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The Greek government defaulted on its payment to the IMF, with wild popular support confirmed by a referendum. Huh? Isn’t default supposed to be a bad thing?
Ecuador’s government defaulted on its sovereign debt in December 2008.
President Rafael Correa, formerly Ecuador’s finance minister and who
holds a Ph. D in Economics from the University of Illinois, declared
Ecuador’s debt “odious debt.” In April 2009, only four months after the
default, he was re-elected in the first round with 51.9% of the vote,
the first time in thirty years a president had been re-elected in the
first round.
Did economic disaster follow? Ecuador’s GDP growth rate in 2009 was 1.16% above the global average.
Next for Greece is the bank workout. Initial indications are that a 30% loss on deposits above 8,000 euros would restore Greek banks to financial health, making them perhaps among the healthiest banks in Europe.
This should be done,
and it should be done quickly, so that the banking system can get up
and running again. Depositors should be senior to all other creditors,
including derivatives liabilities, who would get a total loss. There is
no need to sell the banks or sell the banks’ assets. It is just an
adjustment of liabilities. Existing shareholders would be wiped out;
depositors would get a debt/equity swap, for example one share of
equity for each 100 euros of debt converted, and thus become the new
owners of the bank.
Of course this would involve some discomfort, but a 30% loss on deposits – with equity in trade
— is hardly the worst thing that could happen. Also, Greek people
implicitly supported such a path with their rejection of all EU
borrowing in the recent referendum. Since the Greek government is in no
position to recapitalize banks (again) with a “bail-out,” a creditor
writedown is the logical next option.
Then what? Then comes the Magic Formula. Low Taxes and Stable Money.
The worst thing that could happen is for a currency disaster to be
piled upon all the other problems of default, bank restructuring, and
various spending reforms – as Argentina experienced in 2001. That’s why
I insist on Stable Money. Argentina had been using a dollar currency
board, and many advisors begged the government to dollarize completely,
as Ecuador had done a year earlier, rather than devaluing the currency
in an effort to prop up insolvent banks. Argentina didn’t dollarize,
and you can compare their results to Ecuador’s. (The Argentine peso
fell from 1:1 to the dollar in 2000 to 9.14/dollar recently.
Argentina’s GDP, in nominal dollar terms, fell more than 50% and took seven years to recover to its 2000 level.)
Technically speaking, Greece can certainly keep the euro.
Ecuador, which dollarized in 2000, continues to use U.S. dollars to
this day. Ten other small states and territories use the euro
exclusively, without being members of the eurozone. If the European
Union has a hissy fit, and somehow makes it difficult for Greek
institutions to continue using the euro, the next-best option would be
a currency linked to the euro with a currency board, such as is used by
at least thirteen African countries with a combined population in excess of 109 million people.
Neighboring Bulgaria uses a highly reliable currency board linked with
the euro, so in a pinch, Bulgarian levs could be used in Greece instead
of euros, until a domestic currency board could be established. The lev
has the advantage of being independent of the Greek government, and
thus not in danger of being debauched by the government in a moment of
weakness.
Keeping the euro, or a currency linked to the euro, is the best
solution for maintaining Stable Money for at least the short term. The
euro itself might not be such a great long-term solution, particularly
if Spain and Italy begin to follow Greece’s example, but other
arrangements can be worked out in the future.
And yet, all of this, added together, won’t get Greece much beyond
where it has been thus far – with 25% unemployment and 50% youth
unemployment, a bloated and corrupt government burdened by a crippling
legacy of entitlements, and an economy that has been in shrinkage since
2008. We could avoid disaster, but Greece would still be left with slow
lingering decline, no better and possibly worse than today. How do we
turn this around?
That’s where we need the other half of the Magic Formula: Low Taxes. This could take many forms, but one excellent proposal was made by Steve Forbes, who suggested a flat individual and corporate income tax with a 10% top rate (the same as Bulgaria), a 10% payroll tax (instead of a 42% combined rate presently), and a 15% VAT (instead of 23% presently).
In 1998, Bulgaria had a corporate tax rate of 40%, and a top personal
income tax rate of 50%. The VAT rate has been unchanged since that
time, while the payroll tax rate has been reduced by a whopping twelve
percentage points. The result? Total tax revenue, as a percentage of
GDP, was 34.6% in 1998, and 35.8% in 2014. Needless to say, these
business-friendly tax rates have allowed Bulgaria’s economy to grow, in
part because of a flood of Greek businessmen seeking a better
environment. A stable revenue/GDP ratio, multiplied by much larger nominal GDP, means more tax revenue, not less.
I might suggest an even more aggressive proposal: a tax system based
only on indirect taxes, something like the “fair tax” ideas floating
around in the U.S. This can work well, but only when government
expenditures are fairly reasonable, for example around 15% of GDP. That
is more than enough for a wide range of government services, including
universal healthcare. The Greek tax system could consist of the present
23% VAT, perhaps the existing local property tax, a few excise taxes on
things like gasoline and tobacco, and nothing else. This might seem
politically improbable at this time, but people can be inspired by such
visions, and when they are inspired, great things can happen.
Even the lefty-as-possible Syriza government – some actually call
themselves “communists” – is now adamant that higher taxes
(“austerity”) are a disaster. If that’s the case, would lower tax rates
be an un-disaster? An un-disaster is exactly what Greece needs, right
here and now. Maybe, as big an un-disaster as you can make.
Once all these things are in place – sovereign default, bank
restructuring, a reliable currency arrangement, and big tax reforms –
then a reform of public spending would be much easier. Everybody in
Greece knows that things need to be fixed. What they don’t want is for
Greek people to make concession after concession while foreign debt tyrants get paid back 100%
— especially since the “troika” loans to the Greek government were
mostly to bail out foreign banks to begin with. The concessions come
after the default – just as is the case with corporate employment and
pension agreements, or municipal bankruptcies in the United States.
The tax reforms also need to come before, or at least concurrently
with, the spending reforms. If thousands of excess government
employees, thousands of pensioners under 65, and hundreds of crony
businesses are going to be kicked out of the government feeding trough
– as everyone knows they should be — they need to have a healthy private economy as a viable alternative. The tax reforms make that possible.
You could make a list of a hundred other reforms, such as the ease of
setting up businesses or a relaxation of labor laws. Go ahead and do
those too. But, they won’t be very effective by themselves. You need
the tax reforms. Would you set up a business in Greece today? Since the
answer is already “no,” who cares what the other details are. And if
the answer is “yes,” then you will try to make it happen, even if there
are obstacles, although it would be better if there weren’t.
That is quite an agenda. But, all the alternatives are worse. Even the
IMF – one of the Greek government’s major creditors – says that the
Greek government needs a debt restructuring. Just piling on more debt
is not a viable solution. Nor is trying to make-believe that banks are
healthy, even with a further “bail-out,” whose financing seems very
unlikely. And printing money/devaluing the currency to make it all
better? This is a popular sort of notion today, which just goes to show
how few supposed experts know what happens to places like Argentina
that actually try it.
I think Greece could be wealthier than Germany in twenty years. With visionary leadership, of the sort that Lee Kuan Yew showed in Singapore (14.2% tax revenue/GDP) or John Cowperthwaite
showed in Hong Kong (13.0% tax revenue/GDP), it might take less than
ten. Or, you could have one heck of a disaster. I suggest taking the
road to prosperity.
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