Why debt sustains corruption in Greece and vice versa

Corruption is typically unobserved in formal data, so it is difficult to document its extent. Since the work of Schattschneider (1935), theories of rent seeking and corrupt legislative bargaining – further developed by Ferejohn (1986) and Persson (1998), and outlined in the book by Persson and Tabellini (2000) – link up the observable effects of corruption to rent-extraction mechanisms. These theories help in estimating rents, but we are unaware of a study that obtains such estimates for Greece. Nevertheless, everyday life in Greece suggests that clientelistic goods traded by political parties include examples such as:

• Civil-servant jobs, for which devoted party members can put in less effort at work, and for which party members may be underqualified.
• Tax evasion, with parties supporting networks of non-transparency through insiders in public authorities.
• Preferential legal treatment using a partisan network of underreporting through public authorities.
• Privileges regarding the management of real estate.
• Fiscal over-invoicing.
• Wasteful public infrastructure related to private benefits, such as building roads leading to specific private properties against city-plan efficiency.
• Fraud in granting disability benefits (Angelos 2012), etc.

Corruption in Greece relative to other Eurozone countries, and its fiscal profligacy problem

Figure 1 plots the Corruption Perceptions Index (CPI) against the average fiscal surplus between 1996-2010. As can also be seen in Table 1, Greece is one of the countries with the highest corruption (CPI) scores. According to Figure 1, Greece is certainly the Eurozone’s outlier in terms of fiscal profligacy. Fiscal surplus to GDP ratios have a correlation coefficient of 73% with the CPI, revealing that corruption is strongly related to fiscal profligacy. Achury et al. (2015) provide a theoretical analysis suggesting a two-sided causality between fiscal profligacy and corruption if a country’s debt-to-GDP ratio is too high (beyond 137%). In that case, a country can be trapped in a vicious circle of corruption and fiscal profligacy that ultimately leads to default. The key to this vicious circle spiral is the unwillingness of rent-seeking groups to cooperate on reforms and on minimum fiscal prudence.

Figure 1 Correlation between the fiscal-surplus/GDP ratio (in percentage points) and the Corruption-Perceptions Index (CPI) for Eurozone countries (t-statistics in parentheses).

Note: For Cyprus, Estonia, Malta, Slovakia and Slovenia averages are calculated since four years prior to joining the Eurozone.
Sources: Eurostat, Transparency International; figure taken from Achury et al. (2015).

Table 1  Corruption Perception Index (CPI)

Note: Higher score means lower corruption and numbers appearing in parentheses next to each score is the country’s world-corruption raking based on the score in each particular year.
Source: Transparency International; table taken from the Online Appendix of Achury et al. (2015).

Why cooperation among political parties matters for reform implementation

The immediate argument in favour of broad coalition governments is that policy reforms and austerity have a high political cost. Cooperation among parties can make them share the political cost. In addition, a broad consensus among parties provides credibility to society concerning technocrat-expert suggestions for solving the fiscal profligacy problem. From the very beginning of the sovereign crisis in the Eurozone, the IMF has provided explicit guidelines in favour of broad coalition governments or for cooperation across parties (see International Monetary Fund, 2010a-d, 2011a-f, and 2012a-f for specific sentences expressing these IMF guidelines).¹

In the case of Greece, coalition governments have never been broad across parties, and reforms have progressed slowly, despite the intense monitoring by the IMF (Campos and Coricelli 2015). According to the theory suggested by Achury et al. (2015), the corruption problem in Greece, combined with its high debt-to-GDP ratio, has led Greece into a trap.

What causes the corruption-debt trap in Greece?

According to the approach of Achury et al. (2015), corrupt political parties in Greece tend to act as rent-seeking groups through the provision of clientelistic goods described above. Cooperation on reforms and austerity measures is a typical coordination game. If the partisan benefits from cooperation exceed the partisan benefits from non-cooperation, then two equilibria are possible: cooperation and non-cooperation, with the latter being the result of bad coordination. If, however, the partisan benefits of non-cooperation exceed those of cooperation, even for one big party, then there is only one sure outcome: non-cooperation (Achury et al. 2015, Section 1.1).

The high cost of servicing the enormous outstanding debt in Greece simply makes non-cooperation more profitable for parties. If parties cooperate, they face a high cost of servicing the debt, especially due to the tight fiscal-surplus requirements. This fiscal burden makes party members think that a partial default and a gang war for rents is more profitable for them, even in a state of economic chaos. This strategic speculation keeps Greece in a trap, because non-cooperating rent-seeking groups engage into a tragedy-of-the-commons equilibrium of excessive rent seeking. Markets pre-calculate the implied fiscal profligacy, Grexit scenarios return with positive probability, investment becomes discouraged, and the debt-to-GDP ratio increases due to a shrinking economy (Greece has lost 26% of its 2008 GDP until year 2014).

