Monday, 28 March 2011

Honesty is More Important Than Cash (or, Value is More Important Than Liquidity)

Never in over a generation has a Greek government asked its voters to accept pay cuts from the public sector. Now local government has faced the harsh reality of not renewing contract hires, amounting to 25,000 layoffs. (Municipal workers occupied city hall, seen in this photo on March 30, blaring music from the windows and being as ostentatiously idle as possible). The question of layoffs is now sneaking closer to loss-making state enterprises, which are no longer to live off the state bounty. All this is being done under the dictates of our new troika of creditors, the European Central Bank, the International Monetary Fund and the European Commission. Perhaps the terms seem colonial, but Greece is only being asked to do what it has avoided doing for over a decade, against its better judgment.

If the woes of the present seem insurmountable, we need only look at the difficulties from which Greece has extricated itself in the past. Greece is recorded as having bankrupted itself no fewer than eight times in its nearly 200 years of independence; but it has never been more precariously perched than it was during its struggle for that independence. The process of raising two revolutionary loans for the fight against the Ottoman Empire is instructive. Greece’s present indebtedness to banks and stockholders around the world began with its very inception and was due to poor money management and a weak political centre.

As William St. Clair tells us in his classic story of the Philhellenes’ part in the revolution, That Greece Might Still Be Free (1972), the first revolutionary loan was floated in London in 1824 and was nominally valued at 800,000 pounds sterling. But its shares were issued at a 41 percent discount, so an investor only needed to pay 59 pounds to secure a 100 pound share. Greece was under further obligation to pay the shareholders a five percent annual interest rate, the first two years’ worth of which was withheld at source. To cap it all, the loan’s brokers, Messrs. Loughnam, Son, and O’Brien, extracted 38,000 pounds in “commissions and expenses”. Thus, out of an 800,000 pound loan, only 300,000 were available to the Greek cause – and that only on paper as investors were only asked to pay 10 pounds of the 59 in advance, the rest being payable in instalments. In the event, 80,000 pounds were dispatched to Greece.

On the back of the bonds was written, “To the payment of the annuities are appropriated all the revenues of Greece. The whole of the national property of Greece is hereby pledged to the holders of all obligations granted in virtue of this loan...”.

If the terms of this first loan seem colonial, the second, floated exactly a year later, was additonally marked by rampant corruption. It was valued at 980,000 pounds, but St. Clair tells us that 113,000 were spent boosting the value of the previous loan, whose trading value had fallen from 59 to 54 pounds, “in other words playing the market in order to keep the price up, an activity affording innumerable opportunities for the exchanging of favours and the lining of pockets.” Hundreds of thousands of pounds were spent on an abortive scheme to build a Greek fleet; and the London Greek Committee’s British and Greek directors simply embezzled large sums. “For example,” says St. Clair, “a sum of 2,695 pounds was charged as lost owing to the failure of a Greek merchant in London: the merchant’s books showed only 500 pounds. The sum of 1,200 pounds was credited as received from Calcutta from a subscription there, but the Calcutta accounts showed that 2,200 pounds was sent.”

Once the money did become available to Alexandros Mavrokordatos, the nominal head of the Greek civilian government, he was forced to spend it on the personal militias built up by the captains who effectively comprised the revolutionary fighting force and could blackmail the weak central government. Rather than entering the market and creating an economy, the money was stashed away in a relatively small number of households.

It is highly doubtful, in sum, that Greece’s first borrowings had any beneficial effect on its development. Quite the opposite, in fact, is likely. The bondholders of the two Greek loans, whose value collapsed as Greece never made a single interest payment, made sure that the newly independent country was barred from ever gaining credit in Europe’s stock markets until 1878. Greece’s debt on 1.78 million pounds’ worth of capital had by then accrued to more than 10 million pounds. As the country was running an irreducible deficit it became apparent that it would never schedule repayments, and the bondholders compromised on a write-down for all interest payments hitherto due in return for the issuing of 1.2 million pounds’ worth of new bonds at five percent. It was a severe haircut for Greece’s creditors on loans that had done Greece little good.

