10 at 1:52 pm

No, the discrimination is by deal type, not by organising bank. A conventional bond issue managed by Goldman Sachs would still be honoured. The result would be a chilling effect on the market for such non-conventional bonds – which is not so much a bug as a feature.

6

JoB 02.16.10 at 1:56 pm

Greece should be happy it is not Iceland or Ireland. For one, there’s the climate. For another, it is a little bit better to have a non-working democracy tending to be fraudulent – than to have the working democracy choosing to defraud other nations of their social security systems. Finally – there is history – history will always be kinder to the Grecians.

(yeah-yeah, that was hyperbole – I love the Irish and I even like most of the Icish – if they do not sing, that is)

7

Nick 02.16.10 at 1:59 pm

One problem is that most Greeks don’t actually pay VAT.

8

Tim Worstall 02.16.10 at 2:16 pm

“No, the discrimination is by deal type, not by organising bank.”

The Greek bond issue based upon landing fees for example? OK, well, that looks very like the PFI deals in the UK. Hypothecating a future revenue stream to pay back the bond.

Not that I was ever in favour of PFI but that seems like quite a change: one that would lead to quite a change in investors perceptions of government assurances and thus might in itself lead to higher interest rates.

9

VV 02.16.10 at 2:34 pm

Well, saying Greece needs to cut social insurance expenses and raise tax revenues isn’t saying very much, is it? These are both kind of obvious. :-)

10

Kieran Healy 02.16.10 at 2:58 pm

This post should have been called “What Would Croesus Do?”

11

Zamfir 02.16.10 at 3:27 pm

For another, it is a little bit better to have a non-working democracy tending to be fraudulent – than to have the working democracy choosing to defraud other nations of their social security systems.
Huh? I would massively prefer to live in a country that tries to defraud others than in one that tries to defraud me.

12

ajay 02.16.10 at 3:28 pm

8: I think you’re losing sight of the big picture, which is that the alternative may well be a general Greek default, which would (in theory*) lead to higher interest rates as well!
If a restructuring of some of the dodgier instruments can forestall that and keep investors in normal Greek bonds OK, at the expense of investors in dodgy Greek PFIs, that seems like a good deal. You’re just deciding that dodgy instruments will be subordinated, which, as I say, is a feature rather than a bug.

*In theory people should be more averse to lending to a country that has recently defaulted. In practice, there isn’t really much of an effect. Weird, that.

13

P O'Neill 02.16.10 at 3:43 pm

I don’t see why going to IMF is viewed so badly in Greece. The normal argument is that it would involve a harsh program of deficit correction. But the EU is already imposing that through the Instability and Recession Pact. In fact, the IMF has proven quite flexible on missed targets for their recent programs — possibly more flexible than the Commission will be. At the very least, if the rest of the Eurozone thinks that a Eurozone country going to the Fund is a bad idea, the Greeks could use the threat for leverage.

14

Henry 02.16.10 at 3:46 pm

Kieran ftw.

15

alex 02.16.10 at 4:12 pm

It looks to me like the Greek government is fucked on this. How much effect that has on the lives of Greeks, who are widely reputed to systematically evade payments to the state, is open to debate.

16

JoB 02.16.10 at 4:16 pm

11- I beg to differ but, then again, I have never taken the fraudulent Volksart of Flemish people very personal. Seriously: Greeks have consistently voted for corrupt politicians because they felt they were going to benefit from it along with everybody else. That’s bad but preferable to voting for politicians precisely because they will make one’s own country more ‘competitive’ at the expense of everybody else’s social benefits. It really is.

17

Barry 02.16.10 at 5:02 pm

John Quiggin: “An outcome in which Goldman Sachs gets stiffed, while bondholders in general are paid, would be an ideal way of softening the political pain associated with expenditure cuts and tax increases. ”

Meh. Stiffing somebody who spends more on weaponry than the rest of the world combined strikes me as risky. I speak, of course, of Goldman Sachs, whose management probably has more say on the policies of the US government than the assembled majority of the American voters.

18

ajay 02.16.10 at 5:03 pm

16: of course, if the rest of the eurozone decides it has to bail Greece out, then the Greeks will indeed have profited (in the form of generous social spending in the boom years) at the expense of everyone else’s (chiefly the Germans’) social benefits; the same will be true if a Greek collapse makes it more difficult for the rest of the eurozone to borrow.

15: inasmuch as Greeks have been relying on generous payments from the state which were paid for by foreign borrowing, they are certainly going to see some pain there, either because the Greek government (either because of a collapse or an austerity plan) won’t be able to keep those payments flowing, or because they’ll have to start paying higher taxes to balance the budget.

