Two Generations and Democracy

Branko Milanovic, who contributed a recent guest post on Inequality and the Global Crisis, spent the last month in Madrid, living at a stone’s throw from La Puerta del Sol. He contributed this guest post on the current rebellion by Los Indignados. This is to start the ball rolling, no doubt others will wish to argue. By all means comment via e-mail if you must, but it is much preferable to comment directly on the post.

Several weeks ago the Spanish newspaper “El Pais”, one of the leading dailies in the world, held a party to celebrate the 35th anniversary of its foundation. "El Pais" has appeared in the days of the Spanish "transition" from Franco's dictatorship to democracy, and has throughout remained consistently pro-democratic and center-left. The daily perhaps best reflects the period of remarkable transformation of Spanish society from dictatorship to one of the most tolerant democracies in the world; from the country of emigrants to the country in which foreigners, coming literally from everywhere, account for 12 percent of the population; from a middle-income and in some respects even an underdeveloped country to an affluent country with first-rate quality railroads and highways. In a display of commitment to democracy and tolerance, the “El Pais” party was attended by all Spanish prime ministers since the transition, whether of the left or the right. The tone of speeches was celebratory and somewhat smug. Praise for democracy and the transformation in Spain was not excessive, considering what was achieved in the previous three decades, yet perhaps a bit deafening", reminding one of rather formulaic declarations about the importance of democracy that can be heard in the United States on every 4th of July. I thought that, except for Poland, the Czech Republic and perhaps the Baltic states, it would be difficult to imagine such optimistic tones on similar occasions in Eastern Europe. The reason is simple: democracy is a good thing and there is reason to celebrate it, but only if it goes together with economic development and higher incomes. And in that Spain was indeed very successful, so the generation that has accomplished this historic feat had many good reasons to celebrate. Or so it seemed.

But just ten days after the celebration and on the eve of local and regional elections in Spain, thousands of young people began rallying in the main squares of Spanish cities. The largest gathering, which attracted the attention of world media, took place on the central square in Madrid, La Puerta de Sol, just a kilometer or so from the headquarters of "El Pais" and the building where its party took place. Young people´s discontent was driven not only by the fact that youth unemployment hovers around 40 percent, that most of those who are employed hold very precarious jobs (working on time-limited contracts), or that salaries are stagnant, but by discontent that has spread to the democratic system itself, as it functions in practice. In contrast to the praise we heard at the "El Pais" gathering, now the speeches were very different: democracy ignores the opinions and interests of a large part of citizenry who have become alienated and no longer participate in the process; all political parties, regardless of their name and professed affiliation, pursue similar economic policies; the real power is in the hands of big capital and bankers who finance all political parties, not in the hands of “people”. These are all criticisms that would be subscribed by most young people throughout both “old” and “new” Europe. So, one might think, there is really something deeply flawed with democracy as we know it, and one of key slogans of los indignados said precisely this: "Real democracy-now!". In other words, "partocracy" and "bancocracy" are not acceptable.

But while the young were attacking the current Spanish "system" from the left, the Spanish right, which, because of the economic crisis and high unemployment which it blames on the socialist government, expected a major victory in the elections, retorted with its own slogan, published on the election day on the front page of a newspaper close to Partido Popular: "Real democracy-today." The message to the youth was clear: if you want to have your voice heard and believe that you have a majority, this is your moment, defend your ideas as everybody else does, go to the polls and see if you can win. "People" is not just you: “people” is others as well.

A lot of young people chose not to go to the polls and these unexpressed votes, that would normally go to the Socialists, made a difference and gave a huge victory to the right. Zapatero´s government is on its deathbed, he will not run again, and early general elections may be called. Here, then, the weaknesses in the position of los indignados began to be revealed. While they, on their posters, did not associate themselves with the soixante-huitards (of which they strongly reminded me) but to the demonstrators in Cairo and Tunis, the differences between them and the Arab youth were glaring. Demonstrations in Cairo and Tunis had a clear objective: to end dictatorships and allow for a meangful universal suffrage, multiparty system, and freedom of speech and association. These were clear and simple demands. The protesters knew what they wanted, and eventually won in both Egypt and Tunisia. But the demonstrators in Madrid were not able to clearly say what they wanted: indeed, they desire a better democracy, but what exactly does it mean? Of course, they also want a less corrupt “system" but this is what we all want. How to achieve it is a problem, and they offered no solution. When los indignados finally formulated their 8 theses, all of them except perhaps two (on changing the electoral system and the financing of political parties) were so general in nature, lacked any clear "addressee" responsible for them, or indication of the way in which things need to be improved, that they were made in fact irrelevant. Anyone would sign on these demands any time, and nobody could do anything with them.

And since real democracy took place on the election day and the right won overwhelmingly, while the demands of protesters appeared so general and vague, the demonstration turned into a fiesta, young people having good time in the central city squares, discussing, chatting, drinking beer, smoking marijuana, listening to jazz and rock music for most of the day and night. At 3 a.m., La Puerta del Sol was full of young men and women who enjoyed themselves the way they enjoy themselves at any music festival. Love blossomed—which is indeed excellent, except that it had nothing to do with politics.

And while some youngsters were speaking passionately about the evils of the "system", at the edges of the square, real poor people slowly emerged trying to sell beer or cigarettes, and to make some extra euro. And so it turns out that the older generation, gathered at the "El Pais" party, was indeed right - although when one looks at these young people, in a good mood, kind, pleasant and decent, and compares them to the well-situated, smug and self-congratulating democratic bourgeois, one is torn between sympathy and reason. But the twentieth century has taught us not to trust what our heart tells us.