Greece had, in 1824 and 1825, benefited from a speculative wave in the fortunes of far-flung states. That wave was not born of a sudden altruism on the behalf of struggling peoples. It came about because the Bank of England reduced the interest paid on its bonds from five percent to 3.5 percent, leaving speculators looking for higher returns but ignoring the higher risk. The speculative bubble collapsed with the Bank of England bailing out investors and banks. Both in the 19th century and recently, therefore, Greece has simply been the victim of the combined venality and greed of its own politicians and that of the banking system.

Nor would this be the last such collapse in creditworthiness. As Professor Thanos Veremis recently wrote, Greece’s nation building prime minister, Harilaos Trikoupis, would avail himself of loans at the end of the 19th century, a time when Western banks were looking for new business on the periphery of Europe to counter a recession at home. Once again he would lead Greece to overborrowing and bankruptcy; but Trikoupis managed the loans in such a way as to leave Greece with its first serious infrastructure in road, rail and harbours, in an effort to render Greece’s agricultural produce exportable.

Trikoupis’ bankruptcy may have led to years of stagnation, but it also generated economic growth. The lesson seems clear: Economic cycles and speculation may cause periodic collapses in growth and credit, but they will be most strongly positioned to weather such collapses who have quietly spent the good times building real value into their economies. Money, equities and bonds rise and fall; productivity and competitiveness cannot be argued with.

Wednesday, 16 March 2011

As good as our bond (and other thoughts)

The stipulations of the May 2010 memorandum between Greece and the troika overseeing its 110 billion euro bailout are patently useful and necessary. Completing a limping privatization programme, reducing the state’s million-strong workforce and improving public transparency in major areas of expenditure such as healthcare are long overdue. So are a slew of development measures such as the opening of closed professions and markets and the parting of a Red Sea of bureaucracy.

But more than the obvious is needed. One of Greece’s greatest assets is its intellectual potential coupled with a national obsession with education. Drawing ideas from as many people as possible, something the government has tried to do by airing bills on, is a potential source of strength and innovation.

The country now needs the most imaginative, forward-looking and prescriptive ideas for policies it can generate, which could be implemented over the remaining two and a half years of the government's term and could boost competitiveness at relatively low cost. Here are a few to start with.

Bonds for taxes: The government wants to secure a level of funding from its shrinking tax base that will persuade the troika to release vital loan instalments. But its tax measures are becoming increasingly shrill and desperate. While it has refrained from raising income tax, its capitulation to higher consumer taxes (VAT has gone from 19 percent to 23 percent) penalises the poor.

The government will be under increasing pressure to be strict about tax collection. Already it has sent audit papers to thousands of businesses and self-employed professionals, reassessing their obligations as far back as ten years. Putting the squeeze on a shrinking tax base will only encourage flight and discourage business. The government, which no longer returns VAT as it is obliged to do, will only appear unpopular and unfair if it persists in being strict on tax collection and lax in cost-cutting and meeting its own obligations.

This is being done to create a steady income on the basis of which the government can borrow. It could instead tie a carrot to the stick of tax collection by allowing taxpayers to divert a proportion of their tax obligations, say 15 percent to begin with, to government bonds. This would turn taxpayers into investors, giving them a return on their money, and could encourage many people to declare their full earnings. In this way the government could actually increase government revenue, while offering the benefit of interest payments to its own subjects rather than foreign bankers. By entering the Greek economy, those interest payments would then boost Greek banks’ liquidity and help loosen up credit. The plan would also send a signal to money markets that the Greek people are backing up their faith in their future, encouraging others to do the same. In short, by selling more of its debt to its tax base, Greece could better control its credit history, repatriate capital and boost national solidarity, a vital component of credibility. Financial health begins at home.

A further annex to this plan could be to emulate Ireland’s recent pension reform and make third pillar retirement insurance mandatory. Greece’s 13 major funds are either tottering or in danger of doing so. It is inevitable that they will at some point shift from defined benefits to defined contributions schemes, meaning that benefits will vary according to funds’ abilities to pay. People under 50 will have to boost their retirement with a private plan in which the government will have no guarantor role. Making such a plan mandatory – to the tune of, say, two percent of salary earnings - would effectively introduce a limited 401K plan to every company Greece and create new growth in the banking and insurance industries.

