The Middle Class Indian Man and His Search for a Benevolent Dictator

 

 

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India needs a benevolent dictator.”

I have heard this being said over and over again, over the years.

Usually, the person saying it is a man.

Usually, he is a successful corporate type who is in the habit of driving his team to meet unreasonable goals set by the organisation.

Usually, he doesn’t like to take no for an answer.

Usually, he is looking to encash his ESOPs at the end of the year.

Usually, you will hear him say things like, this year we did Turkey, next year we plan to do New Zealand.

Usually his heart is in the right place. It beats for his country. It wants the country to do well. And in the process, he ends up saying the nonsense that he does.

In some cases, he is a Non-Resident Indian, living in the United States, the oldest and one of the most successful democracies in the world. In some cases, he is someone who has lived through Indira Gandhi’s emergency between 1975 and 1977 and is nostalgic about it.

“You know, trains ran on time,” he says. I don’t know if they did, but at least that is the argument that is offered.

And in some other cases, he opens the argument with the line: “Look at Singapore”.

So what is this Look at Singapore argument? Allow me to explain. As Arvind Pangariya writes in India—The Emerging Giant: “Countries, such as the Republic of Korea, Taiwan, Singapore Hong Kong, and the People’s Republic of China…have attained high rates of growth under authoritarian regimes.

India on the other hand almost always been a democracy since its independence in 1947. And on top, it has been one of the few countries which has managed to be a democracy almost all along. As Panagariya writes: “Along with Costa Rica, Jamaica, and Sri Lanka, India is only one of the four developing countries to have had democratically elected governments throughout the second half of the twentieth century and beyond…The remaining three countries…are all relatively tiny. The brief period of emergency rule—from June 26, 1975, to March 21,1977—in India may be viewed as representing a break in its democratic tradition.”

The people who argue in favour of benevolent dictators have basically this to say—countries in Asia that have done well, are those which have had autocratic regimes. India lost out because it was a democracy.

As Ruchir Sharma writes in Breakout Nations: “Of the eight countries that quadrupled their incomes between 1950 and 1990, two (Taiwan and Singapore) were ruled by dictators during the entire period, one (South Korea) was ruled by a dictator during most of it, two (Japan and Malta) were democracies throughout the period and three (Thailand, Portugal and Greece) waffled between autocracy and democracy.” China has also had an autocratic regime through its period of economic development through the late 1970s.

This is offered as evidence as to why India would have done much better if it had been run by a benevolent dictator and an autocratic regime. The trouble with this argument is that it looks at just one side of the equation—the countries which have had benevolent dictators and have done well. It doesn’t look at countries, which have had dictators and gone absolutely to the dogs.

The African continent is littered with examples of such countries. Closer to home, there is Pakistan. Look at the mess the country currently is in. Or look at what has happened in a country like Myanmar.

Economist William Easterly has done some interesting research in this area, which he summarises in a research paper titled Benevolent Autocrats. As he writes: “The probability that you are an autocrat IF you are a growth success is 90 percent. This probability seems to influence the discussion in favour of autocrats.”

But that is the wrong question to ask. The question that needs to be asked should be exactly the opposite—if a country is governed by an autocrat what are the chances that it will be a growth success? “The relevant probability is whether you are a growth success IF you are an autocrat, which is only 10 percent,” writes Easterly.

To put it simply—most fast growing nations are ruled by autocrats. Nevertheless, most autocracies do not grow fast. The point being, if the government in a country is being ruled by a dictator, there is no way to figure out in advance, whether he will turn out to be a disaster or be benevolent.

The question is why do so many educated middle class Indian men believe in the idea of a benevolent dictator then? (I know I am stereotyping here, but I have experienced this many times over the years).

I guess what behavioural economists call availability bias is at play here. As Leonard Mlodinow writes in The Drunkard’s Walk—How Randomness Rules Our Lives: “In reconstructing the past, we give unwarranted importance to memories that are most vivid and hence most available for retrieval. The nasty thing about the availability bias is that it insidiously distorts our views of the word by distorting our perception of past events and our environment.”

