Can Europe Make It?

Negotiating the Greek public debt: wrong finance minister was fired

Expenditure reduction leads to falling household incomes, contraction in public services and a rising incidence of poverty, all without progress toward the professed goal, reduction in the nominal public debt.

John Weeks
10 May 2015
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Flickr/Brookings Institution. Some rights reserved.At the end of April the media reported that a government "downgraded" the role of its finance minister because of his allegedly poor handling of the negotiations over the Greek debt. I regret that this targeted the wrong finance minister, Yanis Varoufakis not Wolfgang Schäuble. If as speculation has it, the role change for Mr Varoufakis from direct negotiations to long-distance oversight resulted from his abrupt and inflexible manner, that only reinforces my view that the wrong finance minister took a hit.  Elements of the German media also assessed its finance minister as a bull in the negotiation china shop.

Mr Schäuble is a man most insistent that the Syriza government fulfil the policy "reform" agreement reached with the previous, discredited government led by Antonis Samaras. When a journalist pointed out to him that the Greek electorate had rejected that agreement, Mr Schäuble took the opportunity to put the knife in,

"The Greeks [sic! Greek government] certainly will have a difficult time to explain the deal to their voters.  As long as the [troika] programme [of December 2014] isn’t successfully completed, there will be no payout."

The German finance minister also gave short shrift to notions of EU mutual support among EU countries, "Solidarity cannot replace necessary decisions by [governments of] member states". Whatever Mr Varoufakis is accused of (by other finance ministers), he can scarcely match Mr Schauble for rude boorish behavior.

From the abstract to the catastrophic

A serious mistake practiced not only by Mr Schauble but also by most commentators both official and in the media is this failure to make the basic distinction between "Greece" and the Greek government.  The former refers to a geographic territory and should not be used as collective noun.

Greece does not have a debt, nor do the people of Greece. Both legally and in practice what the media and Mr Schauble call "the Greek debt" represents loans taken by various Greek governments.  The distinction is important, not least because in a democracy governments rule by the consent of their electorates. 

The concrete problem that the other EU finance ministers wish to avoid by use of "the Greek debt" should be obvious--public debts remain after the governments that incurred them depart the scene. The Greece/Greek government distinction implies another invalid abstraction, "the Greek people". For some purposes in international law we can refer to the Greek government as representing "the Greek people". A mundane example is that Greek embassies in every country have the obligation to represent all their citizens.

Except for trivial matters in no country do the policies of governments reflect the will of "the people". The population of every country has class, ethnic and regional differences generating conflicts of interest. It is this political reality that the term "Greek debt" seeks to avoid confronting.

Imagine if instead of using the term "Greek debt" and referring to "Greek obligations" the EU finance ministers were to enter the world of concrete reality and discuss the Greek government's debt. It would then be necessary to explicitly consider which government incurred the debt and the extent to which that debt should be honored by subsequent governments.

International and national practice has established the precedent that sitting governments should service the debts incurred by previous governments. There are notable exceptions, most frequently associated with a consensus that the debt-incurring government lacked democratic legitimacy.  The funds borrowed by the Nazi government represent an obvious and extreme case of illegitimate or "odious" debt, and was formally recognized as such in the 1953 London Agreement on German External Debts.

While some of the current debt of the Greek public might be considered "odious", the Syriza government has a stronger argument for reimbursement of the principle and interest for the forced loan to the Nazi occupying authority towards the end of World War II. However it is resolved, the forced loan claim will not help the Syriza government meet its immediate debt service.

At this point the analysis requires a third distinction, between the generally accepted legitimacy of the debt service faced by the Syriza government and the policies to make that servicing possible. At the end of January 2015 the Greek electorate did not formally deny responsibility for the public debt (Syriza did not include debt cancellation in its platform). A plurality of voters sufficient to remove the Samaras government rejected the policies it implemented with the purpose of meeting debt service obligations.

So, international practice obligates governments to service inherited public debts. It does not require incoming governments to continue the same policies as preceding governments. To put the matter simply, obligation to service debt passes from one government to the next; the policies to achieve debt service do not convey from one government to the next. The latter, a generally accepted principle outside the euro zone, holds all the more if the previous government's policies failed in their purpose.

