The Crisis of Austerity (Panel discussion)

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January 3-5, 2016
San Francisco, CA




Marshall Auerback, Moderator:

“Austerity in Ireland”
Patrick Honohan:
          --So debt and austerity are really the stories in the Irish economy the last seven, eight years. What I want to do is to ask a little bit about, could things have been handled better once the crisis emerged. Before that I do need to give you a little bit of background.
          First of all, where the Irish economy is now more or less. Has there been a recovery? Is there life after austerity? And I also want to then track back a little bit to give the—sort of explain why Ireland moved into an austerity regime. I’m just taking that word; it’s not a word that I use spontaneously, but I take it from the topic of the session.
          So look, from late 2008, it was inevitable that there was going to be a devastating economic downturn in Ireland with massive job losses and acute indebtedness […?]. And the task of the Irish authorities from then on was to limit the damage and to navigate through the coming years in such a way as to maximize the chances of a strong recovery. And that would entail choices about how the burden, the looming burden, was to be distributed.
          Recovery is underway, I don’t want to say anything stronger than underway. Unemployment, you can see in this chart, runs from [1988?] to the present, having leapt from about 4 percent all the way through the first 2000s right up to 15 percent. It’s back down to single digits. The decline is partly attributable to emigration; but job growth has clearly returned.
          Let me just compare briefly for your just delectation, this has happened before. There was a big downturn in the 1980s, and there is a tendency for people to say early on in the crisis, this is the worst economic crisis faced by Ireland in its independent history. And actually the way it’s shaping up it may not end up as the worst, because this is unemployment, and I prefer to look at employment-unemployment numbers other than GDP-GNP.  GDP-GNP, very very complicated to interpret in Ireland because of the role of multinational companies, and profit-shifting, and so forth. So there’s the red line, is our current crisis, and the blue line is the previous one, which was the early 1980s. And you can see that the dynamics of the current crisis, very severe downturn, but very rapid improvement as well; so maybe not the worst crisis, maybe only the second worst crisis. And I say that as a context for our discussion of whether the policy handling was as good as it might be.
          In this room half an hour ago—I don’t know whether many of you were here, but there was a big discussion about the recovery overall, and people were emphasizing how weak the recovery has been in employment terms in the United States and in the Euro area, and indeed in Japan in their recession in the 1990s. But here you can see in Ireland there’s actually an employment recovery as well as an unemployment recovery; so it’s not just a migration story. You can see there that since the trough mid-2012, recovery has been solid, I would say. Employment grew by a cumulative 7 percent in the following three years. You can see that in that line [that] continues to jack up expectations for that sort of rate of growth. But you can also see that employment is way way below where it was at the peak. So, solid recovery but we are not there yet, whatever there means.
          I’ll just show you one other chart of recovery there, personal disposable income, so no multinational profits in that. You can see again well away from the peak, but a strong enough recovery. People talk about 6 percent growth and maybe 7 percent growth. It’s not like that. Two-and-a-half percent growth in employment with a little bit of productivity on top of that. GDP-GNP numbers shouldn’t be taken too seriously.
          Okay, so where did the crisis come from? This is well understood, so I’m not going to tell you anything that’s surprising, or new, or different. It’s a housing boom and bust, and the damage done by the housing boom and bust to the stability of the public finances. Qualitatively similar features to the Irish boom were also in evidence in other countries in the run-up. What made Ireland distinctive was the scale of credit expansion, the same type but much bigger, and the fact that the credit-fueled property price bubble was accompanied and yet not noticeably moderated by a construction boom; so there was quantity and price moving in the same direction and a big run-up in property prices. You can see the big run-up. This is real house prices in Ireland going back to 1971. We thought we had a property bubble back here in 1980. I bought my house just there [laughter] and I thought I’d done badly, but in the end it all came out. So you have a very big run-up, three-and-a-half times the level of the debt before. Real incomes had only increased by about 40 percent. Housing prices peaked in the first half of 2007 and started falling quite sharply.
          This fiscal position suddenly started to deteriorate with the downturn in house prices, and people stopped wanting to buy houses because they were afraid—up to then they were afraid they were going to lose out on a property price increase. Suddenly there was a collapse in demand and the public finances had been very much supported by the tax revenue from the construction boom, and the purchase of houses, building of houses and so forth.
          There had been a general government surplus for the previous decade before the crisis, and gross government debt had shrunk to below 25 percent of GDP. But now reliance on boom-time revenue sources till 2008-2009 were now evaporating. The rise had been so large that a sizable debt was emerging augmented by the increased cost of increased social protection spending. So nobody wants to buy houses, nobody wants to build houses, nobody can work in the housing industry; so 14 percent of the population who were working in construction now suddenly collapses to your normal level of 6 percent or lower. Deficit was growing both in absolute terms and especially as a percentage of GDP. GDP was also shrinking alarmingly.
          Total government spending jumped from 39 percent of GDP in 2007 to 58 percent two years later—39 percent to 58 percent in two years. Tax revenue fell by 30 percent in the same period. So that was good as an automatic stabilizer. I’m no way a believer in anything like expansionary fiscal contraction as a good automatic stabilizer; but the general government position moved from balance to a deficit of about 14 percent of GDP in those two years. That would have been 11.5 percent in the absence of bank rescue spending. It would not be sustainable for long. So something is going to have to be done, a lot of some things to be done.     The government already began a program of fiscal adjustment in 2008 that might be considered pro-cyclical. The economy is down and the government is now trying to get control over its budget, although a deficit of 14 or even just that lower number of 11 percent of GDP can hardly be considered, I think, austere. Taxation of income in particular was increased, and a four-year plan of tax and spending changes designed to restore stability to the public finances, underway. So that was the whole public financial housing collapse.
          But additional fiscal pressure was emerging from the banking system. So just after the bankruptcy of Lehmann Brothers, a few days after that, with an imminent collapse of the third largest bank, wholly unaware of the scale of embedded losses in the bank balance sheets, the government stepped in with a blanket guarantee for the liabilities of all the overly controlled banks. It wasn’t expected by them that the guarantee, which was copperfastened (To reinforce, strengthen; to make permanent, embed) in legislation, wasn’t just a sort of statement by the finance minister or something. It wasn’t expected that that would entail a significant budgetary outlay, but they hadn’t built in any safety first, they hadn’t said, well, we guarantee—What about short-term debt, what about new debt, what about--? They said everything, more or less everything. A slight exaggeration, but more or less everything. There was no safety first mechanism to limit the state’s exposure to this pig-in-a-poke that they had acquired. And it soon transpired that supervisory awareness of the vulnerability of the banks in the property downturn had been very limited.
          Well, the combination of the loss of tax revenue and the increased spending on social transfers, with the crystallization of this huge contingent liability on the bank guarantee, well that’s what created the vulnerability of the Irish sovereign to a sudden stop in its access to international lending. And now we move into the EU/IMF program, because it was a sudden stop. The government could not access financing. It still had a buffer of cash, but it could see that running out. And the spreads on Irish government debt were rising, and bank depositors were fleeing because they could see this was not going to solve itself in the private economic system. Private markets are not going to finance Ireland, and therefore there’s going to be some kind of massive collapse unless the IMF steps in, which they did.
          The fiscal plan embedded in the EU/IMF program negotiated in November 2010 fully recognized the deterioration in the economic and fiscal conditions that had occurred since the government’s own four-year adjustment program had been launched back almost two years earlier. The deterioration of conditions at home and abroad meant that further belt-tightening would be needed, though in fact most of the heavy lifting had already been done in 2008-10. The new plan envisaged reaching a 3 percent deficit by 2015, and that could have seemed a stretch to a naïve observer noting that when you add in and include the bank recapitalization costs, the recorded deficit for the government in 2010 was 31 percent of GDP, about two-thirds of which lay in the bank recapitalization.
          Actually that 3 percent deficit target was actually achieved in 2015. So why did it work? We’ll hear more about other countries where things did or didn’t work later. Unlike the situation with Greece and, to a lesser extent, other stressed countries making fiscal adjustments at the time, the Irish program employed a realistic sense of macroeconomic spending multipliers from the outset. So it said, look, if we’re going to cut government spending, we’re going to raise taxes, the economy is going to shrink. That was realistically modeled into the program. If you work through to the model and say, well, okay, so it’s going to shrink so much, so it’s not going to work, then we wouldn’t have done it. It looked as if it might just about work. And with lowering interest rates—we didn’t have to pay these very high penalty interest rates that the program initially started with—and if the indebtedness of the state resulting from the bank guaranty could be handled over a long period of time, it would work. The initial situation looked very marginal, it might not work, but close to working, and could be fixed by lowering interest rates.
So the realistic macroeconomic projections meant that we were close to something that would work.
          I want to now answer four frequently asked questions. First of all, the pace and extent of fiscal adjustment: Could it have been different, should it have been different? Secondly, briefly on the question of bail-in and the assumption of bank debts: Is that the whole story, or how much of the story is that? Thirdly, I want to ask, how was the distributional aspect handled here, because austerity programs are not just a question of how much, they’re a question of who; and I want to know about internal distributional issues.  I think they’re vitally important. Then finally I want to ask the question, could the support from the EU partners have been different or better?
          Question one: Should the fiscal plan built into the Irish program have involved larger deficits? That’s austerity, if you like. Whatever about other EU countries, with Ireland’s gross government debt soaring to 120 percent of GDP by 2012, and with much punditry at first about the apparent attractions of a sovereign default or debt restructuring, Ireland’s unilateral ability to run a more relaxed fiscal stance was extremely limited. So that’s the first point; and maybe you could have organized something with somebody; but nobody was prepared to lend that kind of money, particularly in an environment where there’s a lot of talk about, oh, well, this is a default situation. Nobody, public or private, is going to lend to a government in a default situation.
          Indeed, it wasn’t altogether clear at the time of the program that Ireland’s emerging debt situation was sustainable, as I’ve just said. Let me just show you just on this slide. I’ve talked already a little bit about the way this deficit line--you can see that big green dashed line going down to 31 percent of GDP deficit. Without the bank costs of bank recapitalization, the red line prevailed. And you can see that—well, you can see how large the deficits were, how they were building up the debt and therefore needed to be adjusted quickly if you wanted to return to the markets and have a credible debt position.