19

Ginger Yellow 02.16.10 at 5:18 pm

On the contrary, action to ensure that no future government can borrow in this surreptitious fashion is highly desirable. So, these deals should be renegotiated to reduce the burden they impose, with the threat of repudiation/default in the absence of a satisfactory agreement.

Many of these deals (eg Hellenic Securitisation, backed by dividends from the CDLF) have already been renegotiated after Eurostat’s rules changed and they were brought back on balance sheet. The irony being that they were renegotiated to make them simpler and more direct obligations of the government. Previously the underlying cashflows were guaranteed by the government, which at the time excluded them from the PSBR. The renegotiations freed up some capital, it’s true.

Also, trying to force a “renegotiation” under threat of repudiation would not be as simple as it sounds. Legally, the bondholders own the underlying cashflows, so you can be sure there would be a lengthy court fight, and the Greek government probably wouldn’t win. Oh yes, and I’m not 100% sure on how cross-default works with sovereign bonds, but as I say for some of these bonds there are unconditional and irrevocable guarantees from the sovereign. It may well be that a default on those guarantees would trigger default on ordinary government bonds.

The result would be a chilling effect on the market for such non-conventional bonds – which is not so much a bug as a feature.

Eurostat has already had a chilling effect on those deals because of its rule changes in 2002 and 2005. There have hardly been any in the last five years, as opposed to tens of billions of euros of deals in the years up to 2004. Greece tried to do another one shortly before the credit crisis, but the EU and Eurostat slapped it down.

20

french derek 02.16.10 at 5:41 pm

As I read it, no EU country is going to put money into a bail-out for Greece (just ask any German). And, let’s face it, Greece has not said that it needs – or will need – financial support.

The real problem the Greek government has to deal with is cracking down on tax avoidance (a national sport, one commentator called it). But this requires local, detailed probing. Tax authorities in many EU countries look at your life-style compared to your declared income: and, if the two don’t quite look right, they investigate. But to do that requires a different way of thinking: and I’m not sure the Greek tax officials (most of whom got their jobs through patronage) can do it.

21

Gabe 02.16.10 at 6:16 pm

@20 – but there’s your solution right there – start employing extra tax collectors and other inspectors, thereby increasing revenue and reducing unemployment into the bargain (think of the uncollected revenue on traffic offences alone).

22

alex 02.16.10 at 6:26 pm

@18 – or not paying higher taxes….

23

JoB 02.16.10 at 7:57 pm

18: yes but that burden will not have been intentional (and it will be less for sure than the invisible hand of global neoliberalism over three decades)

I mean: Greeks will have to wisen up to the fact that the party promising the goldenest mountains isn’t always the best party. The rest of us have to be Christian about it – it is a unique opportunity for forgiveness ;-)

24

Oliver 02.16.10 at 8:32 pm

@12

I don’t think so. After a default, the defaulter can afford to pay interest again. While a default looms you should refuse to lend money.

25

hix 02.16.10 at 8:39 pm

Default is default. A default on some type of debt will have the same negative effect on all type of debt as a general default. The Greece situation looks a bit like self fulfilling prophecy. The risk premiums on Greece bonds are so high now that they cause most of the risk themself.

26

shah8 02.17.10 at 5:14 am

Most of the debt of concern here was sold back to greek banks, so a default would not help the situation.

I do not actually believe that Greece has the credibility or even the technical ability to satisfy the outstanding debt. Sure, you can raise pension age limits and all that, but people tend to treat defaults to the populace at large as of no consequence, when there is–later down the road, you’ll pay via lowered internal demand and much more inflexible wage demands. You could drop the pretensions of democracy and support for union rights, but I also think the world economy is well past the stage where autocratic governance of any sort is able to sustain a diverse economy. China does it, of course, but it relies on the outside world to supply the incentives to be diverse and it also forces extreme savings rates that hurts the long term ability to make its own course in the global economic waters. Neither is anything like a long term solution, and China will either cede more power to the people or it will have…problems. Greece has very little ability to be autocratic, and the junta of old is still well within the memory of many here such that they probably would have civil issues.

I don’t think there is a deal here to be made. Of course, one easily can make a deal to push the day of reckoning a bit further down the road, but there isn’t much road left to go…

27

Omega Centauri 02.17.10 at 5:41 am

I’m mostly hearing solutions on the policy wonk level. What are the domestic political constraints? Sounds like anything other than an externally funded bailout is going to cause a lot of pain to a lot of Greek citizens. The way they react is probably not impacted by whether they are in fact tax chiselers, and poor voters to boot (who always choose the politician promising the best magic poney). They will feel screwed through no fault of their own. We already have had some pretty serious strikes over there. So how much austerity can be imposed on the social fabric?

