Tuesday, May 17, 2011

Is Roubini Right on Greece?

Nouriel Roubini has written another piece on the PIIGS where he lambasts the EU's approach to dealing with the Continent's debt crisis. His point of departure is plausible, but his analysis is too narrow, and in the end, his assessment is wrong, at least insofar as Greece is concerned. 

His argument rests on three premises: (a) Greece faces a solvency not a liquidity crisis and its debt level is clearly unsustainable - it will thus be forced to default eventually; (b) giving Greece money just delays that inevitable reckoning, so it is throwing good money after bad money; and (c) a Plan B would be better by imposing some losses on bond holders but making them part of the solution rather than the problem and "bailing them in" rather than "out." 

Let us look at each claim in turn. 

Is Greece's debt sustainable? Probably not, but frankly we do not know. If Greece were Argentina, it would have defaulted in the late 1980s; if Greece were Japan, it would have another decade to go before facing any trouble. Greece is neither Argentina nor Japan, but these comparisons should remind us that sustainability is a nebulous term. What makes Greek debt unsustainable these days is that the market thinks it is, and so it demands interest rates which act as a self-fulfilling prophecy. The IMF, for its part, shows that faster (but possible) growth could push Greece's debt levels below 100% by decade's end. Not that this means that Greece's debt is clearly sustainable - it is not. But it is also not clearly unsustainable. Pardon the double negatives, but these are different. 

If Greece's debt can be made sustainable, it is not clear that this is "good money after bad money." But the more important observation is Roubini's assumption that sooner is better for dealing with the problem. As an economist I can sympathize - default and restructuring are painful and they are made more painful by denying and delaying the inevitable. No arguments there. 

Politically, however, this is not so. How a country defaults and when - these questions have political ramifications. Timing and process matters. Consider this analogy: economic sanctions. Now sanctions are hugely contentious, of course, with much debate as to whether they work and in what cases. But one of the arguments in their favor is that they enable diplomatic or military escalation. You ask nicely before you ask not nicely. And having asked nicely makes the harsh asking more tenable. In other words, you can make an effort to avoid default and end up defaulting anyway, or you can just default from the start. Roubini thinks these two outcomes are the same and so a country might as well accept the inevitable. I think he is wrong. 

Put simply, a Greek default in 2012 would likely better than a Greek default in 2010. I don't mean this from an economic standpoint, although that is probably true in the sense that the shifting of liabilities from the private to the public sector will help lessen the contagion from a default. Banks are likely going to be better prepared in 2012, although again I have no qualms about a scenario that imposes losses on Greece's lenders. Plus, if Greece has managed to make a reform or two, a debt-restructuring offer would be more attractive in 2012 than in 2010. 

Instead, what I mean is that this process, much as it may seem futile to the economist, is useful politically and, in the long-term, economically as well. Think about a Greek default in May 2010. We can only guess, of course, but here are likely outcomes: 

First, the Greek government and public would have blamed default on speculators that attacked Greece because of greed and/or other nefarious conspiracy-theory-reasons. Prime Minister George Papandreou has often blamed speculators for the crisis after all. The lesson would be "we defaulted because the speculators decided to make a buck on our plight." 

Second, the government could have fallen, possibly triggering a political crisis with no party commanding a parliamentary majority. Greece could have found itself in a series of elections with no decisive outcome - a plausible scenario if one thinks in retrospect about how poorly all parties have done in the past twelve months in the absence of convincing solutions and inspiring leaders. 

Third, Greece's faith in Europe would have been shaken, weakening the anchor that membership in the EU has provided for Greek politics since 1974. This is what happened when Greece felt abandoned by NATO during the 1974 crisis in Cyprus. The urgency to enter the EU (EEC at the time) was driven by a feeling that NATO did not stand by Greece in a crisis and that the country needed to hedge its political bets. 

To go back to my favorite theme, Greece does not face a debt crisis - it is a political crisis whose most apparent manifestation is debt. Now imagine Greek politics after a May 2010 default, and compare that to what has happened instead. I am assuming, of course, that none of the conditionality, none of the troika visits, none of the benchmarks would occur in the "May 2010 Default" scenario. I say that because even assuming an orderly restructuring, external influence would peak at the start of the exchange (to agree on the terms) rather than be retained throughout. More importantly, it is hard politically to declare default and present a series of tough reforms at the same time - versus a scenario where measures are introduced in an effort to "avoid the humiliation that comes with default." 

This is not good money thrown after bad money as much as it is good money trying to buy political reform. Europe and the IMF are being "bailed into" Greece in an effort to create political change. Tough as these years may be, Greece has made changes that governments have failed to pass for decades. The remaining agenda is enormous, and the resolve and unity of the government can be questioned at times. Yet there is space for the country to start discussing taboos such as tenure for public sector employees, privatizations, and the relationship between the market and the state. This is aided of course by continuous external pressure to both pass and implement changes - in a way that would have been difficult in an "early default" world. 

This is a more serious effort to come to terms with the deep structural causes of the crisis. By no means is the debate complete, but in the event of a Greek default, we would have ended up with lots of finger-pointing. Now we have finger-pointing paired with a reform program that is worth the name. 

Now think of a default in 2012. Several of the political shocks will remain of course. But the country has crossed some psychological thresholds. It is one thing to say "we defaulted because George Soros was out to get us," and it is another altogether to say, "we were handed €110 billion and still managed to default." These two defaults may end up looking similar on paper and on the numbers. But they are a world apart politically. And that distance matters for Greece in the end.


  1. In terms of policy you make an excellent point about delaying default, however wouldn't an earlier bailout play into the ruling party's favour? At least in terms of re-election.

  2. I appreciate the intelligence and effort exemplified in your writing. Thank you. But surely a consideration in postponing default would be capital flight as people liquidate assets. I would be surprised if any Greek has any appreciable money in a Greek bank today.


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