          Now, sustainability is not something for which we have very very good ways of measuring. In addition to debt ratios, there’s a question of servicing costs. And debt ratios, too, I already mentioned GDP, problems in interpreting what the GDP means when it includes very large amounts, 20 percent sometimes, of GDP in some years. It’s the profits of multinational corporations, so maybe you should have a smaller denominator. So maybe that ratio is worse than 120 percent.  Maybe it’s 120 percent of GDP, but 150 percent of GNP. So what’s the right measure there?
          On the other hand, servicing costs are important. Interest rates are very high going into the program. Market rates, the rate at which the government could borrow in the market was considerably higher than the rate at which they got money from the EU and the IMF; but the rate in turn was much higher than it became subsequently. The rates on these loans—the same applies to Greece—you go to the IMF, they’ve got a set of rules. If you’re borrowing a large sum of money, you’ve got to pay more. If it’s a big multiple of your quota at the IMF, then there’s going to be a big surcharge. So the initial borrowing rates were 5.8 percent. The EU took those rates as well. At those rates sustainability was very problematic at 120 percent of GDP. The IMF’s rules are not designed for countries with such high levels of indebtedness.
          But this borrowing policy improved dramatically from the year 2011, when the surcharges of the cost of funds were greatly reduced in respect to borrowing from the European official creditors. The IMF kept their rules, but the Europeans said, This is really unrealistic. Greece can’t make it at these rates and, by the way, we shouldn’t have these rates at all. So now the European borrowings are being serviced at rates very little above the cost of funds to the European borrowers. Then subsequently repayment of higher-cost IMF borrowers in 2013, 2014, and their substitution by market borrowings now available at spreads of less than 100 basis points above the […?] also greatly eased debt servicing costs, as did the general lowering of long-term interest rates in the Euro area and the arrangements around the collateral received by the central bank when the successor to the Anglo-Irish bank was liquidated in 2013.
          Without these reductions in interest rates, in the view of many including myself, we probably wouldn’t have made it. It made the difference between a sustainable program and one which would have likely had to have been prolonged or renegotiated. Instead of sitting on that knife edge, we went well below the knife edge.
          Could fiscal adjustment have been slowed sufficiently to reduce the employment loss without this simply postponing an inevitable adjustment and potentially making the long-run effect of the needed adjustments even worse? Well, I could go on about this, but I just want to go back to that employment chart to show you this vertical line is where the IMF program came in. The employment loss had already happened, so I don’t hold any [?] for the IMF; but you cannot blame the IMF on the employment loss. You can blame them for the slower recovery, but can’t blame them for this loss. I wonder, can you really imagine a fiscal response that could have kept all those construction workers and a lot of these construction workers just out of a job because construction costs. I’m not sure that a Keynesian response is going to help you very much, and it certainly can’t eliminate ex post this fall […?]. So I’m not sure we can blame the program for the employment fall, though we could imagine the bounce back could have been faster if the program had been better designed and if it had some things which I’ve already mentioned, including the lower interest rates from the start. There’re a few other things I could say there, but I think I need to rush ahead.
          I’ve promised to mention the bank guaranty, whether bank guaranty created the need for fiscal contraction. It’s probably the most discussed aspect of the Irish debt crisis. The guaranty was too wide and too unconditional; but it’s often correctly emphasized that the government guaranteed—The guarantee socialized private bank losses. And an overall assessment needs to consider a comprehensive alternative path, and not simply fixate the direct fiscal long-term costs of making good on the guaranty.
          What are those costs? Costs that are somewhere between 35 and 43 billion. My number is 40 billion. The government auditor says 43 billion, and the minister for finance says 35 billion. That’s between 22 and 27 percent of the starting GNP. Spread that out over a number of years, it’s not all, and it’s not even the majority; it’s a significant chunk, but it’s nothing like the determining factor. I think more relevant is to consider a counter-factual in which I would not have provided an extensive bank guaranty in September 2008, either hoping to persuade European partner countries to share in the risk of such guaranty because of spillover effects, or same resolving the two weakest banks of heavy losses to senior bank creditors, as would now be implied by European legislation. European legislation now requires it to prevent European governments bailing out bond holders in that way. I think you could have reduced the cost by doing that, but only by some single digits of figures. You might have brought it down from 40 billion to 30 billion. You couldn’t have done much better.
          And of course the larger policy errors were made long before bank guaranty. Perhaps the most interesting counterfactual to be considered is to imagine that the bank lending excess of 2004 to 2007, the big period, could have been eliminated by much more aggressive bank regulation then. If so, the post-crisis period of fiscal contraction could have been wholly avoided; but you would have lost out earlier on. So you get something to go back down to where it was.
You could run macro models of this. The macro models aren’t all that good, and they don’t model the crisis very well; but you get some pattern like this. This is what happens. Consumption per head is the black line, is what happened. You see the peak in 2008; then it drops down sharply thereafter. Without that boom, of course the consumption per head would not have grown as much, but it would have been able to continue through the late period of the international boom. We would have had a good 2008 instead of a bad 2008, and the decline subsequently would not have been so severe. So, a pattern like that.
          Okay, I’ve got two other FAQ’s. One is how much aggregate inequality moves in boom and bust. It’s one thing to suggest, as I am more or less suggesting, that aggregate economic activity was protected post the crash by the Irish government as well […?]; but it’s another to say that income and capital losses were distributed in an equitable manner. By its very nature the crisis hit some people, for example those hit by unemployment in the downturn, or by having bought property and borrowed money to buy property at the top of the market, more than others. How did aggregate inequality change?
          The first situation here might not seem to be too inegalitarian. So, for example,  the gini coefficient of market income did jump between 2008, 2009; and by 2012 was still notably than it had been during the boom; but the gini for disposable income after tax, after social benefits is pretty stable, and that’s because the Irish social system and tax system, it built in that safety net, and that automatic stabilizer at the micro level. In fact the gini for post-[?] 2012 is lower than what it had been eight years earlier. There’s the numbers there.
          Relative poverty instead of gini: before it’s 50 percent of median income. It goes up in market income, but after redistribution it actually improves to 2012. The reason I don’t have 2013 or ‘14. It’s the way these things are calculated.  These are OECD figures; they haven’t updated to then. […?] a little bit, 2013, 2014. The early period of 2008, ’09, ’10, the government was more progressive; whereas the government now in place until the election in a few months’ time was less progressive. So gini is not the whole situation, because there are a lot of horizontal inequities involved; but it is interesting.
          We do have also figures on wealth inequality, which I managed to—We’ve set up a survey. That’s a comparison with Britain [referring to slide]. Wealth inequality. This gives you just a hint of some of the horizontal inequalities. We’ve got a lot of data on wealth inequality for 2013. Then we can sort of backward track to the crisis. What you see here is by age, and you can see a very badly hit age group here. This is the people who are 35-to-44 age group in 2006. They had a median net wealth of 115,000 Euros. But the median net wealth of not the same people, but the same age group seven years later was down to 30,000. Whereas the fall is proportional from the other age group, so a disproportional fall, just hinting at a number of the complicated inequalities that arise and which will have their effects on the political environment.
          My final FAQ: Could international solidarity have done more? I think it could, and I think there are four things that could have been done better. First of all, financial engineering, bank recapitalization: A significant amount of the money—it was actually 64 billion, net it would end up as 35 to 43 billion; a significant block of money was injected by the government to recapitalize the banks, keep them going, keep them going at the standard, higher rate standards now prevailing. And about half of that, 35 billion, one-fifth of annual GNP, was earmarked by the lenders to be borrowed by government to inject into the banks. You’ve got to borrow 35 billion, you’ve got to do a stress test on the banks, and you’re going to inject as much of that 35 billion into the banks as is needed in the stress test. In the end, the stress test proved that things were not quite as bad and they only put 16 or 17 billion of that 35 billion.
          But money was borrowed by the government to inject into the banks. It was available as an option for the European official bodies to devise something better. For example, they could have had some insurance scheme, or they could have simply injected the capital, European capital, directly into the banks. They would have owned the banks, yes; but the government would not have been burdened by this excessive debt, and the debt overhang period would have been shorter. This was a no-brainer.
          We assumed that this would be part of the deal that they worked. They said we don’t have any mechanisms for this. We don’t have the legal authority to do it with the European Stability Fund. The IMF don’t have the mechanism for it. And anyway, there’s no political backing for it; they think it’s a black hole. You can’t take money from Europe and throw it into the black hole of your banks.
          They would have made more money by investing in the banks than they’re going to get the return on the lending to the government. It was a no-brainer.
          Less no-brainish, but also, I think, worth considering, and I think a very live possibility for Greece and perhaps other cases: Instead of a simple loan, a GDP growth-linked loan. This could also have enabled a faster growth response with lower servicing at first. Okay, we’re going to put this money in, and while your GDP is so low, don’t worry, you don’t have to pay anything. But as your GDP comes back and starts to exceed some threshold, you’re going to have to pay more, more than you would on a straight loan. Would that have been a good deal for Ireland? Yes! Because their growth recovery would have happened faster, they could have easily afforded to pay more. Would it have been a good deal for the lenders? Look at the way the growth path has happened. It certainly, depending on how it was calibrated, could have been a very good deal for the lenders. Not so much of a no-brainer as the bank recapitalization, but definitely the sort of idea that should have been activated in a severe crisis like this and could still be relevant, I think will still be relevant, though I don’t hear anyone else saying they’re about to do it, for Greece.
          The third possibility: stronger EU demand policy for countries with […?] aggregate demand in the Euro area stronger fiscal policy […?] too weak.
          And finally, could the ECB have calmed the markets? Could the ECB have done something in the autumn of 2010 to make the sudden stop go away? Actually it probably could have. It could have said, We know you’re running away from Irish banks. We know you’re not prepared to lend to the Irish government. But actually we’re not worried about the Irish banks, and we’re going to look after that situation, and you’re not going to have any problems, so stop worrying. I think they could have said that. Would it have been good? I’m not quite sure that it actually would have been good. I would have welcomed it at the time, but afterwards, you know, the government could have still been faced with the challenge of limping on with its market access damaged and entailing ultimately unaffordable refinancing costs. They would have had to borrow more and more from the market at high interest rates. And it’s not so easy to say to the market six months later, Look here, this package you put together doesn’t make sense. Please lower the interest rates. That’s what they did with the official borrowers, the official lenders. They couldn’t have done that with the market.
          They’re not quite sure, although at the time I wish the ECB would have been more forthcoming with statements. I went as far as I could with my own statements, but a little man in Dublin saying it’s alright, is not the same as somebody else saying, we’ll do whatever it takes.


