Yet Another Post on Sovereign Debt and Democracy

Dr. Oatley disagreed with my post on democracy and sovereign debt, and cited some of his own recent research to smack me down. I don't disagree with a word of what he wrote. (And believe it or not, I noticed that that paper -- which I had previously read -- had just come out, but was waiting to post on it until he had a chance to.) I also don't think anything he wrote contradicts anything I wrote.

Why does he think it does? It's my fault. I used the phrase "democracies are exceptionally prone to the sort of time inconsistency problems that lead to things like debt crises" but didn't clarify what I meant by "exceptionally prone" (although "the sort of time inconsistency problems" was intended to temper the statement). I did not mean that democracies have the same perverse incentives that autocracies have with regards to accumulation of sovereign debt. In fact, I meant the opposite: democracies have completely different perverse incentives to accumulate sovereign debt than do autocracies, and this leads to different kinds of debt problems. What does that mean? For one thing, it means that democracies should be less prone to massive accumulation of sovereign debt than autocracies, but they should be more prone to debt shocks. Let's flesh this out.

Democracies face time-inconsistency problems stemming from the fact that democratic leaders are in principle-agent relationships with their constituents. Autocracies are not. So when autocracies increase sovereign debt it is often to confer rents to autocratic leaders and their cronies. An autocratic leader will have no trouble committing his citizens to austerity if necessary to pay down debt (or attract more loans) so long as he is safe in power, because those costs are not borne by him. Even if he defaults and is unable to secure future loans he may draw down funds funneled into Swiss bank accounts while the credit was flowing and live well. Or he may massively inflate his currency in an attempt to service his debts, which is another form of austerity. Indeed, autocratic leaders may wish to promote austerity, according to Acemoglu & Robinson (2006), if it will help maintain their domestic position.

Democratic leaders face incentives to spend in deficit, but also to not accumulate so much debt that austerity or default is required. Citizens in democracies are able to demand (and receive) social welfare spending programs that have automatic stabilizers built in. So in the event of a revenue shock like a major recession or demographic shift, democracies will be prone to a sudden debt crisis. Citizens accustomed to welfare spending (and the public sector employment that entails) will be loathe to give it up and may punish politicians that attempt to impose austerity (see Greece and Iceland right now, and Latin American democracies in the 1980s). They may be less concerned with the long-run effects that default will bring, or they may be better able to get "bridge loans" that tide them over until economic recovery without requiring austerity conditions.

Dr. Oatley acknowledges that Greece was not in his sample, but how about the other countries under discussion: Italy, Ireland, Spain, Portugal? No, because they aren't developing countries. The Baltic states? No, because during most of the sample period they were still part of the USSR. On the other hand, the Latin American countries that experienced debt crises in the 1980s and 1990s, many of which were democracies, were included in his analysis.

The point is that even if I can't generalize from Greece to the whole world, I may be able to generalize from Greece to other similar countries. Like those Muir suggests, and I was referring to originally, that are relatively new democracies, were recently autocracies and often have violent civil conflict within recent memory.

Off the top of my head I can't recall any research that addresses this question directly (perhaps readers can illuminate), but it seems like it maps fairly well to me and is congruent with Dr. Oatley's research because it asks a somewhat different question.

Democracies and Sovereign Debt (Again)

I have a very different take on Greece's sovereign debt struggles.

Here’s a random thought (writes Doug Muir): this blog has seen a lot of posts recently talking about economic problems in Greece, Spain and the Baltic States. All of these are countries that were, within living memory, governed by brutal non-democratic authoritarian regimes. Accident? Or is there something else at work here?

Will develops the point further: "democracies are exceptionally prone to the sort of time inconsistency problems that lead to things like debt crises. As such, there is a huge potential for moral hazard built in if states are able to escape their debt obligations without pain. Just ask California. It's an internal contradiction of democracy, if you like."

I must demur. I just published a piece in ISQ (ungated version) that explores the relationship between democracy, autocracy, and sovereign foreign debt in developing societies. The article suggests that in general, democracies are substantially less likely to accumulate crushing sovereign debt burdens than autocracies. The finding is robust to model specification and estimation technique. The relationship is so apparent it even shows up in simple descriptive statistics: not one of the 44 countries that evolved into so-called Heavily-Indebted Poor Countries Initiative was a democracy for any meaningful period of the time during which it accumulated sovereign debt.

