Posts Tagged 'European Debt Crisis'

France and the New Balance of Power in a Crisis-Stricken Europe

So the main reason I’ve been neglecting my blogging duties of late is because I’ve been preoccupied studying for an exam on international relations theory and history. With the exam safely behind me I’m back to blogging, but still have academic IR debates on the mind, so today I want to write about what the history of early 20th century European relations can tell us about the continent’s current political economy.

To grossly oversimplify, back in the pre-WWI days Europe was controlled by a number of Great Powers of roughly equal strength, who were in continual competition with one another to run the world. They typically pursued their goals by forming loose and shifting alliances; whenever any one state seemed to be getting too strong, a collection of the others would team up to balance against it (hence the “balance of power”). Britain, which then as now prized its position as being of but not in Europe, considered itself the ultimate balancer, frequently weighing in against the strongest continental power to ensure no state could establish hegemony over the mainland.

Now fast-forward to the Europe of today, as the debt crisis stretches into its third year. Of everything that has been written on the Euro crisis so far, I think one of the most perceptive and insightful pieces was an op-ed by Anne Applebaum all the way back in September 2010 (doesn’t that feel like a long time ago?), which made one simple but important point: thanks to the crisis, the East-West divide, which had dominated intra-European relations since at least the end of World War II, has now been overtaken by the North-South divide. The “North” – represented by Germany, Scandinavia, and some Eastern European economies like Poland and Estonia – are ruled by budget hawks committed to fiscal discipline; the “South” – including Greece, Portugal, Spain, Italy, and perhaps Bulgaria and Hungary – are home to bloated public sectors and seem unable to get their public finances under control. The geography doesn’t match up perfectly, of course, and it’s easy to argue about which countries belong on which side, but the fundamental divide is hard to ignore. And while the two groups aren’t anything like formal alliances, the economic interests within each group are more closely aligned than those across the divide, and hence it’s easy to imagine the major disagreements about how to manage the European economy over the coming years falling more or less along this fault line.

As Applebaum noted at the time, “France floats somewhere in between”. I think this means that France is positioned, if it wanted to, to play something like the role Britain played 100 years ago, able to weigh in – perhaps decisively – on the side of either the North or the South. The analogy isn’t watertight – Britain’s role as balancer was based in its fundamental strength, whereas for France today it’s more about being considerably weaker than Germany but aspiring to be viewed as its neighbour’s equal. (Which, incidentally, is another theme that reappears throughout European history…) But still, in the new North-South Europe France could represent the crucial swing vote, and throw some political clout behind the interests of the South, preventing Germany from fully setting the economic agenda for the continent.

In any case, up until now France has clearly sided with the North, epitomized in the “Merkozy” romance. But as the French prepare to head to the polls it appears increasingly likely Sarkozy is on his way out, which could dramatically shake up the picture. From many of the campaign statements he’s made to date, it seems at least possible a Hollande government would rupture the informal Franco-German alliance and move the French into the “South” camp. (It’s worth noting that I’m not particularly talking about whether Hollande would actually harm the French economy and investment culture, as some seem to fear, but rather whether France will continue to stand behind Germany in intra-European political economy battles or rather take up the cause of the Southern nations.)

To bring back some academic IR terms, the impetus for such a transition can be understood in both realist/materialist terms and constructivist/identity terms. From a realist point of view, it could be that France’s interests no longer lie with the Northern interests of tight money and imposed austerity. From a constructivist point of view, it’s easy to imagine the French self-identity under Hollande evolving from Germany’s little brother to the champion of the downtrodden South. As these two forces interact, I don’t think it’d be that surprising to see France pivot from backing up Germany to balancing against the strongest power on the continent, and challenging the Germans on their vision for the future of the European economy.

Over the past several months the Eurozone has entered a strange period of stasis, what has effectively become a period of permanent crisis. Since the crisis first erupted pretty much every policy measure adopted has been an effort to “buy time”, but nothing’s really been accomplished with this time, and so nothing’s really changed. There aren’t a lot of ways to break out of this status quo; you could have some sort of surprise, disorderly default from a periphery economy, but no one really wants that outcome (though I’m starting to think it might be better than continuing down the current path). One thing that could really shake up this political equilibrium, though, would be if France decidedly announces that it no longer supports the current Northern establishment position of forcing austerity on the South.

