Would a Greek default strengthen anti-austerity parties in other countries?

Governments in Ireland, Portugal, and Spain have adopted a conspicuously hard line stance in negotiations with the new Greek government, partly out of concern that a Greek default would strengthen anti-austerity parties at home (Wyplosz 2015).¹ How do we know if a default would have such an effect? Since most of the academic literature on the politics of debt default overlooks political and economic interdependence, it is not of much help in answering this question (Jackson et al. 2015). Our new research starts with the simple premise that interdependencies among different countries in economic networks are likely to have a profound impact on the politics of default (Chwieroth et al. 2015). Specifically, we provide evidence that foreign defaults tend to increase the propensity of voters to punish their own governments for failing to repay external private creditors.

Ultimately, our results suggest that a Greek default would be more likely to lower rather than to raise the political incentives for other European governments to default, contrary to the expectations of many commentators and political leaders.

Default and political survival

A standard argument is that a government’s willingness to repay its debts will in general be much more important in shaping decisions than its ability to repay (Eaton and Gersovitz 1981, Reinhart and Rogoff 2009, ch.4, Tomz 2007). If so, voters will plausibly view default as an exercise of political choice. Most studies agree that defaulting governments in democratic polities experience a significantly heightened risk of loss of office – one reason why default is rare in democracies (Borensztein and Panizza 2009, McGillivray and Smith 2008, Livshits et al. 2014).

On the other hand, scholars have argued that elected incumbent governments may nonetheless choose default for various reasons:

• Public sector employees, pensioners, low-income and unemployed voters are numerous and favour prioritising short-term domestic transfers over repayments to creditors (Saiegh 2005);
• Voters believe creditors will be more forgiving in demonstrably hard times or cannot effectively sanction defaulters (Borenzstein and Panizza 2009, Bulow and Rogoff 1989, Tomz 2007);
• Domestic political institutions discourage creditor coalitions (Saiegh 2005, 2009, Stasavage 2003); or
• Foreign creditors can easily be cast as unreasonable and rapacious (Broner et al. 2010, Gelpern and Setser 2004, Reinhart and Rogoff 2011, Sturzenegger and Zettlemeyer 2007, Tomz and Wright 2013).

The continuous re-election of Argentina’s ruling Peronists since 2001, the success of Syriza in the January elections in Greece, and the Greek government’s behaviour since then are recent examples of the role these factors play in the survival of incumbent political parties in the context of actual or near-default.

How international networks matter

While most of this literature assumes that the politics of default in different countries are effectively independent, studies have shown that the international context matters for the domestic vote (Duch and Stevenson 2008, Hellwig 2001, Hellwig and Samuels 2007, Kayser and Peress 2012). From a network perspective, two alternative possibilities arise – networked default either reduces or increases the propensity of voters to punish incumbents for failure to repay.²

Most of the literature on economic voting implies that networked default will reduce the propensity of voters to punish incumbents for default because it will indicate to voters that default is more ‘excusable’ due to exogenous shocks beyond the government’s control (Alesina and Rosenthal 1995, Duch and Stevenson 2008, Hellwig 2001, Hellwig and Samuels 2007, Kayser and Peress 2012, Persson and Tabellini 1990, Scheve 2004, on excusable default see Grossman and Van Huyck 1988).³

However, we think that this proposition is less applicable because default is both complex and rare. Excluding countries that have never defaulted, the average number of years between defaults among independent democracies in our dataset is 42 years over 1870-2009, making default on average a more or less once-in-a-lifetime experience for individual voters. By comparison, the US economy experienced a recession every 4.8 years over this period.⁴ The inexperience of voters with default will make it unusually difficult for them to assess its likely consequences, thus increasing the salience and perceived value of information provided by networked default. Rareness also enhances vividness, predisposing voters to weigh such events and their (presumed) consequences highly when assessing the competence of political incumbents and the likely effects of national default (Kahneman et al. 1982).

Default also typically entails significant short-run costs, including large output losses, lower credit ratings, higher interest rate spreads, a decline in trade and trade credit, and a heightened risk of a banking crisis (Borensztein and Panizza 2009, De Paoli et al. 2006). Networked default also tends to occur in difficult global economic times. Thus, networked default will highlight the costs of default to voters, increasing their anxiety about default at home. Voters may also be sensitive to the argument that repayment in the context of networked default will constitute a helpful reputational counterpoint for their own country. Since 2010, the UK Conservative Party successfully used the Greek example to reinforce political support for fiscal austerity.

