It's All The Greeks' Fault

If the polls are right, then this Sunday Greece will elect Syriza, the left-wing coalition party (its name is actually a Greek acronym for “Coalition of the Radical Left”). This will bring to power the first staunchly anti-austerity party in the EU, and the first element in their policy document is to “Write-off the greater part of public debt”.

That is likely to lead to some fractious negotiations with the EU, and possibly even a messy exit from the Euro. Before that happens, there will be some messy commentary in the media as well, and I fully expect most commentators to take a line like that in my title.

After all, it’s common knowledge that the Greeks lied about their levels of public debt to appear to qualify for the EU’s entry criteria, which include that aggregate public debt should be below 60% of GDP. Though there’s an argument that Goldman Sachs, many of whose ex-staff are now leading Central Bankers, helped the Greeks make this alleged lie, the responsibility for it will be shafted home to the Greeks, and that in turn will be used to argue that the Greeks deserve to suffer.

The story, in other words, will be that the Greeks were architects of their own dilemma, and that therefore they should pay for it, rather than making the rest of the world suffer through a write-down of their debts. Emotion will rule the debate rather than logic.

So to cast a logical eye over this forthcoming debate, I’m going to consider who is really to blame for the Greek dilemma by considering another country entirely: Spain.

Spain’s situation lets us get away from Greece’s emotional baggage. Today, Greece and Spain are in very similar situations, with unemployment rates of well over 25%—higher than the worst the USA recorded during the Great Depression (see Figure 1). But unlike Greece, Spain before the crisis was doing everything right, according to the EU.

Figure 1: Unemployment in Greece, Spain and the USA

Not only did Spain qualify for EU entry on both Maastricht rules—aggregate public sector debt was below 6% of GDP, and the budget deficit was below 3% of GDP—it actually had falling public debt before the crisis began (August 9^th 2007), and its government debt level at the start of the crisis was well below America’s (see Figure 2).

More importantly still, Spain’s government debt when the EU imposed its austerity regime (mid-2010) was still well below America’s, even though both had risen substantially since the crisis. As Figure 2 shows, Spain’s government debt ratio was 65% of GDP then, versus 78% for the USA.

The whole purpose of the EU’s austerity program was to reduce government debt levels. Reducing government debt was the political topic du jour in America as well from 2010 on, but the various attempts to impose austerity came to naught: instead, after shooting up because of deliberate policy at the time of the crisis (think “Cash for Clunkers”) America’s budget deficit merely responded to the state of the economy. Politically paralyzed Washington talked austerity, but never actually imposed it.

So who was more successful: the deliberate, policy-driven EU attempt to reduce government debt, or the “muddle through” USA? Figure 2 shows that muddle through was a hands-down winner: the USA’s government debt to GDP ratio has stabilized at 90% of GDP, while Spain’s has sailed past 100%.

The USA’s macroeconomic performance has also been far better than Spain’s under the EU’s policy of austerity. Comparing the USA’s unemployment rate to Spain’s has to account for the fact that it was higher before the crisis—at 8.5%, Spain’s unemployment was 1.75 times the USA’s when the crisis began. It is now about 4 times the USA’s.

Figure 2: Government debt levels in Spain and the USA

So simply on the data, the prima facie case is that all of Spain’s problems—and by inference, most of Greece’s—are due to austerity, rather than Spain’s (or Greece’s) own failings. On the data alone, the EU should “Cry Uncle”, concede Greece’s point, stop imposing austerity, and talk debt-writeoffs—especially since the Greeks can argue that at least part of its excessive public debt ratio is due to the failure of the EU’s austerity policies to reduce it.

Figure 3: Government debt levels in Greece and the USA

But I know that data isn’t enough to sway the public opinion—let alone the bureaucrats in Brussels. So we need to know the why: why did austerity in Europe fail to reduce the government debt ratio, while muddle-through has stabilized it in the USA? Here I return to my hobby-horse: the key factor that I consider and mainstream economists ignore—the level and rate of change of private debt.

The first clue this gives us is that the EU’s pre-crisis poster-boy, Spain, had the greatest growth in private debt of the three—far exceeding the USA’s. Its peak debt level was also much higher—225% of GDP in mid-2010 versus 170% of GDP for the USA in 2009 (see Figure 4).

Figure 4: Private debt ratios in Spain, Greece and the USA

The second clue comes from the change in debt data: the factor that Greece and Spain have in common is that the private sector is reducing its debt level drastically—in Spain’s case by over 20% per year. The USA, on the other hand, ended its private sector deleveraging way back in 2012. Today, Americans are increasing their private debt levels at a rate of about 5% of GDP per year—well below the peak levels prior to the crisis, but roughly in line with the rate of growth of nominal GDP.

Figure 5: Annual change in private debt in Spain, Greece and the USA

The third clue? I’ll leave that for my next post—this one is long enough already. But the conclusion is that Greece’s crisis is the EU’s fault, and the EU should “pay” via the debt write-offs that Syriza wants—and then some.