Tuesday, February 14, 2012


What did happen, what could happen and what will happen.

What did happen:
When Greece joined the Euro the government got access to cheap credit. The politicians used the cheap credit to take up public debt. (In other European countries private debt was the problem). The politicians then used the cheap money to buy votes and ignore severe problems, like rent-seeking minorities.

Rent seeking minorities are one of the biggest problem in any society. The problem exists in the US (e.g. sugar regulation) as well as in Germany (e.g. sales tax for flowers is reduced.). The reason such nonsense happens is that a well-organized minority exerts political power to enforce its own interests. The reason this is possible is that the minority is small. For example, the typical US citizen doesn't care all that much that he pays a few dollars the year more for sugar. But the sugar industry cares a hell of a lot because these dollars, added over the entire US, mean millions of $ for them.

In Greece e.g. you can't just open a taxi business. Instead, you need to apply for a license. But the existing taxi drivers don't have an interest in competition. That's why they made an agreement with politicians to vote and support them financially only if the politicians keep the supply of taxi licenses artificially small. Now, there are usually a few good reasons for such licenses. Be it quality of the service or fraud protection for the customers. The taxi driver organization probably lists these advantages when they argue publicly. But fact is that there is no reason for society to keep the pool of licenses small. This only leads to not enough taxis and artificially high prices. These artificially high prices, created by lack of competition, are called a rent. Just like US citizen pay too much money for sugar, the Greek pay too much money when they want to use a taxi.

The taxi drivers are a rent-seeking minority. The problem is that the majority of the citizen doesn't really care about the minority. But in aggregate the minorities can pose a big problem for any society - including the taxi drivers. Greece has many, many, many rent-seeking minorities.

The Greek politicians also employed much more public servants than necessary. From a societal point of view these people are practically unemployed as there's nothing to do for them. Moreover, processes in the public sector are kept deliberately labor-intensive to justify the presence of many public servants. But even though they are practically unemployed - or their work is useless as what they do could be done more efficiently - they receive a generous payment and pension from society.

These public servants need to be fired. It would be good to do it slowly as it can and does financially ruin families. But unfortunately there's no time ..

The Greek government fails to tax their rich citizen. This results in a very high tax burden for the poor and the middle class. This is not just a problem of social justice but really a problem of revenue as the rich by definition have much more money than the rest.

In a way this is also a way of rent-seeking. In this case, those politicians in power had no interest in taxing their financiers more. It's basically the same problem the US is getting itself into right now. Just that in Greece's case the theoretical taxes on the rich are reasonable. There's just no institution which is able to make the rich actually pay.

Finally, evading (value-added) taxes in Greece is considered a trivial offense. The Greece don't like their government because they know it is inefficient. But, in contrast to the US, they still really like to receive benefits from it. And they consider it acceptable to cheat the government. The wider public hasn't understood yet that by cheating the government, society cheats itself. This leads to the honest citizen having to bear a larger burden to make up for the dishonest. It also leads to the dishonest having more money than the honest and thus more influence.

When private external investors gave money to the Greek government and the government to the people, everybody had a lot of money (relative) to spend. This lead to very high prices. The high prices lead to high wages. These wages were so high that the products Greece could produce, were not competitive with the products from other countries outside Greece. And this lead to companies which produced products for consumers in other countries going bankrupt. The workers in these companies found jobs in companies which produced for Greek people. This also lead to Greece importing much more than exporting. But this is only possible as long as the money from the outside flows in. Now that this flow of money has stopped, there's not enough money to buy all the goods from other countries.

More about this further down. The point here is that the people producing goods and services for other Greeks would need to find new jobs in companies that sell goods and services to other countries. But the Greek wages are too high to do this competitively. This problem can only be solved by either reducing wages or by the Greek people (and the organizational structures of their companies), magically, becoming more productive. The latter is not going to happen overnight. That's why wages and thus prices have to go down. Greece needs a deflation. If they had their own currency they could inflate it and achieve the same effect (and a few problems). But now that they are in the Eurozone they can't. Wages need to go down before they can go up again. So, if reporters say that Greece needs growth they are only half-correct. Greece needs a recession to reduce wages and prices today in order to grow tomorrow. This process is very painful, unfortunately.

