Don’t bail out Greece



European leaders did their best to avoid a clear stance on Greece yesterday. But with a budget deficit of over 12% of GDP, a debt ratio of almost 120% of GDP, an electorate fiercely opposed to the mere announcement of spending cuts, the leeway for tax increases largely exhausted, and European neighbours terrified of the consequences of a Greek default, a bailout is only a matter of time. Yet it will only exacerbate structural flaws at both the European and the Greek level.   

In principle, there are two ways to organise a confederation like the EU fiscally. Either each member state retains full fiscal autonomy and assumes full responsibility for its finances, or some form of bailout option is arranged, but at a substantial loss of autonomy for the member states. The EU was originally organised according to the first principle. With the fulfilment of the currency union, it was no longer credible that member states would stand idle if a neighbour went bust. Hence, the Maastricht criteria tried to move the EU closer to the second principle.

Except that absent an enforcement mechanism, they remained ineffective. Big member states softened these rules when required; small member states like Greece ignored them when required. So the EU ended up combining the worst bits of the autonomy principle and the vertical administration principle. “Conditions” attached to a bailout would suffer from the same problem. A bailout would exacerbate the perverse incentives arising from this combination.           

Furthermore, the history of Greece since the 1980s shows one thing: it is easy to import the social spending levels of a typical Western European social democracy, but it is not so easy to import Western Europeans’ willingness to pay the corresponding tax level and adhere to the strictures of a big welfare state. The Greek welfare state has become a hotbed of rent-seeking, with middle-class working-age households receiving more in cash benefits than the poor. At the same time, Greece has Western Europe’s largest shadow economy. Apparently Peter Saunders had a point when he wrote that:

“Social democratic welfare regimes […] are probably only sustainable in countries with relatively strong collectivistic cultures.”

In short, there is no point in Greece trying to be Sweden. And there is no point in the rest of Europe subsidising the attempt through a flawed fiscal architecture either.

6 thoughts on “Don’t bail out Greece”

  1. Posted 12/02/2010 at 11:37 | Permalink

    When I see headline numbers relating to Greece’s financial situation I get a bit confused, as many of them seem similar to the United Kingdom’s numbers. I know the UK’s national debt is supposed to be a lower proportion of GDP, but official numbers are far too low.

    Both UK main parties seem to think our electorate, like Greece’s, is terrified of the mere announcement of spending cuts; and to me there doesn’t seem to be very much scope for significant UK tax increases. We are already over-burdened and many of our most productive people are relatively mobile.

    The risk of UK default may not frighten other EU countries, but it probably does frighten potential lenders to the UK government.

  2. Posted 12/02/2010 at 13:02 | Permalink

    European central bankers always hoped that the Euro would force liberal labour market reforms in continental Europe. That has not happened and will (as European central bankers feared) lead to more pressure for fiscal transfers to alleviate asymmetrical shocks. I never subscribed to the view that a single currency had to lead to a single state, but to stop that happening there needs to be no bail out (ever) and labour market reform (or an acceptance of high and variable levels of unemployment and booms and busts in specific countries).

  3. Posted 15/02/2010 at 12:10 | Permalink

    Fine theory. IMF bailouts to Central Europe? In practice, Lord Lawson expressed strong support for a 1981 style budget; tax increases, spending cuts and interest rate rises. 20% VAT seems a preferred option. Transaction taxes on banks are touted as another.

    UK GILTs’ default risk is much less; its obligations are longer term than Greece’s, which has many more bond maturities within 6 months. Germany needs its €uro zone exports, including Greece.

    The €uro agreement contains specific measures preventing budget profligacy and flexibility to respond to economic shocks of the type confronted now.

    Competitive devaluations, Yuan to US$ pegging and oil price inflation are bigger risks

  4. Posted 03/03/2010 at 17:19 | Permalink

    […] in all their forms (and insufficiently suspicious of markets), I tend to believe them when they say: The Greek welfare state has become a hotbed of rent-seeking, with middle-class working-age […]

  5. Posted 27/06/2015 at 22:01 | Permalink

    This has turned out to be very telling commentary. The only main thing missing was a few notes on Greece’s stupendous agricultural subsidies. Debt and deficit to GDP are surely failed measures of how a country is doing financially, and economists will need to find better ones in the future that measure debt and deficit to the tax base of a country.
    Well foretold Mr Niemitz.

  6. Posted 29/06/2015 at 22:21 | Permalink

    I should try to explain that better.
    The mainstream economic view is that GDP represents the income base or tax base of an economy and therefore deficit to GDP is a useful measure of how badly a national government is overspending.
    During the Greek fiasco we have learned of widespread tax evasion. We also know that imputations from owner-occupied houses are not part of the tax base, unless as part of some kind of land value tax. And we know that prostitution and drugs are included in GDP but usually are not part of the tax base.
    Evasion, untaxable imputations, and illegal untaxed activities can add up to quite a lot, so in the next decade I hope a really good economist finds a better metric than deficit and debt to GDP to describe just how fecked up a national government’s finances have become.

    A most excellent recent paper for the JRF by the way, linked to in my name.

Comments are closed.