Some American readers ask me to shed some light on the weird turn of affairs in Europe these days. I thank them for this opportunity. I will ask them to be patient with me if it seems I am taking the long road to get my point through. And one point above all: all what follows has less to do with economic issues and much more with political ones: wear new glasses and proceed to read.
It turns out that another country, the USA, involved in creating a credible and long-lasting monetary union, handled a similar situation better, much better. By understanding how it worked it out, we might in the process figure out more clearly the reasons of the current standstill.
Some United States financial history is therefore needed, bear with me. One has to travel to more than a century ago, in the first century of the US monetary union, we might call them the “early years” of a United Monetary Union, just like in Europe today: many different states, with very different cultures and beliefs, much larger anyway than today.
So let us go back in time, to … Tennessee, XIX° century, a State certainly neither too rich nor productive, yesterday like today, within the realm of US States. We will go to a specific point in time, when the (US) state of Tennessee was facing tough repayment problems with its public debt, 1872. It will actually take 12 years to sort them out and this is the short tail of what happened and why and how it ended.
To understand why did the problems of Tennessee’s government budgets arise, let us go back even further, to 1850, quite a bit of time before the crisis erupted. Just like many other States of the US, Tennessee launched itself in a heavy program of public investment to sustain productivity in its local economy, mainly through the development of railroads. Differently from other States, however, it goes at it by borrowing money in the market and lending it back to private railroad companies in exchange for collateral such as stock, bonds and contracts of those same companies.
Until 1865 everything runs smoothly: loans were largely well-allocated and the cost of debt was compensated by interest revenues from companies.
Minor parenthesis and a first parallel between Greece and Tennessee: for those who say that Greece has always been an underperforming economy, a shameful black sheep in the honest family of European countries, think again. Indeed, McKinsey reports how between 1999 and 2009 annual productivity growth was: USA +2%, EU +1,1%, Continental EU +1,6%, Southern EU +0,7%, Northern EU +1,6%, Greece +2,4% !
Let us go back to growing-Tennessee. In 1865, suddenly, everything unravels: following the first crisis due to the end of the Civil War and a series of loans to the wrong companies, fraud and corruption, the State of Tennessee finds itself as the owner of valueless paper credit and collateral.
Notice: we are talking about a crisis that is born both from internal mistakes and external circumstances, a parallel that again allows us to compare Greece today (hit by the consequences of the 2007 financial crisis and also by the discovery of its window-dressing of public accounts during the entry in the euro in the early 2000s) and Tennessee then.
Cumulated debt in Tennessee rises to very high levels. All of a sudden, however, between 1872 and 1883, it halves from 40 to 20 million dollars. What had happened?
A default, the State declares it annot repay its debts. Yes, a default, contrary to what happened so far in Greece. Ah ha! A first difference here emerges, you might say. Indeed. How did this default come about? After a lengthy but democratic process.
The Democratic Party of the time – dominant across Tennessee – was divided across two party-lines: the State Credit Wing – favorable to debt repayment to creditors (internal and external to the State) and the Low Tax Wing – favorable to save a heavy burden to local taxpayers. Well, it turns out that taxpayers won and default occurred, with a loss for the creditors, including New York bankers and all those United States citizens that had taken the risk to lend to Tennessee.
The then President of United States, Ulysses Grant, did not care that much for the internal drama of Tenneesseans nor of the markets. He actually did the right thing: leave it up to Tennessee citizens to decide what to do with the debt, even if a potential default would have somewhat endangered the already full pockets of a few rich bankers in the state of New York.
This did not happen in Greece. Europe got involved in the relationship between foreign investors and Greece and decided to contradict its initial constitutional rule of “no-bail out”. It bailed out (reckless?) banks that had lent to Geece at the beginning of the XXI century, and took charge of the Greek debt. All of a sudden Greek creditors from private actors had become European taxpayers.
And European Governents started asking Greece to do all the wrong policies: extreme austerity was ordered from above (something Tennessee citizens would have never allowed then), GDP and employment in Greece collapsed and, guess what, public debt over GDP skyrocketed, making public finances unsustainable.
While you will hear that Greece has done nothing to fix its own problems, one might argue, to the contrary, that it has done too much, following the wrong advice of European creditors. In just 5 years pension cuts amounted to 48%, public employees declined by 25% while the deficit shrank from 15,6% of GDP to 2,5%, and as a result unemployment rose to 27% and the debt over GDP ratio to 180%. Reforms were implemented (Greece rose in the World Bank indicator Doing Business from the rank of 109th in the world to the 61st position), but as we know these take time to change growth performance, while austerity hits immediately and painfully. This is probably why Greeks voted 2 days ago to stop austerity imposed from outside: they knew better than to repeat for a sixth consecutive year the same mistake that had ben forced on the without advantage.