The typical difference between autocracies and democracies is very large. For example, take the average debt held by all developing country governments in the late 1970s, roughly 33 percent of GDP. Then allow this debt to grow at the average borrowing rate for the average autocracy and by the average annual borrowing rate of the typical democracy. After twenty years, the autocracy owes its foreign creditors 98% of GDP while the democracy owes its foreign creditors half as much (49% of GDP). Thus, at least during the last forty years, democracies are substantially less likely to accumulate large sovereign debt burdens than autocracies. Consequently, democracies are substantially less likely to confront sovereign debt crises than autocracies.

Of course, because my sample does not include Greece my results don't speak to the Greek situation directly. They do suggest, however, that Greece is an anomaly, i.e., a democracy that accumulated a very large sovereign debt. Because it is an anomaly, I would be reluctant to use the Greek case to derive general propositions.

Sovereign Debt As Social Contract

The Economist blogger Charlamagne has written an insightful post on Greece:

The Greek civil war, and the bloody score-settling that followed, is a living memory for many Greeks. Any consideration of Greek nepotism or clientelism needs to be seen in that light. So for example, it is not enough to say that Greek civil servants enjoy jobs for life, and that is a big problem. (Though it is a big problem, not least because many Greek civil servants are paid pitiful wages—partly because there are so many of them. That means they will resist austerity measures all the harder, because they feel like victims in this crisis, not fat cats.) But the bloated public sector is also a function of history. ...

Newspapers here in Belgium talk all the time about the government needing to "buy social peace" by paying off some interest group or other. In Belgium, the alternative to "paix sociale" is a strike. In Greece, plenty of grown-ups remember when the alternative to social peace was their neighbour, or their loved-one, vanishing in the night into a jail cell or worse. The current clientelist truce between right and left is the price (albeit a horrible, wasteful price) established for the current version of social peace enjoyed in Greece.

Douglas Muir adds to it:

I’ve always had a very low opinion of Papandreou pere; it hadn’t occurred to me to think of him as a post-conflict figure, trying to restore social comity to a country still riven by its past. I’m still not sure that was really the case, but it’s an interesting perspective. ...

Here’s a random thought: this blog has seen a lot of posts recently talking about economic problems in Greece, Spain and the Baltic States. All of these are countries that were, within living memory, governed by brutal non-democratic authoritarian regimes. Accident? Or is there something else at work here?

It is an interesting question and maybe there's something to it. On the other hand, almost all of Europe and much of the rest of the world has been governed by brutal non-democratic regimes within living memory, yet not all countries are at risk of sovereign debt default. It seems like there's a missing variable somewhere, and I think it's incentives built into the EMU.

More generally I think it's worth thinking about how the evolution of the concept of "liberal democracy" since the end of World War II has left many states in difficult positions. All democratic states have embedded liberalism in a web of social welfare institutions in order to build consensus and maintain social stability, but the price of those compromises has varied cross-nationally. As I've argued before, democracies are exceptionally prone to the sort of time inconsistency problems that lead to things like debt crises. As such, there is a huge potential for moral hazard built in if states are able to escape their debt obligations without pain. Just ask California. It's an internal contradiction of democracy, if you like.

I have empathy for the citizens of Greece and other states that find themselves in difficult positions. But I have even more empathy for the future citizens of Greece and other states who will surely suffer more if their governments cannot get their house in order. I'm not quite sure how to escape this trap without austerity.

Happy Pi Day!

Geithner Files

Things I learned from Joshua Green's very long (but excellent) profile of Timothy Geithner:

1. Contrary to popular belief, Geithner was not only aware of the dangers of derivatives and off-balance sheet transactions, but he spoke out about them repeatedly over a number of years. His talk about "fat tails" sounds like it came straight from Nassim Taleb.