The short-run solution and the long-run solution for escaping the political infeasibility trap: A synthesis

The ideal long-run solution to Greece’s problem would be to eradicate rent-seeking groups in politics.  However, this requires time and a deep understanding of the problem. The short-run solution would be to restructure Greek debt, postponing payments and giving enough time for economic recovery. This short-run strategy could make benefits from a broad-coalition government more attractive to political parties, because it would take away the debt-servicing burden. The working hypothesis is that some rent-seeking activities would still be speculated by parties (Achury et al. 2015, Sections 2.5, 3.1.2, and 3.1.4).

Of course, such debt restructuring requires a new agreement. And certainly the EU should ask for reforms in exchange for debt restructuring. Whether these reforms could solve the corruption problem (or not) in the long run, is a matter of understanding the roots of the corruption problem in Greek society.

The vast majority of Greek citizens are not corrupt: Corruption is a social coordination problem leading to a prisoner’s dilemma

A small but critical mass of citizens and politicians break the rules of fair play and equitability against the law. Businesses that do not pay their taxes oblige other businesses to do the same in order to survive competition. Skilled young people who apply for civil servant jobs are obliged to invest in clientelistic political connections, after seeing inapt persons obtaining such jobs. Citizens see their taxes ending up in the private pockets of people they know, but are unlikely to win a court case because of the political support for involved persons. Lawful citizens, knowing that taxes will not finance public goods but private benefits, are unwilling to pay their income taxes, becoming friendly to parties that promise lenience regarding tax collection.

The list can go on and on, but the issue is not morality. It is the technical perils of a coordination problem that ends up in prisoner’s dilemma situations that arise in everyday life. The sad equilibrium is that Greek citizens do not feel equal among equals against taxpayer law. A feeling of social mistrust pervades citizens, especially young people.

Can society and the partisan network of vividly supporting voters and politicians bring reforms to Greece? This is not likely, unless a key reform is implemented first: transparency. Greece can innovate on that front, making use of information technologies.

Basic things about transparency first

A key transparency reform is to put every Greek citizen’s existing personal data into a centralised database. Currently, such data are scattered across different public authorities, a strategy that is most likely intentional. This strategy has led to frivolities with tragic fiscal consequences. An example is the famous disability fraud of certified taxi drivers receiving blindness disability aid in the island of Zakynthos (Angelos 2012). Because of the radical nature of this reform, it is crucial to protect privacy rights in the transition phase.

A careful ‘name and shame’ transparency act

Another key transparency reform would be to list the names of all Greek citizens on the web, explaining who has paid all taxes, and if not, the stated reason why. This act should fully protect personal data, such as income and wealth records, exactly because political rent seekers inside and outside Greece may attempt to confiscate wealth through ad hoc bail-in acts. If implemented correctly, this reform is most likely to convince Greek citizens that everyone is equal among equals against taxpayer law. This sense of equality can lead to a new social contract that can fight clientelism and pork-barrel politics, restore social trust, and bring policy certainty. In turn, policy certainty can give confidence to domestic and foreign investors to unlock Greece’s potential for innovation and growth.

Conclusion

The implementation of the ‘aGreekment’ reached on 13 July 2015, after a 17-hour Eurogroup summit, needs a broad coalition government in Greece. The urgent and necessary political cooperation among parties is unlikely to be forthcoming. Political parties have rent-seeking agendas that are crowded out by the burden of servicing the debt. This is a trap.

To escape this trap, we suggest an urgent additional agreement. Drastic debt restructuring (postponing debt maturity) should be exchanged with immediate implementation of radical transparency reforms that aim at eradicating corruption. Debt restructuring should convince rent-seeking political parties that it is more profitable to cooperate. In the short run, parties could keep a small part of their rent-seeking activities, while servicing a smaller, manageable amount of debt.

It is impossible to instantly reverse the momentum of political corruption in Greece, but it is urgent that parties first cooperate on implementing simple and basic transparency reforms. In the beginning, the political cost of implementing these transparency reforms will be low. In the medium and long run, transparency can raise the feeling of equitability among citizens. This feeling can encourage Greek society to move away from supporting rent-seeking parties and to demand governments with public-resource management skills.