Demonstrable failure

The policies of the Samaras government failed to achieve the narrow purpose of debt service and debt reduction. This conclusion was reached not only by critics, also by one of the Troika members, the International Monetary Fund (see reports from different perspectives, in the Financial Times and The Guardian).

Two charts show the demonstrable failure of pre-Syriza policies. The one below traces three measures of the ratio of public debt to GDP by quarter, 2009-2014:  1) the ratio of the measured debt to measured GDP (solid black line); 2) the ratio of the 2009Q1 debt value to actual GDP (dashed black line); and 3) the ratio of actual debt to GDP at its 2009Q1 value (solid blue line). 

I interpret the first counter-factual measure as the "austerity path", indicating the effectiveness of the 2010-2014 policies of demand compression/output-suppression.  The result of this counterfactual tracks the actual ratio very closely.  In other words, the entire increase in the public debt to GDP ratio resulted from declining GDP, not increase in debt. 

On the contrary, measured in constant prices, for example the composite EU price index, the public debt of Greece was lower at the end of 2014 than it had been five years before (the nominal increase was by 1.4%, see Central Bank of Greece spreadsheet).  Demand compression policies sought by the EU and IMF and duly implemented had their predictable result, declining output and reduced ability to service the public debt.

The blue line represents a counterfactual in which "bailout" funds would be used to maintain public expenditure and aggregate demand such that nominal GDP did not change (zero growth). In this case we find no increase in the public debt to GDP ratio.  The chart sends a clear message: the public debt to GDP ratio rose because output fell.

Greece: Gross Public Debt as Percent of GDP, Actual (black), Constant level of Debt & Actual GDP (black, dashed), and Actual Debt & Constant GDP (blue), 2009Q4 - 2014Q4

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If the reader remains unconvinced, I offer more evidence of demonstrable failure in the chart below that reports the contribution of changes in expenditure and revenue to reducing the fiscal deficit. These contributions are shown as positive numbers; i.e., an expenditure reduction is a positive contribution to the fiscal balance, and a revenue decrease is a negative contribution.

The chart tells a simple story and conveys a clear message.  The simple story is that from 2010Q1 to 2014Q4 the fiscal balance changed from minus €36.3 billion euro to minus 6.4 billion, a reduction of €30 billion.  Over 100% of this reduction came from cuts in expenditure. This €30 billion decline ("improvement") in the fiscal balance resulted from a 10 billion decline in revenue off-set by a 40 billion contraction in public expenditure.

The message from the chart is that relying on expenditure reduction to achieve a positive fiscal balance produces extremely dysfunctional side effects. The output decline must by necessity be a multiple of the expenditure reduction. The fall in spending results in falling output that reduces revenue. The side effects take the form of falling household incomes, contraction in public services and a rising incidence of poverty, all without progress toward the professed goal, reduction in the nominal public debt.

Greece: Contribution of Changes in Expenditure and Revenue to Reducing the Fiscal Balance, 2010Q1 - 2014Q4 (billions of euros)

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Clearing away the fog

The persistent and indiscriminate use of invalid abstractions by the official creditors of the Greek government has made negotiations over the public debt a protracted and futile exercise. The abstractions obscure a reality inconvenient for the creditors:

1. Governments not countries or peoples contract debts and incur the obligation to service them;

2. The obligation to service debts passes from one government to the next, but the policies to achieve debt service do not.

3. Political parties offer alternatives to the citizenry and in the EU elections provide the legitimacy of a government and its policies.

Thus: By international practice the current Greek government has the obligation to service the debt incurred by previous governments, but need not do so with the same policies.

From this reality arises an obvious exit from the currently stalled and acrimonious negotiations in which the basic dispute is that the EU and the IMF claim that they not the Greek government have the power to dictate domestic economic and social policies. The EU finance ministers, with the formidable Wolfgang Schauble in the lead, should follow international practice and tell the Syriza government, "You must service the public debt; how you do it is your problem, not ours".

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