Thursday, February 05, 2015

Joseph Stiglitz – A Greek Morality Tale

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.

Every (advanced) country has realized that making capitalism work requires giving individuals a fresh start. The debtors’ prisons of the nineteenth 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.

At the international level, we have not yet created an orderly process for giving countries a fresh start. Since even before the 2008 crisis, the United Nations, with the support of almost all of the developing and emerging countries, has been seeking to create such a framework. But the US has been adamantly opposed; perhaps it wants to reinstitute debtor prisons for over indebted countries’ officials (if so, space may be opening up at Guantánamo Bay).

The idea of bringing back debtors’ prisons may seem far-fetched, but it resonates with current talk of moral hazard and accountability. There is a fear that if Greece is allowed to restructure its debt, it will simply get itself into trouble again, as will others.

This is sheer nonsense. Does anyone in their right mind think that any country would willingly put itself through what Greece has gone through, just to get a free ride from its creditors? If there is a moral hazard, it is on the part of the lenders – especially in the private sector – who have been bailed out repeatedly. If Europe has allowed these debts to move from the private sector to the public sector – a well-established pattern over the past half-century – it is Europe, not Greece, that should bear the consequences. Indeed, Greece’s current plight, including the massive run-up in the debt ratio, is largely the fault of the misguided troika programs foisted on it.

So it is not debt restructuring, but its absence, that is “immoral.” There is nothing particularly special about the dilemmas that Greece faces today; many countries have been in the same position. What makes Greece’s problems more difficult to address is the structure of the eurozone: monetary union implies that member states cannot devalue their way out of trouble, yet the modicum of European solidarity that must accompany this loss of policy flexibility simply is not there.

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, a debt-equity swap is a fair and efficient solution. 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.

Seldom do democratic elections give as clear a message as that in Greece. If Europe says no to Greek voters’ demand for a change of course, it is saying that democracy is of no importance, at least when it comes to economics. Why not just shut down democracy, as Newfoundland effectively did when it entered into receivership before World War II?

One hopes that those who understand the economics of debt and austerity, and who believe in democracy and humane values, will prevail. Whether they will remains to be seen.

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