 “Austerity in the Baltics”
Jeffrey Sommers:
          I have several presentations on this particular topic.  I decided to bring a relatively short one.
          Most people know a bit about the macroeconomic situation in the Baltic states. They’ve been well covered in the financial press and increasingly in the academic presses as well. Rather than focus on all three Balkan states, also in consideration of time, I’m going to focus chiefly on Latvia, which is one Baltic state where I have the greatest experience, although I do have experience in all three Baltic states.
          So let’s take a look at Latvia and also, again, with some allusion to the rest of the Baltic states as well. One of the things that we need to recognize about the Baltic states is that they really can’t be understood by just the macroeconomic data alone. There’s a greater political economy context which is really essential for understanding both what transpired there in terms of the crash, the internal devaluation, medicine that’s applied to restore macroeconomic stability, and what has ensued since; and so that’s I endeavor to deliver here today.
          In the book that I did with Charles Wilson, along with some other colleagues, on the contradictions of austerity in the Baltic States here, Jamie contributed this remark [Slide 2] in a fine forward to the work in which he said it is the fate of small countries to serve as pilot projects, as battlegrounds, and as point-of-origin for myths. In the wake of the great financial crisis, the three Baltic republics of Latvia, Lithuania, and Estonia have played these roles, and I think, as you will see, and how. These have been places which went under the surgeon’s knife, and not without some small measure of pain ensuing.
          Now Latvia has been presented as a model austerity state. It’s been presented as this exemplar of prudent policy, demonstrating a path for others to follow, and it’s one which was of course counsel for Greece and others in the European Union [that] were grappling with financial difficulties to also pursue. I think you’ll see by the end of my presentation that it’s not the best model for all countries to follow, and in fact it’s one that most countries cannot follow. They simply cannot because of the historically specific conditions and because of the way that the economy is structured in Latvia, not to mention in the other Baltic states.
          [slide 3] So the story, just in terms of the background—it’s a familiar one—the state which suffered the worst decline in terms of GDP dropping of any state from the 2008 shock, roughly 25 percent. A tough program of internal devaluation was implemented, macroeconomic stability restored, unemployment now just a touch under 10 percent after being well over 20 percent; so some successes there. But again, not mentioned are these very unusual circumstances which we saw in Latvia and in the Baltic states, which I will be [engaging?].        
          [slide 4] So the remedy: First, internal devaluation. What did that mean in terms of a really existing program on the ground? One, it meant more regressive taxation, so we saw increases on the VAT. Of course this affected the poor disproportionately. We saw a lowering of the non-taxable minimum on income; so the poor, again, hit with increased taxation, extensive cuts in the public sector, welfare, education, social benefits. They attempted to cut pensions. I should actually say that the European Union, because of a specific legal issue which I’m not going to get into, did end up restoring those. Again, mass unemployment following a growing of envelope wages to avoid taxation. As we’ll see shortly, that’s been part of Latvia’s story since 1991, when they regained independence during the Second Republic. An increasing flexible private sector, reductions in salaries, getting rid of redundancy rights, various employment protections, and a growth of long-term and youth unemployment, an increase of part-time employment, a reduction of full-time employment.
          Well, a little bit about this place that so few know anything about, a country that now has under two million people living in it, the entire country. It’s about the size of West Virginia in terms of its geographic area, under two million people living in it. In the 1980s, as the Soviet Union was collapsing, many of course saw the handwriting on the wall. They decided to take action in terms of preparing a better situation for themselves after the collapse of the Soviet system. Among those were Chekists, who began to essentially privatize the bank accounts of the Soviet Communist Party, which were used for all sorts of things. Essentially the Chekists engaged in a good bit of offshore banking. They were given this task, and the Soviets were running all sorts of operations abroad, whether it be just giving aid to friendly political forces or to revolutionary regimes. Whatever the reasons, they needed to launder money to get it abroad; so these Chekists did the job. By the 1980s, they decided to privatize these accounts, and a lot of these windfall profits of sorts that were captured—not profits per se, but just this plunder—was then used in those early privatization efforts of the Soviet Bloc to capture significant assets and to, again, privatize them.
          Well, Latvia played a really really big role in this. Because of its proximity to West Europe it was also the transit point for much of the oil coming out of the Soviet Union--in fact, the port of Ventspils was the largest ice-free port the Soviets had—and they pushed most of their oil through it. And so here we saw an opportunity for really huge fortunes to be made, and they were. [slide 6] So we had figures here such as Mark Rich. I think we’re all familiar with Bill Clinton pardoning him on his last day in his office. He was a very big contributor to the DNC and the Clinton administration generally, not that he had any political end or ideological allegiances; he was looking for protection and got it, and there was a price for that. We also had figures like Grigori Louchansky, now persona non grata in several countries, including this one. Here he was I believe he was still the vice rector of the University of Latvia in 1982. As I told Jamie and I tell my students all the time, who are rather demoralized right now regarding the job market in the Academy, they really shouldn’t fear, there are still opportunities out there. So here was a guy who was a vice rector and he became a billionaire oligarch; so you too can make it if you try. Those Horatio Alger stories are still there.
          So Louchansky figured out that he could start selling oil at world prices while acquiring it either through the back door or at state prices and make a huge windfall on the arbitrage. And he did just that and became a billionaire. A lot of other guys followed his lead. And so, again, a lot of this stuff was coming out of Latvia. And what ended up being set up was the offshore financial structures to facilitate the outflow of raw materials from post-Soviet Russia and the CIS generally—Kazakhstan, Belarus,  several other places. And so these offshore banks were all set up in Latvia, and they handled a lot of this traffic, and still do—and still do. So you have all these correspondent banks essentially. This is where you go to launder your money. This is where you go to launder your money from the CIS.
          [slide 7] So, correspondent banking: As I said, really really big business in Latvia, one that it can rely on. And in the early 1990s there were over 100 banks for a country that then had a little over two million people. Now a little bit under two million, but they still have twenty five banks. And this is where organizations like Shorex, which is one of the main professional associations for people who are in the correspondent banking industry, often go for their meetings because this is where the business is running through. Of course Ireland knows a little bit about this as well, as we know.

