What should Greece do?
There’s been a lot of discussion of the problems of Greek sovereign debt, its implications for the euro and so on. But I haven’t seen much discussion of what the Greek government should do in dealing with the simultaneous problems of an economic downturn and unsustainable debt (feel free to point me to good discussions).
The course of action being demanded by the bondholders and their advocates, as well as by the EU governments that are likely to bear the costs of a bailout is that of drastic retrenchment on the lines the IMF would normally advocate in cases of this kind. But that is obviously not a desirable policy response when considered in macroeconomic terms. I’m not well informed on the details of Greece’s budget problems, so I’m mostly going to make generic suggestions that are applicable to a case like this.
What Greece needs, if it can be delivered is a policy that will maintain its access to credit markets, while avoiding a drastic contraction in the short run. That requires a credible commitment that holders of Greek government bonds will be paid in full, or fairly close to it, a commitment that is inconsistent with sustained budget deficits.
The strategy that seems to be indicated is one that has the following main characteristics
* A sustained increase in the ratio of tax revenue to national income over time. That suggests a commitment to raise the VAT rate gradually over several years, with the extra revenue being hypothecated to debt service. On the income tax side, the most credible commitment to raise revenue in the long run is probably one of vigorous action against tax avoidance and evasion, benefitting from the efforts of the bigger European economies in this respect
* On the expenditure side, it’s likely that Greece, like most countries has unsustainable commitments on retirement incomes. A staged increase in retirement and pension ages, as has been done in Australia, is a reasonably credible way of constraining future growth in expenditure without too much adverse impact in the short run.
* Finally, there are the various non-conventional ways previous governments found to take on debt obligations, for example by mortgaging future income flows. Unlike the case of standard government bonds, there is no need to preserve access to this kind of borrowing in the future. On the contrary, action to ensure that no future government can borrow in this surreptitious fashion is highly desirable. So, these deals should be renegotiated to reduce the burden they impose, with the threat of repudiation/default in the absence of a satisfactory agreement. The prominent role of major Wall Street banks in organising these deals is a potential political asset here. An outcome in which Goldman Sachs gets stiffed, while bondholders in general are paid, would be an ideal way of softening the political pain associated with expenditure cuts and tax increases.