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The Great Greek Default

Tuesday February 7th, 2012   •   Posted by Emily Skarbek at 10:27am PST   •  

Just last October, Greece received a huge injection of bailout funds to help avert bankruptcy but the country remains on the brink of default. Greek Prime Minister Lucas Papademos plans to gather the nation’s political leaders in an attempt to garner consensus on the necessary budget cuts. But the party chiefs have only agreed to cuts for this year equal to 1.5% of GDP and have not come close to closing the gap demanded by creditors for the $171 billion rescue.

Meanwhile, the economy of Greece is stagnate. Since October, the slump in the Greek economy has been much deeper than anticipated. The Greek government needs approximately $20 billion on top of the October bailout to cover its immediate financing needs. The prospects for economic growth are bleak.

Greece’s creditors are demanding the government bring its fiscal accounts into balance in exchange for the agreement to write off $130 billion worth of Greek debt held by foreign lenders—an amount of debt equal to roughly 70% of its total debt burden. To satisfy these demands, Greece would have to bring it’s debt-to-GDP ratio down to 120% by 2020 (and even that is an exceptionally high ratio).

But here’s the bad news.

As Dalibor Rohac, deputy director of economic studies at the Legatum Institute, points out in an article in the the National Review Online:

But that reduction is not going to occur unless the most optimistic of scenarios materializes and the Greek economy rebounds. So far, there have been no signs of that occurring. In 2012, the Greek economy is expected to contract by 3.7 percent, after a 6 percent fall in output last year. Unemployment is getting dangerously close to 20 percent, with almost one half of all young Greeks out of work.

The ugly truth is that Greece has a distinctly inhospitable business environment. It ranks 100th in the World Bank’s “Doing Business” report, below Kyrgyzstan, Yemen, and Zambia. Its protection of investors is worse than that of Liberia, Mauritania, and Togo. According to Transparency International, the country suffers from higher corruption levels than Brazil or China—or Macedonia, Greece’s very poor immediate neighbor.

All of this points to a dreadful situation. Even if the Greek government manages to cut spending and improve revenue collection policies, there are still deep structural problems with the economy. Perhaps even more importantly there are strong prevailing collectivist views regarding the role of government in society. Labor unions in Greece are striking, protesting, and calling the demands to scale back the state “blackmail”.

In reflecting on Joseph Schumpeter’s “Capitalism, Socialism, and Democracy”, James Buchanan made a gloomy prediction that despite the fall of communism and fact that collectivist views had fallen into disrepute, socialism will not only survive but advance in the future.

His argument was that socialism would survive not because it was more efficient or more equitable, but “because ceding control over their actions to others allows individuals to escape, evade and even deny personal responsibilities. People are afraid to be free; the state stands in loco parentis. The breaching of plausibly acceptable fiscal limits in the first half of the new century will determine how the basic conflict between welfare dependency and liberal principles will be resolved. (emphasis added).”

Eerie, isn’t it? How this argument can be seen playing out on the Greek stage as a result of “breaching plausibly acceptable fiscal limits”. Sadly, there are no simple solutions. But there are a few simple lessons that policy makers would be wise to learn sooner rather than later.

First, government spending is not the source of economic growth. Pundits reporting on the Greek crisis say that Greece is in some kind of catch-22: they need economic growth to get out of their problems but if you cut government spending, you won’t get economic growth. The argument is the same Keynesian logic that underpins U.S. policy-makers decisions. Real economic growth comes when private entrepreneurs and businesses can operate within a framework that enables protection of property, performance of promises, and transference by consent. IF government can produce that framework, only then does it have a role in providing the conditions under which growth can occur.

Second, ideas matter. It is important that we—regular people, leading regular lives—learn the first lesson. Part of the reason why politicians adopt spending and bailout policies is because they think that you think those policies work. If you know better, they have more of an incentive to do better. If we consistently allow the Keynesian economic logic to prevail, we run the risk of destroying the principles of a free society and surrendering our liberty to control.

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© PIAZZA del POPOLO from Flikr Creative Commons

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February 2012