Air-crashes are an excellent example of this. As Jason Zweig writes in The Devil’s Financial Dictionary: “Flying is among the safest ways to travel, but on the rare occasions when an airplane does crash, the fireball on the runway is broadcast worldwide and burned into the brain of everyone who sees it.”

This leads people to believe that airplane travel is unsafe. But what they don’t realise is that the media does not report about the thousands of planes that land safely every day all over the world. It also does not report the many car crashes that happen all over the world every day, unless a celebrity is involved.

Availability bias comes into the picture with an event being over-reported. As Easterly writes: “One way this can happen are with an event that is over-reported relative to its actual frequency. A common example is that probability of death from murder is overestimated because of intensive coverage of murders by the media relative to other causes of death that are not as newsworthy (e.g. heart disease).”

When it comes to the idea of a benevolent dictator, this phenomenon is at play. Indians who go to countries like Singapore and China, see how much progress the country has made, and come to the conclusion that autocracy leads to economic growth. But these individuals never go to Pakistan, so that they can see that the opposite is also true. Or Myanmar for that matter.

The media with its stories of China’s progress also has a role to play. But then the stories of how much mess dictators have made in Africa, over the decades, never really make it to the Indian press.

The column was originally published in the Vivek Kaul Diary on June 6, 2016

“ India should have been after Pakistan to start talking after 26/11”

Stuart DiamondVivek Kaul

Stuart Diamond has taught and advised on negotiation and cultural diversity to corporate and government leaders in more than 40 countries. For more than 90% of the semesters over the past 15 years his negotiation course has been the most popular at the Wharton Business School, based on the course auction. He is also the author of Getting More – How You Can Negotiate to Succeed in Work and Life. In this interview he speaks to Firstpost on why India and Pakistan need to negotiate, how the soldiers negotiate with tribal leaders in Afghanistan and why the lack of people skills is proving costly for technology firms.

