Dear friends, good morning,
I must confess that I feel awkward that I have to speak in English in my hometown, but, at the same time, I feel proud that TEI Ionion Nisson has managed to upgrade its research and academic activities and to organize this wonderful conference. I would like to congratulate the organizers. I take a personal satisfaction for this successful event because, when as Minister of Education I founded TEI Ionion Nisson, I had the dream that it would become a Centre not only for training but also for research at the international level.
Now, to come to the subject, everybody talks today about debt crisis, euro crisis, the Greek exit – we have a new world for that, the Grexit – and there is actually a lot of confusion about what is really happening and what should be done. I want to contribute to this discussion by looking at the issue from a historical point of view and provide a historical perspective to the present day crisis.
But, before I do so, I want first of all to clarify some terms concerning the meaning of the debt burden and to demystify the nexus of “debt crisis”. It is often said that sovereign debt is a burden on citizens and on the economy. This is not always true. We had a debate about this subject in the Parliament, long ago, in the 90’s when the then P.M. Mitsotakis, criticized me as a former Minister of finance about the rising debt in Greece, saying that each new born baby in Greece is born with a debt tag of 20.000. Now, as a matter of general principle, this is not always true.
Consider first, internal sovereign debt which means that the government borrows from its citizens and spends the money. What happens when you have an internal debt? You simply issue bonds, you take savings from George and Nick and you pay, in terms of government disbursements, other citizens, Gerassimos and Spyros. In accounting terms, the flows cancel out, the plus and minus, at the level of national income. Consider now the repayment of the debt: What happens? Simply, the government taxes citizens A and B and pays the owners of the bonds C and D. Here again the flows cancel out. Internal debt does not extinguish income but does not create income. So, there is no burden when there is internal government debt. Mr. Mitsotakis was right when he said that each new born baby in Greece is born with a debt tag of 20.000. But he failed to add that, at the same time, that same baby is also born with a fortune of 20.000 bonds which belong to the Greek society, since most debt was internal. So, let us clear that confusion with regard to the internal debt, there is no such thing as government burden.
The subject is very different though when we talk about external debt, when we borrow from citizens from other countries. In that case, what we do when we issue bonds is that we transfer resources from abroad into our domestic economy and that allows us to spend beyond our means. What happens when we repay our debt? The reverse takes place, since we have to tax our citizens to transfer resources abroad. As a result, we have to live below our means because we have to transfer part of our national income to citizens outside the country. This, indeed, is a debt burden. So, external debt is a burden and this is the issue I want now to focus on.
Debt is not necessarily a bad thing, it depends on what you do with it. If you borrow to sustain consumption above the level of your income, then that debt will be detrimental to your growth prospects. If, on the other hand, you use that debt for investment purposes and you increase your income, external debt may be a good thing.
What are the conditions for a successful process of borrowing? It is very simple and intuitively you can understand why this is so. If the increase in your nominal – not real, I emphasize nominal – national income is large enough to allow you to pay the interest payments on foreign debt, that means that you can repay the debt without having to reduce the historical standards of living and everything is fine.
This fundamental property is not a new thing, it was first proposed way back in 1944 by an American economist named Domar who examined the conditions for a successful debt process and argued that the rate of growth of nominal national income, r, should be equal and possibly higher than the interest rate on foreign debt, i, adjusted by the ratio of debt, D, to nominal national income, Y:
r >i (D/Y)
This inequality links the rate of growth in a country and the conditions of its loan. This is the fundamental property which we often forget when we discuss issues of debt.
The typical case of a successful process is when a country’s national income grows by 6% with 2% inflation and 4% growth and the interest rate is 3%. Note also that in successful cases the ratio of Debt to National Income is less than unity. That’s fine. You may ask: yes, but you forgot the payments on account of amortization required to repay the debt. Well, I say “forget about it”. Because if you can afford to pay the interest payments without affecting the standards of living of the country, the lenders will be all too happy to continue to lend you so that you can roll over the debt. In fact, this is a surprising phenomenon coming from economic experience, the countries never pay back their debt because they roll it over. Take for example the US which had huge debts after WWII and the Vietnam War. Simply, its growth rate was higher than the interest rate so that it rolled over its debt and as income increased hugely over the decades, the outstanding debt became a small proportion of national income. This is a success story. But what happens if the rate of growth is lower than the interest rate. For example, if a country does not grow, has an inflation of 2% and the interest rate is 6%, as it is the case now in Spain and Italy.