28

David Wright 02.17.10 at 6:28 am

Quiggen leaves out a salient fact that, while relatively specific to Greece, is crucial to the analysis of their fiscal prediciment. Greece has an unusually large number of public sector employees who are paid unusually well relative to the average Greek worker and who provide relatively little in the way of public services compared to other European government functionaries. Government jobs in Greece fuction as a political rewards system on a scale unheard of in the rest of Europe.

You would think that, upon discovering that that the richest 25% of the population was being effectively subsidized by the poorer 75%, the progressive response would be to relieve the poorer group of this burdeon. You would think that, in difficult times, the progressive case for ending such a transfer would be even stronger. But apparently when the richest 25% consists of government workers, progressive solidarity with government workers trumps progressive concern for the little guy.

29

alex 02.17.10 at 8:18 am

@26: I think the answer from most outsiders is ‘Who gives a shit?’ And given what 27 mentions, it sounds like they could do with a little breakdown in their social fabric.

30

ajay 02.17.10 at 9:51 am

I think the problem is that all those individually inefficient public sector workers do, collectively, do a lot of important stuff, and if you tell them “we’re sacking 25% of you and the rest are getting a 20% pay cut” they’ll all go on strike and Greece will basically shut down. This would be a bad thing from a human welfare standpoint.

31

dsquared 02.17.10 at 9:58 am

You would think that, upon discovering that that the richest 25% of the population was being effectively subsidized by the poorer 75%, the progressive response would be to relieve the poorer group of this burdeon.

I do not find myself wanting to get into an argument about numbers with someone who thinks that “25% of Greek workers work for the government and government salaries ae above the average” means the same thing as “the richest 25% of the Greek population are government workers”.

32

Chris Williams 02.17.10 at 11:30 am

Where does issuing a bond which is guaranteed on the hypothecated revenue based on landing fees stop, and the EU having the right to audit the books of the Chine^h^h^h Hellenic Customs Service begin?

33

Richard J 02.17.10 at 11:35 am

Somewhere in the depths of the warranties and indemnities enforcement clauses in the underlying contracts, I’d guess.

34

John Quiggin 02.17.10 at 11:54 am

@David Wright: Leaving aside the numerical problems pointed out by DD, when a hostile commenter mis-spells my name, I rarely read past the first line. It is after all, right there in the post, and if you haven’t paid enough attention to get it right, I don’t feel inclined to pay attention to you.

35

ajay 02.17.10 at 2:12 pm

31: the EU does more or less have the right to audit the books of the Hellenic Customs Service already. That’s what Eurostat does – at least, it tries to, and raises large red flags if it finds it can’t get reliable data. It can’t enforce compliance. though.

36

JoB 02.17.10 at 2:22 pm

34 – in fact Eurostat cán do a lot of things, but up to 2004 it was allowed to cook the books in this specific way. Unallowing it however didn’t impress Greek politicians and Goldman Sachs. At least that’s what economist in Belgium say (Belgium having used these mechanisms in 90s, until a member of parliament pulled it out in the open).

37

ajay 02.17.10 at 2:29 pm

35 is exactly right. See the story I linked in 1.

38

JoB 02.17.10 at 2:42 pm

ajay, I guess not everybody clicks the links in a comment ;-)

39

ajay 02.17.10 at 2:48 pm

Sorry, I didn’t mean to be over-critical…

40

Chris Williams 02.17.10 at 3:38 pm

OK, so when Eurostat decide that the landing fees would support a rather higher payback regime than is currently operating, and the Greeks demur, whose gunboats get sent where to bombard what until who signs a check?

41

ajay 02.17.10 at 3:44 pm

39: Well, that would be a sovereign default, wouldn’t it? If the bond says “we will pay you x% of the total landing fees” and the Greek government says “actually, we think we should only pay you x-2%”, then it’s defaulting on its obligations. And no one’s gunboats get to bombard anyone, any more than they did when Ecuador defaulted last year. It’s just tough for the borrower. Sovereign risk.

42

dsquared 02.17.10 at 4:00 pm

just to note that you shouldn’t get your investment advice from blogs and that particularly, anyone planning on trading in the sovereign CDS market should be very careful to do their own due diligence on all these funny derivatives and revenue-collateralised entities to determine whether they are “state or state guaranteed obligations” in the sense that a default on them would constitute a trigger event for settlement of the relevant CDS contract.