I’m not saying this necessarily will happen, or even that it’s particularly likely to. But I definitely think it’s a storyline worth watching, and a reason we should all be paying close attention to the upcoming French election…

File Under “Austerity Doesn’t Work Without Political Buy-in”

So it turns out the Greeks aren’t the only ones capable of skirting austerity-friendly legislation, driving a wedge between de jure and de facto fiscal tightening. The latest from Ireland (via NYT):

DUBLIN — Anti-austerity protesters are claiming victory after the government acknowledged that around 50 percent of Ireland’s estimated 1.6 million homeowners failed to pay a new, flat-rate $133 property tax by the March 31 deadline. […]

Introduced on Jan. 1, the household charge was intended as a forerunner to a comprehensive property tax next year. It has become a lightning rod for widespread disenchantment on an assortment of issues like cuts to services, findings of political corruption, taxpayer liability for debts to private banks and even European legislation intended to enhance wastewater treatment from septic tanks. […]

The Irish government argues that it has no choice but to introduce the interim tax at the behest of its lenders and has vowed to identify and prosecute those who have refused to pay.

“We will begin with sending out letters and then escalate it from there to the maximum fine of 2,500 euros” — $3,330 — “on top of the outstanding amounts due in late fees and interest,” a spokesman for the Department of Environment said in an interview on Monday. “We will be taking people to court if necessary, and if there is refusal to pay, then that could be seen by a judge as contempt of court.”

That last sentence hints at the hidden costs of unpopular austerity programs, in the form of compliance costs. How much does it cost to have a judge make a ruling on whether a failure to pay a small fine is a contempt of court? I’d imagine pretty high, undoubtedly way way too high to have anything like half of the population held in contempt.

Obviously the government’s plan isn’t to hold half the population in contempt, but rather to turn up the social pressure in hopes of getting people to come forward and pay themselves  (though it’s worth noting that even this can come at a pretty high administrative cost, just in terms of keeping track of who’s paid, finding those who haven’t, etc). Maybe this will work, but I’m not too optimistic, especially for the Irish. Other peripheral economies with deep structural problems can (somewhat) convincingly spin a story of the need for shared sacrifice for the national good. But the Irish for the most part have a reasonably well-functioning economy, and are being asked to swallow deep-cutting austerity simply to pay off the misguided 2008 all-encompassing bank guarantee, much of which went to pay back foreigners. That’s a tough sell.

Did the German Finance Minister Seriously Just Suggest Greece Postpone Elections?

I didn’t think it was possible, but the situation between the Greeks and the Germans just grew considerably more ridiculous. German finance minister Wolfgang Schäuble said in a radio interview that the Greeks should postpone national elections planned for April and instead adopt a technocratic government that leaves out the country’s major political parties (h/t Tyler Cowen, who correctly files this under ‘Department of Yikes’, and it’s worth noting that the Finns and the Netherlands are also apparently on board with this plan).

Good lord. Due to the Eurozone crisis a lot of things which would have seemed unthinkable a few years ago are now plausible, but even by our new 2012 standards this is just insane. Suffice it to say, the German finance ministry should not be in charge of determining whether Greece is a democracy or not! A situation where the Greek people want to choose their own government and the German finance ministry tells them they cannot is completely untenable. For anyone who forgets their European history, the response from Greek President Karolos Papoulias was a not-so-subtle reminder: “[W]e cannot accept insults from Mr Schäuble. Who is Mr Schäuble to insult Greece? … We have always defended not only the freedom of our own country, but the freedom of Europe.”

What’s particularly bizarre is that the current fight comes down to the Germans demanding various Greek politicians sign letters saying they’ll stick to austerity after the next election, and not all the politicians are happy about it. For the life of me I don’t understand why the Germans care about these letters. It’s clear that Greek politicians have a problem credibly committing to undertaking wide-sweeping austerity measures, and for good reason – their people don’t want them, and austerity without political buy-in doesn’t really work. But how are signed letters supposed to solve that problem? What magical powers are these letters supposed to have?