In such a case, the country is obliged to pay its debt by reducing the standards of living. This gives rise to social unrest and the foreign lenders not only refuse to extend new loans but refuse to accept also a roll – over of the debt and demand immediate payment of amortization on account of previous loans. This is the definition of debt crisis.
The history of the world is full of debt crises. From the days of Solon, in Athens, to current events. In fact, the European Wars of the 16th, 17th, 18th and 19th century were nothing more than wars emanating from bad debt management.
There are two methods of dealing with debt crises. One method, a shortsighted one, is to demand first of all the repayment of the debt, even if that means shrinking national income and reduction in the standards of living of the borrowing country. This is the austerity program which, more or less, apply as a rule when you have a debt crisis. There is another method however which goes back to the fundamental inequality I just described to you, which says that we first increase the national income, by taking care of the reconstruction in the economy. Thus, by securing high growth rates, we can repay the debt, not by affecting the welfare of the people but by transferring part of the surplus we have produced.
Now, more often than not, the lenders are shortsighted and follow the first approach. Very rarely, lenders adopt the second approach.
I have a long experience on the matter. In this Conference, I was introduced as an ex minister but in my previous “incarnation” I was an economist in the UN and as an expert I dealt with 22 debt renegotiation cases in the context of the Paris Club. From my long experience, I have one conclusion that I want to share with you. The debt issue is dealt properly only when the debtor has bargaining power and can press the lenders to accept a development oriented solution of the debt. So, you need bargaining power.
I said I would speak about the historical perspective. I do not want to speak at length but I want to highlight the point that I have just made by referring to the experience of the German debt crisis, yes you hear well, German debt crisis and German default. And I want to dedicate these remarks to Ms. Merkel and her associates who, like the dynasty of Bourbons, they seem to have forgotten nothing from history but have learned nothing from it as well. What happened in the German case about 70 years ago?
At the conclusion of WWI, the Triple Entente, the Allies, imposed tough, even punitive, terms for repayment of German debt as well as for reparations. The terms were so tough that in 1923 Germany defaulted on its obligations. In the midst of this crisis, with hyperinflation and massive unemployment, a Committee chaired by Dawes, an American, introduced the so-called “Dawes plan”, a plan for which Dawes himself received the Nobel Peace Price in 1925. The main feature of the Plan was that it provided a time table of reparation payments but also provided substantial export credit to Germany by a consortium of American investment banks. That helped Germany to stabilize its economy and honor its obligations but made her excessively dependent upon foreign markets and economies. In a sense, the Allies provided Germany new loans in order to repay old loans. In the process, it became quite clear that Germany could not meet its huge annual payments.
As a result, the Young Plan (after another American chairman of the Committee), in 1930, reduced significantly the amount of total reparations (sort of a haircut) and more importantly it divided the annual payment into two parts, an unconditioned part, 1/3 of the sum, and a postponable part, the remainder incurring interest, which was financed by a consortium of American Investment Banks.
In spite of the generous haircut and the refinancing arrangement for part of the debt, the plan come too late. The depression was in full force and the Nazis were coming to power. When Hitler took over, he defaulted on the reparations and debt. In a way, the manner with which the Allies handled the German debt and reparations contributed to no small degree to the rise of Nazis and to the outbreak of WWII.
After WWII, the Allies changed dramatically their attitude towards the German Debt. For two reasons: first, they learned their lesson but, second, they were anxious to support Germany to stand by its own bootstraps and become a key factor in the Atlantic bloc against the Easter bloc.
As a result, in the 1953 London Debt Agreement, the Allies decided to reduce significantly the debt by 62,6%. You realize that a haircut of that magnitude was an extremely generous gesture towards a defeated country. But that was not all: Listen to some other elements of the Agreement:
1. The servicing of debt had to be arranged in a manner so as to permit Germany to achieve a high level of growth, employment and living standards. It was thus stipulated that the debt service / export revenue ratio should not exceed 5%! By the way, in the Greek case, under the honerous conditions of the memorandum, this ratio is more than 100%!
2. The agreement provided the possibility to suspend payments and renegotiate conditions in the event that a substantial change limiting the availability of resources should occur.
3. Through the Marshall Plan, Germany was provided with huge financial resources (grants) which helped her reconstruct the economy.
Without wishing to downplay the importance of the resolution and ability of the Germans to reconstruct and develop their economy, I must say that Germany should have tried very hard not to succeed in the face of such generous debt relief and huge grants.