A few years ago private investors started to doubt that the Greek government will ever be able to pay back the debt. Since then they don't give any more loans. Unfortunately the Greek society, over the last decade, has been transformed to depend on the flow of money from the private investors. Without it there's just not enough money to pay the public servants or really the public sector, which has grown very large. And as the workers in the public sector receive less income, they can spend less on products created by private companies. The result is a severe recession. (Vice versa, this is the reason why increasing public spending does increase GDP - temporarily).

What could happen:
The Eurozone has basically two options.

First it can do nothing. In that case Greece goes bankrupt. And since Greece can't print its own money right now, it had to cut government spending down to what it takes in. This would cause an incredible economic shock. Whole families would starve to death and the population would probably revolt. Some kind of leader would rise to power and start printing a new currency in a chaotic process.
This currency would not be worth very much but it would help. Of course, the rich Greek citizen have transferred their Euros somewhere else a long time ago. Only the less well off and those who don't understand economics would suffer when they try to get their money from their bank, because they would only receive the new currency and not Euros. And the new currency would buy much less goods and services than the Euro.

The magnitude of the problem can be understood best when looking at what Greece imports and what it exports. Imports in 2011 were 43 billion Euros but exports were only 22 billion Euros. Since no one outside of Greece gives Greece any money, the imports would necessarily be reduced to a maximum of about 22 billion Euros overnight.
Since Greece is a very small country, most of what the citizen consume is produced somewhere else in the world. And many of these things are very important nowadays. Take oil, meat, wood or computer chips as an example. To suddenly cut the imports of these things down from 43 to 22 billion Euros would be one, if not the, most extreme shock in modern economic history. The economic recession would rival any in Sub-Saharan Africa over the last hundred years. It's so extreme that its effects would really be completely unpredictable ..

The alternative is the Eurozone giving Greece money. It does so in the form of debt, but we all know that Greece won't repay most of it. In return for the money the Greek politicians are required to reform the country. For example, to deprive rent-seeking minorities of their power. Now, this is causing a hell of a lot of problems for the Greek politicians. They need the rent-seeking minorities to be reelected. But they won't be reelected without the money from the Eurozone. The result are extremely agitated negotiations and a few politicians who think that they'd rather be the prime minister of a failed nation than not being reelected ...

Should the reforms actually succeed to a satisfying degree, which I doubt, the Eurozone might be convinced to actually help with an investment program; a kind of Marshall plan for Greece. Right now, however, would be the wrong time as such a plan would remove pressure from the Greek politicians. But if the government reforms turn out to be convincing, such a plan, in a few years, would be a great help for Greece - and for the European project. The point really is that the Eurozone will only throw more money at Greece if it thinks that it will help long-term. Right now it would help only short-term.

What will happen:
Now, unfortunately the future is bleak. Most citizen don't understand what is happening and they behave perfectly humanly if they try to break out of dire problems by doing anything. For example, by electing some politician who promises to have some simple answers. Germans have some experience with politicians who offer such promises in the time of economic need.. mix in some nationalism, for example, by threatening Turkey and there you go. Greece still spends over twice the percentage of GDP (3.2%) on the military as e.g. Germany (1.4%) - and somehow the Greek politicians rather cut pensions than military spending ...

If you ask me this is what will probably happen. The Eurozone can't give much more credit to Greece because four to five European countries have problems themselves. And the politicians of the countries who don't have problems, most prominently Germany but also Finland, the Netherlands, Luxembourg and Austria, have a really hard time being reelected if they transfer ever more tax payer money to Greece.

Furthermore, the Eurozone public debt crisis, except for Greece, is about to be solved by the ECB (as I predicted) and a little support by reforms in Spain, Italy, Portugal and Ireland. This means that the Eurozone has very good chances now (as opposed to a year ago) to survive Greece leaving the monetary union (no irrational chain reaction). And thus the willingness to transfer money to Greece is dwindling fast.

Thus, if you are a young Greek: get your money out of the country and learn a second language to a degree that you can find work in another country. Because, no matter what happens, Greece will have dire economic problems for at least the next ten years. If everything works perfectly it could then rise again .. but if Greece steps out of the Eurozone, or even the European Union, hope will not return for a long time, ...


  1. Nils,

    You forgot to mention Greece's #1 export....Hardworking middle class Greeks.

    Hardwork was punished through unfair tax laws (or lack of enforcement) and government handouts.

    Couple the loss of hardworking talent with the enabling powers of loose and irresponsible lending practices and you end up with the current situation.

