Sunday, June 28, 2015

Former Finance Minister of Cyprus on the Greek crisis

While on vacations in Greece, I had a chance today (Sunday 28 June) to have a long discussion with Michael Sarris who was Cypriot Minister of Finance between 2005 and 2008 when the Euro was introduced in Cyprus and then again Minister of Finance during the March 2013 crisis when Cyprus faced negotiations with “the institutions” very similar to those faced today by Greece.  Very few people in the world have as informed and first-hand knowledge of the situation as Michael Sarris does. Here are my questions and his answers.

Michael, you were Minister of Finance when Cyprus, like Greece today, had to negotiate the terms on which the EU would continue supporting Cypriot banks, so I am sure you have important insights both on how such negotiations proceed and what Greece should do. But before we move to that, let us deal with the present situation. The referendum is on. If you were Greek, how would you vote next Sunday (and why)?

We start with the assumption that Greece wants the best possible deal. In that context, I will not have resorted to the referendum because the “no” vote will not strengthen Greece’s bargaining position while polarizing the population.  The “democratic mandate” card had already been played with limited success. If you push me to give a specific answer, I would vote “yes” because it takes us back to the negotiating table with the chance of a better outcome.

The situation looks to have reached an impasse. You were able to reach a compromise with other EU countries. I know that the two situations are different, but do you think that the Greek side might have overplayed its hand? Could things have been handled differently?

Yes, I believe there was a real chance early on to reach a workable solution. I think the Greek side overplayed the democratic mandate card, showed disrespect to the technocrats working on the issue, and claimed the mandate to solve a more general euro problem. And in all those respects it was a counterproductive  approach.

You would agree that the recovery in Greece is impossible without a significant debt rescheduling which would reduce the total value of the Greek debt. But Europeans were very inflexible on that point.  Are they wrong on this, and what could have the Greek government done differently, if anything, if there is unwillingness to reschedule a part of the debt? Does this not end negotiations right there?

Debt rescheduling is in my view an important part of a comprehensive approach which would have had a chance to work. But debt rescheduling cannot be a substitute for reforms that will support growth.  In my view, if the Greeks came forward with bold reform proposals they would have forced the institutions,  particularly  because the IMF was already pushing for some debt relief, to include more concrete promises for lightening the debt burden as progress was made in the reform agenda.

You would have linked lightening of the debt burden to the reform?

Yes.  And to complete the answer, not only because it would have given EU a chance to do something  novel in dealing with the advanced  economies but also because reduction of the debt combined with an improvement in economic activity would allow debt/GDP ratio to go down, and debt burden to become more sustainable.

In the Cypriot settlement Cypriot depositors (and banks) lost almost a quarter of the GDP. So loss had to be absorbed by somebody in order for the system to continue functioning. Some people argue that in the Greek case the loss should have been absorbed early on by German and French banks that lent irresponsibly, and that the whole operation of bailing out of Greece was really a massive bail out of German and French banks. Now the risk is carried by EU taxpayers (through ECB holding of the debt). Does this seem to you a realistic description of what happened?

It is an accurate description of what happened in the sense that the cost of past excesses by both lenders and borrowers was passed onto the Greek tax-payers who have to repay the new money Greece got. A combination, in my view, of misplaced fear of moral hazard and the desire to protect the large French and German banks led to what can now be called “the original sin”  of crisis mismanagement with whose consequences we are still living. Once the Europeans decided not to observe the no bail-out clause in order to protect their own financial stability, they should have gone all the way and forgiven a part of Greek debt against credible reform program.

Let’s end with a more optimistic note. How is Cyprus doing now? Is the worst over, and what would be, in your opinion, lessons for Greece?

Cyprus is doing much better than was expected at the time of the depositors’ bail-in. We have removed capital controls and stopped the output decline but unemployment remains high and banks non-performing loans are still a challenge. But the direction is positive.

For Greece the lesson is that you implement as faithfully as you can your agreements, move on, and go easy on the blame game.

Finally, for Greece would you have accepted the creditors’ program even if there is no debt reduction at all?

This is not an easy question to answer because I believe that a good program with positive growth prospects would have eventually forced some sort of debt relief. So I would not have caused a rift at the beginning and would have taken my chances of debt relief as program implementation proceeded.

Friday, June 26, 2015

The two trilemmas today

At a talk on global inequality that I gave at IESE Business School in Barcelona this week, Professor Francesc Trillas asked me a very good and unexpected question: how do you reconcile the Rodrik trilemma with what he kindly called the Milanovic trilemma (defined in my The haves and the have-nots). I had to confess that I never thought of these two trilemmas together, but the question looked most interesting and I promised to think about it. So, here is the preliminary result.