Oh! Calcutta!

The French magazine Le Point reported that Dominique Strauss-Kahn’s last words, before being hauled off the Air France AF023 flight to Paris by two New York Port Authority detectives, were addressed to one of the air hostesses “loudly and openly” and in front of witnesses: “Quel beau cul!”.

Admittedly this utterance sounds better in French than in English. Camille Clovis Trouille (1889-1975) - a minor part-time painter and decorator, Surrealist and anti-clerical – used a pun on that kind of French remark to name his painting of a naked woman’s buttocks: “Oh! Calcutta! Calcutta!”. And Kenneth Tynan used both that title and that painting in his 1969 Broadway show, featuring extensive scenes of total nudity, that at the time became the longest running and is said to be still today the sixth-longest running in Broadway’s history.

Nevertheless, the remark is not endearing or charming, but gross and aggressive. DSK is sub judice and the courts will decide whether he is guilty and of what. But there can be no doubt, regardless of the courts’ eventual ruling – especially if it is the case that his line of defence is the consensual nature of sexual acts with the Sofitel chambermaid - that he is “a man with a problem that may make him ill-equipped to lead an institution where women work under his command”. These are the words used by a colleague of his, with whom he had an affair, in a letter she addressed to the IMF Executive Board in 2008. A public external enquiry on that case cleared DSK because there had been “no harassment” but ruled that he had made “a serious error of judgment”. The Fund lacked - and still lacks - “clear and protected arrangements for reporting possible misconduct” and “clear disciplinary arrangements” to deal with it if it occurred.

Unfortunately, DSK’s latest little error of judgment has already had the most devastating consequences, not only for him and his family but for the IMF, which in the three and a half years of his tenure he had steered to a larger scale and to a greater role in global governance during the greatest world economic crisis since 1929; for the sovereign debt crisis in the Eurozone and the future of the euro; for the French presidential elections in which he had been a frontrunner who could have led the Socialists to their first victory since Mitterand’s 1988 re-election.

DSK is a Keynesian, like his Chief Economist Olivier Blanchard (from MIT). He persuaded IMF shareholders to raise $500bn additional capital thus trebling its resources. At the emergency summit of G-20 leaders on 15 November 2008 he proposed, and obtained, a large scale global fiscal stimulus of the order of 2% of global GDP, and encouraged a parallel monetary expansion. He opposed calls for an early exit strategy (for instance by the German Chancellor Angela Merkel and the ECB President Jean-Claude Trichet), which he viewed as premature, and above all a collective exit strategy considered by the G-8 of 8-10 July 2009 at L’Aquila, which would have been disastrous.

He junked the old “Washington Consensus” that had inspired IMF operations in the 1980s in Latin America and in the 1990s in the post-socialist transition economies. He was well aware of debt sustainability issues, but was also very conscious of the impact of fiscal austerity on poverty and distribution. Under his leadership there was concern for gradualism, and for client countries’ ownership of stabilization programmes. He aimed higher than he could reach, just to make progress; an instance would be his argument for a new role for the IMF as a global Lender of Last Resort, which was inappropriate, for which he never really developed a case and let drop.

His revolution was unfinished. He was acknowledged to be a very good diplomat, who listened to both North and South; was trusted by the Greeks, was the only non-German with an influence on Angela Merkel.

He is virtually irreplaceable. The problem with Christine Lagarde is not the Tapie affair, of which she is likely to be cleared on 10 June, but – as Martin Wolf puts it in the FT of 25 May – “her limited knowledge of economics”. DSK’s letter of resignation as IMF Managing Director ended, incongruously, with the words “Au revoir”. Sadly, he clearly meant “Adieu”.

Cuba’s Pre-Perestroika

On 16-19 April 2011 the Cuban Communist Party PCC held its sixth Congress since the 1959 revolution, the first since 1997. The date is historic: on 16 April 1961 Fidel Castro proclaimed the socialist character of the revolution, the next day a contingent of Cuban exiles attacked the Bay of Pigs, two days later they were routed. The timing of this year’s Congress might be taken to suggest that Cuban socialism is in danger now as it was then; on Christmas’ Eve last year the party paper Grandma stated that «it [was] no longer the coming year but the coming country».

If so the frequency of Party Congresses leaves a great deal to be desired: one every almost-nine years, 14 years since the last one, in a period that saw the fastest and most complex changes on the planet, do not say much about the quality of democracy under Cuban socialism, even in its diluted form of «democratic centralism», prevailing on the island. Especially since the Cuban population is aware that Fidel Castro has transferred the Presidency of the country to his brother Raúl in 2008, but discovered only on 22 March 2011 that he had transferred to him also the direction of the Cuban Communist Party five years earlier (Renaud Lambert, «Ainsi vivent les Cubains», Le Monde Diplomatique, April 2011). A Party secret secretary seems bad form, to say the least.

Cuba today – mutatis mutandis - has reached the stage of economic and political development that the Soviet system had reached on the eve of Gorbachev coming to power in March 1985: a gerontocratic leadership, moreover transferring power within the family in North Korean style; an authoritarian political system; much talk of price liberalisation but continued generalised shortages of goods in excess demand at state prices, with rationing for the last 52 years; a dual currency, an unconvertible peso and a convertible one that replaced the dollar in 1994 (something that the Soviets thought of but fortunately refrained from doing); special economic zones to attract foreign investment; long-term leases of state assets in the tourism sector; leases of uncultivated land to landless farmers (about 140,000 leases in the last year); and endless talk about free private enterprises, still in practice restricted largely to self-employment (200,000 new licences since last October) and family firms in the service sector.