What is the most important point in any negotiation?
Almost any negotiation worth doing with anybody, whether its a billion dollar deal, diplomacy or my kid wants an ice cream cone, is a high stakes negotiation to that person. So almost every negotiation that is done in the world begins as an emotional negotiation. When stakes are high people get emotional and listen less.
That’s a very perceptive point you make….
Hence, unless you deal with that in the beginning you are not going to get the response you like. Also, I’d like to point out that we have begun to study the cost of conflict i.e. the cost of not collaborating. It turns out that India is in a fair amount of trouble when it comes to this. Only 20% of the people in India, trust each other, 80% don’t. If India had the same amount of trust as Sweden, its GDP would be $95 billion higher, which is twice as much as the defence budget, ten times the education budget, fourteen times the health budget and equal to the entire budget shortfall. In addition to that it would have 38 million more jobs, which is twice the population of Mumbai. Therefore the lack of trust in this country is a significant social and economic issue.
Why would that be? Isn’t trust also a function the amount of equality in the country? Like you gave the example of Sweden. Sweden has one of the highest equality levels in the world…
I would phrase it differently. I would say that trust occurs when someone thinks you want to do something for them, even if you are unequal. It begins with the notion of do I care about them? For example, when we had terrorist attacks in Mumbai around five years back, that’s when India and Pakistan should have started talking non stop. That’s part and parcel of the problem, which is even if Pakistan wanted to stop talking, India should have been after Pakistan to start talking, because you cannot solve a problem by not talking. In other words, if we mistrust each other, that’s the time to start talking. So this is counter-intuitive to many people because it says that the less I trust you the more I need to talk to you.
Can you elaborate on that?
For example, instead of India threatening to clean out terrorist cells in Pakistan, and instead of Pakistan putting people on the border, India should say to Pakistan, do you like terrorism? If you don’t like terrorism, we don’t. You want us to be able to do something about it? Let’s start small. What’s the worse problem we can solve in the easiest way? How do we start? Have a discussion about it. As opposed to do it my way. Or I demand this. There needs to be discussion. Even my 11 year old son, when he breaks something on the floor, I don’t blame the floor, I say Alexander how can you prevent this from happening again? Even a 11 year old kid understands that. How do we fix the process?
Not many people would buy that argument these days…
So much time is being spent arguing over yesterday instead of fixing the process for tomorrow. Yesterday adds no value. It is done and you can’t fix it and you can’t do anything about it. Tomorrow is what we can add value to. Too many people are backward facing when they should be forward facing.
One of the interesting examples that I came across was where you allowed your son to watch Scooby Doo for every minute that he played the piano. What was that all about?
It was a trade. First of all life is about a trade. Even a relationship. Quid pro quo. If you don’t need each others needs, soon you won’t have a relationship. And parents expect kids to do things for nothing, when they themselves would never do things for nothing. I wanted to teach my child the value of the trade. I paid money for the piano. I knew he would grow out of Scooby Doo, but he still plays the piano.
What is the lesson?
I wanted to know what do we trade. It teaches people to be responsible. That’s a really good thing to be thinking about with kids and others. What do they value? It doesn’t have to be monetary. It can be something intangible. It can be a letter of reference.
Letter of reference? 
Let me tell you an interesting story. About three months ago one of Google’s senior negotiators went to do a deal in the Southern United States where they doubled the fibre optics capacity. The first tranche cost $6 million and it closed two years ago. The vendor wanted $6 million for the second tranche. Instead of asking for a discount this Google negotiator said what can Google do for you? And the vendor said you can write us a letter of reference, so we could build our business.
That’s interesting…
The Google negotiator said fine we will do that. And then he said, what can you do for Google? The vendor decided to offer a discount to Google. And the vendor charged Google $6000 for an installation of $6 million, a 99.9% discount. This happened because they made the human connection and it wasn’t just about the money.
Can you give us another example of where an intangible played an important part in a negotiation?
My models are not only used by Google but by Special Operations in Afghanistan. If they make a connection with the tribal leaders, which may be something as simple as praising the fact that he(i.e. the tribal leader) was a war hero against the Soviets, the tribal leader will tell them where the bombs are buried and where the Taliban are. People say negotiations are complicated. No they are that simple. I like to watch kids negotiate. Kids are very simple. I am happy. I am sad. I am hungry. We are not getting along. A lot of what passes for negotiation is too complicated. Its just a conversation about what’s going on. The thing is it is not rocket science. But unless you know how to do it, it’s completely invisible. These tools are obvious when you see them, but are invisible unless you know them.
The Afghanistan example was interesting..
Let me give you another example. In Afghanistan, you have got tribal leaders interested in co-operating with the Allies. So, I teach the soldiers to say, think your kid is going to be sick next year? It takes some months to get medicines in Afghanistan. Your kid might die. We can get the medicine the same day. Who cares about that in your village? Whether they are a hard bargainer or a soft bargainer, it will be very hard for them(i.e. the tribal leaders) to turn down the alliance. So the more you can create a vision for someone, the more they are likely to buy in.
Any other example?
Here is one. Google wanted to put cigarette advertising and liquor advertising on cell phones. The legal department of Google did not want to do this because there was danger of kids getting access to it. We realised that whenever people think this is risky if you are more incremental you can be more persuasive. So then what was proposed was a limited experiment. We try with cigarette advertising in Britain and liquor advertising in the US for a small portion of the market and see if it can protected from under age people. Google would use that as a test to see how people self regulate. Google would be a leader in the industry as opposed to someone trying to get a heads up. So you can completely turn something around by being more incremental and by re-framing it in a way to capture the imagination of people.
In complicated situations do outsiders tend to be the best negotiators?
In fact, somebody without an emotional history is often the right negotiator. There are times when you can do it yourself but by the time it gets to a situation where the husband and wife are fighting with each other, you need a marriage counsellor. Before that point you can often do it yourself. But it is also true that sometimes the best negotiator with my wife is my son. So the right negotiator is the person who can make the best connection with the other side. The right negotiator is not the smartest, the most skilled and the most experienced. It might be the weakest member of your team.
That’s interesting. Can you give us an example?
I told this to the senior management of Morgan Stanley last month and they said that this flies in the face of a 100 years of investment banking experience. They are going to think of changing this. For 100 years, the most senior person did the negotiation. And that’s not often the right negotiator.
Because he has got too many things to do anyway. You need someone who does not come with a baggage…
Yes. Exactly.