    Current and future problems facing Greece:

    -Majority of tax records are not computerized on purpose so that they can be easily evaded.
    -Youth unemployment is at 50%.
    -Hardworking and talented workers are leaving.
    -Tax evasion has become a way of life.
    -Lack of adequate leadership.
    -Reduced wages.
    -Increased crime and health problems.
    -Government waste is off the charts.

    Hard times indeed are ahead for Greece regardless of what happens.

  2. Russia went through a similar shock in the nineties, but has more or less recovered since then. Having oil and nukes helped a lot, though.

    1. Russia outright defaulted in 1998. A lot of it had to do with abysmal tax collection, and extremely lenient tax regime toward oligarchs and their businesses.

      Then in 2000s Russia tightened taxes, paid off debts, and is in great position in today's crisis with less then 10% of Public Debt/GDP ratio. Thing improve? We'll gladly take new credit offered! Things get worse? Our trade sulprus and direct agreements will cover most major economic cataclysms - we certainly wouldn't get out of it unscathed, though.

      It's interesting that i've seen GDP/Debt ratios graph for Greece somewhere, and it in fact had quite similar GDP/Debt ratios in 1998 (when we defaulted) as in current crisis! Then they tightened their monetary policy to join Eurozone, and debt got lower for a while. Then it rised again after they joined. Their GDP rised too - but debt rised faster.

      As such, any current measures by Greece can only be seen in the same way - not a permanent change, but rather attempt to stay in Eurozone longer and wait out crisis instead of true reform - which can only come from within, not from outside.

    2. I'm not an expert on Russia, but I don't think Russia ever had a problem with imports being much higher than exports. Russia just had (and has) a corrupt public sector.

      One really needs to differentiate between the government and the whole society. For example the German government has increased its debt last year, like every year since 1950 or so :). But the society as a whole did not. In fact we exported much more than we imported.
      Russia's problems in 2000 were more similar to this: the public sector spent too much but the economy as a whole did not.

      Today Russia exports $376.7 billion and imports only $237.3 billion. Of course, most of the exports are raw materials like oil and gas - similar to Saudi Arabia.

      The problem of Greece is not just that the public sector spent too much. This applies to the US, Japan and others, too. The problem is that the economy as a whole spent much too much and the reason was a corrupt public sector. Add the inability to print their own currency and you get the current situation.

      If Greence had put all the money it got due to the low interest rates of the Euro into future investments, like education, science, broadband, etc, it could be a very prosperous place right now. But, instead, it went only into consumption: German cars, expensive food, flatscreen TVs, etc ...

    3. "But, instead, it went [b]only[/b] into consumption: German cars, expensive food, flatscreen TVs, etc ..."

      This is true, but not entirely true. In the years leading up to the 2004 olympics Greece DID put lots of money into things like roads, ports, bridges, trains etc..

      Athens in the mid to late 90s looked a lot different than it does now in terms of infrastructure, which aided commerce. You are right though, other things like education and supporting its private sector should have been a much higher priority than it was. And then theres the tax problem.

    4. Looking at import/GDP ratio, it was relatively stable, and in fact worse before they joined Eurozone.

      And as far as i know (and as far as i've seen data), they never were "net exporter" in modern history. They always had trade deficit. And they managed to survive as state, so you can make it work long-term. Perhaps imperfect, but traditional situation.

      Maybe German CAN perform miracle and turn this situation around to balanced budget. I'll only believe it when i'll see it in action though. :)

    5. Before they had the Euro they simply printed more Drachme to pay for new stuff. Basically they exported green paper. This absolutely works :)

      .. But it causes inflation and makes outside goods quite expensive. That's why Greece (and many others) wanted the Euro: They constantly had the problem that the Dollar or the German Mark was so damn expensive. And the tourists had fun when they visited the 'cheap' countries.

      Right now we basically see that you can't have the cake and eat it too. .. Either you have a strong and stable currency and no long-term trade deficit; or you have a constantly devaluating currency, inflation, and a long-term trade deficit.

      At the end of the day you need to produce goods and services which the world wants. This is the only way to convince the world to give you goods and services that you want.
      You can export ever more green paper! But even though you are basically cheating the world then, it's not exactly optimal for you, either :)

    6. Roads and ports are good, but you need truckers on them to actually make use of it. Scarcity in licenses just makes Nils' point.

      It's hard to expand GDP when you really can't ship goods out of the country.