Inevitably, at the beginning of September 2010 even Fidel Castro recognised and stated, in an interview to the US monthly The Atlantic, that the Cuban model «does not work anymore». In mid-September the Cuban Workers Union CTC announced the suppression of 500 thousand public sector jobs by March 2011 (as already anticipated by Raúl on 1 August 2010). This was justified by «the need to raise production and the quality of services, to reduce the enormous social expenditures, to eliminate free benefits and excessive subsidies». The half a million are only 12% of public sector workers (who make up 80% of the active population, i.e. 4,400 thousand) one out of each four of them being regarded as redundant by Raoul, thus making total re-deployment from the public sector affect as much as 20% of active population (the figures are provided by Janette Habel, «Changement de cap a Cuba», Le Monde Diplomatique, October 2010; they add up only approximately. The FT of 24 April puts public employment at 85%, i.e. about 5 million). But bureaucratic impediments, lack of credit and of necessary material supplies, crippling turnover taxation, remain the main obstacles to the absorption of redundant workers through the growth of small scale private sector. The quality of education has suffered as a result of teachers leaving underpaid jobs; only 14% of the population uses Internet.

“We are convinced that the main enemy we face and will continue to face is our own shortcomings,” Raúl Castro said at the end of the Congress, echoing what Gorbachev might have said in 1985. The preliminary lineamientos (over 300 directives) of the Party Congress aimed at legalising what was already discrete current practice, such as price-fixing according to market principles (there has been a free peasant market for agricultural products since 1994, promoted by Raúl in spite of Fidel’s opposition), links between wages and productivity, greater autonomy for state enterprises. Above all there is a perceived urgency to open the economy, following the example of Vietnam and China. With the economic collapse of the Soviet economic and political system, Cubans lost their former benefactor and GDP fell by 35% during the «Special Period» of 1991-2000; today Venezuela’s subsidised oil in exchange for Cuban teachers and doctors is not enough to replace former Soviet support. Cubans now have to contend with the harsh reality of global markets, though they prefer to blame their aggravating economic backwardness not on globalisation but on their being denied access to it by the US trade embargo - perhaps the most myopic and counterproductive policy ever adopted by the United States towards a weak opponent.

There are bright spots. Since 1950, average life expectancy has risen from 58 to 77 years (as it did in Russia under Gorbachev). A recent issue of Foreign Affairs stressed that «Cuba is the only poor country in the world that can claim that health does not represent a fundamental problem for its population. Its success in this field is unrivalled». But tourism and nickel, the most dynamic sectors of the economy, were severely hit by the 2008 crisis; in the same year three successive hurricanes destroyed infrastructures worth $10 bn, equivalent to 20% of GDP. In 2009 agricultural production fell by 7.3%; the country imports 80% of its food, up from 50% in 2004, a growing vulnerability given the volatility of food prices over the last couple of years. Lending to Cuba by international financial institutions has been falling over the last four years, but total debt has been accumulating fast, from just over $16bn in 2006 to $20bn today, mostly towards China. (FT, 24 April 2011)

























The ration card (tableta de abastacimiento) had some egalitarian merit in the distribution of basic goods, as an exceptional, temporary measure during short emergencies when established supply channels are suddenly disrupted by wars or natural calamities. Otherwise its continued persistent use since 1962, and the associated black/grey/multicoloured markets in which scarce goods are re-traded (whenever this is physically possible) at a premium, is a tragic misunderstanding of socialist values. Socialist planning ought to be capable of balancing supply and demand at stable prices, but if it fails it is much preferable to let prices do the rationing through price rises, at the same time subsidising the monetary incomes of the poorer groups of the population in order to support their real consumption levels. Yet the redistributive effects of market-clearing prices – in the absence of re-distributive, compensatory measures – are clearly undesirable. Urban poverty – i.e. inability to cover basic needs - is said to have risen from 6.3% in 1988 to 20% in 2000 (Mayra Espina, quoted by Jeanette Habel, «Cuba en quête d’un modèle socialiste renouvelé», Le Monde Diplomatique, January 2009).


Raúl recognises that the tableta is «irrational and unsustainable» but expresses vocal concern for the dangers of inequality, growth of the informal sector and the black market, themselves being generated in part by the rationing system: such concern should lead to generalised income subsidies rather than place a major drag on price-liberalisation. For without market-clearing prices you cannot imitate China and play with markets, with private entrepreneurship, hard budgets and export-led growth. A set up only too familiar from the last days of the Soviet régime.

o O o

In December 1969-January 1970 (the year of the 10 million tons of sugar) I visited Havana from Cambridge to lecture on investment planning at the Institute of Economics, following up on Richard Stone who had just been there to lecture on input-output models. In my course I tried to legitimise the use of an interest rate in investment selection, which was regarded then by Cuban economists as an exploitative bourgeois practice to be rejected. I pointed out that even Soviet Academician Stanislav Strumilin had advocated an interest rate within the Marxian Theory of Value, as the growth rate of labour productivity that reduced the labour value of future goods. I also argued that there was an implicit, shadow interest rate in investment choice in Soviet-type systems in the form of a minimum «recoupment period» within which additional investment costs had to be recovered by yearly savings in current operating costs.