In light of such costs and the inherent rareness of default, networked default should thus increase the risk that national default will incur voter punishment. Our research illustrates the importance of this effect using historical examples from Australia in the 1930s and Venezuela in the early 1980s. In both cases, incumbent governments faced significant exposure to default in their respective networks. In Australia, voters repeatedly rewarded a United Australia Party government for honouring its onerous repayment obligations via severe austerity at home. In Venezuela, by contrast, the incumbent Christian Democratic government suffered an avoidable default and in 1983 experienced the most severe election loss in the country’s postwar history.

Empirical findings

Our quantitative results for democracies over the period 1870-2009 support our expectations. We use a Partisan spells indicator to measure when incumbent political parties lost office, allowing us to compare results across different democratic systems.⁵ Our measures of default are taken from Reinhart and Rogoff (2009) and Standard & Poors (2013), and include all instances of a failure of a government to fulfil ex ante obligations to external private creditors in the first year of default.⁶ For reasons of data availability and because trade ties will be relatively tangible and visible to voters, we use the share of a country’s total exports in a given year which go to defaulting countries to measure each country’s yearly networked default exposure.⁷

We use this network variable and our measures of default to create an interaction term in a series of Cox proportional hazard models to assess the conditional effect of default across varying levels of default export market exposure on the expected rate of incumbency survival.⁸ Figure 1 plots the marginal effect for defaulters as default export market exposure varies from its observed minimum to one standard deviation above the mean (the median line summarises the central tendency from the simulations). The magnitude of this effect is large. A government with relatively high exposure to networked default is approximately ten times more likely to suffer a partisan spell termination than one with low exposure.⁹ These results are consistent with our argument that networked default negatively frames voter evaluations of national default, making them more likely to punish incumbents who replicate foreign misbehaviour.

Figure 1. Marginal effect of sovereign default conditional on default export market exposure – R&R and S&P defaults in polity democracies

Note: The ribbon represents the middle 95% of 1,000 simulations and the density of the ribbon indicates the set of values with the highest probability. We also include a rug plot of the distribution of the Default Export Market Exposure variable.

Implications

Our findings provide systematic evidence that, contrary to fear that a Greek default would lead voters elsewhere in Europe to favour default over austerity, it is more likely to have the opposite effect. A substantial Greek default would be highly chaotic and costly (at least in the short run), vividly framing default for foreign voters as something to be avoided rather than replicated, not least given the signs of recent recovery elsewhere. It would also likely highlight the potential advantages of debt repayment as a counterpoint to Greek misbehaviour. Economic misbehaviour elsewhere in an international network appears to reinforce the tendency of voters to eject leaders who also misbehave when facing severe financial shocks. Of course, political leaders could still misread voter preferences and default anyway. As the Venezuelan case demonstrates, they would do so at their peril.

References

Alesina, A, and H Rosenthal (1995), Partisan Politics, Divided Government and the Economy, Cambridge: Cambridge University Press.

Borensztein, E, and U Panizza (2009), “The Costs of Sovereign Default”, IMF Staff Papers 56 (4): 683-741.

Broner, F, A Martin, and J Ventura (2010), “Sovereign Risk and Secondary Markets”, The American Economic Review 100 (4): 1523-1555.

Bulow, J, and K Rogoff (1989), “Sovereign Debt: Is to Forgive to Forget”, The American Economic Review 79(1): 43-50.

Chwieroth, J M, C R Simpson, and A Walter (2015), “Networked Default: Public Debt, Trade Embeddedness, and Partisan Survival in Democracies since 1870”,   SSRN working paper.

De Paoli, B, G Hoggarth, and V Saporta (2006), “Costs of Sovereign Default”, Financial Stability Paper No1, London: Bank of England.

Duch, R M, and R T Stevenson (2008.), The Economic Vote: How Political and Economic Institutions Condition Election Results, Cambridge, UK: Cambridge University Press.

Eaton, J, and M Gersovitz (1981), “Debt with Potential Repudiation: Theoretical and Empirical Analysis”, Review of Economic Studies 48(2): 289-309.

Friedkin, N E (2001), “Norm Formation in Social Influence Networks”, Social Networks 23 (3): 167-189.

Gelpern, A, and B Setser (2004), “Domestic and External Debt: The Doomed Quest for Equal Treatment”, Georgetown Journal of International Law 35 (4): 795-814.

Grossman, H I, and J B Van Huyck (1988), “Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation”, The American Economic Review, 78 (5):1088-1097.

