20 July 2015

VoxEU: Why debt sustains corruption in Greece and vice versa

The way out to tackle corruption in Greek politics which may prevent the implementation of the latest deal is to sign a new agreement that combines debt restructuring and radical transparency reforms, including naming-and-shaming practices, to block clientelism in the medium and long run.

Why cooperation among political parties matters for reform implementation

The immediate argument in favour of broad coalition governments is that policy reforms and austerity have a high political cost. Cooperation among parties can make them share the political cost. In addition, a broad consensus among parties provides credibility to society concerning technocrat-expert suggestions for solving the fiscal profligacy problem. From the very beginning of the sovereign crisis in the Eurozone, the IMF has provided explicit guidelines in favour of broad coalition governments or for cooperation across parties [...]

In the case of Greece, coalition governments have never been broad across parties, and reforms have progressed slowly, despite the intense monitoring by the IMF (Campos and Coricelli 2015). According to the theory suggested by Achury et al. (2015), the corruption problem in Greece, combined with its high debt-to-GDP ratio, has led Greece into a trap.

What causes the corruption-debt trap in Greece?

According to the approach of Achury et al. (2015), corrupt political parties in Greece tend to act as rent-seeking groups through the provision of clientelistic goods described above. Cooperation on reforms and austerity measures is a typical coordination game. If the partisan benefits from cooperation exceed the partisan benefits from non-cooperation, then two equilibria are possible: cooperation and non-cooperation, with the latter being the result of bad coordination. If, however, the partisan benefits of non-cooperation exceed those of cooperation, even for one big party, then there is only one sure outcome: non-cooperation (Achury et al. 2015, Section 1.1).

The high cost of servicing the enormous outstanding debt in Greece simply makes non-cooperation more profitable for parties. If parties cooperate, they face a high cost of servicing the debt, especially due to the tight fiscal-surplus requirements. This fiscal burden makes party members think that a partial default and a gang war for rents is more profitable for them, even in a state of economic chaos. This strategic speculation keeps Greece in a trap, because non-cooperating rent-seeking groups engage into a tragedy-of-the-commons equilibrium of excessive rent seeking. Markets pre-calculate the implied fiscal profligacy, Grexit scenarios return with positive probability, investment becomes discouraged, and the debt-to-GDP ratio increases due to a shrinking economy (Greece has lost 26% of its 2008 GDP until year 2014).

The short-run solution and the long-run solution for escaping the political infeasibility trap: A synthesis

The ideal long-run solution to Greece’s problem would be to eradicate rent-seeking groups in politics.  However, this requires time and a deep understanding of the problem. The short-run solution would be to restructure Greek debt, postponing payments and giving enough time for economic recovery. This short-run strategy could make benefits from a broad-coalition government more attractive to political parties, because it would take away the debt-servicing burden. The working hypothesis is that some rent-seeking activities would still be speculated by parties (Achury et al. 2015, Sections 2.5, 3.1.2, and 3.1.4).

Of course, such debt restructuring requires a new agreement. And certainly the EU should ask for reforms in exchange for debt restructuring. Whether these reforms could solve the corruption problem (or not) in the long run, is a matter of understanding the roots of the corruption problem in Greek society.

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Can society and the partisan network of vividly supporting voters and politicians bring reforms to Greece? This is not likely, unless a key reform is implemented first: transparency. Greece can innovate on that front, making use of information technologies.

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Conclusion

The implementation of the ‘aGreekment’ reached on 13 July 2015, after a 17-hour Eurogroup summit, needs a broad coalition government in Greece. The urgent and necessary political cooperation among parties is unlikely to be forthcoming. Political parties have rent-seeking agendas that are crowded out by the burden of servicing the debt. This is a trap.

To escape this trap, we suggest an urgent additional agreement. Drastic debt restructuring (postponing debt maturity) should be exchanged with immediate implementation of radical transparency reforms that aim at eradicating corruption. Debt restructuring should convince rent-seeking political parties that it is more profitable to cooperate. In the short run, parties could keep a small part of their rent-seeking activities, while servicing a smaller, manageable amount of debt.

It is impossible to instantly reverse the momentum of political corruption in Greece, but it is urgent that parties first cooperate on implementing simple and basic transparency reforms. In the beginning, the political cost of implementing these transparency reforms will be low. In the medium and long run, transparency can raise the feeling of equitability among citizens. This feeling can encourage Greek society to move away from supporting rent-seeking parties and to demand governments with public-resource management skills.

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