I was curious to see what had been discussed in Cuban journals in the years immediately after 1959, and did some research in the Institute library. I was surprised to discover that the peak of the debate was a discussion between Che Guevara and Charles Bettelheim on whether or not the concept of value required a contradiction (sic). Bettelheim might as well have been sent to Cuba by the CIA, and perhaps he had been, to divert Cuban energies from the real tasks of building a socialist economy.

It was a memorable trip. Cubana Airlines from Madrid, stopover in Zander, Newfoundland, 17 hours on a propeller plane to Havana, stopover in the Canaries in the 17 hours on the way back to Madrid. Staying at the Hotel Nacional, together with large numbers of Russians and of the most gigantic multicoloured insects; lobster at every meal for a while, until I would have given anything for a sausage. Privileged access to free meals on a card and subsidised hotel shops, also for the spy-chaperon who was shadowing me all the time.

I visited Barradero beach (then deserted and to die for), Hemingway's house, a cigar factory, the most luxurious villa formerly belonging to the Rockefellers, with vast expanses of Carrara marble, beautiful succulents exotic flowers and colibri birds. I saw parts of the Cuban interior, including the Sierra, Santiago and its open sewers, sugar cane plantations where students and professors cut cane painfully and inefficiently at week-ends with dangerous looking machetes, a crocodile farm and the most over-built over-expensive cattle farm.

Empty shops everywhere, which two Italian town planners working there were planning to convert into cultural centres, and were horrified at my suggestion that it would be desirable to fill them with goods. Rationing for everything, not even tropical fruit was available for sale, though everything was available on the black market. An amazing display on the public roads of ancient-antique US cars, often cannibalised into the most curious hybrids. Buses (uauas) were driven around at terrifying speed, but I had a chauffeur-driven Alpha Romeo at my disposal, which Cuba had imported directly from Italy through a barter deal for nickel. I asked to be taken to the Bay of Pigs and, faced with vague promises, I went on strike i.e. refused to go on any other local trip until they did take me.

In Havana I met by chance an interesting young man, Carlos Vidali, a personal guest of Fidel’s being the son of Vittorio, the prominent Italian Communist who had traveled extensively in Cuba before and after the Revolution. Carlos arranged for me to meet the economy supremo Carlos Rafael Rodriguez, who firmly criticised my starry-eyed égalitarianism on pragmatic grounds. Only after my return to Europe did I learn that Carlos’ father was reputed – rightly or wrongly – to have had a role in organising Trotsky’s assassination.

According to Wikipedia Vittorio Vidali – also known as Enea Sormenti, Jacobo Hurwitz Zender, Carlos Contreras, "Comandante Carlos" – was a colourful figure, a founding member of the Italian CP, Comintern agent and finally Communist MP in the Italian Parliament. He «was definitely involved in the May 24, 1940 failed frontal assault on Trotsky's residence in Mexico City, along with [Iosif] Grigulevich and Mexican painter David Alfaro Siqueiros. Vidali is thought to have been involved with the insertion of assassin Ramón Mercader into Trotsky's inner circle – Mercader was to kill Trotsky later that year», though the Italian version claims that Vidali’s presence in Mexico at the time of Trotsky’s assassination may have been «a sheer coincidence».

o O o

The shocking thing is that in over forty years since my 1970 visit not much has changed in Cuba by all accounts; not much is different from the Soviet days just before and just after the beginning of Perestroika, and a self-selected self-perpetuating small group of dogmatic and decrepit old men have been repressing the development of an entire country and its people for over half a century without having the slightest idea of what they are doing and why, heading for total and unmitigated disaster not only for themselves but also for the people they have taken it upon themselves to rule.

Cucumber season

The Silly Season, or Cucumber Season as it is called in several European languages – the diffusion of frivolous news to compensate for the mid-summer rarefaction of real events – has begun early this year. On 6 May Der Spiegel reported that “Greece Considers Exit from Euro Zone” with a view to re-introduce the Drachma, negotiating to that effect with EC and Eurozone authorities at “a secret crisis meeting in Luxembourg” that evening. The fact that the meeting was at first officially denied by Luxembourg Premier Jean-Claude Juncker, then admitted ("When it becomes serious, you have to lie"), lent credibility to the story. The euro lost 2 cents overnight with respect to the dollar.

No Exit

This non-scoop is utter nonsense, and not just because there is no provision for exiting the Eurozone other than by leaving the European Union – a drastic and traumatic step in nobody’s interest. Nor just because this would annihilate the Greek banking system (and heavily damage German and other European banks, including the ECB), or because Euros in the hands of the Greek public would continue to circulate – possibly curtailed by the amounts that the Greek public might be unable to recover from their banks (though they have already salted away €30bn abroad as a result of the crisis). Nor just because Greece would lose the financial support already committed by European institutions (half of €110bn, which have not yet been disbursed), and support lined up in the near future (there is current talk of another €60bn).

Greek exit from the euro is nonsense primarily because the re-introduction of the drachma would not allow Greece to reduce its debt denominated in euro through drachma inflation. The euro debt would rise in terms of drachma through drachma devaluation to compensate for drachma differential inflation with respect to the euro, and remain exactly the same as before the exit.