Men better do better at negotiations than women” you point out. Why is that?
And that’s only because men practice more. Women are instinctively better negotiators than men. They listen more. But they don’t practice enough and so they are not trained enough. And some training is better than no training. As soon as they get trained at negotiations they do very very well. In fact, 30% of the people in my classes are women and they get more than half the highest marks.
One of the things that you write about is that the lack of people skills is proving costly to technology firms…
Absolutely. I gave a talk four years ago to 400 people from Microsoft from the business development and legal departments. I started the talk by saying that this morning I googled Microsoft. I typed “Europe hates Microsoft”. Why did I get 10 million hits in a tenth of a second? I said you are thinking it costs you money because people don’t like you. People investigate you because they don’t like you. The notion is that it is not just about the technology, if people don’t like you they will find a way not to buy your products and services.
Hmmm. And that’s impacting technology firms?
The FBI in Washington tells me that they use Oracle. They hate Larry Ellison and they are trying to find a way to use something else. And of course if you have got $12 billion like Larry Ellison has, you can be an SOB, but the problem is when you get to an America’s Cup race, only two people show up, including you. So there are costs to that even if you can get away with it for a short period of time.
True…
Around 25 years ago I read a really an interesting quote from a treatise called The Myth of US Industrial Supremacy. though I am not sure of it.“There is no human organisation, institution or civilization, that cannot given enough time be ruined”. So I worry about it. However, powerful I am, if I make myself the issue over and over again, people are going to run away. The lack of people skills is the Achilles’ heal for the technology industry because it is not just about the technology. It is about how people feel about the technology.
The interview originally appeared on www.firstpost.com on October 1, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)

 
 
 
 
 

Would India have grown faster if it wasn’t a democracy?


