Wednesday, May 05, 2010

Do Greek Protesters Want a Default? Should They?

Lots of people in Greece have been demonstrating, sometimes violently, against the government's "austerity" program, adopted as the price of getting loans to cover Greece's very large national debt. It is not clear from the stories I have seen what alternative they propose.

One possibility is that they believe the Greek government could continue its current policies if it wanted to, that the austerity program is merely a plot by wicked people to make the protesters, and people like them, worse off. It is hard to see how a government can continue to spend much more than it takes in if nobody is willing to lend it money, but that may not be how they are looking at the question.

An alternative possibility is that they realize that rejection of the program will result in their government being unable to either borrow more money or turn over its present debts, leading to a sovereign default, and are in favor of it. That raises two questions. The first is whether that is what the protesters, or many of them, want. Readers who have followed the situation more closely than I have are invited to offer any relevant evidence.

The second is whether, in terms of their own self-interest, it is what they ought to want. At first glance, one would think not. The program being proposed is not austere enough to put the Greek budget into surplus; under it the government would still be spending more money than it takes in, although not as much more. If defaulting on its present debt makes the Greek government unable to borrow, that would force a balanced budget and presumably lower, not higher, expenditures than currently proposed—the opposite of what the protesters want.

But the answer is not that clear. For one thing, current budget calculations include interest payment on the current debt; defaulting on that debt would eliminate those payments. I don not know the details of the proposed budget, but it is at least possible that a balanced budget with current income and without interest payments would result in an increase in (non-interest) expenditure.

Furthermore, default will not make borrowing impossible. My friend Jeff Hummel quotes me as saying—when and where I don't know—that sovereign default is the one balanced budget amendment with teeth. I do not know if I really said it, but if so I was exaggerating. Defaulting once is bad for one's credit rating, but defaulting twice is worse, so after a sovereign default a government still has some incentive not to do it again, hence some reason to pay off on any further borrowing. And the first default reduces the incentive for the second, since there is no wless debt to default on—the benefit of eliminating a billion dollar debt is much less than the benefit of eliminating a hundred billion dollar debt. So after default, a government should still have some ability to borrow.

Which raises the question of whether a Greek government that had defaulted would be willing and able to spend more money, some of it taxed and some of it borrowed, than currently proposed. If so, perhaps the protesters are correct in believing that rejecting of proposed program would lead to a better result, from their standpoint, than accepting it.

This is not only a post about Greece. The argument in favor of sovereign default applies to a lot of other governments as well, including the U.S. I find the rarity of such defaults—and the willingness of people to lend large amounts of money to borrowers who face no legal penalties if they fail to pay it back—at least mildly puzzling. Presumably the explanation lies in indirect costs to default, reputational and otherwise.

One further point is worth making, emphasized by the Greek situation—the existence of positive feedback. The greater the perceived risk of default, the higher the risk premium that lenders will require on their loans. The higher the risk premium, the more costly the debt, hence the greater the incentive to default. So if a sovereign default does happen, it could be surprisingly sudden.


dWj said...

I went to a talk maybe 6 months ago about Philip II of Spain, who defaulted on his debts three or four times. I think one was shortly after he assumed the throne, and so he was kind of forgiven for it, and for the most part he paid high enough interest rates, and made good enough concessions in default (paying back most of the money, or providing other favors to victimized lenders) that any lender who did long-term business with him made out reasonably well, and he was almost always able to borrow when he wanted, with some brief exceptions when he was in default and negotiating with lenders. (The lenders also had a social equilibrium amongst themselves that gave them a pretty good cartel, with everyone willing and able to punish defectors, and they also controlled many other banking services to which he needed access. This helped a bit, too.)

Greek debt is a bit more than annual GDP right now, so if the projected deficit of around 10% of GDP is based on paying e.g. 6% interest, the primary budget is still in deficit. Still, the bailout is supposed to get them to 3% of GDP, including interest, which is surely a primary surplus with any reasonable assumption. If you dismiss precautionary motives for maintaining access to capital markets -- not to mention other knock-on foreign policy issues at play -- they're probably better off defaulting.

Richard P. said...

I have a significant other who is greek and works for the government of Greece.

Many of the protesters are Communists and Anarchists that actually want the government and state to fall. The signs on the Acropolis this week were put up by Communists and in the past 2 weeks an Anarchist Groups was broken up that was responsible for a number of terrorist attacks over the past decade. The Anarchists were not lowly citizens but members of Athens' Elite and who lived in pretty posh neighborhoods.

From my perspective I see this as a collective action problem. Each and every group is going to take a hit from the austerity program. Protesting and burning things makes your group's claims on government spending harder to ignore. So each group engages in competitive protesting to make sure they don't get the short end of the stick when cuts do come down. The reason the protest come in the form they do, is because you can't really march with the slogan, "Cuts: Everybody but Us!"

August said...

As to the Greeks, I have a suspicions Lenin3 is right and many of the protesters are communists and anarchists. Some protests occurred in Iceland as well, but sadly the same erroneous slogans where in play there.