True, the possibility of drachma devaluation – beginning with the re-introduction of the national currency – might make Greece more competitive and make it prosper to the point of re-gaining solvency. But if a devaluation was 1) politically acceptable (unlikely, after 10 general strikes since the first austerity measures were introduced by the Socialist government) and 2) economically effective (in terms of import and export elasticities with respect to devaluation), the Greek government could replicate its effects via a Latvian-style domestic deflation without the additional costs and turmoil of leaving the Euro.

Which is why Greek exit from the euro is a non-starter, pace Der Spiegel’s news and Hans Werner-Sinn’s advocacy. The only other two possibilities are: a bail-out, or a default: Quartum non datur, to coin an expression.

No Bail-Out

When a debtor is solvent but illiquid, a bail-out involves temporary assistance, perhaps by European institutions on terms friendlier than those that might be offered otherwise by financial markets, with full later re-payment. But there is an increasing consensus that certainly Greece – at any rate, leaving aside the similar cases of Ireland and Portugal – is not illiquid but insolvent. The provision of additional loans to allow Greece to repay outstanding loans as they mature, at an interest rate higher than the likely growth rate of the country's GDP (taking both either in nominal or real terms) is a recipe for bankruptcy – unless there is a commitment, on the part of European institutions, to continue to provide non-repayable loans until Kingdom Come.

Paradoxically, this kind of approach appears to have a Keynesian connotation. In “Economic Possibilities for our Grandchildren” (1930) Maynard Keynes quotes approvingly a passage from a book by Lewis Carroll, 1889, [Ch. 10, The other Professor]:

“Let me remind you of the Professor in Sylvie and Bruno:”
[“Come in!”]
“Only the tailor, sir, with your little bill,” said a meek voce outside the door.
“Ah, well, I can soon settle his business,” the Professor said to the children, “if you’ll just wait a minute. How much is it, this year, my man?”
The tailor had come in while he was speaking.
“Well, it’s been a-doubling so many years, you see,” the tailor replied, a little grufy, “and I think I’d like the money now. It’s two thousand pound, it is!”
“Oh, that’s nothing!” the Professor carelessly remarked, feeling in his pocket, as if he always carried at least that amount about with him.
“But wouldn’t you like to wait just another year and make it four thousand? Just think how rich you’d be! Why, you might be a king, if you liked!”
“I don’t know as I’d care about being a king,” the man said thoughtfully. “But it dew sound a powerful sight o’ money! Well, I think I’ll wait-“
“Of course you will!” said the Professor. “There’s good sense in you, I see. Good-day to you, my man!”
“Will you ever have to pay him that four thousand pounds?” Sylvie asked as the door closed on the departing creditor.
“Never, my child!” the Professor replied emphatically. “He’ll go on doubling it till he dies. You see, it’s always worth while waiting another year to get twice as much money!”

The trouble is that this approach can hold only in Lewis Carroll’s Wonderlands, for in the real economy there simply may not exist an interest rate such as to make a creditor, or the financial market as a whole, willing to renew a mature loan in its entirety for another period – let alone another and another. The creditor is more likely to want to cash in at least some of his credit and of the accrued interest, and re-lend only the rest. Clearly Maynard Keynes was not being serious, he was only amusing himself with literary references, as he might have done in conversation with fellows and guests at High Table dinner or over Wine Room drinks.

Bail-outs as Ponzi Schemes

The nature of European bail-outs has been well understood and demonstrated in an article in the Financial Times of 5 May by Mario Blejer – former Governor of Argentina’s Central Bank and director of the Centre for Central Banking Studies at the Bank of England. Blejer likens financial support for Greece, Ireland and Portugal to a giant “pyramid or a Ponzi Scheme”. Ponzi paid insustainably high interest rates out of new deposits, before running away with the residual loot. European bail-outs involve the accumulation of non-sustainable interest rates without the possibility of their ever being paid together with the original loans. The principle is the same.

The bail-outs raise total debt and its share of GDP. “A case in point is the €78bn ($116bn) loan to Portugal. It is equivalent to more than 47 per cent of its gross domestic product in 2010, possibly increasing Portugal’s public debt to about 120 per cent of GDP.”

“It could be claimed that this mechanism is helping the countries involved since the official loans, although onerous, carry better conditions than the ones that need to be serviced. But the countries’ debts will increase (as a percentage of GDP the debts of Greece, Ireland, Portugal and Spain are expected to be higher by the end of 2012 than at the start of the crisis). The share of debt owed to the official sector will also increase (in addition to the bond purchases by the European Central Bank, which reportedly owns 17 per cent of these countries’ bonds with a much higher percentage held as collateral).”

“Some of the original bondholders are being paid with the official loans that also finance the remaining primary deficits. When it turns out that countries cannot meet the austerity and structural conditions imposed on them, and therefore cannot return to the voluntary market, these loans will eventually be rolled over and enhanced by eurozone members and international organisations. … “… this “public sector Ponzi scheme” is more flexible than a private one. In a private scheme, the pyramid collapses when you cannot find enough new investors willing to hand over their money so old investors can be paid. But in a public scheme such as this, the Ponzi scheme could, in theory, go on for ever. As long as it is financed with public money, the peripheral countries’ debt could continue to grow without a hypothetical limit.”

