With Greek finance minister Euclid Tsakalotos having warned late this May that there are “no excuses” for the nation not to receive the next instalment of its multi-billion-dollar bailout, some might be wondering if the medicine being doled out might be a step too far. But should Greece be released entirely from its debt to reboot the economy? One might even dub that a ‘Grelease’.
Mr Tsakalotos, the Oxford University-educated economist who was born in Rotterdam in the Netherlands, stated in recent days that the Greek government had “done its part”, adding “the ball is very much on the side of our creditors and the International Monetary Fund (IMF).” This came after discussions the previous week broke down between Eurozone finance ministers seeking unlock Greece’s next set of loans.
The left-wing minister and antithesis of his predecessor Yanis Varoufakis, said a deal at the next meet ing this June was now an urgent matter. He was quoted by the BBC as saying: “There are no excuses for not getting this overall deal that the Greek economy so desperately needs in its efforts to access the markets.”
The upcoming meeting is aimed at deciding whether Greece has undertaken sufficient measures to be in a position to receive a €7.5bn (c.$8.3bn/£6.4bn) loan plus debt relief. It is crucial for the country to avoid defaulting on a debt repayment, which is due this July
But in order to gain the funds, Greece has had to initiate a series of economic reforms. Towards that goal, in early May the Greek parliament approved a new package of austerity measures. These included tax rises and additional cuts to pensions due to be implemented in 2019-20. Tsakalotos said the government had done its part of what it promised.”
A flag with the logo of Greece’s Alpha Bank being burned by protestors outside the Greek parliament in the capital Athens, May 18, 2017, during a demonstration on the sidelines of voting on new austerity measures that saw some youths throwing Molotov cocktails in protest at the austerity cuts. (Photo: Louisa Gouliamaki/AFP/Getty Images).
A deal is reported to be held up because the IMF and Germany are at odds over how to help ease Greece’s debts once its rescue programme ends in 2018. IMF involvement in the country’s latest bailout rests critically on overcoming this issue.
Tsakalotos was quoted as saying: “There is very little point in entering a programme if the goal is not to leave the programme and leaving the programme should be not only the responsibility of the debtor country but the creditor countries as well.”
A Reboot For Europe
With all this in mind , I couldn’t help reflecting on what Dan Ciuriak, an international trade expert who heads up Ciuriak Consulting Inc. in Ottawa, Canada, said to me when I met up with him in London just prior the UK’s referendum on Brexit.
Meeting up at The FrontLine Club, a hangout for war correspondents in Paddington that serves also as an arts and restaurant venue, the Canadian economist outlined the gist of an argument to reboot European economies with what – amongst other things – he referred to as a ‘debt jubilee’ and an end to Quantitative Easing (QE).
In a wide ranging discussion on the economic impact of a Brexit outcome for the UK and other macro and productivity issues facing European nations, he rolled out a rough blue-print of this debt jubilee.
Effectively it would involve wiping out over onerous debt obligations for European Union (EU) nations countries with their backs to the proverbial wall.
Think here Greece for starters, but o ne could add ‘Olive Oil’ countries like Italy and Spain, who aren’t exactly looking too clever on the sovereign debt front, as well as and France with its frankly sclerotic economy. One might though ask, if Greece were let off the hook then every other country in the EU would want to be met with much the same. And, where does that lead?
Subsequently and many months later, Ciuriak, whose economic modelling team in Ottawa crunched the numbers for a Brexit impact study published by non-partisan EU think tank Open Europe, won joint first prize in McKinsey Global Institute’s (MGI) ‘Opportunity for Europe’ contest for his essay titled ‘Rebooting Europe’.
He acknowledged in the aftermath of this accolade, which was presided over by a panel headed by Pascal Lamy, a former director-general of the World Trade Organization, and presented last October in Brussels, that his entry was “provocative” and was a mazed the jury was able to accept it. Several hundred economists and others has submitted entries for consideration. The main prize was shared with Professor Volker Brühl, managing director of the Center for Financial Studies at Goethe University in Frankfurt, Germany.
Ciuriak’s essay proposes radical monetary shocks to unblock European investment and restore growth. He advocates ending QE and raising interest rates to reprice labor relative to capital; cancelling excess public-sector debt in heavily indebted European countries without worrying about moral-hazard implications during times of crisis, and reorienting industrial policy to stimulate public investments.