43

Ginger Yellow 02.17.10 at 5:15 pm

“OK, so when Eurostat decide that the landing fees would support a rather higher payback regime than is currently operating, and the Greeks demur, whose gunboats get sent where to bombard what until who signs a check?”

Not quite sure what you’re asking here. The landing fees securitisation (and all others with a similar structure) was ruled to be on balance sheet by Eurostat in 2002. Of course, Greece being Greece, it pretty much ignored Eurostat. But what Eurostat decides doesn’t have any bearing on whether bondholders get paid.

44

VV 02.17.10 at 8:48 pm

Hi from Greece.

27, 30, despite the 25% fallacy, there is a bit of truth to both observations in 25.
The main thing it lacks is an appreciation of the many other categories of beneficiaries of the broken Greek system: small business owners and the professions have their own deceptions going on, specifically massive tax evasion — the one sin civil servants can’t commit. In all, many people are living off effectively EU loans. The people getting mostly s**ed are the salaried of the private sector and the many people on “flexible” work contracts.

But it remains amazing that in view of the clear dead end of the current situation, and the clear social injustices it entails, the “progressives” in Greece still fight tooth and nail for it, and will probably contribute to measures that spread the pain equally to the well-fed and the almost starved.

45

VV 02.17.10 at 8:49 pm

Sorry… I meant there is some truth in 27.

46

Joshua Holmes 02.18.10 at 2:43 am

So, you have a nation where:

1. The rich don’t feel like they have to obey the same laws as everyone else.

2. The state feels fine deceiving its creditors.

3. A whole class of folks receives fake jobs and does essentially nothing.

Perhaps Greece could dissolve itself and start over?

47

John Quiggin 02.18.10 at 4:48 am

@Joshua Holmes I think that particular shoe fits more than one foot, including at least one very big one.

48

VV 02.18.10 at 9:08 am

46: Including 2 and 3? I must have missed that… “whole class of folks” becomes critical when it is significant in relation to the population that supports them. It may be sad, but widespread corruption is less sustainable than corruption for the few….

49

John Quiggin 02.18.10 at 10:26 am

VV, as regards 2, look at the way the printing press has been running lately. As regards 3, the US financial sector received 40 per cent of all corporate profits pre-crisis, and payments to senior employees were probably at least as much again.

50

Ewan Blackledge 02.18.10 at 11:25 am

Just to proffer an opine…what’s stopping Greece freezing debt service payments until they can get their house in order?
If the option is clearly between default or delay there’d be no real choice involved for creditors, and hell once there’s evidence of some fiscal reforms and pursuit of tax evaders going on, the market might even calm enough to begin lending again (though not fast). Plus the image of not being dictated to by creditors couldn’t hurt the Greek government domestically.

Unless thats against EU regulations, which it may well be (I haven’t checked).

51

ajay 02.18.10 at 11:51 am

I hate to side with VV, but the US is hardly deceiving its creditors by running the printing press: the creditors are fully aware of what’s going on. Yes, the US government is being very stupid, but it is at least being stupid in a transparent way.

52

John Quiggin 02.18.10 at 4:16 pm

Well, if it comes to that, Greece wasn’t deceiving the creditors either. It was colluding with them (GS in particular), to take on more debt than it was allowed to by the EU, probably with the hidden assumption that it would be bailed out by the other EU members.

That’s pretty much the deal implied by the “Bretton Woods II” theory of the US growth in indebtedness.

53

ajay 02.19.10 at 4:10 pm

52: Ah, but it was doing those deals – and various other things including out-and-out lying – in order to hide how big its true debt was from Eurostat and thus from the rest of the world. And “total debt burden” is the sort of thing that creditors like to know.

54

Oliver 02.19.10 at 6:26 pm

@50:
Simple. They run a budget deficit. Therefore they constantly need credit. If they don’t pay interest they won’t get it. That option is only open to countries that can resort to the printing press to cover the deficit.

55

ajay 02.22.10 at 4:12 pm

50, 54: that would effectively be a default; you don’t have to say “we will never pay back on this bond” to be in default, you just have to say “we will not make every payment on time”. And a default would mean that Greece would find it more difficult and expensive to borrow (though probably not impossible).

56

Barry 02.22.10 at 4:26 pm

Joshua Holmes 02.18.10 at 2:43 am

“So, you have a nation where:

1. The rich don’t feel like they have to obey the same laws as everyone else.

2. The state feels fine deceiving its creditors.

3. A whole class of folks receives fake jobs and does essentially nothing.

Perhaps Greece could dissolve itself and start over?”

Or just join the USA.

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