Except that there is a political limit to solvent countries’ willingness to take on the debt of those insolvent: “We are starting to observe public opposition to financing this Ponzi scheme in its current form, but it could still have quite a way to go. It is apparent that, if not forced sooner by politics, the inevitable default will only be allowed to take place when the vast part of the European distressed debt is transferred from the private to the official sector. As in a pyramid scheme, it will be the last holder of the “asset” that takes the full loss. In this case, it will be the taxpayer that foots the bill, rather than the original bondholders that made the wrong investment decisions.”

Blejer points out that the desirability of this approach depends entirely “on how one assesses the value of the time gained. Would a bank crisis now be more damaging to the European economy than a future debt write-off? Or, alternatively, is recognising reality and accepting a debt restructuring now preferable to increasing the burden on future taxpayers? At the end, it is a political decision, but it would be refreshing if things are called by their name. Euphemisms may be useful in the short run, but one finally recognises a Ponzi scheme when it persists.”

No Default?

The undesirability and ineffectiveness of exit from the Eurozone, and the Ponzi-like nature of continued assistance to insolvent sovereign debtors, leaves only one option: default – preferably consensual, negotiated with creditors rather than unilaterally declared and abrupt; in the form of lengthening debt maturity, interest rate haircuts, as well as debt reduction, but default nevertheless. There is no way “No Exit, no Bail-Outs, no Default”, or immovable objects and irresistible forces, can co-exist other than in a Wonderland.

Richard Portes (who was involved in Poland’s 1981 default) makes a powerful case for the restructuring of Ireland’s debt: “A reasonable target would be a debt reduction of €40-50 billion, in present value. That is on the order of 30% of GDP and would bring the debt ratio down to a sustainable 80% or so. The required haircuts would be in line with current market valuations of Irish sovereign debt.”… “Of course, there is a way for Ireland to escape responsibility. Just wait for Greece to restructure its debt, at which point there will be general confusion and the markets will shun Ireland anyway. Then restructure, when it will be widely accepted as unavoidable. Maybe that is the unspoken strategy. If so, there may not be long to wait.”

Martin Wolf (in his FT Column of 11 May) works out that with a debt/GDP ratio of 160%, and with very optimistic assumptions of a 6% interest rate (less than half of the current 15%, or the 25% on two-year bonds), and a 4% nominal growth rate, even to stabilize debt Greece would need to run a primary surplus (before interest payments) of 3.2%; and a 6% primary surplus would be necessary to reduce the debt/GDP ratio down to the Maastricht Treaty ceiling of 60% by 2040. “Every year, then, the Greek people would need to be cajoled and coerced into paying far more in taxes than they receive in government spending.” “What might persuade investors that this is sufficiently likely to justify funding Greece? Nothing I can imagine. But remember that 6 per cent would be a spread of less than 3 percentage points over German bunds. The default risk does not need to be very high to make this extremely unappealing.”

Wolf recommends “a pre-emptive restructuring of the debt, perhaps next year. Since market prices tell us that this is what investors expect, it should not come as a shock to them. A restructuring ought to raise the country’s creditworthiness and increase the incentives to sustain a programme of stabilisation and reform. Moreover, with a planned, pre-emptive restructuring the authorities could also prepare the needed support for banks, both inside Greece and outside it.” “Overindebted countries with their own currencies inflate. But countries that borrow in foreign currencies default. By joining the eurozone, members have moved from the former state to the latter. If restructuring is ruled out, members must both finance and police one another. More precisely, the bigger and the stronger will finance and police the smaller and the weaker.”

What used to be isolated voices contemplating default are turning into an increasing chorus. “A Reuters poll finds that investors and economists believe Greece will have to restructure its sovereign debt, with 14 out of 15 fund managers and 26 out of 28 economists polled. Opinions are more divided when it comes to the timing. Half of these economists and a third of the fund managers believe it will happen after April 2012. From those 11 economists and 8 fund managers believe restructuring will happen through haircuts, while a majority believes it will happen through extending maturity and lowering interest rates.” (Eurointelligence.com, 13 May). “FT Alphaville picked up on a paper by Barclays Capital, which looked at the haircut needed by Greece to achieve a primary balance - which is 67% in 2012 – based on a primary balance of minus 2.5% this year. It goes into a great detail about recovery values to conclude that the situation is really messy.” (Ibidem).

The most vocal opposition to any talk of default comes from Lorenzo Bini Smaghi, at present a member of the ECB Executive Board. Bini Smaghi’s solution of the sovereign debt crisis is the issue of European sovereign bonds, that would compete with US Treasury Bonds, lowering interest rates and financing the bail-outs. It is immensely naïve to believe that a EU institution, backed by a tiny budget of just over 1% of EU GDP and a built-in zero primary surplus might successfully compete with the US Treasury, with a tax revenue of over 35% of GDP out of which it is conceivable that a primary surplus sooner or later might be sufficiently high to service its debt.

With Mario Draghi’s coming appointment as ECB President, after Angela Merkel’s endorsement, Bini Smaghi is expected to have to leave his ECB post to make room for a Frenchman, and was considered to be in a strong position for a bid to succeed Draghi as Governor of the Bank of Italy. But other frontrunners for the post, Vittorio Grilli (Director General of the Italian Treasury and the president of the EU’s economic and financial committee), Fabrizio Saccomanni (the Director General of the Bank of Italy) and Ignazio Visco (his deputy), are less committed to Bini Smaghi’s agenda. Certainly Draghi has already stated firmly that there can be no European sovereign bond ahead of Fiscal Union. Maybe he will also be more open to orderly but unmitigated defaults, before the sovereign debt crisis becomes unmanageable.

