Wednesday, July 08, 2015

What Demands May Greece's Creditors Make, Consistent With Democracy?

by Michael Dorf

Much of the discussion by commentators sympathetic to this past Sunday's Greek "no" vote on the referendum whether to accept Europe's terms offered in exchange for additional credit and the ensuing negotiations yesterday has been couched in terms of democracy. (This brief blog post by Paul Krugman is a good example.) Germany, the ECB, and (behind the scenes) the private banks to which so much of the Greek debt is ultimately owed were and are, in this view, unfairly attempting to leverage Greece's economic vulnerability to obtain political results: either the outright fall of PM Tsipras and Siriza or, at the very least, a change of policy that is dramatically inconsistent with their core commitments and the now-twice-expressed clear preference of Greek citizens.

Is that an accurate characterization? Maybe, but it depends on a number of unstated assumptions about what creditors may fairly demand of debtors, both in general and in the special case of sovereign debt. Here I'll try to unpack those assumptions with a hypothetical example.

Suppose Angela lends Alexis $100,000 so that Alexis can open a restaurant that serves Greek cuisine. Under the terms of the loan, Alexis will pay Angela 5% annual interest on the outstanding principal for ten years, plus any principal payments he chooses to make, with the remaining principal to be fully paid back in a balloon payment at the end of 10 years. The loan instrument also permits Angela to demand full principal repayment if Alexis is delinquent in his interest owed. At the end of year 1, Alexis makes his $5,000 interest payment but pays no principal. At the end of year 2, Alexis tells Angela that the restaurant is still not making a profit but that reviews have been good, the customer base is growing, and that he would like to delay payment for the year so that he can use the $5,000 he would otherwise pay her for advertising and marketing. Angela agrees in writing to a "one-time" delay. After year 3, Alexis tells Angela more or less the same thing. Worse, Angela learns that instead of spending on advertising and marketing, Alexis spent $5,000 in year 3 on a "team-building" retreat for himself and his wait staff. Angela has had it with Alexis. She tells him he must either pay the $10,000 in interest (the delayed year 2 payment plus the year 3 payment) or she will demand full repayment of the principal. Alexis cannot afford either option. Angela then says that she will forgive the year 2 and year 3 interest payments but only if Alexis relinquishes control of the day-to-day operations of the restaurant to a manager she will install, Otto, who plans to replace the dolmades and other Greek delicacies with a menu featuring potato pancakes, sauerkraut, spargel, and other German stalwarts.

Angela's proposal could well be ill-advised. Converting a Greek restaurant to a German restaurant will likely sacrifice most of its value as a going concern. However, perhaps Angela has good reason to think that a German restaurant managed by Otto will provide a better chance at maximizing her payout than either continuing to permit Alexis to operate a Greek restaurant or demanding full principal repayment, which would (let's assume) result in bankruptcy and liquidation. If so, then her plan makes financial sense.

From Alexis's perspective, of course, Angela's offer is a bitter pill. In order to avoid bankruptcy he must relinquish control of the restaurant of his dreams and watch as it becomes something else entirely.

But does that make Angela's offer unfair? I'm inclined to say no. Alexis accepted Angela's terms when he took the original loan. Assuming that there was nothing unfair about the original terms, now that things have gone south, Alexis could declare bankruptcy and walk away or, if he thinks that a German restaurant run by Otto is better than nothing, accept Angela's offer.

To be sure, this sort of logic has its limits. Alexis might also prefer to permit Angela to raise his first-born son than to see his restaurant go bankrupt, but that doesn't mean that Angela may condition debt relief on Alexis's relinquishment of Alexis Jr.

In my own field, this sort of puzzle concerns what are called "unconstitutional conditions." Courts and scholars struggle to articulate sensible principles that distinguish between permissible and impermissible conditions. I emphasize struggle. For example, in partly invalidating the Medicaid expansion under Obamacare in 2012, the Supreme Court seemed most struck by how much money was at stake, finding that this factor--together with a mysterious distinction between "old" and "new" money even when all the money was in the most relevant sense "new", as Justice Ginsburg explained in dissent (on this point)--turned what would have been an otherwise permissible carrot into an impermissibly coercive stick.

