A Program for Greece

The Greek government and its lenders are at an impasse.  Greece wants better terms; the Euro governments want Greek reforms and to be repaid.

Is this hard to do?  For a former investment banker like myself, the task is merely transaction structuring, with the goal of creating terms which can plausibly be met, on the one hand, and the aligning incentives, on the other.  The latter item is the big prize.  Let's be honest.  The money given by Germany to Greece is gone.  It's spent.  Meanwhile, Germany, like other OECD countries, runs cash accounts. Germany is not depending on that money to keep the lights on.  The cost to the German citizen has already been incurred. 

Even if Greece could pay its loans back, the process will take so long and be such a small annual payment as to be essentially meaningless to Germany.  Of course, being paid back is important.  But the bigger prize, the thing of true value, is good governance in Greece.   The heart of any deal should seek to achieve this goal, for good governance--by which I mean solid, fiscally sustainable GDP growth with an incentive to repay debt--is the best guarantor of the repayment of the monies owed to Germany, other Euro countries, the ECB and the IMF.

If this is the task, then the rest is merely transaction structuring, which primarily involves creating the desired incentives and effectively insulating them from the Greek democratic process (which historically has shown an penchant for high spending and borrowing).

Greece currently owes about  €322 billion to various Euro governments (82% of the total), the European Central Bank (ECB) (10%) and the IMF (8%).  This amount we'll collectively refer to as the 'Official Debt'.  The GDP of Greece is around  €185 billion.  Thus the Official Debt-to-GDP ratio is around 175%, which frankly would be considered unmanageable by most rational metrics.  But the issue is as much the will, as the ability, to repay.

The best we can do to insure both the will and ability to repay the debt is to build incentives into the political system for doing so.  That is, Greek parliamentarians of all parties should be rewarded for maximizing GDP growth and paying back Official Debt.  More specifically, they should be paid--and paid handsomely--for doing so.  Here's one plan for to achieve the desired goals:

Greece: GDP, Official Debt and Bonus Payments to Members of Parliament, Selected Years

Greece: GDP, Official Debt and Bonus Payments to Members of Parliament, Selected Years

Bonus for Growth

For each billion Euros of real GDP growth, Greek members of Parliament collectively (the 'Bonus Pool') would receive 0.8%.  Thus, if GDP grew from €185 bn in 2014 to €191 bn in 2015, the Bonus Pool for the year 2015 would be €44 million, which would be equally divided among all members of Parliament.

This bonus insures that all members of Parliament are incentivized to maximize GDP growth.

Bonus for Official Debt Repayment

In addition to the bonus for GDP growth, Parliament would be paid for reducing government debt, in this case to the tune of 0.4% of the Official Debt repaid, and 0.3% of other government debt reduced.  If we assume that 3% of GDP would be allocated to repayment of Official Debt, then the Debt Bonus Pool for Official Debt would be €23 million in 2015, rising to €44 million in 2020.  If the debt is repaid faster, the bonus pool is larger.

The Official Debt Bonus therefore incentivizes Parliament to repay the debt as quickly as possible.  However, the bonus rate on debt is only half the rate on growth (0.4% vs 0.8%).  Thus, Parliament has a greater incentive to increase GDP growth than to decrease debt.  In practice, however, the two are likely to go hand-in-hand.  Stronger economic growth will allow more rapid repayment of debt, and members of Parliament will be heavily motivated to repay debt as fast as possible in order to maximize bonuses.

Protecting the Incentive System

In order to protect the incentive system, the Official lenders will forgive debt at the rate of 25 times the Total Bonus Pool.  Thus, if the Total Bonus Pool in 2015 were €67 million, then the amount of Official Debt forgiven would be 25 times greater, that is,  €1.7 bn.  The faster the debt is repaid, the greater the amount forgiven. 

In this sense, the Bonuses are not being paid by the Greek voter.  They are being paid by the Creditors.  The bigger the Bonus, the greater the sum of debt forgiven.  Consequently, no one in the political class will challenge the Bonus system, because doing so would have an adverse effect on Greece's external debt position.  Greek politicians would not only be doing well, they would be doing good.

Repaying the Debt

Under the scenario presented above, the amount of debt forgiven is €88 bn to 2040, equaling about one quarter of the Official Debt and around €3 bn per year.  The Official Debt, under this plan, is discharged fully in 2040.

The burden of debt forgiveness on the lenders should be modest.  The German government, for example, spends €500 billion per year.  Assuming Germany had to waive €2 bn due from Greece per year, the cost would be less than 0.5% of Germany's government budget--not a big sum, in other words.  And this would be opportunity cost, not cash. Germany has already laid out the cash; the loss has already been absorbed, as a practical matter.

Bonuses and Their Payment

Bonuses and waivers would be due the year after they have accrued, subject to the acceptance by the IMF of the audit of Greek national accounts to the satisfaction of that multilateral agency.

Creating Demand for Good Governance

Anyone who has worked in the developing world knows that--contrary to what economics textbooks would tell us--there is in fact very little demand for good governance in the bureaucratic and political classes out there.  Greek politicians are not paid for good governance.  Historically, they have been rewarded for protecting special interests and favored voting blocks, as well as for lying about the country's finances and for profligate borrowing from other countries.  Governing in Greece--as in Italy or Argentina--is not about growing the pie, it's about splitting the pie up.

With the Bonus Plan, the system works in reverse.  We create an incentive for good governance, at least to the extent that this implies maximizing sustainable GDP growth and paying down borrowed monies.  We do not dictate the policies which Greece should undertake.   These are left to the Parliament to decide.   If Parliament wants shorter working hours or to defer privatization, so be it. But if this leads to lower growth, then the politicians will pay from their own pockets. History has shown that it is one thing to be generous with the money of others, something different to be generous with one's own.  It will prove to be true again in Greece.

The big prize in Greece is not the repayment of the Official Debt.  It is good governance.  Pro-growth policies and fiscal sustainability are not quite the same thing as good governance, but for purposes of the Creditors, it is good enough.  Greece will learn how to grow, to live within its means, and over time, repay the trust, credit and goodwill of the European countries who have sacrificed to support the Greek people and their economy in a time of need.