Greece Advances a Good Idea: Indexing Its Debt Repayments to Economic Growth
In renegotiating its aid package with the newly elected government of Greece, European governments and institutions should stand firm on demanding fiscal sustainability and reforms. But that does not mean they should reject good ideas put forward by Athens.
An idea worth embracing is that debt repayments to eurozone creditor governments should be indexed to the performance of the Greek economy. If Greece grows fast, it should pay more; if Greece continues to stagnate, it should pay less. This makes good economic sense: European creditors would share in the risk according to an agreed formula, rather than facing periodic crises in the event of stagnant growth and excessive debt-to-GDP ratios. To be consistent with the notion of risk-sharing among euro area members, repayments by Greece to eurozone creditor governments could be indexed to the economic growth differential between Greece and the eurozone.
But for the scheme to work, Greece has to earn the trust of European taxpayers by guaranteeing the quality of its economic statistics and the independence of its statistical agency from political interference.
Prime Minister Alexis Tsipras and several ministers in his government have been consistently and eloquently making the case for repayments linked to economic performance and, thus, Greece's ability to pay, for at least a year or two. The case for growth-indexed debt and the potential obstacles to its emergence have long been analyzed by economists.1 Thus far, actual issuance of growth-indexed securities on financial markets has been observed only in the context of debt restructurings, in the form of GDP-linked warrants, most recently in 2005 in Argentina, whose warrants have been regularly priced and traded since then. With regard to government-to-government obligations, a precedent exists (as noted by several prominent economists in a January 22 letter to the Financial Times): the "bisque clause" in the Anglo-American Financial Agreement of 1946, which provided a waiver on interest payments in any year in which the United Kingdom's foreign exchange income was insufficient to meet its pre-war level of imports in real terms.
Three counterarguments are likely to be put forward. The first relates to the origins of the debt: Skeptics might argue that the United Kingdom's debt resulted from its defense spending during World War II, whereas Greece's debt stemmed from crass mismanagement of its public finances. To preempt this view, the new government of Greece seems to be suggesting that its debts are "odious," a technical legal term referring to debts that result from failed policies by previous governments and their arrangement with the European Commission, the European Central Bank, and the International Monetary Fund, known as the Troika. Such considerations are essentially moral in nature and are not going to convince either side. They hardly trump the economic merit of moving constructively toward a solution to the current impasse.
The second counterargument might point to the possibility that payments dependent on economic growth might reduce the incentives of the Greek government and Greek citizens to foster growth, a variant of the "moral hazard" concept. This is implausible. Which governments would not want growth, and which entrepreneurs would not want their companies to do well? Proponents of the "moral hazard" view might point to reduced incentives for "structural reforms." To be sure, most economists believe that lifting excessive regulations, opening up markets and, more generally, improving Greece's currently weak scores on the various Doing Business dimensions, would foster its long-run growth rate. But the economics profession is simply unable to produce generally accepted estimates of the size and timing of the impact of economic reforms on economic growth. Arguing that indexation to growth would reduce incentives to reform is unconvincing.
The third counterargument is more mundane and needs to be taken more seriously. Faced with large payments linked to the economic growth rate, the Greek government might well be tempted to tamper with the GDP data. This happened in Brazil in the 1980s, when inflation was underreported in order to reduce payments on inflation-indexed bonds. From a political standpoint, the incentive to misreport economic growth is weaker than for inflation: Whereas governments do not mind pretending that inflation is lower than it is (witness Argentina recently), underreporting GDP growth has greater political costs. This said, Greece's underreporting of its fiscal deficits—which after all triggered the crisis in 2009—will loom large on the minds of European policymakers and the general public. Greek policymakers thus need to commit convincingly not to tamper with their GDP data in the years and decades to come.
European leaders need to listen with an open mind to the ideas of the new Greek government, stand firm when appropriate, and embrace good ideas that can lead to mutually beneficial compromise. The Greek side, for its part, needs to signal that it will treat the quality of its statistics as sacrosanct and fully respect the political independence of its statistical agency. Letting a few European technicians snoop around its statistical agency to make sure that the statistical plumbing is in good working order is a price worth paying to turn good economic ideas into reality.
1. For a review, see Eduardo Borensztein and Paolo Mauro, "The Case for GDP-Indexed Bonds," Economic Policy 19, no. 38 (April 2004): 165–216.