Patrick Honohan:  
          Not anymore!

          So here we deal with matters such as wealth management, tax optimization, or what my friends in the bar like to call stealing. It’s a very very very big business in Latvia.
          Now this model in effect was given space. It was kind of a parallel structure existing to the real structure of the economy in Latvia. You had economists who, in 1991, saw that the Soviet Union was dissolving, and they went to hell in their estimation. [slide 8] So you had people like George Viksnins from Georgetown, now deceased—kind of a nice guy, used to have lunch with him periodically. Here is with [Art Lather?]. Here’s Art Lather’s cocktail napkin from 1974 where he charted out the future monetary policy for the world—very sophisticated in terms of the model there. But at any rate, these guys, they had a program, and they saw that, as Jamie said, this could be a zone of experimentation. And it was small enough that they could be the people that were controlling the mannequins of this puppet show.
          So George here was from Georgetown—they used to call themselves the Georgetown Gang; that’s not a name that I’ve given them—he and some of his—I don’t know if we have many of the faculty from Georgetown here, but perhaps you knew George. George identified who he thought  the young talent was in the country and then really in a solid  [Bolshevik…?] fashion launched a really impressive organizational effort that created this country in the image that he wanted to see. And those figures who he brought together in some eight meetings in Latvia, brought them to Jurmala, beautiful seaside community—I don’t know if any of you have ever been there, but it’s absolutely gorgeous, 30 kilometers of just absolutely pristine beach. It’s where people in the Soviet Union chiefly went to vacation. As Gore Vidal once remarked in the 1970s when he was accused of being a spy—just to reference its past glory, one that he knew from his step-half-brother, John F. Kennedy, going there to rut, I guess, in his youth: “I’m not a Soviet spy, but if I was I would demand a dacha in Jurmala. A really nice place.
          So they convened there, and they came up with a plan for the country. And they brought together people who would essentially control the country’s financial policy for the next 25 years. They’re still players, people who would be prime ministers, finance ministers, central bank managers, central bank chiefs. The guy that’s in charge of the central bank now was one of them. They came up with this report called Latvia 2000. [slide 9] Then, as they clearly stated, the reform continued despite changes in government; so it had to be made public-proof. And it’s the usual stuff—tight monetary policy, peg currency at a high exchange rate, progressive taxation, very high labor tax, no capital gains tax. Sometimes they would introduce one, but at very low levels. That is more or less the program.
          Now, fast forward to 2012. Of course, we saw this very very big bubble burst, as we know, in 2008, and of course the prescription that was being counseled was to take this austerity medicine. But the problem was that in 2010 and in 2011 no successes could be found from anyone who’d received treatment. So this proved to be problematic. But by 2012, as there was this increasingly desperate search to find a success story, they finally found one, in Latvia. So it kind of came to the rescue here. As I said in the slide, [slide 10] it was kind of a tabula rasa that you could just write anything on. It’s a small place, people didn’t know much about it; so it’s kind of a frictionless opportunity, as I indicate here, for people just to impose whatever narratives on it that they want. And the narrative was that this was a success case, this was the one that we had to follow.
          I have the visiting appointment at the Stockholm School of Economics in Riga, there a couple of times a year. Anders Aslund is a frequent visitor to our august institution. [slide 11] He just swept in right after the crisis and got cozy with the country’s prime minister, declared immediately that he knew what to do, and that he would work to insure this successful transition to macroeconomic stability and a return to prosperity in Latvia. To my mind, Anders was silent for kind of a long time prior to this. I mean he’d been writing for the Pierce Institute, but you didn’t see much coming from him beforehand. I think he was really trying to rehabilitate his reputation here with Latvia, remembering that this was his last pupil. [slide 12, pictures of President Yeltsin drinking and dancing] Remember what had transpired with Russia under Anders’ guidance and the firm hand of Mr. Yeltsin here in Russia.
          So to move back a little bit in time and understand what happened in Latvia with this boom—because there was a boom; it was huge. I’ve lived about six years in total in the country; I know a little bit about it, having visited for the first time in 1995, having spent a lot of time on the ground there. [slide 13] There was this kind of Viking reprise. You have to remember that the Swedes once ruled Latvia, before the 19th century, and at one point Riga was really the wealthiest city in the kingdom. So they came back as kind of conquistadors of sorts, and their banks stormed the country, SEB and Swedbank in particular during the boom years. The boom years, being between 2005 and 2008, saw their largest profits being made in the Baltic states, more so than was being made in Scandinavia. There were really really big windfalls here.
          Well, the story’s familiar enough to all of us in terms of how this bubble got inflated. We have NATO and EU accession in 2004. [slide 14] With that, some confidence is gained for the Baltic states. At the same time, globally we have this period of kind of global liquidity. We have the Japanese carrying trade, lots of cheap money flowing around. Alan Greenspan throws more in there with this kind of credit Keynesian turn. We have EU’s structural funds now that are added to the mix, commodity inflations--this is when commodity prices increased. George Bush’s war in Iraq went to facilitate that a little bit; wasn’t the only reason, but it was one. You have to remember, as I said, initially that all this oil money washes out through Latvia; and so it’s handled not by the Swedish banks. By this time they start to get out of that and move into real estate.
          Now there was a huge balance of payments imbalance that emerges by 2006, 25 percent. There’s massive import-based consumption which is paid for by all of this cash that’s just washing through. But there was this kind of El Dorado situation here. [slide 15] It was found—The Spanish Conquistadors didn’t find it; the Swedish bankers found it. They found it in Riga, and Riga, again—Jamie was just there, and he can tell, it’s both a grim city in some ways and an absolutely gorgeous city in other ways. Fully half of the buildings in the city center are designated as the UNESCO heritage area for being part of this wonderful art nouveau style of building here. Jamie gave a presentation in a building just adjacent to this one—this is the Riga Graduate School of Law; our building is the, again, Stockholm School of Economics. And all of these buildings—just absolutely gorgeous—debt free. Debt free after the Soviets left. All of them waiting to be loaded down with debt. For bankers—and this was just—they couldn’t imagine a more beautiful situation, taking a debt-free economy and turning it into a debt-burdened one.
          So they rush in and they do just that. They take on an economy unburdened by debt and they burden it with private debt. Latvia’s public debt-to-GDP ratios were negligible, which is one of the reasons they were able to impose this internal devaluation strategy, and they do a little bit of borrowing as well. They only went into crisis with the 9 percent debt-to-GDP level, so in terms of government they had almost none. But all of this private borrowing—At the peak of the real estate bubble of 2007, real estate consumed over 70 percent of the credit extended to the country. This wasn’t for new construction for the most part; you were inflating the price of existing, beautiful, art nouveau buildings and then giving bigger mortgages; so it was a nice windfall. And at the purchase of these properties the capital gains made on the sale fueled the growth of consumer-led consumption, etc. [slide 16]
          Myself and my colleague, Michael Hudson, we began to note as early as February of 2005 that something was seriously amiss, and we began publishing on this in Latvia, trying to warn them of what was an impending real estate bubble burst that was about to happen. We met with the prime minister, we met with the finance minister, we met with various people in the central bank. What we quickly discovered was that nobody cared. Well, they feigned to care, but what we surmised very quickly was that they were all in the property markets, and so they had a direct interest in seeing that this game continued.
          [slide 17] Now we saw a kind of Sartrian no-exit situation for Latvia’s borrowers. They were in this unending, terrible situation that they could not exit. As you know, in much of Europe, if you have a loan that’s a property, you can’t get rid of it, you can’t just send the title and keys back to the banker, the lender. You’re saddled with it, and a lot of Latvians actually lost their properties because they can no longer make their mortgage payments. But the Swedish banks, they made these people cosign--usually older aunts, uncles, grandfathers who had country farms, etc.—and they all kind of got daisy-chained into these debts. And so not only did they lose their, say, their apartment that they bought in the capital city of Riga, but they had to keep paying the mortgage on it, even though the bank already turned around and maybe sold it again; because if they didn’t do that, then the bank would go after the aunt’s place out in the countryside. I’ve been working with the Latvian parliament trying to get this overturned, but we haven’t had much success, unfortunately, with that.
          [slide 18] Now the Latvian crisis […?] in the fall of 2008, after the money had stopped coming in from the Swedes. It started with a bank run on Parex Bank, which was the biggest bank in the country at the time, which was owned by these two oligarchs who had the oldest legal currency exchange in the Soviet Union. It actually started in 1990. Actually first they started doing it illegally; they were just carrying huge sacks of rubles in 1989 and 1990 on a train from Riga to Russia, and on the black markets there was a small arbitrage on the exchange rate, and that’s how they got started. And then they moved into that stuff that I was referencing before, hooking up with various Chekists and getting into offshore banking and they launch a really really big bank like that themselves.
          But in November of 2008 they had a run on deposits. People panicked, and the Latvian taxpayer would come to the rescue here. Was it the Latvian depositor that was being bailed out here? No. It was really SEB and Swedbank, the Swedish banks, because as the run began on this local Latvian bank it was starting to bleed over to SEB; and so the Latvians decided to bail out this bank, including its chief correspondent bank accounts which it held, most of those of course being from abroad. That’s what these accounts are, as you know, these correspondent banking accounts. And so they were all bailed out to insure that the correspondent banking sector, the offshore banking sector, would not be damaged; but, two, to make sure that there was not a run on the Swedish banks and an exit of Swedish capital. So the Latvian taxpayer got stuck with that, and then, by January of 2009, the European Commission sent a letter from Joachim Almunia to the Latvians essentially stating that they were going to get a bailout as well to help pay off the bailout for Parex Bank, but that they shouldn’t get any fancy ideas about using this money for developing like a real export sector or anything like that. This money was to go to bailout banks.