2. Bush was routinely lambasted for not properly vetting administration officials, as was McCain during the campaign, but Obama seems to have chosen Geithner based primarily on one hour-long interview. True, Geithner had great references, but given the context -- the height of the financial crisis and administration of the new TARP program -- it still is a bit odd.

3. The Geithner financial crisis plan was forged in the Tequila and Asian crises in the 1990s. The plan: get the muscle of the government involved early and often, or deeper and more costly intervention will be necessary later. No surprise there. But the price of government involvement might be: "shut down weak banks, bust up oligarchies, and clean up corruption. Then withdraw." This is not the popular view of the government bailouts, but I think it expresses the pattern of government involvement pretty well.

4. The entire orientation of the Geithner plan was to minimize government involvement. That's why the stress tests happened, why the banks weren't nationalized, why TARP was structured the way it was. The goal was to recapitalize the banking sector by maximizing private sector input, and thus save taxpayers hundreds of billions, if not trillions, in the process. It was a big gamble, but it seems to have paid off pretty well.

5. Criticisms of Geithner as being too friendly to Wall Street are spot on: he has systematically resisted punitive measures against banks, and has even argued against tight monitoring of how TARP funds are used. The interesting thing? Unlike almost anyone else in senior levels of any recent presidential administration, he's a career bureaucrat. He's never worked on Wall Street, and recently turned down the presidency of Citigroup.

6. Geithner is a pragmatist above all else: “In a crisis, you have to choose: Are you going to solve the problem, or are you going to teach people a lesson? They’re in direct conflict.” This is not good horse-race politics, but if it leads to better outcomes it may be the best political strategy possible.

7. As I've mentioned before, TARP is turning out to be an exceptional bargain. Here's some figures:

Geithner likes to point out that after a year on the job, he’s spent $7 billion recapitalizing financial firms while private investors have put up $140 billion. TARP money is being repaid faster than anyone imagined, and if Obama gets the $90 billion tax on big banks he proposed in January, it could eventually be recouped. It’s likely that the cost to taxpayers will be much less than the 5 to 10 percent of GDP that the Cleveland Fed says is typical for a crisis, and possibly as little as 2 to 4 percent—about the cost of the much smaller savings-and-loan crisis of the 1980s. A recent Treasury study indicates that it could be less than 1 percent. By any reasonable standard, this would be an impressive achievement, and it would owe a great deal to Geithner’s strategy.

Green has some criticisms too, but they are pretty boilerplate: regulatory reform hasn't been strict enough, etc. Still, the overall picture that emerges is that Geithner has helped saved US taxpayers quite a lot of pain, and quite a lot of money, by taking the actions he did.

University Administration Jobs and Hiring Practices

This morning, UNC students and faculty awoke to an email from UNC Chancellor Holden Thorp notifying the university community that Dr. Bruce Carney, Samuel Baron Professor of Physics and Astronomy and the interim Executive Vice Chancellor and Provost at UNC, has been appointed the permanent Executive Vice Chancellor and Provost. I have absolutely no doubt that Dr. Carney deserves the job, will serve the university proudly and competently and will prove to be a very good hire in the years to come. Dr. Carney has been at UNC since 1980, starting off as a lowly assistant professor and working all the way up to his current endowed chair and serving as chair of the Physics department and both Senior Associate Dean and Interim Dean of the College of Arts and Sciences along the way.

What was interesting to me when I read the email from Chancellor Thorp was that the university held a national search, brought in three external candidates for interviews, lectures and Q&A, and then hired the internal, interim position-holder that was not a candidate for the position. In the almost two years that I have now been associated with UNC, the university has hired at least a couple internal scholars/administrators for top university administrative positions, including Chancellor Thorp himself, who previously was Dean of the College of Arts and Sciences, Director of the Morehead Planetarium and Kenan Professor of Chemistry at UNC.

When I was at Marquette University during my undergrad years, a similar hiring process phenomenon occurred when Dr. John J. Pauly, the Dean of the College of Communication, a fantastic scholar and overall really nice guy, was hired as the university's Provost. A couple of data points at two different universities caused me to ask myself whether a university's reputation for hiring internal candidates for top positions reduces the quality of external applicants since external candidates may have a reasonable belief that certain universities are biased towards internal candidates. Additionally, could it be that universities target the hiring of high quality administrators, those who have the potential to become chancellors, provosts, university presidents, etc. earlier in their careers, grooming them for these top positions while acclimating them to the culture and internal workings of the university at a lesser position?