  3. The main problem is that it's an extreme version of the problem facing Europe and the U.S..

    For years the political parties have been spending money on political gain and graft or social engineering that was at odds with each other. All the while telling everyone that things are fine. I remember in the 90's in the U.S. when the mantra became "deficits don't matter". We've all been living on the government credit card and the bills are coming due. Greece was just the middle class lady buying Furs and diamonds and nice cars so her bills are higher. Now all the bankers who made bad loans want everyone to pay them back. Good luck with that.

    To fix any of those problems means it has to seem fair. People would get behind the idea of "shared sacrifice" but when the bankers go home to their mansions and the government bails them out because they are too big to fail then no one will get on board with the solution.

    Start throwing bankers and financial industry execs in jail for gaming the system and I'd bet people would be a lot more interested in supporting the system.

  4. Nils, really good article. I would like to add a couple of points.

    First off this should prove that Keynesian economics will never work. In fact Greece is a perfect example that Keyensian economics will only lead to this situation. Greece used massive government spending programs and it ultimately lead to this type of financial ruin.

    My other point is about taxing the rich. There are two major flaws in this overly simple appraoch. You point out the first one. The rich are a rent seeking minority and they give hugh political contributions to get their way. So that tax increase doesn't really impact the current rich but greatly hinders those trying to move up. A perfect example of this happened in Illinois in the US. The governor raised taxes 67% (to get the rich to pay more). Except the big corporations threatened to move and got exemptions. So only the middle or small companies and people actually end up paying more in taxes.

    And the second flaw is the belief that the rich alone can sustain the crazy spending levels. Even if you comfiscated all the wealth (not just income, but also all their wealth), it wouldn't even pay off the US debt.

    Once governments get into the habit of spending more then they can possible take in there is nothing but financial ruin ahead. And the public unions in the US (another rent seeking minority) do everything they can to keep spending on an increased trajectory and will NEVER let it decline in the US. So unfortunately in 10-15 years I see the US following in Greece's footsteps.

    1. I think Greece proves that some forms of government spending and regulation can hurt the society. ...

      Depending on what you actually mean when you say "Keynesian economics" Greece is even a wonderful example that K. economics work, in my opinion. More on that in my next post "Austerity". (My next job starts in a few weeks and I guess I'll have written an economics book by then ;)

      Reading this and Sam's comment I really have to stress once again: There is a huge difference between a government spending more than it takes in in taxes and a society importing more goods than it exports. Both create debt, but the latter can create a much bigger problem. If, in addition, you have no own currency it can be very difficult to fix this problem in anything but a very painful way.

      To take Greece and argue that it is a good example for how bad high public debt is, is really very incomplete. If public debt were a big problem Japan were a third world country by now; Japan is anything but that.
      Greece is a combination of terrible governance, a broken democratic system with no trust for the politicians, no own currency, a very high public deficit and a very high "balance of trade deficit", i.e. imports>exports.

    2. And the US is importing much more than it exports. While the US has its own currency there is risk to the whole world. this is why OPEC wants to untie oil to the dollar. Most of the rise in oil prices during Obama's term was due to QE1 and QE2, which just printed money.

      Japan tried big time Keyensian and has been stagnant for almost 15 years now. Only saving grace is they export more than they import.

      So with the US importing more than exporting and hugh deficits sooner or later other countries and the private sector will stop funding that deficit. That is when US will become like Greece.

    3. The US is anything but on a course to stability. But the fact that you can print the world's current reserve currency gives you much more room to navigate than Greece. If Greece could print dollars I assure you that the party would go on for a very long time, still :)

      The question whether Japan's status is really that bad is a good one. A few newspapers had some interesting points to make about this some time ago.

    4. I've seen fairly recent "return of barter economy" story on ZeroHedge - a bit sensational (as expected from things linked to Iran/gold though), but still interesting as idea.

      And i'm aware of growing number of currency swap agreements Russia, China and others have with many countries - all aimed to circumventing dollar exchange.

      So perhaps dollar's hold on world is growing weaker every minute.

    5. The us just has better tools being a federal govt it can smooth over the fact that California's economy is barely better than Greece.

    6. Actually, Nils summed it up nicely in the original post: the short-term solution is systemic reform. Monetarist pressure is brought to bear not because it's the right thing for Greece's economy, but because it is the gun to the head of Greece's politicians. It is an important distinction to make.

      The long-term solution is a Keynesian one, a European stimulus. There is simply no incentive for purely private investment in Greece for the next decade, apart from a Yeltsin's Russia-style predatory picking apart of national monopolies. Central spending has to be a part of it.

