The conventional wisdom, pushed by the IMF and others, is that Greece’s economy will never recover unless there is substantial debt relief.
Translated into English, that means the Greek government should be allowed to break the contracts it made with the people and institutions that lent money to Greece. That may mean a “haircut,” which would mean lenders (often called creditors) only get back some of what they’ve been promised, or a “default,” which would mean they get none of the money they were promised.
I wouldn’t be surprised if Greece has a full or partial default. And that actually might not be a bad result if it meant an end to bailouts and Greece was immediately forced to balance its budget.
But let’s set that issue aside and look at the specific issue of whether Greece’s debt is unsustainable. Here’s a look at Greek government debt, measured as a share of economic output.
As you can see, when the crisis started in Greece, government debt was about 100 percent of GDP.
Was Greece doomed at that point?
Well, if the situation was hopeless, then someone needs to explain why the United States didn’t collapse after World War II.
As you can see from this chart, debt climbed to more than 100 percent of economic output because of the heavy expense of defeating Nazi Germany and Imperial Japan. Yet the American economy rebounded after the war (notwithstanding dire predictions from Keynesians) and the debt burden shrank.
So maybe the more interesting issue is to look at how America reduced its debt burden after 1945, which may give us some insights into what should happen (or should have happened) in Greece.
Here’s one question to consider: Did the burden of the federal debt drop between the end of World War II and the 1970s because of big budget surpluses?
Nope. If you look at Table 7.1 of OMB’s Historical Tables, you’ll see that there was a steady increase in the amount of government debt in America after 1945. Yes, there were a few years with budget surpluses, but those surpluses were more than offset by years with budget deficits.
The reason that the national debt shrank as a share of economic output was completely the result of the economy growing faster than the debt.
Here’s an analogy. Imagine you graduate from college and you have $20,000 of credit card debt. That might be a very big burden relative to your income.
But in your 50s and (hopefully) earning a lot more money, you might have $40,000 of credit card debt, yet be in a much stronger financial position.
So the real issue for Greece (and Spain, and Japan, and the United States, etc) is not so much whether the amount of debt shrinks. It’s whether debt is constrained compared to private-sector growth.
That doesn’t require any sort of miracle. Yes, it would be nice if Greece and other nations decided to become like Hong Kong and Singapore, high-growth economies thanks to small government and non-interventionism.
But all that’s needed is a semi-sincere effort to avoid big deficits, combined with a semi-decent amount of economic growth. Which is an apt description of U.S. policy between WWII and the 1970s.
Is it unreasonable to ask Greece to follow that model?
Some may say Greece is now in a different situation because debt levels have climbed too high. Debt in the United States peaked a bit above 100 percent of GDP at the end of World War II, whereas government debt in Greece is now closer to 200 percent of GDP.
It’s certainly true that today’s debt burden in Greece is higher than America’s post-WWII debt burden. So let’s look at another example.
Government debt in the United Kingdom jumped to almost 250 percent of economic output by the end of the World War II.
Did that cause the U.K. economy to collapse? Did Britain have to default?
The answer to both questions is no.
The United Kingdom simply did what America did. It combined a semi-sincere effort to avoid big deficits with a semi-decent amount of economic growth.
And the result, as you can see from the above graph, is that debt fell sharply as a share of GDP.
In other words, Greece can fulfill its promises and pay its bills. And the recipe isn’t that difficult. Simply impose a modest bit of spending restraint and enact a modest amount of pro-growth reforms.
Unfortunately, prior bailouts have given Greece an excuse to avoid reforms. Though the IMF, ECB and European Commission (the so-called troika) have learned somewhat from those mistakes and are now making greater demands of the Greek government as a condition of another bailout.
The problem is the troika doesn’t seem to understand what’s really needed in Greece. They’re pushing for lots of tax increases, which will make it hard for Greece’s private sector to generate growth. The only good news (or, to be more accurate, less bad news) is that the troika doesn’t want as many tax hikes as the Greek government would like.
In other words, don’t be too optimistic about the long-run outcome. Which is basically what I said in this interview on Canadian TV.
The bottom line is that a rescue of the Greek economy is possible. But so long as nobody with any power wants to make the right kind of reforms, don’t hold your breath waiting for good results.
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this article reveals a complete ignorance of basic macroeconomics and the relevant facts. The key point distinguishing Greece from both the US and UK post-WWII is that the US and UK borrowed in and controlled their own currencies and Greece does not. The author says blandly states that all Greece needs is a “modest” bit of spending restraint, completely ignoring the fact that Greek govt. spending has in fact plummeted with austerity, causing massive hardship to the population and creating primary surpluses. The reason for Greece’s skyrocketing debt-to-GDP ratio is the hit to GDP caused by austerity, not any increase in spending (or deficits). And further cost-cutting (read: austerity) will not help, because every euro cut from government spending will have a multiplier effect causing more than a euro in lost GDP.
I accept that there is some point in the case you are making about Greece. However, I urge caution in equivalencing things too much on just public debt as a function of GDP.
As an alternative view on government debt, to be viewed alongside your figure 2 (USA debt as % of GDP) and your figure 3 (UK debt as % of GDP), I offer you an alternative interpretation, over the same time period (though without future predictions, ie beyond 2015).
Firstly there is USA Gross Public Debt per capita, inflation indexed to 2009 dollars. Secondly there is UK Gross Public Debt per Capita, inflation indexed to 2005 pounds Sterling.
You will see immediately, in both cases (though far worse for the USA), that the relative peak values between now and the end of WW2 are reversed. You will also see that there is, in both cases, a fairly steep decline in the debt after WW2 – showing that the decline was not dependent mainly on increasing GDP, but was dependent otherwise: on paying off the debt (and possibly on an increase in population).
In the current circumstances (2015), both the USA and the UK governments are (IMHO) in a dodgy set of circumstances. The risks are threefold:
(i) The debt levels are, in absolute terms, highly imprudent. In the UK, this is just over £21,000 per man, woman and child. In the USA this is nearly $53,000 for every man, woman and child.
(ii) Should the need arise to fight and win a world war, the starting position for debt is extremely high. Should not we view the likely end position of debt as so extreme as to be unmanageable (USA public debt tripled across the sort few years of WW2): this even for such rich countries as the USA and the UK. This is very likely to impinge substantially on the ability of these countries to fund such a war, and therefore is a terrible inhibitor on foreign policy.
(iii) With a private household, toleration of high debt is normally dependent on adequacy of income to fund at least interest on the debt: loss of employment therefore represents a very great danger. The equivalent for nations and governments is another recession (and/or a forced rise in interest rates). USA public debt has increased by around 75% (in per capita, inflation indexed terms – so around 7.2%pa) over the period since the 2007 financial crisis. Is any slowdown in this actually visible? Are you seriously suggesting GDP growth will rise to match this?
As one of your other commentors has written, Greece has a far narrowed (and hence more vulnerable) economy than either of the USA and UK. Encouraging them to follow our lead therefore seems to be less than friendly advice. This is especially the case when, at least to me, the USA and UK do not themselves look to have a anything near a robust financial position.
Best regards
The US in the late 40’s and 50’s is not a good example of how to do it. After WWII, we were the only developed nation that did not have damage to our infrastructure. The world wanted whatever we could provide. Other than tourism and olive oil, nobody wants what Greece can provide. Greece needs a change in culture that cannot happen as long as the EU keeps bringing back the punch bowl.
Great post, Dan.