Why Piketty Is Wrong about Debt Forgiveness

6 July 2015, 1726 EDT

[UPDATE: This provides more detail and context than I do. Read it instead of, or at least in addition to, my post.]

Thomas Piketty has decided that because Germany was the beneficiary of debt relief in 1953 that they should extend the same privilege to Greece today:

When I hear the Germans say that they maintain a very moral stance about debt and strongly believe that debts must be repaid, then I think: What a huge joke! Germany is the country that has never repaid its debts. It has no standing to lecture other nations.

Before explaining why this is both normatively and positively misguided I would like to clear some brush by mentioning two things. First, everyone (including me!) agrees that Greece’s debt must be written down. In fact, a gradual disposal of Greece’s debt has been a part of bailout program since 2010 and more of it will be discharged in the future. Greece has not paid back a single cent on net. In the meantime the debt is being financed through rollovers whose interest is mostly being paid by the rest of Europe while Greece has received fiscal transfers equivalent to more than 100% of GDP. So it is not an accurate characterization of the situation to say that the Greek economy is being squeezed in order to pay back debt; it is being squeezed because its level of spending was not matched by its level of productivity. And in some ways it still is not, although it is now quite close.

Second, while it would be very nice to have an international bankruptcy mechanism that would allow us to discharge debt and reorganize national economies in an orderly fashion, governments are unlikely to cede sovereignty over this issue for understandable reasons. So ad hoc bargaining is what we’re stuck with for the foreseeable future.

Still, Piketty’s claims have gotten a lot of attention so they are worth addressing. Unfortunately, Piketty both misunderstands the situation of Germany in the 1950s, misunderstands the situation of Greece today, and contains a ridiculous logic: must it be the case that all debts must be forgiven everywhere if they were ever forgiven anywhere? Of course not. There is a clear equilibrium there: no one lends to anyone without exceptional credit. The first country left out in the cold in such a scenario would be Greece. Greece is going to need financing from the rest of the world — lots of it — before it returns to steady growth. That financing will not come so long as Greece’s attitude is that it should repudiate the debt because it feels morally justified in so doing. So as a matter of simple logic Piketty’s appeal falls short. But beyond that the statement contains enough untruths and confusions as to be wholly inane and unproductive.

For example, in linking the current situation to Germany’s mid-century behavior Piketty echoes Syriza and its supporters, who have spent the past 6 months linking contemporary Germans to Nazis and insinuating or outright saying that Germany still owes penance for the war. For example, shortly after being elected Tsipras said:

We are going to demand debt reduction, and the money Germany owes us from World War II, including reparations [of at least €200 billion].

Believe me, those statements and others like them were noted in Berlin and Frankfurt. This is the context of the last 6 months of negotiations, which surely is relevant. In Syriza’s words the reduction of Greece’s debt is explicitly linked to continued German genuflection over the War. In addition to being unbelievably offensive, this does not seem to have the desired effect on Germans or the rest of Europe, which was as damaged by World War II as Greece was, so doubling-down on this strategy is unlikely to have any positive impression on anyone.

Before you interject that it isn’t clear that Piketty meant, you know, that read these words from later in the same interview:

We cannot demand that new generations must pay for decades for the mistakes of their parents. The Greeks have, without a doubt, made big mistakes. Until 2009, the government in Athens forged its books. But despite this, the younger generation of Greeks carries no more responsibility for the mistakes of its elders than the younger generation of Germans did in the 1950s and 1960s.

Piketty also fails to note the situation under which German debt was forgiven at the London conference in 1953. Germany had spent the preceding eight years under military occupation that enforced top-to-bottom political and institutional reforms. Or, as Daniel Davies put it in January when this stuff was already coming up:

There’s more than a couple of Germans I’ve spoken to over the last few years who have pointed out that although Germany got massive debt relief in the twentieth century, it got it in the context of an equally massive national admission that the entire political system was rotten and needed to be totally restructured with foreign help; this was also the basis on which the integration of Eastern Germany was managed in the 1990s.

I suspect the same terms would not be accepted in Athens today. In fact, a lesser form of them is precisely what Syriza stands against.

The conditions for Germany’s debt forgiveness in 1953 also included an insistence that Germany continue to maintain a trade surplus and primary budget surplus, which guaranteed highly-subsidized exports to a Europe that was still lacking industrial capacity right after the war. This, too, is what Greece is now being asked to do and is resisting. The Troika has already indicated that if Greece does now what Germany did from 1945-1953 that debt forgiveness would be on the table. In fact, the past five years have been motivated by getting them to that point. But due to failed implementation, frequent renegotiation, and sufficiently poor governance at the local level not nearly enough of this has yet been achieved. As a result, debt forgiveness is also not yet feasible. So it is not that Greece has suffered as Germany suffered and thus deserves jubilee; it is that Greece refuses to take the path that Germany took but insists on debt forgiveness anyway. Reciprocity cuts more than one way.

Moreover, the debt Germany was forgiven in 1953 largely came from the Treaty of Versailles, and so was easy to repudiate. Others came from direct lending to the National Socialists in the 1930s, which was also easy to repudiate. Other debt was delayed until Reunification, and so payments resumed post-1990. None of this has any parallel to the current situation.

So I believe Piketty’s normative point is logically questionable and historically inappropriate. But even if it were not there are strong positive reasons why this program is a non-starter. Contemporary Greece is not a pivot-point in an emerging Cold War. I.e., an economically-healthy Greece today is not nearly so important to, well, anyone as an economically-healthy Germany was then. And the German writedowns in 1953 were pushed — hard — by the same Americans who were providing counter-cyclical finance and security guarantees to the European continent. Thus it was not out of the goodwill and kind spirit that Europe forgave Germany; it was the result of power politics.

Greece’s debt was being gradually discharged under the old terms, via ELA. It had already been written down several times prior, including a 75% haircut on private bondholders in 2012. Greece has received more than 100% in direct fiscal aid in the past 5 years, and several multiples of that through low-interest financing and emergency liquidity. This despite failing to fully implement any of the terms of these programs. But because Greece is still unable to run a primary surplus, during a time when government expenditure is 60% of GDP (!), it continues to accrue debt rather than establishing the baselines conditions necessary for further growth. This rhetoric of “squeezing blood from a stone” really needs to end, or at least wait until they begin paying any of this back.

When Germany’s debt was forgiven it was not linked in a political and monetary union with anyone else. Thus, forgiving its debt had no real consequences for Germany’s interactions with others. Simply forgiving Greece’s debt would shatter the entire basis of the Common Market and monetary union. (As many have noted, it would provide clear incentives for Italy, Portugal, Spain — at minimum — to renegotiate their standing within the EMU.) The lesson of this for the European Union are clear: it will destroy it. The Union cannot stand on the principle that some members get to borrow and renege while others stand by. This was the entire purpose of the rules-based fiscal limits that were put into place at the very origin of the monetary union, and even stronger rules are likely to be necessary in the future to save the project.


In closing, I want to reiterate that moralizing about this as Piketty does adds no value. None at all. What needs to happen now is for credible plans for putting Greece on a sustainable growth trajectory — that understands that its true level of income should likely not be where it was in 2007 — that is complemented by a true counter-cyclical fiscal policy. Commitment to such a plan has to come firstly from Greece’s political class. But they’ve done no such thing. In 1953 Germany had. And that’s the difference.