Restructure or default?

**When you can’t fix a problem yourself, you ask for help. So did Greece, Ireland, Portugal, Spain, and most recently, Cyprus. As speculators drove up the interest on their debt, servicing it became increasingly unsustainable.**

To ensure they don’t follow similar fates, countries across Europe are taking the path of austerity, hoping to reduce their debt before it becomes too much of an issue. Austerity is the attempt by a government to decrease its budget deficit through changing policies. The potential benefits of austerity, however, appear to be diminishing.

Thanks to austerity, tax revenue has fallen, in spite of tax hikes. While it is natural that a shrinking GDP should produce shrinking tax returns, the reality is tax revenue is falling faster than national income. The jobs that do remain pay less, while costs have gone up. Because of the high marginal propensity to consume of the ordinary worker, any cut in income for these members of society will translate into a big fall in sales tax. Due to the smaller incomes, higher tax brackets won’t be reached, pulling back the effective income tax rate on the economy.

In some ways, austerity is strikingly similar to bad business. Imagine an orange juice company. If you squeeze all the orange juice while cutting down the orchard from which you get the oranges, you may get money for the juice and the timber today. But an orange has only got so much juice, and a tree can only give so many oranges. Soon enough, you will find you’ve run out of oranges to squeeze. Europe is beginning to witness this first-hand.

Realising they’re running out of oranges to squeeze, politicians have begun the operation to knock down and sell off the orchard. Governments have stepped up their privatisation and state reform agenda. In Portugal, the government promoted a conference on reforming state functions under the secretive Chatham House rule, with one suggested reform being the dismissal of tens of thousands of public employees and the creation of tuition fees for state schools. Across Europe, the right-wing is organised to take this programme even further, with the unashamed dismantlement of the welfare state. The IMF has admitted that the effects of further cuts would be highly recessive, making the task of containing and rolling back deficit spending even harder.

The more the economy shrinks, the more unsustainable it will become. For this reason, some economists have been entirely more radical. In order to be able to foster growth, they propose that we give up the foolish policy of austerity, and default on debt payments, even if temporarily. As a result of cuts made in the past few years, primary budget deficits (before debt payments) are now close to zero. By defaulting, southern Europe could balance the books, stop (or at least soften) the cuts, and the economy could be given breathing space to grow.

While, in the world of ceteris paribus this could work, what would ensue? Rightly or not, national sovereign debt has been increasingly concentrated in the banks of their respective countries. A default would throw them off the cliff of bankruptcy, and take other European banks and the whole economy down with it. Savings would vanish and money flow would stop, until the economy recreated institutions to manage its financial resources. While there are arguably benefits to this ‘creative destruction’, it is not a risk I’d like to take.

The debate on the fiscal prospects of bailed-out economies has been conveniently framed between these two catastrophe policies: austerity or default. Because a default would be unthinkable to many, we are told we just have to bear the brunt of the cuts and swallow the harsh medicine. With the profits bankers are making from speculating on European debt, and the glee they get from increasing their relative privilege over those who previously depended on the state to guarantee them a decent standard of living, the official line has been that there is no alternative to austerity.

This is a lie. Historically, the most common and indeed the most successful way to deal with debt has been restructuring, not austerity. Compared to the other two options, restructuring should be seen as a sensible, middle-of-the-road response. If we can’t fast-track debt reduction through lower deficits, as the failure of austerity seems to show, and if we can’t just admit defeat and default on our debt, we should adopt a more balanced position that addresses the mutual interest in paying down debt of both creditor and debtor states.

Restructuring recognises that the best way for us to recover from this crisis is by us coming together as partners, and not trying to punish one another for our own inadequacies. The choice we have to make is simple: do we want to continue the nose-dive into an abyss of poverty, or have we got the courage to shake off the prejudices of the past, restructure, and doing so, give birth to a new tomorrow.