18 July 2016
Nations in trouble and welfare systems
It was the 4th century BC when thirteen Greek cities of the Delio Attica league failed to repay their military loans to the Temple of Delos, which at that time worked as a kind of bank. It was the first default in history. Or, at least, that’s what some sources - including the Economist - asserted as a story during the most recent Greek crisis.
The term “default” originally means “an absence, a lack of”. In IT jargon, it represents the pre-selected option a computer program or other mechanism would automatically revert to. In economics it’s the failure to repay a loan according to the terms agreed. In other words, it is the bankruptcy. When a country is involved in a sovereign default – i.e. objectively unable to repay bondholders – it exits from the government bond market and applies for assistance to the International Monetary Fund. Credit default swaps (CDS) are the instruments used to calculate the risk of State failure over five years.
If the Ancient Greece case is the oldest example of sovereign default, in recent years the most symbolic is certainly the one of Argentina, which has been fluctuating between inflation and devaluation. However, in the course of history defaults have been numerous and heterogeneous: from the triple bankruptcies under the reign of Philip II of Spain (1527-1598) to the German crisis of the Weimar Republic (1919-33) and the aftermath of WWII. From 1800, there have been 227 defaults all over the world, documented and collected in a book by Carmen Reinhart (former Chief Economist at the International Monetary Fund) and Kenneth S. Rogoff. The 70% of sovereign defaults is due to financial crises of 1820, 1870, 1930 and 1980. More precisely, 17 different States failed in 1983.
Interestingly, the economic consequences of a default – as shown by this chart from Economist – are often recoverable in a few years and the loss of State’s credibility doesn’t endure over time. Indeed, even countries that are considered solvent today – as Austria, Japan, Netherlands – have gone through different moments of default and restructuring in the past. Relative to previous periods of economic malaise, a significant role in the current economic crisis boils down to the tax and welfare systems, as well as the bureaucratic organizations that come with them. While expenditures on passive policies increase – the so called “social safety net” – those on active policies and health decrease. The reason is to be ascribed to the welfare system not sufficiently taking into account the importance of current demographic changes. Population is ageing, the average working age is increasingly higher and young people risk to be left out from a saturated job market. This means fewer taxpayers but more expenses.
In line with the EU requirements, member states should move towards a multi-pillar pension approach: a mix of a pay-as-you-go compulsory welfare system and a private pension system, thus relying on public finances as well as financial markets, so that the future retiree and the pension sponsor share the risks. Being able to deal with this crisis means to understand today’s labour market instead of fighting against it. Nowadays, the target policies should support the the development of skills which are marketable and demanded for in the job market. This is one of the most remarkable forms of protection and welfare.