There are questions whether creditors especially banks and bond holders are ever going to get paid back. This is a serious problem not only in Europe, but also in China. The only real way that these places can grow is through structural reform, which in far more improbable than most of the experts now expect
William Gamble
Should, could, might, ought, may—all words quite appropriate to reform. Whether it is Greece or China, there are thousands of well-meaning, well-informed people, from the World Bank to the Nobel laureates who have prescriptions for reform. Some might even work. One problem. It won’t happen. Why? Simple, economics. To be more precise, the logic of collective action.
Investors, businesses and ordinary citizens all have invested in the status quo. To protect their interests they form into what Mancur Olson called distributional coalitions, basically organized power groups. These special interests groups come in all shapes and sizes. From hedge funds in the US fighting to preserve favourable tax treatment; striking Italian taxi cab drivers trying to maintain their monopolies or the Chinese Communist Party’s efforts to control everything—they all have powerful economic incentives to prevent change. The probability of reform is determined by the difficulty of restricting these groups. This is no where better illustrated than the problems with Greece.
The usual suspect that stands in the way of reform is the government itself. All governments come equipped with large bureaucracies tasked with running the country. In “for profit” companies these would be called staff positions. They consume revenue. The opposite are line positions, positions that produce revenue. To insure profit and insure survival, companies are constantly looking for efficiencies, which often involve paring staff positions. Governments really don’t die and have few incentives to cut costs, so the bureaucracy’s incentives are to maintain their size or, even better, increase it.
Given these incentives, it is hardly surprising that every bureaucracy tends to be a conservative organization highly resistant to any type of change. Even worse, bureaucracies are a perennial dumping ground for patronage. This is especially true for a relationship based system where favours are the basic currency. The result is that neither the institutions themselves nor the politicians who are nominally in control of them will help either encourage or enforce reform.
Greece is an excellent example. Although the Greek private sector has lost about 500,000 jobs, almost 5% of the total population, the government has lost only 1,000. It has taken the extreme pressure from the so called troika, European Commission, International Monetary Fund and European Central Bank, and threat of withholding billions of bailout money to get the government to merely promise to cut 15,000 civil service jobs.
The bureaucrats not only increase the cost of the state, they prevent reform by diligently enforcing needless regulations. The burden of regulations usually falls on the more vibrant sectors of the economy—small entrepreneurs. These businesses not only help the economy grow, they also create the most jobs. The potential for selective enforcement can encourage corruption as bureaucrats farm their positions for bribes. Countries which lack strong independent enforcement methods are especially vulnerable as one arm of the government protects or conceals malfeasance by their colleagues.
It is not just the bureaucrats who have an economic incentive to prevent reform. Wealthy taxpayers are masters at manipulating the system to suit their needs. The enormous size and complexity of the US tax code is clear evidence of their efforts. In the US though, taxpayers use influence to change the law. In Greece they just ignore it. Not only do self-employed doctors and dentists tax at a lower rate than their secretaries, they actually pay less tax. Since there is so much money involved, tax collection is one of the most corrupt functions of the Greek state.
Elites in the government and the rich are the usual suspects when it comes to groups who have an interest in blocking reform, but they are also joined by blue-collar union members. Civil service state-owned company unions are often the most virulent. Private sector unions at least understand that if they ask for too much, their employers will go out of business. There are no such restrictions for government workers. Their incentives are to manipulate politicians to get the best deal no matter what it costs the rest of the taxpayers.
In Greece they have demonstrated some rather unique ways to prevent reform. The police are normally charged with upholding the law. In Greece the police union threatened to arrest senior government officials leading missions form the International Monetary Fund, the European Central Bank and European Commission. Not to be outdone Greek workers at the state-controlled power company prevented power cuts to customers who don’t pay their bills.
The question of reform is acute for any long-term investor. There are questions all over the world as to whether creditors especially banks and bond holders are ever going to get paid back. This is a serious problem not only in Europe, but in places where you might not consider like China. The only real way that these places can grow is through structural reform, which in far more improbable than most of the experts now expect.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected]).
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