Charter schools: Secondary education in Greece is, by the common consent of both parents and academics, where the system founders. Outdated textbooks, lack of critical thought, poorly funded computer and science laboratories, serial strikes and student sit-ins are the major problems plaguing public education. The private sector has flourished, to some extent, but it is still beholden to a poorly designed national curriculum, and also creates a divide between those who can afford good schooling and those who can’t.

One answer would be to allow charter schools, a regime unknown in Greece. These would be recognised by the education ministry and offer national diplomas, but would have a degree of freedom to hire and fire their teachers according to ability. They would also be able to veer away from state textbooks and towards better courses produced by independent publishers, and mould their curriculum outside a core of mandatory courses.

The benefits of such a system would be manifold. A well-governed school could become a paradigm of meritocracy, teaching students by example; legitimising non-state textbooks would galvanise nonfiction publishers and authors, an area where Greece has tremendous intellectual resources; and better educated graduates would be an enormous boon to the economy.

It is an alomst unnecessary addendum to say that the liberalisation of higher education would give the tertiary sector in Greece wings with which to turn education into an export industry.

Give the church a stronger social role: The Church of Greece has vast, unused real estate holdings dating back to revolutionary times. Many of these go undeclared by the 100 metropolitanates that make up the church’s constituency. A proper auditing of church property would strengthen the hand of the Holy Synod, and enable it to begin to put this property to good use.

Under Archbishop Christodoulos the church applied for a license to build a hotel on some of its land. But merely commercial use of church land lacks imagination and moral depth. Unlike the Catholic church, the Orthodox church has not, in recent history, made a name for itself in secondary or tertiary education. Church-sponsored schools in Greece are held in very low esteem for their tendency to indoctrinate rather than teach. The church could very well work with the state in co-financing a small number of secular, high-quality charter schools that could charge modest fees and command tax-deductible, corporate social responsibility contributions. These could in turn become feeder schools for a church-owned but secular campus university. Should the church enter the fray of Greek secondary and tertiary education, it could strengthen the role of other non-state schools in trying to break a culture of mediocrity that condemns generations of students to uncompetitive and uncreative ways of thinking.

Liberalise energy: The other great potential export industry is energy, but not on the model of centralised, large generating plants. In order to have the green energy revolution the Pasok government claims to want, Greece needs to go into micro-generation. A revolution in solar water heaters popularised green energy in the 1970s. The same can happen today with solar panels on roofs, but only if the finance ministry offers tax incentives.

Power is worth 10 percent of Greek GDP today. With the right incentives and, above all, liberalisation, it can become an export industry worth much more. There is also a security reason for micro-generation. With generating capacity spread over roofs across the country, it is much more difficult for power supplies to be knocked out by earthquakes, floods or bombs.

Give parliament’s audit committee the power to check political parties: A 2001 constitutional revision introduced representatives of the country’s three top courts – the Supreme Court, the Council of State and the Court of Audit – in a parliamentary Audit Committee that checks the annual financial declarations of parties and their deputies (previously it was peopled exclusively by party appointees).

A law the following year obliged “political parties and coalitions in receipt of state funding [to] publish annual balance sheets showing income and expenditure.” These balance sheets, published in summary form in the first two months of each year, are subject to review by parliament’s Audit Committee, which employs the services of chartered accountants.

Yet the system remains vulnerable to massive fraud. The Audit Committee may only work on the basis of documents submitted by the parties and MPs; lacking prosecutorial powers to raid offices and open bank accounts, it can only check the internal consistency of what it is given. A second weakness of the Committee is that it may not prosecute legally.

George Papandreou came to power on a commitment to unprecedented transparency in government. He should now prove his commitment by giving the Audit Committee the legal teeth to act independently of political power, and act as a check. The committee should be given power to initiate raids and investigations, solicit documents and follow money trails. Merely the provision that the auditor’s report, and possibly its minutes, should become a matter of public record would provide a powerful bulwark against mollification.

The parties that have molded the political scene since democracy was restored in 1974 are increasingly seen as the architects of Greece’s crisis through their nonchalance and corruption. Casting out of those who are demonstrably corrupt is now necessary to their survival. Failure to shore up principle and build institutional depth will have greater costs for the socialists and conservatives than all the upheaval of change. If the inducements of high office are irresistible, they are also self-destructive.