Nonetheless, there does seem to be something intuitively appealing to distinguishing between kinds of conditions. The Spending Clause cases also distinguish between conditions that are permissibly germane to the purpose for which the funds are allocated and those that are not. Using that idea as a guideline, we might say that Angela's insistence on running the restaurant the way she thinks will make money (even if she is mistaken about that) is legitimate because related to the purpose of the loan, while asking for Alexis, Jr. is not.

Turning back to the actual debt crisis, are European demands for continued Greek austerity more like installing Otto or demanding Alexis, Jr.? The question is challenging because austerity both is clearly germane to how Greece runs its economy and also strikes at the heart of matters of self-government in the political realm. Election contests are very often (indeed, some would say always) fought over such matters as taxes and spending. Thus, for the rest of Europe to tell Greece to raise taxes and cut pensions and other spending is both an economic and a political demand.

But of course that will almost always be the case where sovereign debt is at issue. Hence, to my mind, the issue is whether the ECB et al are going beyond the incidentally political into the gratuitously political in their demands. And the answer here appears to be no. Europe does not say, that as the price of a bailout, Greece must revise its formula for representation in the Greek parliament or change the appearance of its national flag.

One way to see the point would be to imagine a reversal. Suppose that Greece was having difficulty repaying its debts but that a conservative Greek government was stubbornly persisting in austerity policies. Now imagine that a Keynesian IMF offered Greece a bailout but only on the condition that Greece abandon austerity in favor of fiscal stimulus and low interest rates (bankrolled externally). I very much doubt that the people who are currently (rightly) critical of Europe's approach to Greece would say that such externally-mandated Keynesianism was anti-democratic.

Accordingly, I conclude that European demands for more austerity from Greece are "merely" stupid, cruel, and counterproductive, but not contrary to principles of democracy.


Hashim said...

Great post mike. Another way of seeing this is that it is quite unlikely Germany would care about Greece's domestic policies or politics if Greece paid off its debt, so the condition is likely a proper means to a legitimate end (repayment) rather than an improper attempt to leverage the debt to achieve an illegitimate end (meddling with Greek politics). Along the lines of elhauge's recent article on the blackmail paradox, I think.

Shag from Brookline said...

Do "principles of democracy" provide for second chances? Consider the fact that the 1787 Constitution included a provision - a principle? - concerning bankruptcy.

But what about the surfacing of an EU North/South divide? "Beware of Greeks with overbearing debt!" Can Spain, Italy and Portugal be far behind (not forgetting Ireland, of course).

Regarding the restaurant hypo, perhaps a reference should be made to the failure rate of restaurants - and bankruptcies - over many years. Contrast this with the fairly recent experiment of the EU and the Euro - let's see how it plays out. Then later we can have a review of Greek Cuisine versus German Cuisine.

jed stiglitz said...

Thanks for the post. I like the analogy, but think I lean toward yes on the question of gratuitous interference. E.g., a troubling aspect of the negotiations is that the europeans appear to have rejected greek proposals that were (roughly) deficit equivalent to what they wanted; greeks wanted to maintain pensions and increase corporate taxes, europeans wanted reduced pensions. (e.g., Recently, the europeans also seem to have adapted their bargaining behavior in an attempt to unseat the greek government (and hence get a new, presumably more compliant bargaining partner). That said, I am in full agreement on stupid, cruel, and counterproductive aspects of your last sentence! [Edited for clarity]

Michael C. Dorf said...

Jed: Nice point. Your first example seems a close question to me. As between two proposals that are current deficit equivalent, one could think that the relative mix of spending cuts and tax increases would have implications for long-term economic growth and thus for the sovereign debtor's solvency. That would be both political and economic in the way that I have in mind. As for the second example, I agree that if unseating Syriza is the goal of the Europeans, even if only because they want a more compliant bargaining partner, that crosses over into the "too political." But I doubt that the troika or its major constituents would ADMIT that this is what they're doing.

Hash: Yes, I agree that this is quite similar to how one ought to think about blackmail. Thanks!

García said...

I am a bit skeptic about the "stupid, cruel and counterproductive" bit.

The Greek state appears to be utterly disfunctional in its spending. Its social security is badly designed. For example, Greece appears to spend too much in (absurdly early) retirements, but lacks strong protections for unemployment. Also, it seems to have huge problems collecting revenue, and tax evasion is widespread.