Hellwig, T (2001), “Interdependence, Government Constraints, and Economic Voting”, Journal of Politics 63 (4):1141-1162.

Hellwig, T, and D Samuels (2007), “Voting in Open Economies: The Electoral Consequences of Globalization”, Comparative Political Studies 40 (3): 283–306.

Jackson, M O, B Rogers and Y Zenou (2015), “Connections in the modern world: Network-based insights”, VoxEU.org, 6 March.

Kahneman, D, P Slovic, and A Tversky (eds) (1982), Judgment Under Uncertainty: Heuristics and Biases, New York and Cambridge: Cambridge University Press.

Kayser, M A and M Peress (2012), “Benchmarking Across Borders: Electoral Accountability and the Necessity of Cooperation”, American Political Science Review 106 (3): 661-84.

Livshits, I, T Phan and C Trebesch (2014), “Sovereign Default and Political Turnover”.

McGillivray, F, and A Smith (2008), Punishing the Prince: A Theory of Interstate Relations, Political Institutions, and Leader Change, Princeton, NJ: Princeton University Press.

Persson, T, and G Tabellini (1990), Macroeconomic Policy, Credibility, and Politics, New York: Harwood Academic.

Reinhart, C M, and K S Rogoff (2009), This Time is Different: Eight Centuries of Financial Folly, Princeton, NJ: Princeton University Press.

Reinhart, C M and K S Rogoff (2011), “A Decade of Debt”, NBER Working Paper 16827.

Saiegh, S (2005), “Do Countries Have a ‘Democratic Advantage?’ Political Institutions, Multilateral Agencies, and Sovereign Borrowing”, Comparative Political Studies 38 (4): 366-387.

Saiegh, S (2009), “Coalition Governments and Sovereign Debt Crises”, Economics and Politics 21 (2): 232-254.

Scheve, K (2004), “Democracy and Globalization: Candidate Selection in Open Economies”, Paper presented at the Conference on Globalization and Self-Determination, Yale Center for International and Area Studies, New Haven, CT.

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Stasavage, D (2003), Public Debt and the Birth of the Democratic State: France and Great Britain, 1688-1789, Cambridge: Cambridge University Press.

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Tomz, M (2007), Reputation and International Cooperation: Sovereign Debt across Three Centuries, Princeton, NJ: Princeton University Press.

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Wyplosz C (2015), “The coming defaults of Greece”, VoxEU.org, 27 April.

Footnotes

1 Phillip Stevens, “How politics will seal the fate of Greece,” Financial Times, 21 May 2015; Gideon Rachman, “Europe cannot agree to write off Greece’s debts,” Financial Times, 26 January 2015; Wolfgang Münchau, “Eurozone’s weakest link is the voters,” Financial Times, 29 December 2014.

2 We define networked default as the degree to which default is prevalent amongst those countries with which a focal country is directly tied.

3 Networked default might also erode a social taboo against misbehaviour, making it easier to do (Friedkin 2001).

4 Default averages calculated using Reinhart and Rogoff (2009); US business cycle data fromhttp://www.nber.org/cycles.html (accessed 27 April 2015).

5 Democracy is defined as years in which the Polity IV measure exceeds five for the full incumbent spell.

6 The R&R and S&P measures each yield 36 defaults in democracies over the whole period. The R&R sample of 56 democracies indicates 28 out of 561 partisan spells (5%) experienced default. The far more complete S&P sample of 99 democracies indicates 30 out of 709 partisan spells (4%) experienced default.

7 We also explored other country ties based on common region, language, religion, and joint membership in international organisations. However, we failed to uncover any significant effect.

8 Our control variables are the degree of democracy, age of the democracy, economic growth, global economic growth, GDP per capita, export receipts, and past default history using the cumulative number of defaults and the number of years since a country’s previous default. We also control for systemic variables (global GDP growth and export receipts) as a way of trying to isolate the causal mechanism we identify.

9 ‘High’/’low’ values of the default export market exposure variable correspond to one standard deviation above/below the mean in the R&R dataset.

This article is published in collaboration with VoxEU. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Jeffrey M. Chwieroth is Professor of International Political Economy in the Department of International Relations and a research associate of the Systemic Risk Centre at the London School of Economics. Cohen R. Simpson is a Doctoral Candidate in Social Research Methods at the London School of Economics & Political Science. Andrew Walter is Professor of International Relations in the School of Social and Political Sciences at the University of Melbourne and a senior fellow in the Melbourne School of Government.

Image: A man walks by the headquarters of the Bank of Greece in central Athens. REUTERS/Yannis Behrakis.