More on Hungarian Populism

My friend the Hungarian economist Yudit Kiss (Geneva) contributes this comment:

Dear Mario,

You are very right about the parallels between Berlusconi and Orban – Viktor Orban is clearly inspired by Berlusconi but there are several points where he goes much further then any of the populist leaders today.

Since last April the Fidesz-MPP Party, that won a 2/3 majority of the Parliamentary seats in Hungary, started to dismantle systematically the democratic institutional system that was built during the last 20 years. The process started with the drastic curtailment of the powers of the Constitutional Court, then those of the Budget Council, the rights of the media, an attack on the independence of the National Bank, the introduction of a whole series of new laws and regulations, crowned with the hasty introduction of a new Constitution, all written to suit the values and interests of the governing party.

The new Constitution will be followed by the introduction of 39 "fundamental laws" (that need the approval of 2/3 of MPs) that regulate such basic dimensions of life as labour, voting rights, the pension system, party financing or the regional administrative system. These laws will be created within a year, probably by the same method as the Constitution and the other new laws that have been accepted by the completely docile Parliament since last April, i.e. with the exclusion of independent experts, social partners and the political opposition.

According to Fidesz, last April a Revolution took place at the ballot box and this gives them the right to change radically key dimensions of public and private life in Hungary – from the tax system to social welfare, from street names to education, from film-making to the right to vote. Since the new Constitution declared that Hungary is a Christian country and life is sacred since the moment of conception, the prohibition of abortion and the introduction of compulsory religious education might be just a question of time. Another measure with long-term consequences is the increased tenure of key public functions, so that even if it lost the next elections, Fidesz' interests would be represented at the highest levels under future governments. The new Constitution limits further the independence of judges (and abruptly lowers their retirement age, so that a large-scale renewal of the profession's staff and its leaders) making it even more difficult for everyday citizens to fight for their rights. The President of the Supreme Court was not consulted or informed about this measure previously; neither were the Director of the 1956 Institute or the Rector of the Corvinus University, who learnt about the end (the planned dissolution, in the case of the latter) of their institutions from the media.

With the signing of the Constitution by the President, who faithfully follows the governing party's directions, Hungary ceased to be a Republic and became “the country of the Hungarians". Fidesz claims to act on behalf of the "nation" and the nation includes Hungarians living abroad. One of Fidesz's first steps was that of offering citizenship to ethnic Hungarians living outside the country, promising them voting rights for the next elections. If the EU cannot prevent this, Fidesz will indeed reign for 20 years (as its leaders promised before the elections) and a very dangerous precedent would be created inside the Union.

According to the canon of the populist-nationalist rhetoric, Ministries and several public institutions became "National" and the government is in permanent fight against external and internal enemies. In the Prime minister's speeches Hungary is portrayed as an exceptional country that is not acknowledged by the world at its true value. The country's external enemies are international capital, the IMF and the World Bank, and according to Orban's speech pronounced at the 15th of March national holiday, Brussels that intends to "dictate Hungarians what to do from outside" but is doomed to fail. Internal enemies are the representatives of the previous governments, many of whom are subject to criminal charges, including former PM Ferenc Gyurcsany, or those who occupied leading positions under the previous government. (Corruption is undoubtedly a very grave and generalized problem of Hungarian society and there were some very corrupt Socialist politicians active during the last two cycles - together with corrupt politicians from other parties, including Fidesz – but the criminalization of the whole previous political leadership is more a political manoeuvre then an exercise in transparency.) The critics of the system, particularly if they raise their voice publicly abroad, are also labelled "enemies of the country", as shown by the current witch-hunt against the best of Hungarian philosophers.

Fidesz is on its way to build a genuine party-state – changing the management of state and public institutions and extending its control over spheres that enjoyed a considerable autonomy before, like regional or local governments or independent institutions, partially financed by the state. According to a decision taken in December, 35 prestigious independent public foundations, including the world-famous Institute Peto for handicapped children, several foundations defending minority rights or the 1956 Research Institute, have been dismantled. The directors of public media, theatres, academic institutions, schools, many public companies and institutions have been changed, when the institution itself is not closed down. Those who occupied leading positions under the former governments, including school headmasters, hospital directors or elected leaders of independent organizations have to reapply for their jobs and many of them are replaced. Party affiliation often overrules professional competence and, if arbitrary decisions are not accepted meekly, sometimes a whole professional team pays for it. In a recent, utterly Ubuesque episode the President of an intergovernmental committee in charge of deciding about geographical names was sacked, because he disagreed with the government's proposed new name for Budapest Airport that left out "Ferihegy", the traditional name that was used for decades. 20 out of 21 members of the professional committee had the same view, but the government's proposal went through and later the whole committee was dissolved.

In his first speech after the elections last year Mr Orban promised to put in order the economy, strengthen public order and then start work on a new Constitution. The economy was "put in order" in a way Janos Kornai describes in the NÉPSZABADSÁG article you quoted in a comment to your post on Populism. Many of the country's best economists criticise sharply the government's economic policy, including experts with such diverse backgrounds as Laszlo Csaba, Tamas Bauer, Gabor Oblath, Andras Inotai or Tamas Mellar. Public order was "restored" by a revision of the penal code and the introduction of severe punishments even for minor offences, like speeding, or smoking in certain public places, like bus stops. There are plans to lower the age of legal responsibility to 14.

