DRI-173 for week of 7-12-15: Beware Greeks Begging Gifts

An Access Advertising EconBrief:

Beware Greeks Begging Gifts

By now everybody is acclimated to the crisis atmosphere pervading economic life. It is the antithesis of life in the late 1980s, 1990s and early 2000s, when day-to-day rhythms had the hum of a well-oiled machine. Crises occasionally interrupted the era known as the Great Moderation, and they seemed all the more acute for their rarity. Events like the stock-market “crash” of 1987 or the technology bubble-burst of 1999 seem ridiculously tame and short-lived compared to the dragged-out, operatic and increasingly ominous spectacles of today. How fitting that the most meaningful one of all is a classic Greek tragedy unfolding in Greece itself.

Even Americans who shun economics and cover their ears to escape the business news know that the U.S. government is deeply in debt. Compared to its Greek counterpart, though, Uncle Sam is the Dave Ramsey of sovereign spenders. The Greek government defaulted on its debts for the first time in 2012 and recently became the first developed nation ever to default on a loan payment due the International Monetary Fund (IMF). Greece’s creditors consist mainly of five classes: its own citizens, institutional investors such as banks and private funds, international organizations to which it belongs such as the Eurozone, international agencies from which it has borrowed money like the European Commission, European lending facilities and the IMF, and fellow European nations such as Germany, France, Italy and Spain. The official members of those five classes – e.g., those in the last three categories – have ganged up to put heavy pressure on the Greek government to pay up. “Pay up” does not mean expunging its debt; it merely means getting current on the debt by making current interest payments and paying off principal as it comes due.

The most recently elected Greek government has refused to do this. The recent referendum showed that over 60% of Greek voters agree with their government. When an individual is hopelessly in debt and refuses to pay, that is bad news for him or her. When a recalcitrant government is likewise indebted, this is bad news – for somebody else.

How did this happen? How and why has it been allowed to persist? Who will suffer because of it? What are the implications of this for the rest of the world?

The Economics of International Debt

Margaret Thatcher once remarked that the trouble with socialism is eventually you run out of other people’s money. As the above classification of Greek-government debt suggests, Greece began by borrowing money from its own citizens for its government to spend. When its spending exhausted the willingness of its own citizens to lend, the government turned to other sources. One by one, Greece tapped them all until eventually they were tapped out. For a government, that point is reached when it loses the ability to pay interest on what it borrowed.

And when does that happen? Well, all of us have a pretty good instinctive grasp of how the process works at the household level. An individual or a family borrows until the size of its debt relative to its annual income gets too big. After all, the family has to eat, keep a roof over its head, get to and from work and clothe itself. It can’t devote all its income to paying interest, let alone paying down debt. The precise tipping point will differ between families, but it exists for everybody. What is the analogue of this for a country?

The standard tools of analysis are to treat the nation’s gross domestic product (GDP) as the national analogue of family income. The size of the national debt relative to GDP is the trouble light that signals which nations are on the verge of suffering a debt crisis. As with individual families, there is no absolute red-line point, but it does provide a good means of comparison between nations at a point in time, and also over time for a particular country.

As of 1970, Greece’s debt/GDP ratio was only 17%. By 1980, it had barely risen to 21%. But in 1985 it was over 60%; the country had started down the road to ruin. By the new millennium, the ratio had climbed over 100% – the country owed more than the value of its annual production. As with individuals, sovereign debt tends to increase exponentially because of the power of compound interest, which works inexorably in favor of savers but just as implacably against chronic debtors.

Once a country gets itself in a fix like this, can it get out? One of the celebrated analytical exercises in economics is the transfer problem. After World War I, the victorious Allied powers imposed stiff war reparations on the defeated Axis powers, which included Germany. In the formal sense, the obligation to pay off war debt is analytically indistinguishable from any other kind of debt, such as the more familiar kind of government debt that nations incur when their governments borrow from domestic or foreign citizens.

As economic textbooks relate, the only way Germany could pay off this war debt was by generating an annual surplus of exports over imports in the current account of its national balance of payments. But it couldn’t do that because (1) Germany, like most of Europe, had lost the cream of its manhood to the wholesale slaughter on the battlefields; and (2) the productive capacity of Germany had been badly mauled by the war. It needed all the consumption goods it was capable of producing just to keep its remaining population on their feet and all the investment goods it could produce to restore its industry to a semblance of its pre-war strength. That left it very little for export. Forcing it to pay reparations was tantamount to heaping further punishment on a country that had already been badly punished by defeat in a dubious cause.

