A better way to deal with debt crises

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One of the major economic lessons of the past decade is that austerity doesn’t work. As Greece and myriad other countries have found, you can’t create growth when both the private sector and the public sector are cutting spending. The mathematics simply do not work.

But, while politicians and the public have largely come to embrace this wisdom, economic policymakers and the financial markets have not — until now.

Last week’s appointment of austerity critic Martín Guzmán as the new economy minister of Argentina, and the subsequent stabilisation of both Argentine bond prices and the peso, marks an important turning point in the conventional wisdom about how to fix failing nations. It also marks another step in the most important economic shift of our time — the transition from an era of wealth accumulation that began in the 1980s, to one of wealth distribution.

At first glance, it might seem that the market optimism around Mr Guzmán makes no sense. He is, after all, someone who has argued for rules that would make it tougher for some creditors to be paid (in the short term).

An economist at Columbia University and protégé of the Nobel laureate and IMF critic Joseph Stiglitz, Mr Guzmán understands that if struggling nations need sufficient breathing room to grow. If they are locked into unrealistic debt repayment programmes, they will be more likely to default again. He co-edited a book with his mentor arguing that sovereign debt restructuring tends to come too little, too late, which is one of the reasons that more than half of them are followed by another restructuring or default within three to seven years.

If Mr Guzmán had his way, it would be a lot tougher for investors such as Paul Singer to parachute in and make 1,270 per cent returns on the debt of overstretched countries. He pulled that off in 2016 after a 14-year legal battle with Argentina that trumped bargaining by the holders of 92 per cent of the country’s bonds who had settled for a less lucrative deal.

Mr Guzmán has argued for an international bankruptcy court that would make it impossible for “rogue creditors” to use legal arbitrage to jump the credit queue and squeeze countries at the expense both of other debtholders and beleaguered national populations.

That is an important shift in thinking. The conventional way of dealing with sovereign crises over the past 40 years, as practised by the IMF and the World Bank has been to prioritise the interests of private creditors over everyone else including citizens on the ground. But this strategy tends to lead to situations like the one we have witnessed in Greece, where efforts to make debt more “sustainable” resulted in a 25 per cent drop in gross domestic product. That not only reduces the likelihood of repayment, but creates political polarisation that drives the interests of politicians and creditors even further apart.

So far, there has been a gaping divide between those who believe in “fiscal discipline” and the more progressive policy types who want to acknowledge the painful reality that austerity can create for average citizens.

Mr Guzmán may, in fact, be able to bridge that gap. “The thing about Martín is that he’s terrific at mathematical models and high theory [of the sort that orthodox economists and markets love] but he’s also interested in changing things in the real world,” says Prof Stiglitz. In fact, over the past several years, he has split his time between academic life in New York, and the messier reality on the ground in Argentina.

That also represents an important rebalancing. For far too long, the economics profession has had physics envy, rewarding and promoting people who are better at maths than morality. But the gap between the ivory tower and the real world has led the profession astray.

So much of the neoliberal conventional wisdom of the past 40 years has assumed a kind of market perfection that never really existed. Debt crises are messy, and to assume a single narrative truth about the best way to deal with “spendthrift” nations and credit crunches is to make policy decisions that will, in the end, leave everyone poorer.

Thanks to inventions such as the Hadron Collider, physicists are now able to see how their theories play out in the real world. Martín Guzmán will have a similar chance, in Argentina, to show the world whether a more heterodox economic approach can work. Already, he has been moving quickly to try to resolve debt negotiations so that the country can once again grow, which is the only outcome that will make it possible to repay its creditors.

Not only does this way forward take economics in the right direction, it also takes our thinking about the political economy (and I stress the word political) in the right direction too. Real events don’t happen in a black box. In the real world there are real ramifications — both economic and political — when you let creditors push in front of pensioners.

Obviously, heavily indebted countries such as Argentina cannot have everything they want. But neither should the private sector. It is a necessary pendulum swing. There is more debt out there in the world today than there was before the financial crisis of 2008. It’s just that now, governments are on the hook for so much more of it. Helping them come up with a better way to repay it will be in everyone’s interest.


rana.foroohar@ft.com


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