The most logical explanation is probably that, like with the call to impose a budget commissioner a few weeks back, this is ultimately another attempt by the Germans to accelerate the Greek endgame. Both the Germans and the Greeks seem to be inching toward the realization that they could live with Greece outside of the Eurozone, at least relative to other available alternatives. The simple fact is, real relative wages in Greece need to fall a lot if the Greek economy is going to sustainably grow again. This can happen one of three ways: through Greek nominal wage cuts (which the Greeks can’t accept), through high Eurozone inflation and stable Greek nominal wages (which the Germans won’t accept), or through Greece getting control over its own currency, which will depreciate considerably relative to the Euro. It increasingly appears the only question left is how to get to the latter option with minimal collateral damage to the European banking system.

This post also appears on Politics in Spires, the joint Oxford/Cambridge politics and international relations blog.

The Greek Structural Adjustment Programme

Taking a step back from the immediate uncertainty over Greece (see here for the latest updates), I’m struck by how similar the situation is to the old IMF and World Bank Structural Adjustment Programmes (SAPs) of the 1980s and ’90s. Reading accounts of the negotiations (especially this one in the Times today about how the Germans, IMF, and ECB don’t trust the Greeks), you could rather easily replace “Greece” with “Nigeria” or “Senegal” and be transported back in time 20 years. An emergency need for new official lending to roll over past debts? Check. Tough loan conditionality attached? Check. Domestic pushback and questionable democratic legitimacy? Check. It’s all playing out more publicly/more quickly in Greece today than in sub-Saharan Africa 20 years ago – maybe because the power imbalance isn’t quite as large, so Greece has more room to manoeuvre – but the fundamentals are remarkably similar.

Now I’m actually someone who thinks history has judged the SAPs a bit too harshly, and that the economics of the Washington Consensus – if not the politics or the implementation process – deserve at least some credit for the great boom being seen across the developing world over the last decade. But even still, it’s pretty clear SAPs didn’t work all that well, mostly because there was never domestic political buy-in and hence little follow through on reform programmes. You don’t need to accept a narrative of the World Bank and IMF as being out to exploit the poor to have a problem with this; from a pure positivist/rationalist perspective, SAPs didn’t do a good job of meeting their stated goals.

Coming back to Greece today, the lesson is simply that imposing austerity from outside – no matter what you think about democratic legitimacy – just generally doesn’t work very well. Over the past couple days there’s been ample media coverage painting the current situation as “will the Greek coalition sign on to the deal or not?”, with the implication that the critical question is whether a deal is agreed, that’s what will rally the markets, etc. To me this largely misses the point. I think the historical lesson from the SAPs is that the deal itself is of very little value, it’s the follow through that counts. And a loan agreement that imposes structural adjustment against the wishes of the domestic political class (not to mention the people) is barely worth the paper it’s written on, and is certainly a very poor predictor of what policy changes we’ll actually see over the coming years.

There’s a chance that the next few days will see the situation in Greece unravel if negotiations completely fall apart. But we should be honest that there’s no real chance of anything being “resolved” if a deal is agreed. And in fact, I’d even say that if the Greeks sign on to a deal that clearly lacks domestic legitimacy, the likelihood of the country’s finances being a mess two or three years from now probably only increases…

This post also appears on Politics in Spires, the joint Oxford/Cambridge politics and international relations blog.

So at what point does Greece just become a German colony?

A few days ago I was talking about the subtle, hidden ways in which sovereignty was being eroded during the European debt crisis, with the possibility of hedge funds taking Greece to the European Court of Human Rights. Today comes news that sovereignty is also being eroded in remarkably blunt, in-your-face ways, via FT reporting on Germany’s latest proposals for conditions on the Greek bailout. The German plan essentially calls for Greece to give up control of taxing and spending decisions, through the appointment (by the other Eurozone members) of an outside “budget commissioner” responsible for overseeing “all major blocks of expenditure” of the government.