Students sometimes have a hard time getting their minds around the concept of repaying international debt via an export surplus, but – as a first approximation – this mimics what goes on at the individual level. Any listener to the Dave Ramsey program knows that the formula for escaping debt is (1) don’t get in debt in the first place; or (2) lower your standard of living (e.g., your personal consumption) as low as possible as quickly as possible for as long as necessary to pay down the debt. Do NOT borrow more money and pay as little interest as possible. What the debtor is doing is “exporting;” consuming less than the value of what is produced (income) in order to send the net surplus “abroad” (to outsiders).

One key difference between the German situation between the World Wars and the Greek situation over the last three decades is that the German war debt was forced upon them by the unwise provisions of the Treaty of Versailles, while the Greeks dug their own money pit by electing and re-electing politicians who celebrated the virtues of deficit spending.

The Greek Welfare State

The term “welfare state” is credited to the British Labor Party theoretician, Lord William Beveridge, who coined it in the famous “Beveridge Report” of 1941 that laid the foundation for British post-war socialism. But it is Greece that has brought the art of the welfare state to its apogee – the asymptotic approach to a condition in which everybody is paid by the government not to work. Only in Greece can one find a sighted citizen receiving a subsidy dedicated to the blind. Only in Greece is it commonplace to retire with full benefits at age fifty.

The Greek Underground Economy

When the government becomes the source of all benefit, we would expect the government to become all powerful and relentless in its search for wealth to confiscate. The problem with an omnipresent government is that it tends to discourage active cooperation by the citizenry. This is particularly true when John Q. Public’s job one is to wangle a subsidy from the government. What is the point of being subsidized when the government deposits the benefit in your left pocket only to yank it out of your right pocket in taxes? Thus, job two in Greece is to evade taxation in order to make your subsidy effective on net balance.

According to a service that studies these things, Greece ranks as the most corrupt of the 19 countries in the Eurozone. The value of goods and services produced “off the books” in the Greek economy – thus, untouched by taxation – is estimated at 24.3% of total Greek GDP. By way of comparison, Italy – another nation so legendary for fiddling on its taxes that Italian movies have been built around this premise – ranks second among European countries at 21.9%. It is estimated that the Greek government collect only about half of all taxes due it.

The structure of the Greek economy undoubtedly lends itself to tax evasion. Of all the world’s economies, Greece may have the biggest comparative advantage in tourism owing to its breathtaking Aegean scenery and stock of venerable historic ruins and temples. An astounding 31.5% of Greek employees are self-employed, which greatly eases the task of avoiding taxes, particularly when the employee is providing a service to foreigners who have no interest and little opportunity to cooperate with the tax man. (Self-employment elsewhere in Europe is nowhere nearly as high as in Greece, averaging only 15%.)


Syriza and Fairness 

The populist party Syriza has built a controlling interest among the Greek electorate by harping on the issue of fairness. How dare foreign creditors insist on lowering the standard of living of the average Greek? Why should poor Greeks suffer to feed the appetites of the 1%? The word “austerity” has become a code word for privilege and wealth gained at the expense of the masses of the common people.

Economic theory itself, in the narrow sense, has nothing to say about fairness for the same reasons that the theory of consumer demand makes no effort to compare the utility or satisfaction gained by one person with that of another. There is nothing in economics that says it is “fair” or unfair that so many Greeks are subsidized by other Greeks (and non-Greeks). Economics merely says that somebody must pay – the money that funds the subsidies is not spontaneously generated and it is diverted away from productive alternative uses. Within Greece itself, the unsubsidized are paying for the subsidies given to their countrymen.

The irony is that the populist left has succeeded so well in turning the logic of fairness on its head. By resorting to international borrowing, the government ensures that the burden of repayment will be spread across the Greek population at large, which is forced to repay the debt in real terms via exports. When repayment takes the form of exports, the burden is reflected in the prices and quantities of all goods and services, not merely those that are internationally traded. So even the hard-working, industrious poor are “taxed” to pay subsidies to the loafers and dissemblers. Even the tax-dodgers pay, since this form of implicit tax can’t be evaded by cheating on taxes.