          [slide 19] Now Latvia, referencing again that Latvia 2000 project, George Viksnins, and all the rest, really existed on the kind of far right margins of the, for lack of a better term, the neoliberal revolution of sorts that occurred within the Academy and within finance ministries in the 1970s, 1980s, and 1990s. And they still stuck to the old-time religion on this; so whereas there was some rethinking of some of those ideas after the East Asian crisis in 1997-1998 in the IMF and the World Bank, in Latvia they still adhered to this kind of hard doctrine. And we have figures like Einars Repse, who was then at the head of the finance ministry, and yet who had been in government both as a prime minister, as the head of the central bank, and in the position of finance minister several times, who, in 2010, advanced a very very very harsh austerity budget, I mean one that was so harsh that it was the IMF and the United States and the Swedes who were trying to restrain him. So it was this kind of through-the-looking-glass world in which a national government is trying to push harder on austerity and being restrained by the IMF. It was just a really really weird reality. It was kind of like looking into the carnival mirror and seeing this very very unusual image of what we’re accustomed to. And as a Wikileaks cable that I found reported from the State Department, in conversation with Repse—we were trying to rein him in—the telephone conference call did not go very well. According to the assistant secretary of state, with the IMF and the EU expressing serious concerns about the income distribution profile proposed budget cuts, the EU and IMF urge the Latvian government to reconsider the measures. But Repse defended the harsh kind of austerity program and also of course used the old quote about never letting a crisis go to waste, and so this was his turn to do that.
          Now, in 2012, we again saw Latvia financed. And again—I don’t want to argue that there was not a macroeconomic success here in terms of returning the country to stability. There was in some sense, although, again, I think the conditions and the price paid was quite high. But by 2012, we see this kind of branding of Latvia as a success story. [slide 20] And we have people who are sometimes quite reasonable, like Chrystia Freeland, fairly liberal in her outlook. She arrives for the May 2012 IMF conference and pretty much adopts the Anders Aslund and the Latvian government’s public relations line on this, that the harsh Latvian plan worked because the whole country was committed to it. I was there. I can tell you this was absolutely not the case. There were huge divisions over this. What trumped the austerity issue in terms of politics was the issue of ethnic division in the country, and I’ll talk about that in a little bit. It was ethnic division and the fear of any kind of return to Russian control that worked to prevent people from voting against austerity. The next elections that came in 2010 and 2011 at the national level were precisely fought on that terrain. It was typical divide-and-conquer.
          Thus, the narrative of – And so of course this is the crux of the matter, right? The argument is that you cannot impose austerity this harsh because in a democracy the people will throw you out. In Latvia they didn’t, and that’s what seemed to be so compelling and exciting to, for lack of a better term, austerians. Here was a country where they were not thrown out, and in fact they could even make the case that they were embraced, although they were not. So we have here a kind of Protestant morality play where these plucky stoic Balts are all committed to taking the harsh medicine, going through these tough conditions, and coming out at the other end of this stronger. These are not the noisy Catholic Greeks—sorry, Orthodox Greeks--and noisy Catholic Spaniards, and Italians, and Argentinians, banging on pots and pans. These people knew how to take the bitter medicine, keep a pleasant face, and gain or reap the benefit afterwards.
          [slide 22] Well, rather than a rather peaceful population, huge protests ensued. I was at this one here on January 13th of 2009. There were 10,000 people on the streets of Riga protesting what was transpiring. I have to admit the Balts are a rather taciturn lot. When they get together, they don’t make a lot of noise. And so they may get together in big numbers, and if they’re going to make any noise they’re going to sing in unison, and it’s very beautiful. I recommend anyone attending one of their— And there were a few, for lack of a better term, wanton elements here who decided to cause trouble; but for the most part they were just really really peaceful. Later students, later doctors, teachers, farmers, pensioners, all coming out in the thousands over the next few months.
          But what then transpired was this: Rather than those protests continuing after the end of, say, the spring, early summer of 2009, people just gave up. They understood that the government was not going to budge on this. They were not going to budge. And so they just started leaving, and they left in huge numbers, like an Old Testament exodus. It was quite bad.
          [slide 23] Comparative poverty rates were just absolutely horrific here, you can see from 2010 and 2011. For those at risk of poverty, as compared to Greece, nearly half the population. Children’s poverty, same thing. Extreme poverty, a third of the population. These are numbers that were far worse than Greece at this time, although I guess as—I wanted to say climbing, but Greece is catching up. As I indicated, people started to, as Mitt Romney would say in the 2012 election, they would start to self-deport. Now they weren’t trying to get rid of their own people per se, but they did want to impose these measures which would, in effect, have this effect. Now some have cynically said that this is how they dealt with the unemployment problem, was by just getting rid of the unemployed. I don’t think that was the intended outcome, although it certainly was an outcome of the crisis.
          [slide 25] Now some argued that people began leaving Latvia because of the EU Accession in 2004. You can see here the number of people leaving. Actually the opposite occurred. Because of the real estate bubble which created lots of employment, emigration actually started to decrease; but it did of course increase dramatically with the 2008 shock, and then again following in 2009 and 2010 being the two worst years. And it continues at a fairly significant rate, although not at those peak rates. Most discouragingly for Latvia’s demographic future—and the situation is fairly closely reflected in Lithuania, not so much in Estonia--live births in Soviet Latvia peaked in 1987 at 42,000, and in 2010 there were only 18,000. [slide 26] And you can see that, after the early 1990s, these fertility rates dropped significantly. People really never started having children at the same numbers that they did during the Soviet period; and so there’s an issue of how they’re going to resolve the situation. The country’s becoming a retirement home and a nature preserve, a bunch of pensioners and a bunch of land without people. [slide 27]
          So you can create macro-economic stability, but there’s a price for it. Here we have wild boar in Riga. Here’s an elk—rather, wild moose in Klaipeda (Lithuania). Here’s another moose running about in Tallinn (Estonia). I mean, it’s returning to nature preserve, the country’s biggest cities; whereas the pensioners are [?].
          [slide 28] Now, again, referencing why people did not revolt, again this is just, to use a United States analogy, this was a waving of the bloody shirt. After the US Civil War, anytime you wanted to stop any kind of progressive reform, all you had to do during the Gilded Age, when you saw this rampant inequality and many abuses that we’re quite familiar with, you just started talking about the Civil War, which was an easy way to distract people and get them off topic. That lasted for 40 years in the United States. It’s still working in Latvia. So it’s, again, an ethnically divided population, and this ethnic part can distract people endlessly.
          Some of the other things that it’s doing—again, as early as the second half of 2009, commodity prices increased again, and so that offshore business came back. There’s also been the selling of resident permits. It’s kind of common. Spain does it, several other countries do it. So you have a lot of people coming from China, Ukraine, Kazakhstan, etc.
          [slide 30] And just summing up here, because I know I’m running out of time: I’ll just reference what some of the present sources of growth and sustaining of demand are. Again, offshore banking, foreign deposits. Periodically we get another big scandal such as what happened with Moldova in the fall of 2014, where an oligarch managed to literally steal 18 percent of the country’s GDP, ran it through Latvia, and then went on to the UK. You’re off the hook there in Ireland; it went to the Imperial Master there. The offshore banks, the big ones like Rietumu and ABLV have been seeing huge profits. Last year they saw an increase of deposits of 39 percent, 33 percent, respectively. Some smaller operations have seen increases of up to 160 percent. The money that fled the crisis in Cyprus in 2012 and 2013, a lot of that went to Latvia. A lot of Ukranian money has gone to Latvia as well.
          Forestry. The Soviets decided for a number of reasons that Latvia shouldn’t have as many farmers as they did during their rule. They thought that Lithuania should be the place to be producing more food, so they let a lot of agricultural land revert back to forests. And so consequently there’s this big reserve of forests now. It’s kind of like a bank account that you can draw down. Half of the country is forested, half of that is publicly owned; so a big response to the crisis was to just begin clear-cutting forests. Now that is not necessarily a bad thing; it just depends upon how long you’re going to do it and at what level it becomes unsustainable.
          So new financial innovations visited the country. Four of our former students at the Stockholm School of Economics in Riga, I’m embarrassed to admit, launched this one. I guess the ethics class didn’t take hold. The do these SMS loans at these usurious rates. People are—they’ve returned to employment, but many of them are making a lot less than they did previously; many of them are working part-time to make ends meet, to pay heating bills, things like this, they’re having to get these SMS loans. I’m going to reference my colleague, Michael Hudson, once again. I remember I took him to the Stockholm School to give a lecture. He asked some of the students what they were studying. They said, Business ethics. And Michael rejoined in his typical fashion, he said, Oh good, that’s exactly what you want your competitors studying.
          But we did, though, see an increase in the inclusion of Latvian production into global production chains, some good news. Latvia’s industrial sector is only about 10 percent of GDP. It’s starting to become actually a little bit more industrialized, and so that’s a good thing. Grain sales went really up, but that’s starting to abate.
          [slide 31] One more point: My book, The Contradictions of Austerity, was published by Rutledge, and I thought this was rather curious: In addition to the economics section it was also listed under their mental health section, which seemed to be a rather curious and somehow appropriate cataloging of the book. It’s now out in paperback, by the way.