Personally though, I want to see defaults, especially a U.S. default. Future generations should not be stuck with this debt made by a mad government which refuses to operate within its legitimate bounds.
Strictly speaking, this may not be in my best interest, because it would likely mean more hardship now, all at once- but I'd feel a lot better knowing the government couldn't spend billions on yet another stupid project. They just screwed up health-care, now they promise to waste billions on high speed trains?
Default is preferable to this ever widening debt-load.

Anonymous said...

On the positive feedback belief about the probability of default depends on what I believe other people believe is the probability of default. This is why a seemingly insigificant change in "fundamentals" can produce a large shock: because it changes what people believe other people believe.

Anonymous said...

Many of the protesters are Communists and Anarchists
What a diverse group of people. I can understand the anarchists wanting the state to fail, but the communists too?
Also, it makes sense that the communists don't want to lose privileges from the state, but the anarchists too?
I guess it makes sense that they both protest, but it would seem to be for very different reasons.

Richard P. said...

The one's that don't want to lose benefits are trade unions and farmers. They should have an interest in this government staying alive. Farmers at least might do as well under default. Trade Unions I am not sure. They are a very large portion of the work force. It would depend on how much higher their wages are than the median worker. Europe in general has a big insider-outsider jobs problem.

The other groups are Communists and anarchists. The Communist Party doesn't recognize the Greek Constitution, although that doesn't stop them from running for elected office. Just to be clear, I am not calling them that to insult them. They are self-proclaimed.

Ayn R. Key said...

Although I do not know the Greek people, your analysis hinges upon them being more economically literate than the average person I have met. That being the case, the Greek people would have resisted the Greek government getting in to this mess in the first place.

On the other hand, they may want free goods from the government without paying for it because they are as economically illiterate as the average person and see no relationship between expenditures and deficits and taxes.

grecko said...

Some bits of thoughts and comments:

-David, their main reasoning(well sort of) is: Dont cut the salaries of civil workers, pensions of any kind, just tax the rich more, default. Keep IMF and its (neo)liberal measures out.

-When you are the 4th/ 5th party in the parliament you dont really have to provide alternatives, you ll never become the governing party.

-Lenin3 n August's analysis of who the protesters are is similar to mine and many others, they are flavors of left wingers. The so called riots are actually party time for the above individuals.

-Even the current governtment(it's name reads "socialist party", is actually center left) in last elections had a leftist agenda even though there were serious concerns about economy. Makes taking actions now more difficult.

-Actually most greeks are x-treme left wingers, libertards at best.

-Anonymous' surprise about communists wanting the state to fail is surprising: Communists in Cuba, Americas, Russia etc firmly believed that a socialist state comes with a revolution.

-I think you are missing another option(or am i missing sth): default after the involvement of IMF, buys you some time and makes default more controlled.

-Current fiscal bomb is to a great extent creation of Andreas Papandreou, keen demagogue and father of current prime minister George Papandreou, who vastly expanded public sector and spending in the 80s. We still produce good tragedies with great doses of irony!

-Greece wasn't the sole country which fudged the numbers to enter euro, and IMHO this isnt the reason for the current crisis. Instead the reason is what anyone did AFTER entering the euro.
None of the south countries made adequate adjustments(reduce stiff employee protections, reforms) after entering eurozone. A greek default is probably sustainable but I dont think an Italian or Spanish is. In that manner greek crisis might be a godsend bell. said...

There's an interesting scene in Monty Python's "the life of Brian". After Brian has written "Romani ite domum" a few hundred times on the city wall Judith storms in to a People's front of Judea declaring that the "first blow has been struck to the opressor".
Brian joined the group just because he wanted to belong somewhere. He went out to write "romans go home" just to get fully accepted.
The Pythons had it spot on. Most action in extremist groups is all about pretending to do something, and about status within the peer group. It's self gratification, it's about the effect it has upon one's own ego.

Something like that probably motivates a large part of the protesters in Greece. Any rational human knows that the government has no other options.
The protesters aren't interested in stopping the reforms, they just want to be able to tell their peers that they were there. As a bonus when the inevitable hardship comes they can claim not having supported it.

Daniel A. Nagy said...

Sovereign default is sudden, indeed. I remember the Russian default of 1998. It was very sudden and unexpected. And it incidentally kick-started the economy.

I do believe that the banking system as it exists in most countries (as a state-granted monopoly) is a huge drag on the economy. The Russian economy was growing fastest, when the banking system was in ruins. Alternatives, such as inter-company lending and electronic currencies such as WebMoney have immediately taken on the task of credit mediation.

Anonymous said...

IMHO, based on what I have heard on international news media, reasoning of the protest groups goes something like this: (N.B. I'm not in Greece)

1) Anarchists - want the state to fail.

2) Communists - want the rich to be taxed more efficiently and at higher rates (they may have a point - taxes for many people are apparently optional in Greece)

3) Many others - want the government to default (and presumably restructure the debt), thereby relieving them of onerous interest payments and, they think, making the savage public spending cuts less necessary.

4) But I would also imagine that there is a sizable minority that don't have an alternative, they just don't want the cuts!

At least this is my understanding...