Syriza is complaining that the inhumane austerity policies transfer real income away from their supporters to the hated capitalists. But economics says that the capitalists only get a “normal” rate of return and nowadays they don’t even get that. It is the input suppliers who are the long-run gainers and losers from the subsidies. We know that some Greeks – subsidy recipients and government employees – are net gainers and non-government non-recipients must be losers. Syriza is in fact complaining about the unfairness of policies that prevent this gravy train from running indefinitely. As a matter of fact, the government and agency negotiators such as the IMF, the European Commission and the Eurozone bailout funds have in the past cheerfully sold out the only participants who could be called “capitalists;” namely, private lenders holding Greek paper. Private lenders have taken haircuts that were publicly announced at 50% in previous negotiations and were probably as high as 74%, according to sources like The Wall Street Journal.

In this case, “indefinitely” definitely does not mean “forever.” When one group of Greeks is subsidizing another one, this gives the non-recipients an incentive to climb on the recipient bandwagon. But when everybody wants to stop working at the same time, the volume of output necessary to pay the subsidies not only begins to decline, but does so at an increasing rate. And that spells trouble, with a capital T and that rhymes with p and that stands for politics.

The Reckoning

In the last two years, unemployment in Greece has risen above 25%. Syriza has tried to put the blame on the austerity policies favored by creditors, but if anything the feeble attempts at reform put forward by the Greek government produced slight improvement. To be sure, higher taxes are not a recipe for higher living standards, but that applies only to taxes that actually get collected. The only fiscal effect one can predict with any confidence in Greece is the bandwagon effect produced by the subsidy gold-rush. It is akin to what happens in hyperinflations when everybody is so busy trying to spend their money before its value declines even further that nobody has time to work and produce. Here, everybody is so busy trying to promote themselves a subsidy – that is, to reach the status where they are not working – that work and production become an afterthought.

Every country in the Eurozone is a welfare state, but not all are in the same stage of decay. For example, Great Britain under the long period of Margaret Thatcher’s leadership was able to divest itself of the state-ownership features of British Labor Party socialism, thereby reversing its label as carrier of the “British disease” to that of the “British miracle.” Thatcher’s economic program was not eviscerated by the subsequent Labor administration of Tony Blair and the current Conservative government has restored a modicum of it, which explain why British unemployment stands around 5.5%. At one end of the spectrum, we have the Eurozone basket cases: Spain (over 23%), Cyprus (over 16%), Portugal (over 13%) and Italy (over 12%). Germany (over 7%) ranks just above, or rather below, Great Britain at the other end. In the middle, are Ireland (just below 10% and on its way down after regaining fiscal discipline) and France (over 10% and rising as it bids to join the basket cases). We can use these unemployment rates as a rough proxy for the progression of this anti-productivity virus throughout the Eurozone. That is, the higher the unemployment rate, the closer is a particular country to eventual collapse when it faces the same day of reckoning that confronts Greece.

What About the Truly Needy?

The public face of Syriza’s constituents, those being subsidized by the Greek government – hence by multiple foreign governments and international agencies – is not a shifty-eyed tax dodger. It is not a blind beggar lifting up his eye patch to count the day’s takings. No, it is a homeless orphan starving on the street. It is a poor widow working two jobs to feed her children. It is an amputee propelling himself on a cart and subsisting on the charity of tourists. These are the deserving poor, the “truly needy.” They constitute the ultimate, conversation-stopping rejoinder to anyone having the temerity to tell the truth about Greece’s descent into subsidy hell.

In fact, the question should be turned back on the questioner. What, indeed, about the truly needy? For over a century, the political left has been allowed to get away with peddling the fantasy that they will disappear if only government gets big enough, intrusive enough and profligate enough. But the actual experience with the welfare state, as epitomized by Greece, is that the truly needy has gone from being cared for by their nearest and dearest relatives and/or friends to being cared for by charitable institutions to being cared for by local government to being cared for by state government to being cared for by a federal (national) government. In this final, terminal, phase, a nation’s truly needy are now at the mercy of foreign governments and international agencies. In other words, the progression puts the truly needy in the hands of ever more impersonal, less caring, more callous, less sensitive, less knowledgeable wards. The truly needy have become political pawns of big government and its fawning acolytes, neither of which gives a rap about them.

What in God’s name is so compassionate about this?

There is one and only one way to serve the truly needy well. It is by producing the largest possible flow of output from which charity can flow. Charity must originate from within the human heart, the geographic production point most efficiently located to serve those in need. Government inherently operates via coercion and compulsion, which is the enemy of the compassion and sensitivity required to serve the truly needy.