This is the historical perspective I wanted to convey to this meeting, hoping that it will help you appreciate the ill-effects of the bad management of a debt and the positive results that can be obtained when the issue is resolved in a partnership spirit.
These considerations bring me to the Greek case:
The Greek problem has a very important difference from all previous cases, namely that Greece belongs to a monetary union, and consequently should not have a debt problem. In a proper monetary and economic union, there should not be such a thing as national debt crisis, as there can be no Chicago, or California debt crisis in the USA monetary union, as there cannot be a Quebec debt crisis in Canada.
But, unfortunately, the Eurozone is an imperfect monetary union. It has an amputated Central Bank, there is no integration of the banking sector, there is no Eurozone fiscal policy and mechanisms to re-allocate resources among member states so as to ensure convergence of the economies and attainment of basic balance of payments equilibrium in all members. We all know that at Maastricht, the EMU was a historical compromise between France and Germany. France managed to draw Germany inside European Institutions but, in return, Germany gained its reunification and won the upper hand in shaping the policy character of ECB. We knew about these shortcomings: I was the parliamentary spokesman of the major opposition at that time, in 1992, when I said that “in the Maastricht Treaty you would not find the superior quality of Goethe’s ideas, or the superb harmony of Beethoven but you will feel strongly the heavy hand of the German banker”. These, in all modesty, prophetic words, were accompanied by a spirit of optimism that in the process we will achieve albeit gradually, a full monetary and economic union.
Let it be as it may, the question is how the Eurozone institutions should now deal with the crisis.
It’s quite clear, from what I said so far that the focus of the collective effort should be on the financing of the development process so that eventually the growth rate of national income will be high enough not only to safeguard the sustainability of living standards but also to start repaying the debt. During the transition period, debt repayments, if any, should be adjusted to the debt servicing capacity of the country, that is, should not adversely affect the standards of living.
Unfortunately, the Eurozone did not follow this approach. It reacted in a shortsighted manner, keeping Greece on short leash, and imposing austerity measures that triggered an ever deepening recession. This was the upshot of the two memoranda that Eurozone imposed upon a subservient and incompetent Government. We all know what was the reaction of the electorate in the recent elections.
The first thing that must be done is that the Eurozone must accept that we should lengthen the adjustment period. We need structural reforms in Greece and these take time. The package needs to be extended over a period of time so that you can do this adjustment without hardship imposing on the Greek people. The second thing we should do is to link the rate of debt repayment to the prospect of economic growth in Greece. That links together Greece and the partners because, in this case, the lenders will have an interest in seeing growth in Greece. We will pay as fast as we grow, and not out of an “immisering” process. These are two conditions which must be introduced in the new policy package.
But, we have to avail this opportunity and take steps forward toward monetary integration. And let me suggest two measures that can be taken immediately, without requiring revision of the Treaty and can be implemented with no fiscal cost.
First, the creation of a eurozone wide institution that would undertake the following tasks:
1. It will ensure all deposits in all banks of the zone with unequivocal guarantees. This scheme will safeguard all economies from probable panic and bank runs. In the case of Greece this would be very important because people would know that if they have their deposits in a Greek, German or British bank they are all guaranteed not by a government but by the eurozone.
2. The same institution should enforce the recapitalization of the banks. The recapitalization of the banks should not be a national task – as is the case now – but it should be the task of the European institution which would force all European banks – Greek, Spanish and all other banks – to recapitalize. The funds for recapitalization of the banks should not be charged to national debts but to the European institution. Certainly, the European Institution will have the authority to enhance bank regulation and supervision.
Second. Issuance of Eurobonds in order to finance big projects of infrastructure, especially in the indebted countries.
These will be important steps toward a viable monetary and economic union while, at the same time, meeting the pressing needs of member states in debt crisis.
At a later stage, but not too far in the future, we should take the next step and change the mandate of the European Central Bank so that it can operate without constraint in the secondary markets and, thus, undertake the role of ensuring financial stability.
These steps can be taken even under the imperfect conditions which surround the eurozone now. Let us hope that, this time around, the Europeans would not act in the shortsighted manner they acted after WWI, but would act with the foresight they showed in London in 1953. I am not very optimistic that Europe’s leadership will rise to the challenge but we cannot resign ourselves to waiting for the doomsday. We should raise our voice and fight for a change in the course of events.