Drs. Thorp and Carney both spent the entirety of their careers at UNC before being appointed Chancellor and Provost, respectively. Were the applicant pools for the positions that they eventually received of lesser quality than they otherwise would have been because there was an expectation that an internal candidate would be chosen? I'm not arguing that either scholar would not have ultimately been chosen for each position, but rather asking about the relative quality of the applicant pool conditional on a given university's reputation. Dr. Pauly bounced around a good deal before arriving at Marquette, receiving various promotions along the way before becoming Dean of the College of Communications and then Provost. Was Dr. Pauly selected as Dean with an expectation of rising the ranks to Provost in the near future? The same question about the quality of external applicants and the expectation of the selection of an internal candidate would also apply.

If anyone knows any research that's been published engaging these questions (I'm guessing it'd come from Sociology, Economics or Business) I'd be quite interested in checking it out. If this research hasn't been previously done, well I hopefully just hooked up an undergrad or grad student in one of these fields with a master's thesis or dissertation topic. I better get a shout-out in the acknowledgements!

Connecting Government and Academia

Yesterday, I spent the day in Washington, DC attending an all-day panel on political violence that brought together an array of academics from various fields including political science, criminology, sociology, public policy, statistics, mathematics and psychology, private sector analysts and researchers, and government practitioners from various departments and agencies. The panel was put together by the Institute for Homeland Security Solutions, a collaborative effort between Research Triangle Institute International, the University of North Carolina at Chapel Hill and Duke University, and the Human Factors and Behavioral Sciences Division (HFD) of the Department of Homeland Security’s Science and Technology Directorate, which is the primary research and development arm of DHS.

I'm not allowed to divulge any details from the all-day event nor can I talk about who was present or what they said since government officials and agencies were involved and are funding the project (which kind of sucks but makes sense and is understandable), but this kind of academia-government interaction is exactly the type of collaborative effort that is needed to foster cooperation between academics and practitioners, and the kind of interaction that Joe Nye, Dan Drezner and others have called for in recent months.

One of the primary goals of the discussion was to bring social science scholarship and methodology to the table to help government agencies find answers to problems and questions that they face on a daily basis. There is a lot that government practitioners can learn from social science research and the ways we approach complex questions. Furthermore, these types of meetings let academics see the types of questions that government officials are dealing with, the types of problems and puzzles that need more attention, and can potentially help us frame our work in a way that can help these agencies solve everyday problems. I'm not saying that we should only be asking questions that are relevant to policy-makers, but rather that engaging the policy community can help keep us relevant and may make our work better. Yesterday's meetings were definitely a step in the right direction towards making social science research and approaches more relevant to the policy-making community.

Now This Is How You Do Journalism

I spend more time bashing bad press work than praising good. I don't know if that's because there isn't very much good stuff, or because I'm mean-spirited, but today I can happily praise this article on Greece and the IMF by Sewell Chan and Liz Alderman of the NY Times. Let's parse it a bit:

In the last two days, Greece’s finance minister has threatened to turn to the International Monetary Fund for a bailout if Chancellor Angela Merkel of Germany and other European politicians resist pledging aid to help Greece cope with its newfound frugality. Asking the fund for help could create a new round of financial and political turmoil by sending the message that Europe cannot resolve its own problems, analysts said.

“It would be damaging for the euro zone going forward because it would sow seeds of doubt about whether this is really a currency union, or just a group of countries that share a currency,” said Simon Tilford, the chief economist of the Center for European Reform in London.

Good, quick summary of the issue, similar to the take I've been taking recently (see here and here for examples, and Dr. Oatley's take here). It frames the issue appropriately: this is not (just) about what Greece has to do about its debt; it's a political issue about who pays for maintaining a non-optimal currency zone. Next we get details about what that political fight is about, and what the stakes are:

Policy makers and leaders of many countries that use the euro see Greece’s troubles as a problem within the family. They want a homegrown political solution to show that Europe can fix internal economic crises without outside help.