The Rodrik trilemma addresses the issue of what is the role of the nation-state in the era of globalization (see the graph below with three “cartouches”). You can have nation-states and democracy, as in Europe in the 1960s and 1970s, but you then have only a very limited globalization: tariff rates, monetary policy etc. are determined by each country separately. Or if you move more forcefully toward globalization, you have to sacrifice either national economic policies or democracy. Why? If you accept to combine globalization with democracy, you move to a cosmopolitan solution where the nation-state plays the role that cities or regions play today within countries. That is, none. If you combine globalization and the nation-state, then democracy suffers because the nation-state is enclosed within the “golden straightjacket” of policies dictated by the imperatives of globalization. This is similar to Greece’s situation today: it cannot democratically decide on economic policy it wants to follow.  

My trilemma is different: it does not deal with economic policy but with global inequality and movement of people. Globalization and large differences in mean country incomes cannot coexist with labor that stays put in their own countries. The knowledge of these income differences and the increasing ability to move from one county to another implies that people in poor countries are not going forever to forego opportunities to multiply their incomes by a factor of 10 by staying at home.  

 Migration must thus be regarded and accepted as an integral part of globalization. So, do not be surprised if Malians come knocking to your door: this was “pre-ordained” when your country joined WTO and Bill Gates (or was it Al Gore?) invented the Internet.

Now of course, you could  have globalization and a world without large migration flows if differences in mean country incomes were low (say, as within the EU-15). But if you have globalization and large income gaps then you have to get prepared for migration, or if you do not like it, you have to start building walls.  

How  do things seem today if we look at them through the Milanovic trilemma? First, globalization  continues as before despite some minor setbacks induced by the North-Atlantic financial crisis. Second, differences in mean country incomes (globally speaking) are being reduced, essentially thanks to the high growth rates in Asia. If this were to go on for another half a century, it could lessen migratory pressures in a big way. But—and this is the key point—currently the effects that encourage migration are much stronger than the negative effects on migration, stemming from an eventual reduction in the differences in standards of living between countries. This is obvious if we look at Europe and Africa. It will take a century until African incomes, even assuming high growth rates, come close to European incomes.  In the meantime, income gaps and knowledge of these gaps will continue to feed migration. The third cartouche “no migration” has therefore to give way. But the rich world does not like that and tries to stem the tide by building the walls and fences that would keep migrants out. That is where we are today.

However, the rich world, working within this trilemma, can, to some extent, influence migration flows by helping poor countries grow faster: through increased aid, or by opening its borders for their products, or generally by making poor countries somewhat better places to live in. This is not however what happened in the past 20 years.  Rather the reverse has occurred, especially in the Middle East, where military interventions in Iraq and Libya (and earlier in Afghanistan), have practically destroyed these countries and produced large flows of migrants. When this happens, and the flows of migration increase above what under peaceful conditions they would be, the response is to create more fences  and walls, which in turn also imply a retreat of globalization, defined to include more than movement of capital, goods and services.

It is through this effect that we can link the two trilemma. Notice that the only element common to the two trilemmas is globalization. So, if the two trilemmas are to be linked, the connection has to go through globalization. Now, if there is some retrenchment of globalization, it would seem that we may go back to the old 1960s solution: nation-state and domestic democracy. And looked upon from Europe such an evolution does not seem unrealistic.  The nation-state is on the ascendant as can be clearly seen in the interminable EU squabbles. Global democracy is being eroded by the creation of mechanisms of global governance which are avowedly plutocratic and respond to the interests and the needs either of the rich countries or rich people. Instead of within the UN, things are decided at the G7 and G20 summits; instead of (often unwieldy) global consultations à la Porto Alegre, we have Davos, Bilderberg and similar fora of the hyper rich.

However, the real world situation is not as clear cut as in Rodrik’s trilemma nor as it was in the 1960s. The rise of the nation-state may indeed occur to the detriment of globalization, but the economic and political structures that have been created (Davos, WTO, G7 etc.) are not going to be dismantled. The Rodrik trilemma seems, at present, to have been “solved”, not by the exclusion of one out of three elements but by the redefinition of “democracy”: some of it is national, but some of it remains “lost” in global, often informal institutions, that are not subject to any democratic oversight.

In the Milanovic trilemma, a similar uneasy equilibrium exists. Movement of people is neither fully free, nor is it totally absent. It continues day after day, pressuring rich countries to wall themselves in and create enclaves closed to the poor. What the trilemmas show is that while they are useful constructs to try to understand things, reality is more complicated to be shoe-horned into the schemata. In effect, in both cases, the three cartouches that we drew above continue to exist (none has been “deleted” as we would expect in a real “solution”) but are being redefined.