“Austerity in Greece”
James Galbraith:
          I have no graphs – too depressing. And I would also almost unambiguously [state] the Greek performance is the worst in the Eurozone, although I have to modify that because the graphs I’ve seen don’t normally include Latvia. It’s certainly the case that the Greek performance has not been meliorated by the stabilization that Latvia experienced.
          There is a standard narrative of the Greek experience which holds that Greece is a country with weak institutions, uncompetitive industry, a culture of dependency and corruption, in need of market reforms and fiscal discipline, which if applied diligently would yield economic recovery and ultimately a return of confidence in credit markets. About half of that is true. That is, the descriptive elements have a certain validity, and what they tend to do in the narrative is to lend weight to the prescriptive elements, but without providing a logical support. And also they ally other questions, specifically to what extent the regime that was imposed on Greece was imposed in good faith expectation of improved performance. And if not, were there other motives involved, and if so, what they were.
          To take a look at that question is what I propose to do in the few minutes that I have today. It requires a view informed by political economy and not merely of the Greek case as such, which has been very much the focus of the other two presentations, but also of the European and the international dimensions. In that respect, then, here are some very brief, generally accepted, or anyway, I think, undisputed facts about the situation:
          First of all, the Greek state, which has never been a strong state, never had strong institutions, never had competitive industry, has been in default for about half of existence as an independent republic since the 1830s, did over-borrow before 2010 for purposes which had no possibility of an economic return, including military recruitment, infrastructure spending, 2004 Olympics, hidden deficits in the health care system and elsewhere. The debt-to-GDP ratio had risen to about 100 percent of GDP at the time of the crisis.
          At the same time, European banks and German arms dealers, German construction companies all booked profits on those loans, and they made those loans in certain expectation, a certain realization, that they were taking a degree of risk.
          After 2000, furthermore, Greece was admitted to the Euro under admittedly false premises, in part disguised by derivative instruments designed for the Greek government by the helpful offices of Goldman Sachs; [and] was on the short end of what became very quickly the chronic European trade imbalances, basically pitting Germany against every other—certainly every Southern European state due to a combination of German industrial superiority and the wage austerity that came into play in Germany in the early 2000s. This was destined inevitably to cause problems throughout the Eurozone system, trade deficits on the opposite side of the German surpluses which had to be financed somehow, and it did cause those problems everywhere else in one form or another as the credit which supported the German position collapsed in the crisis.
          The third point at the larger level of the world economy: The Greek credit position collapsed in a general flight to safety to 2009-2010. That’s to say what happened as a result of the financial crisis, which had its origins obviously in the mortgage debacle in the United States which it then exported to Europe through asset-backed securities rated triple-A by reputable institutions, was that the investment community generally sought to strengthen its portfolio by dumping those assets which were at risk, which included the sovereign debts of a whole raft of countries, all of which were dumped simultaneously; and this would have happened even if Greek policy had been much better than it was. In fact, in other countries with much less in the way of debt-to-GDP at the time, the same general flight to quality occurred.
          The result, however, was a further collapse of GDP and a rise of Greek indebtedness so that the ratios are now on the order of 170 percent of GDP, or they were at the start of this past year. Today they’re closer to 200 percent of GDP.
          Austerity in Greece came in abruptly following the election of George Papandreou at the end of 2009 with the financial collapse and the bailout that was imposed by May of 2010. There were a number of elements […?] the main purpose of the program was to rescue the banking systems in the rest of Europe, including especially French banks, also German banks, [and] Greek banks, two of the four of which were owned by the French banks, which had thoughtfully placed a lot of the Greek sovereign debt on the balance sheet of their Greek subsidiaries. It transferred the Greek debt to the European taxpayer, including to the taxpayers of a number of countries that were much less wealthy than Greece is, creating a political obligation problem of admitting the whole thing was going to be unpayable. It became, instead of being a commercial consideration, also a consideration that entailed the reputations of the governments that had agreed to the deal.
          The IMF came into the program in 2010 for two internal reasons and one external reason. The first internal reason is that otherwise the IMF was largely out of business. It had no longer got—Its programs had been paid off in Latin America and elsewhere, so it was not only out of work, but it was running out of revenue. And secondly, it’s worth remember that the managing director of the IMF at the time, a man of impeccable probity and high reputation, as you recall, a guy by the name of Dominic Strauss-Kahn—I’m serious!—wanted to become president of France and had a very good chance of becoming of president of France, particularly if he was able to deploy the resources of an international institution that he happened to control in order to serve the interests and promote the salvation of the French banking classes, which is always a useful thing for a socialist candidate to be claiming.
          The external reason that Angela Merkel needed the authority of the IMF in order to design a new post. Partly for internal political reasons in Germany and partly to design a new post, the program was instituted in Greece. Therefore austerity was a political necessity, not something that was designed by the Greek government [that] had been elected at the end of 2009 on completely opposite premises, on the idea that they could actually deepen and improve the efficiency of the very weakly functioning Greek welfare state; but rather, as I say, as a complement to this financial bailout package. It was also done with the very strong support of the United States Treasury, which at that time was concerned about the CES exposure of American banks, and therefore did not want to entertain a massive write-down of the Greek debt.
          The elements of the austerity which were implemented from 2010 through the end of 2014 included very large cuts in the Greek civil service, and Greek civil service was arguably, some could say indisputably bloated, but the cuts were on the order of, I believe, around 300,000 employees. Pensions were cut on the order of 44 to 49 percent. There were pay cuts in teaching, in universities, in health care; there was a cut in the minimum wage. Public investment basically came to an end, as did investment supported by European institutions because the Greek government couldn’t meet the copayment requirements. Unions by and large, which had never been very strong in Greece, lost whatever collective bargaining power that they had. There was a forced draft privatization of Greek public assets, which did not bring anything remotely close to the revenue targets that were extended for it, because, as an elementary proposition, when you put everything on the auction block at once, there’s a tendency for the price to fall.
          Over all, the austerity imposed on Greece was on the order of twice to three times greater than any other of the major European crisis countries. So you can imagine about 10 percent of GDP going away very quickly in the US case had there been no automatic stabilizers and no stimulus package after 2008, would have been a rough comparison to what actually did happen in Greece because there was no inter-European automatic stabilization going on. None of this was under the control of the Greek government. It was a policy that was entirely designed “from the outside” under a memorandum of understanding. The finance minister that immediately preceded Yanis Varoufakis asked his prime minister, Antonis Samaras, how he should approach the creditors, and the answer came back, On your knees. That will give you the idea for the general approach of the Greek government in this period toward the policies that were being suggested for it.
          Overarching on this at the macro level was a target for the primary surplus of 4.5 percent, a target which was not going to be reached, although Greece did come to primary balance by the end of 2014, […?] government of Samaras at the end of 2014. The mechanism that was supposed to work was the same one that was advertised for Latvia: efficiency gains through privatization and management reforms and the elimination of inefficient, allegedly inefficient, public servants, improved fiscal stance through increased taxation; and an internal devaluation through reduction of what had admittedly been an overly rapid gain in unit labor costs. That was supposed to produce, according the IMF forecast, a drop in GDP of about 5 percent in 2010-2011, and it would be followed by a full recovery by 2013.
          In contrast to the Irish case, this was not a realistic forecast. It was a piece of window dressing which already at the time it was imposed in May of 2010, was objected to by elements of the IMF staff and certain members of the IMF executive directors, including the Australians and the Chinese and the Swiss.
          The reality was a total collapse of investment, both public and private, and over time a drop in GDP of 25 percent from the peak, which was not recovered at all. Unemployment rose to an excess of 25 percent, well over 50 percent for young people. The labor market went to a high degree of informalization, which undercut the funding of the pension system as well; so they’re funding the state. Privatization, as I mentioned, brought essentially no money and no efficiency gains. They were substantially also a question of transferring public monopolies to private ones, which gives you the chance for fleecing your customers. There’s no real reason to believe that an electric utility, for example, is going to become more efficient simply because you transfer it to private ownership. The primary surplus target was of course a fraud pure and simple whose alleged severity was intended to obscure the fact that a great many other things that were in the memorandum of understanding were simply not going to be enacted even under the conservative government that came in, the coalition government between New Democracy and PASOK came in with Samaras at the end of the Lucas Papademos period.
          In 2012 there was a partial restructuring of the Greek debt which had the effect, since the pensions were not protected, of destroying the funding basis of the Greek pensions while not affecting those bonds that had been bought by the European Central Bank under the Securities Market Program in 2010 at a deep discount. And in 2014, at the end of the day, when people started saying that the Greek recovery was going on, what was in fact happening was a debt deflation. The price level was falling more rapidly than the nominal GDP, but both were in negative territory.
          What happened in Greece in that context was a little bit of a political miracle, which was that, instead of yielding to the temptations of Golden Dawn, the Greek Nazi party, which was playing very heavily the game you described of division politics. They have basically concentration camps for immigrants as part of the party platform. Admittedly when you have the entire leadership of your party on trial for murder, it’s likely to give pause to what remains of a rational electorate; but the fact was that the Greeks went another way. They coalesced behind a progressive coalition, admittedly rather ragtag, people rather like the people in this room, expatriate college professors, union activists, ecological activists, political militants, under the title of the Coalition of the Parties of the Radical Left, Syriza, which was elected on January 25. And my friend Yanis Varoufakis, who had been teaching with me at the University of Texas at Austin, became finance minister on the following day.
          The Greek government that came in did not seek, because there was no chance of being entertained in the prospect, to open a discussion about pan-European reform, clearly necessary under the circumstances I just described. We did in fact have something called a modest proposal, which had been coauthored by Yanis, myself, and former Labour MP, Stuart Holland, now of the University of Coimbra in Portugal, which had a number of elements for creating a viable resolution of not just the Greek but the wider European crisis country debt problem through the European Central Bank: resolution of the banks on a case-by-case basis, investment programs of the European Investment Fund, and a solidarity program to provide some support for the most vulnerable households directly in the crisis countries. That was never on the agenda because there was no avenue and no place that the Greek government could seriously get a new agenda on to discussions.
What the government had to do from the very beginning—from the end of January/start of February when the government came in; Parliament opened on the 8th of February, which was the day that I arrived in Athens--was to try to negotiate with its European partners and with the IMF a number of programmatic changes that would at least attempt to mitigate some of the worst and most dysfunctional features of the program that had been imposed in the previous four years. The basic hope was for, first of all, a realistic primary surplus target in line with what had already been achieved; something on the order of one percent of GDP would have been negotiable; labor relations that would at least meet the minimum standards of the International Labor Organization and [were] not worse than those available elsewhere in Europe; protection of pensions of the lowest end of the spectrum which were on the order in Greece of a number of hundreds of thousands of pensioners of €350 a month, and which the program was calling for cuts, and a supplementary program of a €120 per month; and a rational privatization program that would be spread out over time that would involve some continuing participation of the Greek government so that if the assets did prove to have an up side they would ultimately be of some benefit to the national fisc from having done it.