      The tragic aspect for Greece is the speed and cruelty of the cuts. I think, sadly, there is an artificial sense of crisis which is deepened by the Eurozone's own need to prove its worth before the overpowered ratings companies and its own rent-seeking constituencies, like banks trying to avoid haircuts.

    7. So the long term solution is exactly what got them in trouble in the first place. Especially since Keynesian economics is government spending beyond more than it takes in which is what they are doing now.

      Keynesian economics is like the Lochness monster. It only exists in fantasy or theory.

    8. Think of it as a Marshallplan, Goodmongo. That was $13 billion at a time when the US GDP was at $258 billion. With today's US GDP that's $725 billion.

      One thing I can promise you, Goodmongo: If it turns out that just scaling back government expenditure turns Greece into a successful economy Germany won't give them money on top of it. Doesn't look like it, at this time, however :)

    9. "Keynesian economics is like the Lochness monster. It only exists in fantasy or theory."

      The Keynesian school is a little more complex than just government deficit spending in hope of outgrowing the deficit, or massive stimuli from assorted central banks to foster growth in a recession, though those tend to be the shorthand at our level of debate.

      However, specifically in response to the 2008 crisis (which, among other things, killed shipping and opened the Greek Pandora's box) the various stimuli around the world worked fairly well to avert or diminish recession. On the global scale, it's hard to underestimate the impact of the 1tn injection by the G20 in 2009. On the national level, they worked best in countries like Russia (few people remember the brief Russian market crash of late 2008) and China where the state is a significant stakeholder in large corporations and central solutions are easiest to implement, as Keynes predicted. But work they did almost everywhere, to varying degrees. Even the American Recovery Act, much as you will probably never admit it, saved your country from a much darker fate.

      Anyway, while I have deep private doubts about the objective value of the credit rating system, our aim here should be to get back to a situation where private lenders can lend to Greece with a reasonable expectation of promised return. The two factors that would make me, personally, consider buying Greek 10-year bonds: a) either bite the bullet and restructure existing debt or guarantee it through ECB and for the love of heaven stop talking about it b) get tax revenue back: reform and grow.

    10. But work they did almost everywhere, to varying degrees. Even the American Recovery Act, much as you will probably never admit it

      This is 100% pure supisition on your part. Since we do not live in a word where we can try both methods at the same time there is no proof that the statement is correct. In fact a number of books have been written taht the US and the world would have been better off without the bailouts and 'stimulus' plans.

      But neither theroy can ever be proved.

      And then your last couple of sentences basically state that for you to buy greek debt would require Greece to get their budget and spending in line to revenues. This is completely contray to big keyensian supports like "senior Enron advisor" Paul Krugman.

  5. It's interesting to see the perspective of someone from Germany on this. Living in Portugal, I can say that it's hard to look at it objectively.

    One of your statements caught my eye, though:
    "Furthermore, the Eurozone public debt crisis, except for Greece, is about to be solved by the ECB (as I predicted)"

    What exactly are you referring to here?

    1. I referred to the ECB basically printing money a few months ago by giving all bank as much (extremely cheap) credit as they wanted for three years. And they will probably do this again, soon.

      This money will go (and went) into financing the public deficits of the member countries. It's really the same thing the US and GB do, just via the banks.

      Moreover, Portugal, like Greece, is small enough to be supported for virtually forever by the Eurozone if necessary. The difference is that Portugal has working public institutions. It's not so much a systematic crisis as 'just' a (very) deep recession. If the Eurozone gives Portugal money it can be reasonably sure that it gets where it was supposed to get - and doesn't vanish in the pockets of some interests groups.

      I know it's hard to believe that things could be worse than in Portugal right now. But, really, Greece is 10x as bad.

    2. I’m from Greece and the article was really spot on. Especially the part for the economic-rent minorities, I could only nod along as the text went on.

      I’ll have to agree with one other poster that mentioned that Greece exports labor. Currently a great number of post grad students are looking for work primarily abroad, and even older people (like myself) are seriously considering migrating somewhere in the EU, NA, or AUS. While visiting some friends in the Netherlands, someone said jokingly to my sister that “Germany exports cars, Italy exports clothing, Japan exports electronics and Greece exports manpower”.

      It’s why a good chunk of people from the 20-40 age bracket can speak at least 1 or 2 foreign languages (usually English + 1 more from the EU region, and it’s not unheard of seeing someone being able to understand 3,4 or more).