He notes that the EU is mired in a bad economic equilibrium of stagnation and deflation – stag-deflation. While the problem is excess supply and inadequate demand, current policy, premised on private-sector-investment-led growth, aims to expand supply further through ultra-low interest rates , this is demonstrably not working.
But why? The reason is that it raises the cost of labour relative to capital, thereby destroying jobs and demand, which negates the incentive for private sector investment. The next interest rate cut simply intensifies the deflationary pressures.
Ciuriak wrote: “In Europe, as in the global economy more generally, growth has been too slow for too long. In Europe, unlike elsewhere in the global economy, this is setting up an existential crisis.”
He added: “Incremental, marginal reforms that could yield a growth dividend by 2020 will be too little, too late. Brexit and electoral trends on the continent towards fringe parties, each of which is fuelled by economic dysfunction, coupled with the implications for open borders of the refugee crisis and of individual acts of terrorism stemming from the horrific consequences of regime change policies for the Middle East and North Africa, mean that the EU – as we kn ow it – will not live to see 2020.”
Debt Burden & Time Bomb
At the same time, this policy is generating a debt burden that is a “tinderbox for crisis” and incremental reforms will not work. As such, the Canadian who is also Fellow-in-Residence with the C.D. Howe Institute in Toronto, widely considered as Canada’s most influential think tank, posits that Europe’s policy settings need to be “reset to a configuration that has worked in the past.”
In his expansive 4,500-word essay the Canadian elaborates by saying this essentially involves the following, namely:
(1) Re-price Labor: Recognizing that monetary stimulus, including quantitative easing, has not triggered interest-sensitive consumption and investment but has priced labor out of factor markets (as interest rates fall, the ratio of wage rates to cost of capital rises), remove the subsidy for investment and price labour back into the market by norm alizing interest rates;
(2) Defuse the Debt Bomb: As raising interest rates in the context of a debt bubble would lead to a crisis, Ciuriak proposes have the European Central Bank (ECB) buy up excess public sector debt and cancel it. This would remove the “tourniquet on fiscal policy”, thus allowing a return to the job-creating expansions of the Keynesian era. Moral hazard? In crisis, ignore; and,
(3) Redefine Industrial Policy: By addressing the problem of adverse selection of investment opportunities: the current consensus supports investments with risk/return metrics that appeal to the private investor, leaving on the table investments that do not. But that may have strong public good characteristics. There is money on the table.Europe should seize it to restore growth, using its new-found fiscal room to manoeuvre.
Restoring growth “now is critical for the European experiment” according to Ciuriak. This requires a & ldquo;discontinuous policy shift to break the European economy out of the bad economic equilibrium” of stagnation and deflation – stag-deflation – in which it is mired.
Stag-deflation emerges from excess supply and inadequate demand. However, current policy, premised on private-sector-investment-led growth, aims to expand supply further through ultra-low interest rates. This he argues is demonstrably not working.
The reason is that it raises the cost of labour relative to capital, thereby destroying jobs and demand, which negates the incentive for private-sector investment. This leads to further interest rate cuts which intensify the deflationary pressures.
A Debt Jubilee
Given that it is also well understood that bankruptcy procedures, by removing crushing debt, enables renewed entrepreneurial activity, the argument goes.
“The debt cancellation proposed here, coupled with the proposal for new public investment in enabling ideas/inno vations, does precisely that,” states Ciuriak. “This stands in opposition to, and neutralizes, concerns about moral hazard.”
The Ottawa-based economist, who has held prior positions within the Department of Foreign Affairs and International Trade (now Global Affairs Canada) including at the Canadian embassy in Germany, adds: “The idea that a debt jubilee will be required has been long in gestation and growing in acceptance, and an informed reading of economic history supports the case of addressing moral hazard when formulating rules, not when dealing with crisis situations.”
The proposal for redefining industrial policy is more fundamental although the Canadian acknowledges the “ground is less well prepared.”
However, he elaborates that “it breaks out of a dysfunctional and polarized debate about industrial policy by introducing a new lens. Importantly, the key idea can be sketched on the back of an envelope. ” This can be seen in Exhibit 1 of the essay.
The proposals envisaged by Ciuriak involve no new taxes. Taxpayers in some EU Member States will not have to pay to bailout debtors in others.
“This is a rather critical point in today’s Europe,” he says, adding. “There will be a need, however, to explain why printing euros will not destroy the euro. The vast body of writing explaining quantitative easing and Central Bank procedures for ensuring it does not result in hyper-inflation provides the raw material for the communications programme.”