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Vivek Kaul
The India growth story as it was originally envisaged to be, is more or less over. Days when 8-9% growth was taken for a given are gone. The gross domestic product (GDP) for the period July 1 to September 30, 2012, grew by 5.3%. GDP growth is a measure of economic growth.
Further, what is true about India, is also true about China. As Ruchir Sharma head of Emerging Market Equities and Global Macro at Morgan Stanley Investment Management told me in a recent interaction “As far as China was concerned the growth expectations were too high out of China. People kept expecting China to grow at 9-10%. But there has been a reset of expectations. This year the growth rate is going to be 7.5% officially. Some suggestions have been made that the actual number would be lower than that if you look at the corresponding data.”
As was the case in the past, expectations are that China will continue to grow at a much faster rate than India. To me this raises the question whether countries with authoritarian governments, or countries with lower levels of democracy or even countries run by dictators, do better during the initial few decades of economic growth than countries which are democracies?
Or to put it simply is India’s democratic form of government slowing down its economic growth? This is a question that makes for engaging discussion in the business circles of Mumbai and the power circles of Delhi. Would have done better if we were more like China or Singapore, than the way we actually are, is a question which is often asked?
Vivek Dehejia and Rupa Subramanya discuss this question in some detail in their new book 
Indianomix – Making Sense of Modern India(Random House India, Rs 399).
As they write “When you look back on the history of the twentieth century – in fact through human history – you notice periods of very high economic growth are associated with autocratic, not democratic regimes. Just think of Chile under the dictatorship of Augusto Pinochet or the ‘miracle’ economies of East Asia – Hong Kong, Singapore, South Korea, and Taiwan. Starting in the 1960s these four economies went from being poor to being rich in just over a generation. The first one was a British colony, the second an oligarchy, and the latter two essentially one-party states. It’s true that Chile, Taiwan and South Korea democratised – but that was 
after they’d experienced a generation of rapid growth, not before.”
As Dehejia told me in an earlier interview “You need to have some sort of political control, you cannot have a free for all, and get marshalling of resources and savings rate and investment rate, that high growth demands.” And this is more possible in an authoritarian regime than in a democracy. 
The same stands true for China now. It has had a generation of fast economic growth without any democracy. The country is ruled by one party, the Chinese Communist Party (CCP). As Richard McGregor, the author of 
The Party: The Secret World of China’s Communist Rulers told me in an earlier interview “The CCP is basically a political machine, as well as being a permanent governing party. As a political machine, it does not consider that its internal mechanisms should be open to public view. The top leaders are unveiled to the country at the end of five years and very little is revealed in the process. After the 2007 Congress, the nine men – and they are all men – walk out onto the stage, all wearing dark suits and all but one wearing a red tie; they all displayed slick, jet-black pompadours (a style of haircut), a product of the uniform addiction to regular hair dyeing of senior Chinese politicians; and they had all worked their up through the same system for all their lives.” Conformity is the name of the game. 
The Western nations which grew at a very fast rate towards the end of the nineteenth century and early twentieth century also had very little democracy back then. As Dehejia and Subramanya point out “All of the rich countries of the West achieved rapid growth and economic development when they weren’t democracies. Just think of Britain during the Industrial Revolution. While it’s true that Britain was a parliamentary democracy it came with one catch, the fact that most people couldn’t vote. Franchise restrictions based on property ownership meant that the poor and the lower middle class were prevented from voting.”