          And in this context what was obviously required to make the economy viable, or at least to prevent it from further collapse, was continued support for the banking system through the European Central Bank and eventually a restructuring of the Greek debt.
          The Greek debt was not actually the most urgent issue because of the restructuring in 2012 and because essentially what was urgent immediately [was] there were a number of repayment deadlines that had to be made to the IMF and to the European Central Bank. But after those were done, there was a grace period through 2022, so there was plenty of time if you got through 2015 to negotiate the debt afterwards. It was the programmatic issues and the stabilization of the underlying economy that were central. The government, although it was a government of the radical left, was by no means a government of enthusiastic Keynesians or modern monetary theorists. Perhaps unfortunately it was also not a government that was the least bit interested in breaking out of Europe or the Eurozone. And so it did not and was not in a position to propose an end to austerity but rather it tried to achieve a stabilization to be followed—which would have been followed if they’d have been successful by a kind of gradual balanced budget expansion. You claw back tax revenues as you improve the tax collection mechanisms and go after the [?] and convert those funds, if you can get them, into increased investment and employment.
          What were the reactions? This is a slightly complicated story--I’ll try to convey it in a very compact form--as it occurred at three different levels. I think it’s fair to say that at the technical or institutional level, which I was involved in particularly beginning around the 11th of February through the initial agreement on the 20th to extend negotiations for about four months, discussions were with the IMF, the representatives to the IMF, the European Central Bank, and the European Commission. And it’s fair to say that, although those officials were not up front about their remit, it’s clear now that they were never actually authorized to negotiate, and certainly not to negotiate the terms of the program. What they were there to do, their job was to conduct a review of the previous financial assistance program, of the memorandum of understanding. That was their agenda, and their reporting requirement was essentially to their own superiors just to say how close to the initial agreement were the Greeks willing to come.
          So the Greeks would make a concession, and then their concession would be pocketed, and the answer would come back, And now you must make another concession. And of course at the political level the rhetoric was the Greeks must work harder. They must stop playing games. This is all around the notion—it wasn’t a serious discussion about the validity of the program, but simply a question of the extent to which the Greek government would hold out against complying fully with what the previous government had already agreed to. And meanwhile the European Central Bank, which, in my notion of a central bank--and we have a distinguished vice chairman of the American Central Bank here; I think she might agree with me—the function of the central bank is generally speaking to stabilize the financial system of a country. In this case the European Central Bank, while stabilizing every other part of the Eurozone, worked to destabilize the Greek financial system and to promote a slow run on Greek bank deposits which was offset by a fairly expensive and conditional form of financing, the Emergency Liquidity Assistance. So that was the problem at the technical level: You were talking to the wall for four solid months.      
          Yanis Varoufakis himself was engaged at a higher level, which is called the Euro Group, which is an ad hoc organization [holding] periodic meetings with the finance ministers, which was a very interesting exercise. Again, as a former member of the congressional staff I really found it quite appalling because I normally think that governmental entities and particularly principals work together better when there are actual rules of procedure and also records of what they’re doing; and this was not the case with the Euro Group; this was an entirely ad hoc and unrecorded entity. But what was going on in the Euro Group was entirely governed by the local considerations in the countries that were members. That is to say, as you’ve already heard, the Baltics and also the Finns were driven by their own internal ideological commitment to austerity as a universal policy of which they were exemplars; therefore no deviation from that policy could be tolerated.
          The Spaniards and the Portuguese and the Irish, whom I don’t believe really hold themselves to the same ideological standards; the Irish less so than the Spaniards and the Portuguese, but they were motivated by the fear of giving aid and comfort to Syriza-like movements in their own countries, Podemos in Spain, Bloco de Escuerda in Portugal, Sinn Fein in Ireland. And so from that point of view making concessions to Greece was a risk that they were not prepared to take.
          The French and Italians, especially the French, were more sympathetic, but they were motivated, at least in part, by the socialist parties’ wariness of the Greek left, which had the potential in each case of having counterparts which would undermine their own political position; and in part by a sense that they could gain some policy flexibility themselves if they were not acting in solidarity with an obstreperous government on the periphery of Europe; and so there was no common front.
          And then the Germans had a complex combination of internal and external politics and the extremely, shall we say, solid and uncompromising position of Herr Schauble, who was in fact our, speaking as the Greek finance ministry, our most direct and most candid interlocutor and the person [with] whom we had, the Greek finance ministry had cordial and direct discussions. He was never, I think, evasive about what he would or would not do. The only question with respect to Schauble was whether there was a higher authority that might possibly constrain him from holding to the positions that he held. And so that pushed the Greek government to dealing at the political level, which was to say directly between the prime minister and the federal chancellor, Angela Merkel, with some help from the government of the United States amongst others.
          But the decision would ultimately turn on whether the German government at its highest levels was prepared to tolerate the government of the left in Europe.  And ultimately, to put not too fine a point on it, that was the basis of the decision. Chancellor Merkel decided that she would not. And that was from her point of view the best thing to have to do, was to create conditions under which the Tsipras government would fall, which led to the stalemate at the end of June; the referendum in which the Greek people rather bravely said No, we do not wish to accept the terms that are being imposed upon us. And the government of Greece at that point had already made its decision that it had no viable alternative except to capitulate.
          It’s interesting to note, I think, the general conclusion I draw from this survey of the scene, is almost none of the conditions that determined what happened to Greece over the course of the first half of 2015 were related to economic conditions in Greece or to any understanding of the particular circumstances of the Greek economy. It was simply not a relevant consideration from the standpoint of the creditors, all of whom were motivated by their exterior ideological and political commitments; not did they have any particular belief, nor did they pretend to for the most part have any particular belief in the efficacy of an austerity program. This simply wasn’t the basis on which their decision was made.
          A good many economists looking at the situation, and I think quite reasonably, and particularly those who perhaps may have felt some remorse for having spent the previous years from 2010 to ’14 forecasting a recovery that never came, concluded that there was no option for Greece inside the Euro and that exit would be the better choice: that you would retain flexibility over the exchange rate and an exit from the strictures of the memorandum. And it was also perhaps the case that Finance Minister Schauble may have held that. Whether he held it or not is a little bit unclear, but he was certainly prepared to discuss it in March and April as if he held that view. He was prevented from doing so by those present at a private meeting with Yanis Varoufakis and Wolfgang Schauble on the 8th of June that made this clear by the simple fact that neither principle, neither Prime Minister Tsipras nor Chancellor Merkel would permit the finance ministers to engage in that discussion. Yanis said that to Schauble at the beginning of that meeting which put an end to any chance that there could be a negotiated way to exit, which meant that if Greece did exit from the Eurozone it would do so under conditions that would be entirely, let’s say, what was within the capacity of the Greek government to manage. And I was charged on a basis of complete discretion to lead a small team to at least list the problems that the government would face; and I have to tell you that the list was long and it was fairly daunting. And while we in the Finance Ministry might possibly have made the opposite choice given the decision of the Greek people on the referendum on the 5th of July, it’s not entirely beyond understanding to me that the government made the opposite call.
          In any event, strategic considerations in Europe simply blocked that option and the transition costs would have been considerable. So while the economists might have been right that in static equilibrium, when you got there, the Greek position would be better off. The prime minister’s question was who was going to support the drachma. If you could have gotten a swap line Federal Reserve, great; but of course nobody in the United States government was going to give the slightest assurance of that, nor would I in their position because then they would have been responsible for creating a circumstance that they didn’t want to be responsible for. So there we were.
          The result was that the Greek government did capitulate, as everybody knows, and the memorandum is now back in full force.
          And so I’ll conclude this by saying a few words about what it’s actually doing. Taking all things together I think you can look at the structure of the higher taxes—that rate’s up to 23 percent everywhere; much lower spending; capital controls still in place; privatization is going forward; bankruptcy and foreclosure reforms so as to accelerate those processes are part of the prior conditions that were imposed on Greece in order to begin to get some of the refinancing that was promised under the program. And in addition to that the banks were recapitalized and American hedge funds got a major share of the equity in the Greek banking system for a very low price.
          I think the answer to this is clear. This is not a program of economic recovery or reform or restructuring; it has nothing to do with the consequences for the Greek people. It is a program of clearance. It’s a dispossession and liquidation carried out under a colonial administration. The issue here is very simple. The issue really is whether the Greek people and Greek enterprises and the Greek state have any prior claim on the physical capital assets of the country, which include of course 13,000 kilometers of shoreline, which is a very substantial capital asset.
          If you were thinking about this in the context of the United States, the question would be obviously not. Just because I live in Texas doesn’t give me a presumptive right to own property there. But the European situation’s a little different. In the European situation you have countries which have come into the European Union and into the Eurozone under at least a general presumption that they would continue to function as quasi-autonomous entities, and I think it’s a general presumption that does not entail the complete abolition of the right of ownership of the poorer countries to the assets of their own, on their own territory.
          The question therefore is still politically to some degree unresolved. Although the direction of European policy is clear and the Greek government for the moment is entirely subordinate to that policy, I do not imagine that it will be free of either passive resistance at the administrative level as foreclosures and evictions begin to take hold. Greek government’s trying to protect, for example, householders in their primary residences, but that does not protect people, many of whom have houses on the islands, which are secondary residences. So this is a situation where you’re going to see things which are perhaps more precious to people than their primary residences in great numbers being taken away under this process; and I think you’re going to see a deepening public resistance which cannot be discouraged by the fact that if there was a larger political movement or purpose in crushing the Greek government, namely to intimidate the voters of Portugal and Spain and elsewhere, it’s clear that the voters of those countries were not effectively intimidated. And at least two of the finance ministers who were adversaries to my friend Yanis Varoufakis over the January to June period are no longer in office because they’ve been turned down as their right-wing governments have lost their majorities. In Portugal a new government has formed. In Spain I don't think the government is in place yet, but it’s clear that when one comes it will most assuredly not be a replica of the government that was just defeated. So with that happening and with that influence of that on Italy I think it’s fair to say at this point that the future of austerity in the South of Europe is by no means a settled question, despite the rather depressing experience of the first half of this year. Thank you.