The twist he says in the QE proposed here is that it “does not benefit Europe’s version of Wall Street, but Europe’s version of Main Street.”
It redistributes wealth from the 1% to the 99% in his vision, as a “just restitution” for the massive transfer of wealth from the 99% to the 1% under the previous version of QE. However, it does so through the “impartial hand of the market as normalization of interest rates restructures returns on asset portfolios.”
The acceptance of this policy, and the repudiation of the failed policies of austerity, are also “necessary precursors” Ciuriak argues to rebuilding trust throughout Europe in the European experiment.
He asserts: “Europe can tolerate a significant monetary shock of the approximate scale required to restore fiscal soundness (about €2 trillion (trn), the amount of net debt of France, Greece, Italy, Portugal and Spain above 60% of GDP, the Maastricht benchmark) without inflationary consequences.”
And, adding: “Given the desirability of countering deflationary pressure, Europe’s €15 trillion (c.$16.6trn/£12.8trn) economy could tolerate an even higher shock to restore fiscal flexibility to make the growth-generating investments that have been neglected under the current or thodox industrial policies.”
This may not, he says though, be enough since Europe’s banking system is also vulnerable.
In the event of a banking crisis, the banks should be immediately nationalized, the creditors paid off, with excess debt created by national authorities purchased and written off by the ECB,” Ciuriak argues.
After a management shake-up, the nationalized banks would be privatized. By way of example, he cites Sweden that has shown how this can be done efficiently, with minimal problems to third parties.
The immediate reaction according the Canadian to such a proposal would be to ask “What about moral hazard?”
Moral hazard theory holds the consequences of excessive risk-taking should be visited on the risk-takers. It is an important factor for the design of public policy in any area where risk is entertained by economic actors, be they individuals, firms, or governments.
&ldquo ;Well-designed policies promote sound behaviour in the normal course of events. However, in managing a potential economic crisis, especially a potentially existential crisis, conditioning policy responses on concerns over moral hazard gives this factor a weight completely out of proportion with its importance.”
The economist cites three recent cases in his essay – the Asian Crisis, the subprime crisis and the Eurozone crisis – where the authorities have made “bad situations far worse by acting in line with the moral hazard doctrine.”
Just consider here in this regard the results of the IMF-dictated closure of Indonesian banks, the Lehman Brothers closure, and the transformation of the “Greek debt molehill into a Eurozone mountain” as he puts it.
A flag of Greece on a rugged wall full on cracks as a metaphor to problem and crisis leading to collapse due to debt. (Credit: Shutterstock).
METAPHOR MEANING: Flag of Greece on rugged wall full of cracks as metaphor of problem and crisis leading to collapse of Greek country – economical bankruptcy because of debt
A counter-example may help the reader here. Take during the Latin debt crisis, the major money centre banks in the United States and Canada had their capital more than wiped out by bad loans. The authorities in both countries exercised “regulatory forbearance” – that is, they looked the other way, while the banks rebuilt their balance sheets. Accordingly, neither country triggered a banking crisis because of moralistic angst over moral hazard.
For the United States this can be said to be the only available opportunity in its history for a banking crisis that it did not seize. Unfortunately, it did not learn from this episode and thus triggered the subprime crisis by closing Lehman Brothers.
In Canada, however, where bank closures were avoided like the plague, the lessons from the “near miss” were learned and applied in subsequent regulatory reforms, enabling Canada to emerge from the subprime-triggered global financial crisis with the soundest financial system in the world.
“Look to Canada to understand why it is best to deal with moral hazard between crises rather than in crises,” he asserts. Of course, being as Ciuriak is Canadian one could regard that view as biased – even if it is true.
But in short, there is “no reason for Europe to hit the rocks over debt” he suggests, least of all because of concerns about moral hazard. All countries learn from near misses, and “systemic issues of moral hazard can and should be dealt with once Europe has been restored to a new and viable equilibrium.”
While he acknowledges that his proposal is “far from comprehensive”, he posits that the core measures outlined in his submission will create the “enabling environment for the many useful suggestions for incremental reform in Europe” that have been produced and will continue to be produced through exercises such as MGI’s essay contest.
Europe is mired in a bad equilibrium in which according to his essay “nothing works well and it needs to be jolted into a new and viable policy space.” As such Ciuriak’s thought-provoking work suggests how Europe can be rebooted. Food for thought.