Topical Terms in Economics: "National Bankruptcy" Interview with Hans-Werner Sinn (11.10.2010, in German) Was ist ein Staatsbankrott? Video Welche Folgen hat ein Staatsbankrott? Video Kann ein Land auch in einer Währungsunion bankrott gehen? Video Wie kann ein Staatsbankrott verhindert werden? Video Was ist ein Twin-Deficit? Video
A state is bankrupt when it is unable to repay its debts or interest obligations on time and to the full or even partial amount as originally agreed. In addition to the debts of a state, this criterion also applies to the debts of the private sector that are covered by government guarantees. A national bankruptcy also becomes evident when governments put a freeze on bank deposits and/or when deposits in foreign currencies are forcefully converted into the domestic currency.
The cause of national bankruptcies is often that the state is no longer able to refinance its expiring debts. If creditors have lost confidence in the state’s ability to pay, they demand a risk premium for new credit. This higher interest rate is an additional burden on the state’s solvency and touches off a downward spiral. At some point in time the only recourse for the state is to declare bankruptcy. Or the creditors at some point refuse to make new loans to pay for the old debts.
From an economic viewpoint a distinction can be made between different types of national bankruptcies (see Manasse and Roubini 2009). Basically solvent countries can run into liquidity problems due to high short-term obligations, i.e. they temporarily have cash flow problems. Such liquidity crises can be solved, for example, with the help of bridge loans – from the International Monetary Fund or from other countries. It is more difficult with solvency problems: here the state is unable to pay because of an excessive burden of debt. It can only escape the debt trap with drastic, confidence-building savings measures. It is particularly dangerous if a downward spiral has set in: the financing problems result in creditors demanding higher risk premiums which in turn increase the cost of servicing the debt. States can also encounter financing difficulties because of macroeconomic deficits. These often occur as a combination of weak economic growth and a relatively fixed exchange rate. These three categories are not mutually exclusive, however. A state can suffer from several problems at the same time. Furthermore, there are also national bankruptcies that are not attributable to an economic cause. Non-economic causes include wars, natural catastrophes or political coups and the new government’s refusal to recognise the old debts after assuming power.
The current problems in Greece are economically complex.[1] In 2010 alone, Greece must borrow 50 billion euros to replace its expiring debts. Added to this is a planned new borrowing of 30 billion euros. Not only this refinancing and new borrowing is problematic but also the mountain of national debt. The EU estimates that Greece’s national debt at the end of 2010 will amount to 304 billion euros, or 125% of GDP. And Greece has a twin deficit: it not only has a budget deficit but also a deficit on current account. The Greeks import much more than they export, which led to a deficit on current account in 2008 of 14.6% of GDP. Greece thus needs considerable amounts of asset transfers from aboard or capital imports (borrowing and sales of assets) for financing its deficits.
State bankruptcies[2] differ from the insolvency of enterprises and private persons in that there are bankruptcy laws for the latter. In Germany, for example, the insolvency laws regulate how the creditors are to be satisfied. In the United States there is the frequently quoted Chapter 11, a section of the Bankruptcy Code that regulates business insolvency. For national bankruptcies there are no such laws. Creditors thus have no reliable guidelines as to how and in what amounts they can recover their money. Although there are often attempts to create such a legal framework (see Economist 2001) – especially after the largest case of a national bankruptcy with foreign liabilities, the bankruptcy of Argentina in 2001 – we still have no obligatory rules. This makes investors’ confidence in being able to get their money back all the more important. Confidence in solvency is crucial when it comes to national debts. Although a legal framework is lacking for national bankruptcies, there is an international organisation that countries in financial difficulties can turn to – the International Monetary Fund. The IMF grants financial aid to support countries with balance of payments difficulties to make the necessary economic-policy adjustments.[3] In order to attain this credit, the states must submit themselves to reform programmes. The IMF monitors and evaluates implementation of the reform measures.
Confidence is important also because states as a rule go bankrupt long before they are unable to repay their debts from their own resources. This is probably the source of the wide-spread opinion that states are actually not able to go bankrupt, since they are usually in principle able to pay off their debts – with their raw materials, their land or with the labour of their citizens. But states stop payments or delay them even if they theoretically have the funds to service the debts. Of course, a state can run into the above-described solvency problems. But otherwise it is much more the case that governments must weigh up different interests. On the one side are the creditors that want their money or their interest payments. On the other side are the citizens of the country. If the creditors are to be paid, this often means deep cuts for the citizens. The state must cut back spending by reducing wages and salaries or pensions, for example. Or it can cut back state infrastructure services. In addition it must increase its revenue, by raising taxes, for example. The results of this are possibly a deep recession, an economic downward spiral or political unrest. The government must decide what demands it can or is willing to place on the population. Frequently it has no other choice except for bankruptcy. The necessary adaptations would be so drastic that only a declaration of insolvency and the plea for help remain. Or the government has no other choice because the creditors simply refuse to give it fresh capital.
Reinhart and Rogoff (2009) have compiled a comprehensive data collection on national bankruptcies. Their list of national bankruptcies in Europe from 1800 to the present shows how frequent national bankruptcies were – also in Europe – and still are today.[4] Since its independence in 1830, Greece has been in a state of national bankruptcy for nearly half the time, placing it at the top of the list in Europe. Taking as a measurement not the duration of the bankruptcy phases but only the number of bankruptcies since 1800, the rankings change. Based on this criterion, Spain tops the list with eight, closely followed by Germany[5] with seven as well as Austria and Hungary, both, including Austria-Hungary, also with seven bankruptcies. Narrowing the view to a shorter and more recent period, for example 1980–2008, other European countries stand for national bankruptcies: Poland, Romania, Russia and Turkey.
[1]For data on Greece, see the Factsheet Griechenland of the Ifo Institute. [2] The word "bankrupt” derives from the Old Italian bancarotta, which refers to a moneychanger’s broken table. [3] For the International Monetary Fund, see the information leaflet "The IMF at a Glance”, accessible at http://www.imf.org/external/np/exr/facts/glance.htm. [4] Reinhard and Rogoff (2009), p. 99, national bankruptcies and/or debt rescheduling. [5] With the German Empire and its precursor states.
Abberger, Klaus, "Was ist ein Staatsbankrott?", ifo Schnelldienst 63 (07), 2010, 37-40. (Abstract / Download)
Economist (2001), “When countries go bust, Argenatina shows the need for sovereign bankruptcy procedure”, The Economist, 6 December 2001.
Ifo Institute (2010), “Factsheet Griechenland“, accessible at: http://www.cesifo-group.de/link/special-greek-facts.pdf
Manasse P. and N. Roubini (2009), “’Rules of thumb’ for sovereign debt crises“, Journal of International Economics 78(2) , 192–205.
Reinhart C.M. and K.S. Rogoff (2009), This Time is Different, Princeton University Press, Princeton.
Ifo Policy Issue: Stability and Growth Pact
Ifo Policy Issue: Greek Budget Crisis
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