References

Achury, C., C. Koulovatianos and J. Tsoukalas (2015), “Political Economics of External Sovereign Defaults”, Center for Financial Studies, Frankfurt, Working Paper, No. 508, and SSRN Working Paper No. 2631418

Angelos, J. (2012), “’Island of the Blind’ Riles a Greek Public Facing Cutbacks”, The Wall Street Journal, April 3, 2012,

Campos, N. F., and F. Coricelli (2015), Reforming Greece, VoxEU, 17 July, 2015

Ferejohn,J. (1986), “Incumbent performance and electoral control”, Public Choice, 50, 5-26.

International Monetary Fund (2010a): “Portugal: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Portugal.” IMF Country Report No. 10/18.

International Monetary Fund (2010b): “Greece: Staff Report on Request for Stand-By Arrangement.” IMF Country Report No. 10/110.

International Monetary Fund (2010c): “Spain: 2010 Article IV Consultation—Staff Statement; Staff Supplement; Staff Report; Statement by the Executive Director for Spain; and Public Information Notice on the Executive Board Discussion” IMF Country Report No. 10/254.

International Monetary Fund (2010d): “Ireland: Request for an Extended Arrangement—Staff Report; Staff Supplement; Staff Statement; and Press Release on the Executive Board Discussion.” IMF Country Report No. 10/366

International Monetary Fund (2011a): “Ireland: Extended Arrangement—Interim Review Under the Emergency Financing Mechanism.” IMF Country Report No. 11/47.

International Monetary Fund (2011b): “Ireland: First and Second Reviews Under the Extended Arrangement and Request for Rephasing of the Arrangement—Staff Report; Letter of Intent; Memorandum of Economic and Financial Policies; Technical Memorandum of Understanding; Letter of Intent and Memorandum of Understanding on Specific Economic Policy Conditionality (College of Commissioners); Staff Supplement; and Press Release on the Executive Board Discussion.” IMF Country Report No. 11/109.

International Monetary Fund (2011c): “Italy—-Staff Report for the 2011 Article IV Consultation; Informational Annex; Public Information Notice; Statement by the Staff Representative; and Statement by the Executive Director for Italy.” IMF Country Report No. 11/173.

International Monetary Fund (2011d): “Spain—-Staff Report for the 2011 Article IV Consultation; Public Information Notice; Statement by the Staff Representative; and Statement by the Executive Director for Spain.” IMF Country Report No. 11/215, downloadable from:

International Monetary Fund (2011e): “Portugal: First Review Under the Extended Arrangement.” IMF Country Report No. 11/279, downloadable from:

International Monetary Fund (2011f): “Greece: Fifth Review Under the Stand-By Arrangement, Rephasing and Request for Waivers of Nonobservance of Performance Criteria; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Greece.” IMF Country Report No. 11/351.

International Monetary Fund (2012a): “Greece: Request for Extended Arrangement Under the Extended Fund Facility—Staff Report; Staff Supplement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Greece.” IMF Country Report No. 12/57.

International Monetary Fund (2012b): “Portugal: Third Review Under the Extended Arrangement and Request for Waiver of Applicability of End-March Performance Criteria—Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Portugal.” IMF Country Report No. 12/77.

International Monetary Fund (2012c): “Portugal: Fourth Review Under the Extended Arrangement and Request for a Waiver of Applicability of End-June Performance Criteria—Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Portugal.” IMF Country Report No. 12/179.

International Monetary Fund (2012d): “Ireland: 2012 Article IV and Seventh Review Under the Extended Arrangement—Staff Report; Informational Annex, Staff Supplement; and Public Information Notice“.

International Monetary Fund (2012e), “2012 Article IV Consultation with Italy- Concluding Statement of the IMF Mission“.

International Monetary Fund (2012f), “Transcript of the Updates to the World Economic Outlook/Global Stability Report/Fiscal Monitor Press Briefing 01.2012”.

Persson, T. (1998), “Economic policy and special interest politics,” Economic Journal, 108, 310–27.

Persson, T. and G. Tabellini (2000), Political Economics: Explaining Economic Policy, The MIT Press.

Schattschneider, E. E. (1935), Politics, Pressures and the Tariff, Englewood Cliffs, N.J.: Prentice Hall.

Endnote

[1] References to the need for broad coalition governments and societal consensus in order to promote structural reforms can be found in IMF reports by country during the 2010-2012 sovereign crisis and these include:

Greece

IMF Country Report No. 10/110: “The large multiyear fiscal and structural adjustment requires a decisive break from past behavior. Greece has run into fiscal problems before, which were often resolved only temporarily and by stop-gap measures. A decisive break now requires strong political will and public support. Mitigating factors include a strong mandate of the governing party and measures in the program to protect vulnerable groups.”  (IMF 2010b, p. 21).

”The challenge ahead will be to implement the program rigorously, while securing the necessary public consensus for reforms.”  (IMF 2010b, pp. 138-9).