Two additional lessons here are to be drawn for a case, today’s Greek one in the euro area, that looks similar to the case of Tennessee in the XIX century: letting democracy work, however imperfectly, is the only solution that keeps societies united. Intervening from above, with little electoral mandate, is bound to make disaster more likely, as it did in the European case. Much of the desider of Greeks to vote was indeeed due to a sense of political imposition, and how can you think to go ahead without bumps when you are dealing with the country where democracy was created?
Oh, and by the way, let us not forget lesson number 2.
You might have not noticed but it is also true that the thought never crossed the mind of President Grant to “ask” for small and unproductive Tennessee to leave the dollar union, as instead a growing numer of Europeans are today!
He probably knew better than that: as my colleague Prof. Whelan has aptly reminded us for Greece (“pushing the Greek government further than their current position will generate infinitesimally small financial gains for European citizens while risking a Greek exit threatens unquantifiably large potential costs”) the cost of a political disruption would have largely outweighted any small gain for a few rich lenders. He kept Tennessee in the (ultimately) successful project of the US since he was aware of a basic truth: that a union becomes a Union with capital U only when you keep the weakest part of the chain tied to the rest.
But it is never too late: listening to the desires of Greek citizens, who insist in wanting to remain in the euro but at a pace that is compatible with non disruptive and too much an abrupt and painful change, might prove to become the trick that will save Europe and Greece alike. Pushing usa head in the construction of the United States of Europe.
But how can an agreement among countries that seem so stubbornly to resist it come about?
Contrary to what is generally thought, it will be very hard to convince the Germans to reduce the Greek debt. Not because Germans are “selfish”: just 2 decade ago they implemented one of the largest transfer of resources ever made in a country. Yes, to its East German brothers who had just come out of communism. But, indeed, these were brothers, unlike Greeks who are today at most a distant 6-degree cousins.
Now, however, here is the potential miracle of the European Union family: it works opposite to a regular family, where each generations becomes ever more distant: first brothers, then first-degree cousins, then second-degree etc. We have built this European project to make sure that over time each generation gets closer: from cousins of sixth degree to… brothers, maybe the grandson of my grandson will be the brother of the grandson of the grandon of a German citizen of my same age today.
But to arrive there you need … time. United States became a federalized system in the 1930s, following more than a century of slow social convergence where each State was very jealous of its own prerogatives to begin with, not allowing Washington DC to decide how much to spend, how much and what to tax. It took a Civil war, the invention of the train that increased mobility, a First World War that increased the awareness of the USA of being a global power and, finally, a President, FDR, that managed to unite a country in the face of hardship in the 1930s.
Europe is facing the same problems of slow convergence of very different cultures that the USA faced in the XIX century.
So to go back to debt cuts, hard to believe that German will allow a transfer to Greek citizens. But less austerity everywhere, in Germany like in Greece, might have a higher chance of being accepted by all parties. It is not an explicit transfer and it benefits everyone. Lower taxes in Germany (that can be spent in nice vacations in Greece) and higher public investment in Greece that can sustain recovery of competitiveness, will go a long way in restoring growth and hope across all of Europe, and stabilizing at the same time the public finances of the weakest countries.
This is what Greeks voted upon with their NO.
Now only a minor matter remains: agreeing on such measures. The alternative? Letting Tennesse, I mean, sorry, Greece go out of the euro area and the European Union. Of course, formally what I say is incorrect: Greece, even out of the euro, would remain in the European Union, like the United Kingdom (for how long?) or many other Eastern European and Scandinavian countries. But it would remain in a very different position from the latter: as a country expelled from the euro union, not as a country that initially exercised its democratic will not to join it. A difference that will make Greek citizens humiliated and unwanted, and thus cause them to look around, not only in terms of new and different economic policies but also of foreign policy and strategic alliances. It is not science fiction: the democratic and secular Turkey to which only 10 years ago entry into the European Union was refused, humiliated, decided to look elsewhere and has rapidly become a less secular society, much closer to Islam and distant from the West.
Losing Greece in the euro, then, means to risk losing Greece in the Europe, bringing it closer to other geopolitical areas as the Russian one with which it shares, among other things, a greater closeness of religious belief.
After Greece will have gone, somebody else’s turn will come about. Nobody realizes that once the weakest link is let go, another weakest link will take its place and will be attacked by markets and ignored by richer neighbours. What is needed is a Constitution that specifies clearly that when a State is in trouble, in some way the others are going to give a helping hand. Otherwise, why unite? It is this Constitution, different from the current one, that many people, not just the Greeks, are seeking to obtain.
One last thing. When we will look, I hope not, to this disastrous outcome, to a European failure of voting for another Europe of the euro, please do not blame the euro. The single currency will have been just that: a symbol, a mere symbol, of a willingness to stay together for a long-term project. Just like a ring in a wedding. If the marriage does not stand up, do not blame the ring, but the lack of a project based on mutual solidarity and sustainable development. And if the ring slips off, please do not expect the two divorcees to go back living together.
Information on Tennessee taken from “A Financial History of Tennessee Since 1870” by James E. Thorogood