Beyond the populist rhetoric, however, actual measures do not serve the interests of ordinary people. The new tax system favours the better-off sections of the population, welfare services are being and will be radically cut back, prices of public services are raised, while the new Constitution curtails seriously labour rights.

One of the first conflicts between the government and the Constitutional court broke out due to a new regulation that makes it possible to dismiss public employees without justification. In his pre-election speeches Orban promised 1 million new jobs in 10 years. According to the latest report of the Hungarian Statistical Office, in one year 13,000 new jobs were created, but at least 50,000 jobs were lost. Unemployment stagnated at 11.6%, but was 26.8% among first job seekers (between age 15-24) and reached 10.8% in the age group of 25-54. Average unemployment lasts 18 month, an increase of 1.8 month. The new regulations are also very harsh on the poor, jobless, homeless, marginalised, handicapped, including those on invalidity pensions. Some of these measures are utterly grotesque, but given the general context, one does not feel like laughing; homeless people can be fined for "using public spaces for living" and in some districts of Budapest those who are caught scavenging in the garbage bins also have to pay fines.

The new power's way of dealing with dissent is also very disturbing. After the first months' startled silence, public protests started with a small group of University students who took to the the streets in December with a slogan: "We are the first generation born in a state of law, we don’t want to be the last one." Demonstrations and meetings have multiplied since, including an approximately 30,000 strong gathering in defence of press freedom on the 15th of March national holiday, organized by a small team of civil society activists and a joint, Hungarian and international trade union protest that gathered about 50,000 participants in April. The government usually ignores these massive expressions of dissent, clearly stating that it does not consider necessary to follow a dialogue with its political adversaries, potential social partners or its people. If there is a dialogue it takes the form of choosing one privileged interlocutor – e.g. one particular trade union or one Roma organization – as the only legitimate representative of a certain constituency, with which the government carries out exclusive discussions. Another form is a practically ex-post and formal "popular consultation" that was used in the case of the Constitution; approximately 2 weeks before the final text was presented to Parliament, every citizen received a personal letter with 12 questions about the future text that did not touch any of the crucial points of the document. According to government sources approximately 920,000 persons responded, so the Constitution could be said to have been publicly and democratically discussed and accepted by the people.

In other cases, however, the government's reaction to criticism is harsher. Following recent demonstrations of public order organisations, including firemen, who protested against new measures that take away some of their social gains and worsen their working conditions, the changing rooms were searched and prosecutions were started against several participants, because they marched in their uniform that is not permitted by the current regulations. For this week-end's planned demonstration the firemen plan to borrow uniforms from their Austrian colleagues and hopefully no one will be persecuted. International solidarity helps…

In another, very telling case, the independent mayor of Esztergom, a city some 45 kms away from Budapest, revolted against the Fidesz majority city council that has been obstructing her work ever since her election in the municipal elections in last October. Following the mismanagement of the previous Fidesz leadership, the town is on the verge of bankruptcy and the new mayor wanted to put things into order. Backed by the inhabitants of the town, she asked for help from the government, but had no reply. Finally, she decided to walk to the Parliament, accompanied by a delegation from the city's civil society representatives and sympathizers all along the road. She was not received by any government representative and could only hand over her protest letter addressed to Viktor Orban to a MP at the gate of Parliament. In her absence the city council met, headed by a senior official and passed some new measures without consulting her.

The case of Hungary also demonstrates one of the most serious dangers of the recent breakthrough of the extreme-right; the adaptation of their language, arguments and objectives by mainstream political currents. The Hungarian extreme-right party Jobbik entered Parliament at the last elections. Jobbik is not a coalition partner and Fidesz and Jobbik often display their differences publicly; however, Jobbik's language has entered the public discourse, its arguments are taken up by mainstream politicians and it has been implementing its policy with increasing self-assurance and tacit support. One of the leit-motifs of Jobbik's political agenda is the "fight against Gypsie criminality" and this Spring they started to put into practice their agenda. Since early March Jobbik activists and uniformed members of the "Civil Guard Association for a Nicer Future" (successor of an outlawed, openly racist paramilitary organization, the Hungarian Guard) marched up and down in the village of Gyongyospata, "maintaining order", terrorizing, humiliating and harassing the entire Gypsy population, as a retaliation after a Roma youth was caught stealing wood in the nearby forest. The police stood by, having the order only to intervene if atrocities were committed on either side. Violence broke out in late April, after a stormy Easter weekend that most Roma families spent separately; women and children were evacuated to a youth camp near Budapest, because "Nicer Future" had scheduled a "training weekend" next to the Gypsy settlement. This led to a country-wide scandal (government officials stating that the Roma just left for a holiday and accusing the opposition of wipping up a scandal to discredit the country), and, finally the arrest of some of the leaders of the paramilitary organisation. When they were released a couple of days later and "shared their joy" with the embattled Gypsy community, a massive fight broke out (fortunately nobody was killed) and the government hastily took a measure to forbid "uniformed violence".

I could go on and on. There are some good sites that cover developments in English, see e.g. http://esbalogh.typepad.com/hungarianspectrum/,
http://hungarianwatch.wordpress.com/. A site summarising events in Gyongyospata http://gyongyospatasolidarity.wordpress.com/ .

You are also right about proposals for solutions. Unfortunately we live in a time of crisis, and the solutions that are being used to tackle this crisis are actually making it worse. People all over the world express their frustration with politics and the present state of affairs, but are not able to offer genuine solutions. New economic and social models are urgently needed!