This is obviously a pretty huge blow to sovereignty, and the German proposal is (rightly) being met with considerable shock. Control over the budgeting process is one of the key pillars of sovereignty and autonomy – it’s no coincidence that debates over how much autonomy “autonomous” regions within states should be granted generally come down to debates over who controls the purse strings. So will the Greeks sign on to this, or will the Germans back down? At this point neither seems all that likely (though the Germans backing down is probably the more likely of the two), which means the likelihood of a Greek default/euro exit just went up…

I think it’s particularly interesting to compare this episode to the last time we were face-to-face with a real likelihood of Greece’s Eurozone exit, then Greek-PM Papandreou’s call for a national referendum over proposed bailout terms in November 2011. This was also met with shock, and ultimately led to his resignation and the installation of current technocrat PM Papademos. At the time Papandreou’s move was widely seen as a mechanism to pave the way for a Greek default and possible euro exit since, as a general rule, publics don’t vote for wage cuts and endless austerity. Similarly, today it’s easy to view Germany’s stance as ultimately aimed more at speeding along a Greek default, as it’s difficult to imagine any state giving up control over taxing and spending to an outside commissioner. This isn’t necessarily a nefarious, cynical move; Germany is being clear about the severity of the situation and the trade-offs involved, and if of the available options default and euro exit is the least bad, then let’s hurry up and get to the end-game already.

But the contrast in the “non-default option” of these two episodes is striking. If the Greeks had voted in a referendum to accept austerity and endorse the bailout terms, then the government would have had popular legitimacy to go ahead and enact steep cuts, and some hope that these would actually be realized and carried through throughout the country. This isn’t to say there wouldn’t be any protests or anything, but a successful referendum would have empowered the government – and critically non-elected public servants – to push forward, and the population would be more likely to swallow the tough medicine they’d voted for.

Conversely, trying to get to austerity by completely stomping on sovereignty is not only a disaster for anyone who cares about democratic legitimacy, but perhaps more to the point probably isn’t even going to work that well. The thing is, austerity without political buy-in is extremely difficult. While an outside commissioner could force austerity-friendly legislation, getting the laws passed is but the first step; what happens next? Do the public servants actually follow through and enforce these laws, identifying spending cuts rather than just stonewalling? Will the public actually pay more in taxes, rather than just finding even more creative forms of tax evasion? No matter how much power is officially vested in the German budget commissioner, at the end of the day a lot will still depend on changes in the behaviour of individual taxpayers and government workers. And, of course, as the power of the foreign budget commissioner increases, these latter groups will be less and less inclined to go along with what s/he says. (Hat tip on this point to the excellent Megan Greene, who really should blog more often.)

I always thought Papandreou’s call for a referendum was something of a political masterstroke, even if it was likely to fail and accelerate Greece’s eurozone exit. The further we go down the current path – as it becomes increasingly obvious we need to get off this route yet each off-ramp looks worse than the one before – I predict many will come to see the referendum that wasn’t as a missed opportunity…

The Big Change in Sovereign Debt Politics No One’s Talking About…

So a few days ago there was an interesting story going around that hedge funds were going to try to sue Greece if the sovereign tried to force its creditors to take a loss. Now this was two or three news cycles ago and the story has since moved on (there was talk a deal was complete, then new talk that a deal was hung up on interest rates, then they were going to be kicking off a new round of negotiations, and I’ve since lost track…), but I want to go back to this hypothetical because it’s crazy for a number of reasons.

The first is simply the usual hypocrisy you hear whenever a creditor who has been earning outsized returns because they were taking on risk turn around and, ex post after the risk has been realized, are completely outraged about losing out on their investment. Look, the reason Greek debt always paid higher returns than risk-free German or US debt (side note: is there any risk-free asset in the world today?) is because Greek debt was never risk free. This is a pretty basic “there’s no free lunch” principle of investing, but it always surprises me how rarely it comes up in these kinds of discussions. Everyone is shocked, just shocked when someone who had a pretty good chance of defaulting actually defaults – it’s ridiculous.

