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Thesis & Antithesis

A critical perspective on energy, international politics & current affairs

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Location: Washington, D.C.

greekdefaultwatch@gmail.com Natural gas consultant by day, blogger on the Greek economy by night. Trained as an economist and political scientist. I believe in common sense and in data, and my aim is to offer insight written in language that is clear and convincing.

07 September 2010

Private sector deleveraging

In my last entry I wrote about the debt reduction imperative confronting governments and how this deleveraging need not harm economic growth. What I did not address was the need for the private sector to deleverage as well. The Bank for International Settlements (BIS) has devoted a chapter in its latest Quarterly Review (here) on private sector deleveraging, which contains valuable insights and builds on the argument I made. 

First, the BIS shows there is a significant reduction in non-government debt after a crisis where credit was booming. In fact, “on average, private sector credit over GDP increased by 44 percentage points before the crisis, followed by a drop of almost the same magnitude (38 percentage points).” So countries end up with a similar private-sector debt level after the crisis as they had before the credit expansion took place. 

Second, the debt reduction path was driven equally by GDP growth, inflation and lower credit, meaning that the debt was not inflated away but there was either GDP growth that was faster than new borrowing or there was an outright reduction in debt (the BIS says that it cannot distinguish between paying off or defaulting on debt based on the data it has.) This is important since markets are jittery that high debt ratios will produce inflation – although governments can inflate away debt more easily than the private sector if they have the help of a central bank. 

Third, the BIS argues that debt reduction is compatible with economic growth, even though its evidence for this is not quite apparent in the paper; what it says is, “A possible concern is that a sustained period of debt reduction might lead to low growth in the future. Our analysis casts doubt on this. Growth rebounds rather quickly in most of our episodes, even though debt ratios continue to fall.” 

The one aspect that the BIS does not explore is what happens when deleveraging needs to take place in both the public and the private sector at the same time. In that case, a country can only resort to exports or savings-financed private investment for growth. And while the latter can be generated internally, the former depends on others sustaining demand, which makes collective deleveraging more difficult. And while this stands as the main caveat to take away to investigate further from the BIS study, I am still heartened by the results presented here.

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05 September 2010

Is Debt Destiny?

The accumulation of debt stands out as the greatest economic challenge facing many developed countries. But the idea that debt is destiny – that a country is “trapped” by debt – is hardly true, and neither is the idea that paying down is extremely painful, if not impossible. In fact, several countries have managed successful fiscal adjustments in relatively short periods, and there is much evidence that these adjustments coincided with (and were aided by) economic growth (see for example, here, here and here). The following graphs are my own attempt to contextualize the story of debt reduction across various countries.

The first graph, from the Congressional Budget Office, shows federal debt held by the public since 1790. As is clear, there are at least four episodes during which the United States has made significant reductions to its debt: from 1790 to 1830 (minus 29.6 percentage points), from 1865 to 1916 (-28.3), from 1919 to 1929 (-18.5), and from 1945 to 1973 (-87.9). Some of these episodes coincided with long-term increases in the standard of living, although these periods also included recessions and times of stagnant incomes.
The second graph shows a similar experience for a much broader set of countries (I have stopped at 2007 before the current recession led to fiscal worsening). Each of these countries managed to make a sustained reduction in gross government debt (the graph above shows net government debt). And each started and ended in very different debt levels suggesting that adjustment was possible for countries with varying initial levels of indebtedness.

In this sample, countries made a fiscal adjustment that was on average 43 percentage points from peak to through and lasted on average 14 years. At one extreme is Ireland which reduced its gross debt from almost 113% of GDP in 1987 to 24.93% of GDP in 2006 (16 years). On the other end is Finland which reduced its debt from 57% in 1996 (debt peaked in 1994) to 34.22% in 2008.
These graphs make clear that debt reduction is possible. The next graph also shows that these adjustments coincided with strong economic growth: on average, these countries grew by 2.65% during their fiscal adjustment periods (real per capita GDP growth). And for all countries save two (Netherlands and Belgium), the growth they experienced after the entered into the process of reducing debt was higher than in the previous five years when debt was either rising or stable.
Of course, there are an enormous number of caveats between what I have written above and saying “therefore a fiscal adjustment for country x in time y is possible.” Nor is it my intention to make this general point. Rather, my goal is to demonstrate (a) that a significant debt reduction is possible, (b) that it can happen during a time when real incomes are rising and (c) that it can be accomplished in the span of a generation or even less.

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04 September 2010

Greece’s Convergence with Europe

Our generation has grown up with the idea of Greece as a laggard in Europe: in this narrative, Greece’s entry into the European Economic Community in 1981 was a political gesture, even though the country was economically less developed than its European peers at the time. The graph below tells a more nuanced story of Greece’s economic path in the last half-century.

The graph shows Greece’s per capita Gross Domestic Product as a share of the average in the EU-15. What it means is that at 100, Greece’s per capita income is equal to the average in the European Union (EU-15) – at 94, it means that Greece’s average income is 6% less than the average European Union income, adjusted for differences in prices (purchasing power parity). Note also that this comparison is against the EU-15, so it includes countries that were not, at the time of the comparison, members of the European Union. 

I have colored certain landmark political years to facilitate the story telling. In 1960, Greece’s average income was 57, which means that on average Greek citizens had a standard of living that was 43% below their European peers. Since 1962, however, the country started to converge with Europe, a trend that remained even during the years of the military junta (1967 to 1974). In fact, by 1973 – the last full year of the military junta and the time of the first oil shock – Greeks were barely below their European counterparts (94 vs. 100).

Between the restoration of democracy in 1974 and the entry into the European Economic Community in 1981, Greece was more or less able to sustain this gap, and in 1978, Greece’s per capita GDP peaked at just 5% below the European average. Then started a secular fall in living standards relative to other European countries and by 1989, Greece had returned the same relative standard of living that it had in 1967.

The next ten years until the entry into the Eurozone in 2001 were a wash as Greece grew just enough to sustain its gap with the rest of Europe. Then came a mini convergence which peaked in 2004 and then again in 2009 (it is not clear to me how much the revision in GDP, which I believe has been backdated only to 1997 affects this mini trend). Effectively, the 2009 number is the highest since 1983, but the European Commission forecasts that the ratio will drop to 80 by 2011.

In other words, the story of Greece as a laggard is true but incomplete. By the time of its entry into the EEC, Greece had accomplished an extraordinary feat in convergence with European incomes. It was in the 1980s when Greece fell behind and throughout the 1990s it just managed to sustain its gap as the focus of economic policy was on meeting the criteria to enter the Eurozone rather than to raise real incomes. By 2009, Greek incomes were on par – relative to the rest of Europe – to what they were in 1970 (rising at the time) and 1983 (falling).

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