The Pursuit of Knowledge

Paying the Price

There's no question but that a Greece should be "allowed" to default.

By From the December 2011 - January 2012 issue

"The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics."

Thomas Sowell's aphorism is of special relevance to us now, when we discover that, without the matter having been discussed or put to the vote, the most important economic decisions are in the hands of politicians. Democratic politicians secure their following by making economic promises--basically to steal from the few in order to reward the many. And in order to protect themselves from the cost of this they set up supposedly independent economic bodies, like the International Monetary Fund, the Federal Reserve Bank, and the European Central Bank, which they place in the hands of political appointees. In all the excitement over Dominique Strauss-Kahn's adventures in a New York hotel the media seems to have forgotten to ask the most important question: how was it that a politician, and one of the French sofa-socialist persuasion, should be in charge of the IMF? What conceivable attribute could have qualified him for such a position? Granted that a gargantuan libido might sometimes be useful in politics, in what way could it possibly contribute to the process of maintaining equilibrium in the world economy, and compensating where possible for the rash promises of politicians?

No doubt DSK's successor is as well qualified for the job as any of the rival candidates. Christine Lagarde has, after all, been a minister of finances in the French government. But this does not alter the fact that she has inherited the IMF as part of a political career, that her main concern is to rescue the political class from the looming disaster that its profligacy has brought upon us, and that she sees the principal task of the IMF as a political one--namely maintaining the status quo and preventing the collapse of the single currency.

This is not to say that things would be better run by the economists. If there is one thing that is evident about economics, it is that no practitioner of the subject agrees with any other about its results. There are economic truths, such as the first lesson given above by Thomas Sowell. But these truths are not hidden in any way from the rest of us, and the theories of the economists rarely make them clearer than they are. The writings of Adam Smith owe their persuasive power to the common sense of the author, who looks on the world as it is, and applies to it the undeceived consciousness of a cultivated mind. The Wealth of Nations describes what markets would be like were there no political class to interfere with them. And one of the lessons that it teaches is this: that markets tend toward equilibrium, but only if people reap the reward of their enterprise and pay the cost of their mistakes. When rewards are stolen and mistakes compensated, the market ceases to function as a self-correcting device. And that is exactly what we are seeing in the world economy, now that the politicians are in charge of it--in charge but not in control.

It is true that the inter-connectedness of national economies, and the opportunities provided by international finance, make it possible for traders and financiers to make enormous profits while passing their risks to those who did nothing to incur them. The global economy, as we now know it, is a demoralized economy, in which old habits of accountability have all but disappeared. But this is exactly what we should expect, when the politicians take charge. Banks become “too big to fail” when governments rely upon them; industries become “too big to fail” when the labor unions persuade governments to take charge of them. And when governments encourage the belief that they will step in to take the cost of mistakes, it is not surprising if the spivs and racketeers take advantage of their promises.

Common sense tells us that if you borrow money that you cannot repay, then at some point you must go bankrupt. Common sense also tells us that proceedings in bankruptcy are essential to economic health. Without them economies cannot regain equilibrium in the wake of large-scale mistakes. This was abundantly proved by the economies of the Soviet Empire, which operated without a law of bankruptcy. The costs of failing industries were redistributed across the economy by a procedure of “economic arbitrage,” which meant that unproductive factories with idle workforces absorbed the profits of the few successful enterprises and guaranteed that, in the long run, they too would fail. When a properly administered law of bankruptcy is in place, money, knowledge, energy, and skills are withdrawn from the places where they are wasted, and deployed to better effect elsewhere. It is arguable that the vast amount of skill and entrepreneurship wrapped up in the American automobile industry would have benefited the economy many times over, if that industry had been allowed to go bankrupt, so releasing its store of human capital into the labor market.

Christine Lagarde tells the world that she will use the resources of the IMF to stabilize the Eurozone and to avert the potential catastrophe of a default by Greece. She even praises DSK for having put this policy in place. But what business does a politician have to interfere in this way in the workings of the market? Why should the contributions of nations that have managed their finances efficiently be used to avert the bankruptcy of those who have not? It is surely clear now, even if it was not clear before, that the Eurozone was a mistake, that you cannot simply impose a single currency while leaving the rest of government in the hands of local politicians and the networks that support them. In economic life mistakes have consequences, and the attempt to avert those consequences is usually another mistake. And each mistake is bigger than the last one, since it enlarges the number of interests and expectations that depend upon rescue.

In my view there should be no such question as whether Greece is allowed to default. A country that runs up debts that it cannot pay is in default, and all the rest is an illusion--a game of economic fictions, designed to avert the eyes of the world from the self-evident reality. As the Soviet example shows, you can keep such fictions going for quite a time, especially if you do it in the name of socialism. But the longer you continue, the bigger the crash.

THE ILLUSION that governments do not default ought to have been dispelled by the case of Argentina, but the further illusion was quickly put in place that Argentina is a special case and outside the network of mutual support that has been created in the Northern Hemisphere. In the event, however, the Argentine default saved the country from ruin, broke its dependency on international finance, stimulated exports, and created the conditions for a long-term recovery. The initial pain was the price paid for a realistic future. And the pain was experienced not only by the Argentine people but by those banks and financial institutions that had made the mistake of buying the bonds of a government that was patently unable to honor them. People who make unwise investments ought to pay the cost of them, and certainly they ought not to pass that cost to others who are innocent of fault.

Look at the case of Greece in this light and you will surely see that default is the right option. The Greek people have consistently voted for politicians who make unrealistic promises, offer unaffordable benefits, and borrow wildly on the international market in order to subsidize their folly. This is a mistake made by the Greek people, and mistakes must be paid for. German banks and others have made the mistake of buying Greek bonds, on the strength of a manifestly absurd conception of what the Eurozone will do for its peripheral members. This mistake too should be paid for. And after the pain, which will be considerable, all parties can begin again in a sober determination to do things differently, as the Argentines did. Only one thing prevents this happening, which is the fact that economic decisions have been confiscated by the politicians, who always strive to ensure that those decisions remain in the hands of some member of their class. 

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About the Author
Roger Scruton is a visiting scholar at the American Enterprise Institute. His latest book, How to Think Seriously About the Planet: The Case for an Environmental Conservatism, has just been published by Oxford University Press.