There’s something extra interesting about this case though, which first requires a bit of background on international relations theory. Unlike at the national level, at the international level there is no supreme authority to enforce rules, ie the global system is ruled by anarchy. For sovereign debt, what this means is that if a country is considering defaulting on its debt to foreign creditors, there isn’t any authority that can force it not to. So why don’t countries default all the time? Because if they did they’d develop a reputation as defaulters (*cough, Argentina, cough*) and the next time they wanted to borrow money they’d find it extremely expensive, if not altogether impossible. So a rational state, knowing that it will want to borrow money in the future at reasonable rates, has an incentive to not anger creditors today, which serves as an enforcement mechanism for repaying sovereign debt.

But note that this mechanism depends on the negative reputation effects of not honouring a debt contract. If a claim on a country is viewed as widely illegitimate or unfair – say, for example, when greedy hedge funds buy up cheap distressed debt and then demand full payment – it seems reasonable that future creditors won’t judge this as harshly as if, say, tomorrow Germany announced it wasn’t going to pay back any of its debts. So when a state is internally debating whether or not to pay back debt, it weighs the legitimacy (in the sense of whether other market actors think the debt should be paid back) of the outstanding debt; as legitimacy falls, the marginal effect of defaulting on the debt on future borrowing ability falls, and so the inclination to default increases.

Now to the interesting part in this case: the hedge funds are essentially trying to get around this anarchy problem by threatening to take Greece to the European Court of Human Rights. Specifically, they’re claiming that changing the terms of Greek bonds would be a property rights violation, and according to European law property rights are human rights. Somewhat remarkably to me, the NYT article suggests this actually could be a successful legal strategy. I don’t know enough (read: anything) about European law to fully understand what kind of power this court holds over Greece; presumably this can’t fully get over the anarchy problem as I doubt the court can deploy soldiers to Greece and/or throw the government in jail, but I assume they have some sort of power to impose costs of some kind, rather than just making proclamations. So if the hedge funds won at court, Greece would have to choose between paying them or suffering the costs of being in violation of the court, a fact which should alter the government’s current calculation of whether to default. Which is a pretty big qualitative change in the international relations of sovereign debt. Did European states know this was what they were signing up for in creating the EU? (I don’t mean that in a rhetorical way to suggest it was a mistake, it’s an honest question – I don’t think the full ramifications of semi-sovereignty have yet been fully realized…)

A final funny point to consider is that everyone knows the hedge funds would happily accept a deal where they get paid 60 or 70 cents on the dollar of the debt they currently hold (the last figure being debated was 50 cents, with the Greeks (read: Germans and IMF) wanting to push it lower.) But, again with the caveat that I have no legal background, it seems to me like it’d be pretty hard to make the case that a cut of 30 cents on the dollar is legal but a cut of 60 cents on the dollar is illegal. Presumably the legal argument has to be built around sticking to the exact letter of the bonds, even though this is something that no investor/policymaker currently takes at face value…

The rise before the fall of Europe’s crisis-stricken economies

Quick quiz: Amongst Greece, Iceland, Latvia, and the US, which country had the worst-performing economy over the last decade?  Perhaps not whom you’d expect:

That’s right, the US comes out worse than the three economies that have seen the most spectacular financial implosions during the crisis.  The key point isn’t the sluggishness of the US, but rather the quite remarkable (yet generally under-remarked-upon) advances of the other three economies in the run-up to the financial crisis.  It’s true that Latvians today are some 25 percent poorer than they were in 2007, a dramatic loss.  But even after this drop, they’re still 50 percent richer than they were in 2000; perhaps not that bad a deal.  Meanwhile, Americans today are about 10 percent richer than they were in 2000.

The graph below presents the same data but in US dollar terms rather than national currencies, i.e. after accounting for exchange rate movements.  Greece, Iceland, and Latvia all experienced considerable exchange rate appreciation in the years up to 2007, which allowed their citizens to buy more foreign goods with the same amount of domestic currency.

Since the crisis, the Euro, Icelandic Krona, and Latvian Lat have all fallen relative to the dollar, but only the Krona has dropped below its 2000 level.  In US dollar terms, Greek per capita income remains about double its real 2000 level.

There is some real suffering going on in these economies today, which shouldn’t be easily discounted.  But when assessing how steep their falls have been, it’s worth remembering just how sharp their ascents were in the years before the downturn.

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