I believe that the European partners of Greece would not put so much emphasis on austerity if they trusted the Greek government to make structural reforms (even if they didn't fully support those reforms). But given the bad precedents with Papandreou, Papademos and Samaras, who implemented no substantial reforms, I find it hard to blame the creditors for their insistence on deficit reduction.

García said...

I may also point out that I disagree with Jed. None of the Greek governments have been "compliant partners". In fact, EU officials initially thought Syriza could be a much better partner, due to its lacking strong contacts with networks of patronage. This seems to have changed in these months. Apparently, loads of civil servants that were members of unions close to PASOK have joined Syriza to keep their influence.

I believe that Tsipras is probably a pragmatic politicial, and that the referedum was triggered by an internal crisis in the party. He has managed to strenghthen his position in Syriza and in Greece. Perhaps he will be able to close a deal now.

Paul Scott said...

The problem is that as soon as you accept that "long-term economic growth" is a relevant "non-political" factor, you have now allowed for pretty much anything. The same thing happened with France almost 5 years ago (though because France is both politically more powerful and had a much less significant debt problem, it got away with it). When general austerity was imposed across the EU, France elected to raise taxes rather than cut benefits. They were resoundingly criticized and even threatened by the Troika for not "getting there" the same way as everyone else. This is an entirely (in American terms) neo-con political agenda to weaken the social safety net.

That is why Greek plans that involve debt restructuring (e.g. forgiveness) that even every part of the Troika (excepting Merkel) agrees is necessary are rejected because they raise taxes on the wealthy instead of reducing benefits to the poor. That is an entirely political agenda; not an economic one designed to keep creditors as whole as possible (everyone agrees it is impossible to keep creditors whole).

Neil H. Buchanan said...

Just as a heads up for interested readers, I'm planning to expand on Professor Dorf's analysis in my post tomorrow.

Shag from Brookline said...

Neil, what we could really use is a song parody: "Greece is the Word." Perhaps it could include what Eduardo Porter described in his recent economic commentary when debt-relief for Germany was the word in 1953. (Paul Krugman commented on this at his blog with a link to Porter.)

Bad Wolf said...

As a layperson my understanding of the situation and what makes it undemocratic are the fact the Siriza ran on a platform of stopping the austerity. They won (democratically). The Troika said in essence "too bad here is the deal for more austerity". The troika not recognizing that the vote for Siriza was a vote against austerity is what makes it undemocratic. Again in essence they are saying "We dont care what your population wants here is the plan now go do what WE want and impliment it." is whats undemocratic.

Economics betwixt countries is very different than betwixt individuals as greece, like the US, could simply turn on the printing press and use that as a means to repay their debt (i know there are constraints but if they had their own currency...) and i for example cant. Also I dont have an army backing me up.

At the end of the day the money cant be repaid. It simply cant. The more austerity they impliment, the less the economy produces, so the less austerity they have to impliment, etc etc. This is nothing new, has happned before and the Europeans have themselves to blame for the monetary straightjacket. How long would the US undergo great depression level unemplyement and society were we in the same situation? How long would we endure it if China were the ones insisting on it? My guess is not long.

Paul Scott said...

That does not make it undemocratic any more than, for example, if Greece elected a party whose platform it was to receive vegan sausages from Germany were elected and then Germany refused to recognize that election promise by failing to send vegan sausages. The Troika are creditors and their failure to accept the outcome of Greece's democratic desires regarding the debt owed to them is not itself a problem.

The issue, from my perspective, is that the means by which a (basically permanent) primary surplus is achieved by Greece (Greece, btw, is not rejecting the need to run a primary surplus - they argue only about 1. the size of that surplus, 2. the means of achieving it and 3. its permanence (they need debt relief or they will literally be running a structural primary surplus forever). At this point, with the exception of Germany, the Troika does not disagree with #3 and they are very close, if not in agreement on #1. Where they are taking a hardline stance, however, is on *how* Greece gets there. The Troika wants permanent reductions in pensions and welfare; Greece wants to increase taxes. Tax increases, however, don't serve the interests of those in (mainly) Germany, so we have now what we have.

Shag from Brookline said...

I wonder if collection lawyers might be a tad upset with Tom Toles' WaPo political cartoon today "German gift to Greece."