The same stands true about the United States of America as well, the biggest economy in the world right now. “Britain was really an oligarchy, not a democracy, and so too was the US and every other Western country that industrialised and got rich.. The US, for example, legally enfranchised the African-Americans after their emancipation from slavery, but this was ‘offset’ by franchise restrictions that meant most Southern blacks couldn’t participate in the political process until the civil write movement of the 1960s. And let’s not forget that women didn’t get the vote in all of these Western countries till very late – well into the twentieth century in many cases,” the authors point out.
India on the other hand was a unique case. As Dehejia told me in an 
earlier interview “The India story is unique. We are the only large emerging economy to have emerged as a fully fledged democracy the moment we were born as a post-colonial state and that is an incredibly daring thing to do.” 
This despite the fact that the Constituent Assembly which drafted the Indian Constitution had been elected under a very limited franchise by 5 to 10% of the Indians at the top of social and the So has Indian economic growth suffered because we are a democracy? Dehejia and Subramanya point out the research of William Easterly, an economics professor at the New York University. “The historical data on growth over time in many different countries that Easterly has analysed show that 
if you’re a fast growing country then there’s a 90 per cent chance that you’re an autocracy. The problem is that you should be asking the reverse question: if you’re an autocracy, what’s the chance that you’ll be a growth success? The answer to that question is an underwhelming 10 per cent?”
What that means is that fast growing countries are almost inevitably autocracies but not all autocracies are fast growing countries. An excellent recent example is Zimbabwe under Robert Mugabe who now functions like a dictator. “What was once a break basket has now become a basket case,” write the authors. The continent of Africa is full of authoritarian regimes which have made a mess of their respective economies.
Closer to home under General Zia-Ul-Haq, Pakistan first turned into an Islamic state and now has turned into a full fledged terrorist state. The horrors that Pol Pot perpetuated as the dictator of Cambodia are well known.
And the biggest example of an authoritarian regime gone wrong was Adolf Hitler. Hitler first rode to power on popular discontent and then used a lot of Keynesian economics ( which John Maynard Keynes was still in the process of formulating) to create economic growth by building roads and then lead his country into a disastrous World War.
So yes, fast growing countries are authoritarian regimes but as explained above things can go terribly wrong as well under these regimes. Hence, we really don’t know which way will the authoritarian regimes go, towards economic growth or towards social disaster.
But then why does the myth of authoritarian regimes always creating economic growth prevail? This is because of what is known as the ‘availability heuristic’. “This refers to the fact that human beings tend to attach too high a probability to an event that’s very vivid in our minds. A classic example is natural disasters like earthquakes and tornadoes. Because they’re splashed all over the news on the rare occasions they do occur, people always think they’re far more likely than they really are,” write the authors. “Compiling data from news stories in the 
New York Times from 1960 to 2008, Easterly shows that successful autocracies are heavily over-reported compared to failed autocracies. Compared to a little under 6,000 stories on failed autocracies and about 15,000 on those in the middle, there were a staggering number of stories – more than 40,000 on autocratic successes. So if China has been on your mind rather than Zimbabwe you’re not entirely to blame,” they add.
Hence, India’s democratic form of government may impact its economic growth to some extent but it saves us from other problems as well. “What the data do show is that autocracies have many more highs and lows than democracies: they tend to be spectacularly successful or unmitigated disasters. Democracies generally are found somewhere in the middle. India, for example, hasn’t yet achieved Chinese-style double digit growth rates, but nor has it ever had negative double-digit growth as in Zimbabwe,” write Dehejia and Subramanya.

