Crumbling Greece
Greece is certainly in a pickle. It needs to borrow more money to keep its wheels turning, but has borrowed to the point where it needs a loan write-off. Try asking your bank manager for a loan write-off while asking for more money and see what she says. The Swiss on the other hand have a remarkable rule to avoid such a tragic end.
Greece got it all wrong
When businesses borrow money they must invest in something that returns the cash borrowed. A country is no different. Extra tax revenues must eventually repay today’s borrowing. Sure economies have ups and downs so tax revenue highs could be used to repay low points’ loans however in the long run the same principle applies.
Greece got nearly everything wrong. It added to its borrowing at an economic high point and spent the money with no compensating uptick in tax revenue. Not only did it miss its chance to pay down its loans but it ended up in a doom loop: an ever-increasing loan to pay an ever-expanding shortfall. This was compounded when an economic downturn drove down tax revenues even further.
Drowning in debt
No way out
Once in this doom loop there are only three remedies.
Do something to increase tax revenues. If this something requires further borrowing (and spending) however, the lender needs to be convinced that the extra spending will increase tax revenues enough to cover not only the new loans but also the existing shortfall. In the 2010 bailout Greece got the money but failed to deliver enough extra tax revenues.
Cut spending so there is no shortfall. This is austerity and if done in the wrong way, it risks compounding the problem by driving down tax revenues still further. This worked for Greece but not well enough.
Eliminate loan payments by writing down debts. If there is a shortfall after this however, the lender is unlikely to lend to plug the gap. Greece is now calling for this but lending more would require a huge leap of faith on the part of the lender given Greece’s perennial track record of defaults, presented here by Mathew Lynn. In his article he says “according to calculations by the economists Carmen M. Reinhart and Kenneth S. Rogoff Greece has spent more time in default to its creditors than any other European country. It has been skipping its repayments for 50 per cent of the years since 1800”.
Swiss parliament building
The Swiss solution
Switzerland shows that it doesn’t need to be this way. In the nineties life was unusually rocky in the alpine nation and Switzerland experienced a steep rise in government debt. So in 2003 the Swiss came up with the debt brake, a rule anchored in the Federal Constitution that requires a budget surplus in boom times but allows deficits in slumps. Surpluses are then used to repay loans so keeping debt at a manageable level while creating a cushion for downturns. The rule essentially constrains politicians decisions on taxation and spending, keeping expenditure even through the whole economic cycle.
People power
Remarkably, 85% of Swiss voters accepted the rule. In the end it seems clear that politicians cannot be trusted to borrow sensibly. Greece is a hyperbolic example. However despite having one of the world’s most prudent governments the Swiss still recognize this. The main difference though, is that their system and political culture has actually allowed them to do something about it.
More on this:
Explanation of the Swiss debt brake (The Swiss Federal Finance Administration – in English)
Greek Economics: Drachmas, debt and Dionysius (Matthew Lynn writing for History Today – in English)