To be sure, charity is not an easy product to produce under the best of circumstances. But government is the worst producer, not the best one – and certainly not the only possible one. The appeal to human need is the most cynical and despicable Trojan horse being rolled out by those supporting a bailout of Greece.

Is There No Hope Without a Bailout?

Implicit in the story told by the mainstream media about Greece is the presumption that, absent a bailout, the country can only spiral to destruction. That is standard operating procedure for big government: “Without big government/ regulation/ programs/ planning, civilization as we know it will soon end and chaos will ensue.” Consigned to the memory hole is the last 35 years of Greek history, which began with Greece enjoying unprecedented prosperity under the commercial shelter of intra-European free trade.

Greece became a top-10 nation worldwide in tourism, astonishing considering that it is only in the top 50 in absolute size. Its shipping and fishing industries boomed. The country even developed a modestly successful manufacturing sector. It is only in the last 10 years that its political choices and subsidy mania overtook and tackled its productivity. This is only the most extreme case of a disease afflicting almost all of Europe. Although the Great Recession intensified its effects, it began years earlier.

This history proves conclusively that Greece can and should succeed economically. Like a convert to Dave Ramsey’s debt-elimination lifestyle, it needs to take the cure and swear fealty to free markets and free trade. Remember that Greece’s travails are nowhere near those suffered by Germany under the Weimar Republic. The Germans were decimated physically and demographically by war. The Greeks have merely suffered a recession, something every developed country suffers periodically.

So What If Greece Leaves the Eurozone?

Numerous commentators have shrugged their shoulders at the prospect of a Greek exit from the Eurozone due to debt default. Why should we care? And, apart from departments of revenue, why should people in the other 18 Eurozone countries care if Greece leaves? (This omits the seven non-Euro members and two “Euro opt-out” members of the European Union.) Germany will be relieved of the necessity of subsidizing Greece. Everybody will be relieved of the wearisome laments and regular bulletins of distress emanating from Athens.

To understand why so many people don’t care whether Greece stays in the Eurozone or not, we have to understand why some people do care. To understand that, we have to understand that the “Eurozone” is two things. In economic theory, it is a customs and (quasi-) monetary union, a group of nations united by a common commercial policy and (mostly) by a common currency. Since the customs union creates a free-trade zone, the mutual trade benefits provide a good reason for consumers in all countries to regret the exit of Greece. The general public gratefully exercises the prerogatives of international trade but somehow overlooks them when contemplating the subject in a public-policy context.

The Eurozone is also a gigantic bureaucracy headquartered in Brussels, Belgium. The bureaucracy ostensibly exists to run the Eurozone. It actually exists to benefit the people who comprise it and its political patrons, just as all giant bureaucracies do. They are desperate to keep Greece in the Eurozone for a perfectly logical reason: all bureaucracies resist getting smaller. If Eurozone countries somehow got it in their heads that they could come and go from the confederation as they pleased, then all those countries on the basket-case list above might decide to exit for roughly the same reasons as Greece. Then that giant bureaucracy would be up the Mediterranean without a paddle. And where do all the newspaper and online stories about the Greece debt crisis originate? From official sources; i.e., from Brussels or the IMF or some other agency with a vested interest in Greece’s Eurozone membership. Thus, while op-eds may display a carefree insouciance to Greece’s peregrinations, the front-page stories will reflect nothing but verbal hand-wringing and grave concern over the crisis.

The Rest of the World

To the world outside of Europe, Greece mostly represents a cautionary tale. Take the United States. We are a welfare state. In terms of unemployment, we are apparently with Great Britain – at the early stages of decay. But this is misleading, because Federal Reserve monetary policy and the Obama administration have combined to drive us far down F. A. Hayek’s “road to serfdom.” If we array countries on a debt/GDP scale ratio scale, for example, we compare less favorably. And our trend is directly opposite to that in Great Britain or Ireland.

Of all recurring headline stories that have preoccupied the public’s attention over the last five years, it is doubtful whether any other has embodied such a gulf between underlying truth and the picture provided to the public in news reports. The reports constantly speculate on the chances that a deal will be struck between Greek politicians and international creditors. This has nothing to do with the underlying economic reality staring Greece in the face – only with the chances of the Eurocracy cutting a deal to keep Greece in the Eurozone a while longer. Which of these two is of life-and-death interest to ordinary people the world over – the latest can-kicking exercise going in between Brussels and Athens or the preview of coming attractions now on view in Greece that will eventually face every welfare state in the world, including ours?

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