The article originally appeared on www.firstpost.com on December 3, 2012.
(Vivek Kaul is a writer. He can be reached at [email protected]
 
 

If PIIGS have to fly, they will need to exit the euro


Vivek Kaul

I’ve long said that capitalism without bankruptcy is like Christianity without hell. – Frank Borman
If you have been following the business newspapers lately, you would have probably come to the conclusion by now that a break-up of the euro will lead to a huge catastrophe in Europe as well as the rest of the world.
Yes, there will be problems. But the world will be a much better place if the countries like Portugal, Ireland, Italy, Greece and Spain opt out of the euro. To know why read on.
How it all started
The European Coal and Steel Community was an economic organisation formed by six European nations in 1958. This gradually evolved into the European Union (EU) which was established by the Maastricht Treaty in 1993. The EU introduced the euro on 1 January 1999. On this day, 11 member countries of the EU started using euro as their currency. Before the euro came into being the German currency deutschemark used to be the premier currency of Europe. The euro inherited the strength of the deutschemark. The world looked at the euro as the new deutschemark.
The move to euro benefitted countries such as Portugal, Italy , Ireland , Greece and Spain (together now known as the PIIGS). Before these countries started to use euro as a currency, they had to borrow money at interest rates much higher than the rates at which a country like Germany borrowed. When these countries started to use the Euro they could borrow money at interest rates close to that of Germany, which was economically the best managed country in the EU.
Easy money and the borrowing binge
With interest rates being low, the PIIGS countries as well as their citizens went on a borrowing binge. Greece took the lead among these countries. The Greek politicians launched a large social spending programme which subsidised most of the key public services. In fact a few years back, the finance minister of Greece claimed that he could save more money shutting down the Railways and driving people around in taxies. In 2009, Greece railways revenues were at around $250 million and the losses of around $1.36billion. All this extravagance has was financed through borrowing.
Greece was not the only country indulging in this extravagance, other PIIGS nations had also joined in. Also other than the low interest rates, the inflation in the PIIGS countries was higher than the rate of interest being charged on loans.
As John Mauldin and Jonathan Tepper write in Endgame – The End of the Debt Supercycle and How it Changes Everything “In plain English, that means that if the borrowing rate is 3 percent while inflation is 4 percent you’re effectively borrowing for 1 percent less than inflation. You’re being paid to borrow. And borrow they did. And the European peripheral countries (PIIGS) racked up enormous amount of debt in euros.”
This was because loans were being made by German, French and British banks who were able to raise deposits at much lower interest rates in their respective countries and offer it at a slightly higher rate in the PIIGS countries.
The citizens of Spain borrowed big time to speculate in real estate. All this building was financed through the bank lending. Loans to developers and construction companies amounted to nearly $700billion or nearly 50% of the Spain’s current GDP of nearly $1.4trillion. Currently Spain has as many homes unsold as the United States (US), though the US is six times bigger than Spain. With homes lying unsold developers are in no position to repay. And Spain’s biggest three banks have assets worth $2.7trillion or that is double Spain’s GDP, are in trouble.
The accumulated debt in Spain is largely in the private sector. On the other hand the Italian government debt stands at $2.6trillion, the fourth largest in the world. The debt works out to around 125% of the Italian gross domestic product (GDP). As a recent report titled A Primer on Euro Breakup brought out by Variant Perception points out “Greece and Italy have a high government debt level. Spain and Ireland have very large private sector debt levels. Portugal has a very high public and private debt level.” Debt as we all know needs to be repaid, and that’s where all the problems are. But before we come to that we need to understand the German role in the entire crisis.
The German connection
Germany became the largest exporter in the world on the strength of the euro. Before euro became a common currency across Europe, German exports stood at around €487billion in 1995. In 1999, the first year of euro being used as a currency the exports were at €469billion euros. Next year they increased to €548billion euros. And now they stand at more than a trillion euros. Germany is the biggest exporter in the world even bigger than China.
With euro as a common currency took away the cost of dealing with multiple currencies and thus helped Germany expand its exports to its European neighbours big time. Also with a common currency at play exchange rate fluctuations which play an important part in the export game no longer mattered and what really mattered was the cost of production.
Germany was more productive than the other members of the European Union given it an edge when it came to exports. As Mauldin and Tepper point out “since the beginning of the Euro in 1999, Germany has become some 30 per cent more productive than Greece. Very roughly, that means it costs 30 per cent more to produce the same amount of goods in Greece than in Germany. That is why Greece imports $64 billion and exports only $21 billion.”
German banks also had a role to play in helping increasing German exports. They were more than happy to lend to citizens, governments and firms in PIIGS countries. So the way it worked was that German banks lent to other countries in Europe at low interest rates, and they in turn bought German goods and services which are extremely competitively priced as well as of good quality. Hence German exports went up.
The PIIGS countries owe a lot of money to German banks. Greece needs to repay $45billion. Spain owes around $238billion to Germany. Italy, Ireland and Portugal owe $190billion, $184 billion and $47billion respectively.
Inability to repay
When the going is good and everything is looking good there is a tendency to borrow more than one has the ability to repay, in the hope that things will continue to remain good in the days to come. But good times do not last forever and when that happens the borrower is in no position to repay the loan taken on.
