Economic projections unanimously show that the Greek debt-to-GDP ratio is on an unsustainable path. Still, European politicians hesitate to bite the bullet of debt restructuring. Their hesitation is understandable. Apart from the – probably manageable – losses which would be inflicted upon European banks, debt restructuring puts the Greek financial system at risk, is hard to sell to the German public and is in the context of EMU an untried and risky step into the unknown. Above all, it sends the wrong political signal to Greece, which is that economic salvation may come from debt forgiveness, instead of from economic reforms. Debt forgiveness reduces the momentum for reform. Yet without tackling its bloated public sector, the many privileges and entitlements, the rigidities in goods and labor markets and its lax tax morale, Greece will never be able to compete in the euro area. Its economic problems would continue to burden the public finances, making it hard to regain the confidence of financial markets. Taxpayers and bank customers in northern Europe are not keen on paying the bill for a country whose predicaments are of their own making and which has been fudging the financial numbers for years. So, while the case for reform is clear, the case for debt restructuring is less so.
Still, the search for alternative solutions remains on the agenda. The austerity measures keep on hitting the Greek people. When they see no light at the end of the tunnel, there is a real danger of reform fatigue. The Greek willingness to indefinitely sustain spending cuts and tax increases to pay off foreign creditors cannot be taken for granted. Sovereign debt crises always result from a lack of willingness to pay, not from an inability to pay.
So what are the options? Any solution should be judged by its ability to deliver the structural reforms which Greece needs to become a competitive member of the euro area. Leaving the euro area doesn’t fit the bill. It would amount to throwing in the towel and turning back to the old unsound policies of devaluation, deficits and inflation. Buiter & Rahbari (2010) list six other ways to restore fiscal sustainability. Fiscal pain is what is being tried now, and might include selling the “table silver”. Debt restructuring (or partial default) and bailout may put back the Greek public finances on a sustainable path at the cost of reducing the incentive for structural reform, sending the wrong signal to debt-ridden countries and risking a popular backlash in Germany. Seigniorage is not an option to the Greek government, as the ECB is in charge of monetary policy. Current inflationary pressures from rising oil and commodity prices, though, might help a bit in reducing the real value of public debt. Higher GDP growth in Greece would also bring down the debt ratio. Yet growth is not a policy instrument and the economic outlook remains weak. Buiter & Rahbari (2010) finally mention paying a lower interest rate on the public debt, but note that this requires the toolkit of financial repression.
The option of financial repression is not further explored by Buiter & Rahbari (2010). It is typically associated with developing countries and fits uneasily with the principle of freedom of capital movement within the EU. So it is understandable that this option is out-of-bounds to European policymakers. Financial repression usually implies that households are forced to save at domestic banks (using capital controls) and banks mandatorily hold public debt. The reason that Japan, with a debt-to-GDP ratio of around 200%, has no sovereign debt crisis is that most Japanese debt is held by Japanese households through the financial system.
A variation on the theme of financial repression could address the problems of Greece, while avoiding debt restructuring, default and devaluation. Instead of limiting the financial options available to households once they have earned their wages, my suggestion would be to start the financial repression one step earlier. This could be done by paying Greek wages partly in long-term government bonds. In this way the Greek public would be forced to adsorb its own public debt. These bonds would not be legal tender, but could be bought or sold at prevailing prices in the bond market. Greek workers would thus not be forced to hold on to these bonds, but would have the choice between selling at low prices and waiting for better times. The government could use the resulting cash savings to redeem bonds held by foreign creditors. In this way, foreign debt would gradually be replaced by domestic debt. Moreover, the interest rate paid to workers would not include risk premia and might be designed to vary with Greek economic fortunes.
This plan would address the three most serious characteristics of the Greek crisis:
1) the current overreliance on foreign funding, which makes Greece extremely vulnerable to changes in international investor sentiment;
2) the fact that Greece has been living beyond its means and needs to reduce consumption and restore external balance;
3) the lack of problem ownership.
Regarding the third point, putting back Greek debt in the hands of the Greek public would put problem ownership where it belongs, with the Greek people, not just with their government or with fellow Europeans. It would give Greek bondholders a stake in their public sector and strengthen their stamina to sustain the reforms. They would have “skin in the game”, as the value of their bond holdings would increase with the success of the reforms.
Greek labor unions and workers might balk at the suggestion that part of the wage bill will be paid in bonds. Yet extreme circumstances warrant extreme policy measures. In times of war, many societies find it quite normal that ordinary citizens invest a substantial part of their income in the national effort through war bonds. Admittedly, war bonds are usually voluntary and depend on patriotism, propaganda and peer pressure for their success. My guess is that these wouldn’t do the job in Greece.
Could this plan have a sizable impact on the debt-to-GDP ratio and bring it back on a sustainable path? Potentially, yes, as labor income is a sizable part of GDP. The annual cash savings will depend on the percentage of wages paid in bonds and on the number of workers involved. It would be best for Greek society if both public and private sector workers would participate and share the burden. Then it would still take time to gradually replace foreign with domestic funding. This is finally where the EU comes in.
The EU has been buying time already and can continue to do so. When the Greek people would hold their own public debt and thus accept ownership of and responsibility for their government’s predicaments, the EU electorates could be more easily persuaded to extend credit on more generous terms (i.e. low interest and long maturity). In combination, Greek financial repression combined with European solidarity could be instrumental in accomplishing a de facto debt restructuring, without all the negative effects of a de jure one.