IMF Country Report No. 11/351: “Staff welcomes the creation of a national unity government in Greece and the endorsement of program objectives and policies by the three major political parties. The previous lack of broad political support for the program in Greece has emboldened vested interests and has thus contributed directly to the slowdown of reform implementation.” (IMF 2011f, p. 35).

IMF Country Report No. 12/57 “staff welcomes the commitments from the political parties supporting the present coalition to continue with the objectives and policies of the new program”  (IMF 2012a, p. 44).

“Structural reforms, which are critical to addressing both of these problems, lost considerable momentum during 2011. [ …] Retaining broad political support for reforms will be crucial to future success.”  (IMF 2012a, p. 42).

Italy

IMF Country Report No. 11/173: “The authorities’ welcome commitment to reduce the fiscal deficit to close to zero by 2014 needs to be accompanied by action. […] The large size of the envisaged fiscal retrenchment requires structural changes which must be designed well in advance. This calls for a strong political consensus and careful planning”.  (IMF 2011c, p. 30).

2012 Article IV Consultation with Italy- Concluding Statement of the IMF Mission: “With broad political support, the authorities have embarked on an ambitious and wide-ranging agenda that has lifted Italy from the brink and is now seen as a model for fiscal stabilization and growth-enhancing reforms”.  (IMF 2012e, p. 1).

Portugal

IMF Country Report No. 10/18: “Political support for reform may need broadening. The Socialist Party was re-elected in September 2009, but lost its overall majority. While there seems consensus among the main parties to comply with the SGP in general, pressure for further stimulus is strong”.  (IMF 2010a, p. 9).

IMF Country Report No. 11/279: “Sustained social and political support is necessary for the comprehensive structural reform program. Strong vested interests could weaken reforms, or reform fatigue could set in, and weaken growth prospects and the required adjustment in the economy”. (IMF 2011e, p. 16).

IMF Country Report No. 12/77 “Prospects of program success remain reasonably strong, given that substantial adjustment and significant reforms is already underway and there is strong political support”.  (IMF 2012b, p. 26).

IMF Country Report No. 12/179: “Finally, one year into the program, the authorities are building a convincing track record of meeting adjustment and reform objectives while preserving political support, and prospects of success for the program remain reasonably strong”. (IMF 2012c, pp.19-20).

Spain

IMF Country Report No. 10/254: “Policies and staff views: Ambitious fiscal consolidation is underway. […] Such a comprehensive strategy, especially with broad political and social support, would underpin investor confidence, and time is of the essence”.   (IMF 2010c, p. 1).

IMF Country Report No. 11/215: “Ambitious fiscal consolidation is underway but […] Such a comprehensive strategy would be helped by broad political and social support”. (IMF 2011d, p. 1).

Transcript of the Updates to the World Economic Outlook/Global Stability Report/Fiscal Monitor Press Briefing 01.2012 “Political agreement is also needed on a medium-term fiscal adjustment plan that will first stabilize and then bring down the debt-to-GDP ratio”. (IMF 2012f, p. 1).

Ireland

IMF Country Report No. 10/366: “Adhering to the fiscal targets and restructuring the financial sector require strong political will and public support”.   (IMF 2010d, p. 12).

IMF Country Report No. 11/109: “the elections brought in a coalition government with strong ownership of the goals and key elements of the EU/IMF-supported program, much reducing these risks compared with the time of program approval. Yet the capacity to sustain fiscal adjustment and other reforms will depend on signs of concrete results in time”. [ …] It is welcome that the new government has affirmed their strong commitment to the fiscal consolidation agreed in the EU/IMF-supported program”. (IMF 2011b, pp. 22-23).

IMF Country Report No. 11/47: “Turning market sentiment to a more positive tone will require sustained implementation and reduced political uncertainty”. (IMF 2011a, p. 7).

IMF Country Report No. 12/264 “Political commitment to consolidation has been a welcome constant, as reflected in the affirmation by the new government (which took office in March 2011) of the medium-term fiscal targets in the EU–IMF supported program agreed in December 2010”. (IMF 2012d, p. 20).

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

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Authors: Christos Koulovatianos is Professor in Macroeconomics at the University of Luxembourg and a Research Fellow of the Center for Financial Studies, Goethe University Frankfurt. John Tsoukalas joined the Adam Smith Business School, where he is an Associate Professor (Reader) in Macroeconomics, in August 2011.

Image: Sixty Euros, the maximum amount allowed after the imposed capital controls in Greek banks, are seen during a withdrawal operation at a bank branch ATM in central Athens, Greece, July 12, 2015. REUTERS/Christian Hartmann.