          Actually I appreciated all of these presentations. Very informative. I enjoyed them. I do have questions that I would like to pose to Patrick Honahan. One has to do with, at one point you made the statement that a Keynesian response would not have worked to keep the construction workers in Ireland. I mean, what was the reason? Is it because—this is a kind of famous, almost [Kaletsky?]-type argument, which is that if you want to maintain the state of confidence, you don’t want to run deficits; but you could run huge deficits by bailing out the banks at the same time? So I mean it’s an issue of what was it that actually would have made it possible for that to happen if the conditions were right to do so?
          And the second question that I have, which gets into the core of your analysis, which I really appreciated, on the issue as to whether or not they had a realistic estimate, as you’ve indicated, as to the ability to address macroeconomic problem. And the fact that your interest rates did come down much more so in a sense to offset the losses arising from the austerity measures themselves is very interesting. But I would like to know to what extent—You never mentioned anything about net exports, and I was just wondering what was going on in Ireland at that time.


          Okay, yes. So on the first point, maybe I didn’t speak clearly enough. What I really intended to say was just choosing a higher deficit, just saying, okay, we won’t ratchet up the tax rate as much, we won’t restrain spending, and there were cuts in public sector pay rates, if we just choose a higher deficit, will that keep all those construction workers at work? No, it will keep some of them at work; but there’s a sectoral problem there. There’s a sectoral collapse in the construction industry. So yes, you could find a way of getting a block of government money and keeping those guys at work; but just a different level of the deficit won’t work. It will keep the activity level higher, but it won’t solve that structural change. That’s the point I’m making. I’m not denying the proposition.
          And the other question is on what’s happening to net exports. Net exports is turning around very very rapidly. There wasn’t a huge balance of payments. It had crept up to 5 percent, which is big, but it’s not huge. It turned around pretty quickly. There was of course a demand compression. There was considerably export recovery, faster than in many other countries because of the mix of the products. But net exports turned around balance of payments into surplus. Again, lots of measurement issues around current account balance of payments.

          Any other questions. Yes?

          I have a question for Dr. Honahan. You didn’t talk at all about multinational companies coming into the country; so I was wondering if you could talk a little about if you thought they contributed at all to the recent recovery, ongoing recovery in Ireland, and do you actually think the gamble’s going to work? Do you think that having all these companies come teaching the Irish, creating that sector, will actually benefit Ireland in the long run, or will other countries such as, like, Poland, or Czech Republic start stealing away those companies, and you’d lose out on that game?

          Okay. So the multinational—The government strategy, broader, deeper strategy in respect to its dealings with the rest of the world were to say something like this: We have a small problem on the construction, on the banking side. Don’t you guys worry about that. We’re still in business for this export-driven, multinational, friendly environment. That was the government’s policy. And in the limited sense it’s definitely worked. The multinationals kept coming. There was hardly any hesitation in their new setup. So if you like that model, it’s still working, and I think, my own personal perspective is, I was in the job for six years, I’m getting this thing back to where it was. It’s up to the politicians to design the long-term. For 40 years I’ve been saying, this is a very risky strategy. It’s great to have multinationals here, nothing against them; but it is a risky strategy if you’re relying so heavily on them. But it has worked for 40 years, and gosh, that’s a long time.
          Your other dimension was—

          Do you think the gamble’s going to work?

          Well, it’s as I say: It’s been working for 40 years. So far so good. And of course the—oh, you know, you hear all the narratives. They do different things now. It’s not just simple assembly stuff. You’ve got the software people, you’ve got a lot of services, value-added—all that stuff. It’s part of the global—Ireland is part of the global economy. Greece is to a much lesser extent, and I fully agree with the idea they’ve got great resources there; but if it’s only beaches, you’re only going to get a certain distance. You should keep the beaches, but the future for Greece in this context that Jamie’s talking about, in a different political context, is also to engage in the global economy.
          I wasn’t asked this question but I’ll answer it anyway: Why did the Irish not riot or have demonstrations? And I think it’s because they might not like the capitalist system, some of them might, some of them don’t; they might think the whole thing is unfair; they might think the government handled the early stages very badly; but they know broadly speaking how the system works. Because so many of them live in the United States, in Australian, they go backwards and forwards, they understand how the system works. They said, We’re in trouble here. If we don’t play ball, we’re going to be in bigger trouble. And if you have a political response that doesn’t recognize that and can’t recognize that because the general people don’t recognize it, you are going to run up against the stone wall not just of the European political regime, but of the global financial system, which likes to get repaid, and if it doesn't get repaid it cuts up rough.

          Okay, I think I’m going to leave it there, because we’ve pretty well run out of time. Thank you.





Economists for Peace and Security