Turning to the I.M.F., which often helps struggling emerging-market nations, is seen as a stigma that is to be avoided, a concern underscored by the European Central Bank’s president, Jean-Claude Trichet, on Wednesday. “I do not trust that it would be appropriate to have the introduction of the I.M.F. as a supplier of help,” he said.

No member of the euro zone has had to borrow from the I.M.F. since the official use of the common currency began in 1999, and no major industrialized country in Europe has done so since Britain in 1976.

But from Greece’s perspective, the I.M.F. would force the government to swallow nearly the same bitter medicine that Germany, France and others have required — but at least Athens would receive guaranteed financial aid from the I.M.F. in return.

In addition, it is not clear that Germany and other European governments seeking to contain the crisis have the resources or expertise to monitor Greece and other profligate euro members for the many years that it will take for the troubles to blow over.

Again, very well said. But even better... the journalists actually talked to some people who know some things about the political economy of the IMF, and named them by name! None of this "some economists say" or "many economists believe" nonsense: get good sources, tell us who they are, and let them say what they mean. This article enlists Randall Stone, Kenneth Rogoff, James Vreeland, Michael Mussa, Mark Copelovitch, and Simon Johnson (among others). That's a strong roster! I don't want to quote all of what they all said for space reasons, but the quotes are used well and impart useful information to readers who may not have a strong knowledge background in these topics. I do want to highlight one part from Copelovitch, tho:

The biggest challenge is in Germany, which has historically tended to enforce fiscal and economic rectitude on its neighbors. Many German taxpayers are vehemently opposed to paying for the profligacy of their free-spending neighbors in Greece and other southern European countries that let their deficits soar sky-high instead of taming them when times were good.

At the same time, German banks also underwrite much of the Continent’s debt and exert considerable influence in domestic politics, according to Mark S. Copelovitch, a political scientist at the University of Wisconsin, Madison. Germany “doesn’t want its banking sector to go under because Greece has defaulted,” he said.

A-ha! Here we have more politics: German citizens don't want to pay for Greece's profligacy, but German leaders don't want to sacrifice the German banking sector (which has underwritten or purchased a lot of Greek debt) to prove a point.

The article closes by talking about the personal/political rivalry between Sarkozy and IMF head Strauss-Kahn as another complicating dimension. It's a very good piece, and I commend Chan and Alderman on their work. They convey a lot of meaningful information in 1000 words, and make use of very good sources. Please read the whole thing.

Art Imitates Life

Sarah's a big South Park fan, so she'll love this. Spencer Ackerman won the internet today:

Around lunchtime on February 23, I attended an embargoed briefing for a couple reporters in Carl Levin’s office. Levin wanted to share the results of an investigation his Senate Armed Services Committee staff launched into Blackwater’s operations in Afghanistan. He distributed a document summarizing the investigation, a couple double-sided pages long, and I read through it as we waited for Levin to get started. Something caught my eye on the top of the sixth page, describing Blackwater signing out hundreds of AK-47s from a U.S. military weapons depot: “Receipts show that the guns were issued to an ‘Eric Cartman’…” I was seated near my friend Tim Starks, who reports on security issues for CQ. Holy shit dude, I whispered to him, look at page six!

Levin gave some brief remarks introducing his findings but didn’t mention Cartman. I raised my hand and asked him if Blackwater actually used the name of a ‘South Park’ character to sign for the guns. Levin, bless him, appeared to be unfamiliar with ‘South Park,’ a sign that the universe works as it is supposed to. His staffers suppressed grins and calmly pointed out that no one with the name ‘Eric Cartman’ has ever worked for Blackwater, and I was free to draw my own conclusions. At 9 p.m. on the dot, when the embargo lifted, I went live with a report on Blackwater, leading with Cartman and featuring a giant picture of him.

Here's a commercial for a new episode of South Park:



I'm setting my DVR as soon as I get home.

PSA: Iraq Election Breakdown

For those curious about the recent Iraq election and what it means, Juan Cole is always a reliable source.