Greece tops this list. It has been rescued several times and the private foreign creditors have already taken a haircut on their debt i.e. they have agreed to the Greek government not returning the full amount of the loan. Between Spain and Italy around €1.5trillion of money needs to be repaid over the next three years. The countries are in no position to repay the debt. It has to be financed by taking on more debt. It remains to be seen whether investors remain ready to continue lending to these countries.
In the past countries which have come under such heavy debt have done one of the following things: a) default on the debt b) inflate the debt c) devalue the currency.
Scores of countries in the past have defaulted on their debt when they have been unable to repay it. A very famous example is that of Russia in 1998. It defaulted both on its national as well as international debt. Oil prices had crashed to $11 per barrel. Oil revenue was the premier source of income for the Russian government and once that fell, there was no way it could continue to repay its debts.
If the country’s debt is in its own currency, all the government needs to do is to print more of it in order to repay it. This has happened time and again over the years all over the world. Every leading developing and developed country has resorted to this at some point of time. The third option is to devalue the currency and export one’s way out of trouble.
Exit the euro
The PIIGS countries cannot print euros and repay their debt. Since they are in a common currency area there is no way that they can devalue the euro. A straight default is ruled out because German and French banks will face huge losses, and Germany being driving force behind the euro, wouldn’t allow that to happen.
So what option do the PIIGS then have? One option that they have is to exit the euro, redominate the foreign debt in their own currency, devalue their currency and hope to export their way out of trouble.
A lot has been written about how you can only enter the euro and not exit it. The situation as is oft repeated is like a line from an old Eagles number Hotel California “You can checkout any time you like / But you can never leave.” A case has also been made as to how it would be disaster for any country leaving the euro.
Let’s try and understand why the situation will not be as bad as it is made out to be. A report titled A Primer on Euro Breakup, about which I briefly talked about a little earlier explains this situation very well.
The first thing to do as per the report is to exit the euro by surprise over a weekend when the markets are closed. Many countries have stopped using one currency and started using another currency in the past. A good example was the division of India and Pakistan. As the report points out “ One example of a currency breakup that went smoothly despite major civil unrest is the separation of India and Pakistan in August 1947. Before the partition of India, the two countries agreed that the Reserve Bank of India (the RBI) would act as the central bank of Pakistan until September 1948….Indian notes overprinted with the inscription “Government of Pakistan” were legal tender. At the end of the transition period, the Government of Pakistan exchanged the non-overprinted Indian notes circulating in Pakistan at par and returned them to India in order to de-monetize them. The overprinted notes would become the liabilities of Pakistan.”
Any country looking to exit Euro could work in a similar way. It will need to have provisions in place to overprint euros and deem them to be their own currency. Then it will have quickly issue new currency and exchange the overprinted notes for the new currency. Capital controls will also have to be put in place for sometime so that the currency does not leave the country.
Despite the fact that there are no exit provisions from the euro, after the creation of the European Central Bank, the individual central banks of countries were not disbanded. And they are still around. “All the euro countries still have fully functioning national central banks, which should greatly facilitate the distribution of bank notes, monetary policy, management of currency reserves, exchange-rate policy, foreign currency exchange, and payment. The mechanics for each central bank remain firmly in place,” the report points out.
Technical default
By applying the legal principle of lex monetae – that a country determines its own currency, the PIIGS countries can re-dominate their debt which they had issued under their local laws into the new currency. As the report points out “Countries may use the principle of lex monetae without problems if the debt contracts were contracted in its territory or under its law. But private and public bonds issued in foreign countries would be ruled on by foreign courts, who would most likely decide that repayment must be in euros.”
The good thing is that in case of Greece, Spain and Portugal, nearly 90% of the bonds issued are governed by local law. While redomination of currencies in their own currencies will legally not be a default, it will be categorized as a default by ratings agencies and international bodies.
Another problem that has brought out is the possibility of bank runs if countries leave the euro. Well bank runs are already happening even when countries are on the euro. (The entire report can be accessed here: http://www.johnmauldin.com/images/uploads/pdf/mwo022712.pdf).
The PIIGS coutnries can devalue their new currencies make themselves export competitive and hope to export their way out of trouble. This is precisely what the countries of South East Asia after the financial crisis of the late 1990s. As the report points out “history shows that following defaults and devaluations, countries experienced two to four quarters of economic contraction, but then real GDP grew at a high, sustained pace for years. The best way to promote growth in the periphery, then, is to exit the euro, default and devalue.”
The German export machinery
A breakup of the euro will create problems for the highly competitive export sector that Germany has built up. The PIIGS countries would start competiting with it when it came to exports. Given this they will not let the euro break so easily. As the bestselling author Michael Lewis said in an interview sometime back “German leadership does not want to be labeled as the people who destroyed the euro.”
But as Lewis also said “If you put Germany together with Greece in a single currency, it’s a little like watching an Olympic sprinter and a fat old man running a three-legged race. The Greeks will never be as productive as the Germans, and the Germans will never be as unproductive as the Greeks.” So it’s best for PIIGS countries to exit the euro.
In the end let me quote my favourite economist John Kenneth Galbraith as a disclaimer: “The only function of economic forecasting is to make astrology look respectable.
(The article originally appeared at www.firstpost.com on May 19,2012. http://www.firstpost.com/world/if-piigs-have-to-fly-they-will-need-to-exit-the-euro-314589.html)
(Vivek Kaul is a writer and can be reached at vivek.ka[email protected])