Home > EMU Crisis, Growth, sovereign debt > On Wage Reduction and the Contract Between Workers and the State

On Wage Reduction and the Contract Between Workers and the State

February 17, 2012 Leave a comment Go to comments

My colleague Sezgin Polat, of Galatasaray University, has an interesting idea on wages and the burden of the crisis. All the more interesting, that just yesterday the ECB called for further wage flexibility, at a moment in which aggregate demand is despairingly low in the eurozone. Here is Sezgin’s proposal (I shortened it):

The latest austerity plan lacks the support of the Greek people. It is addressed, as usually happens in Europe when democratic backing of a policy emerges, by making recourse to “technocrats”. The democratic deficit is neglected by dictating the rules [from above].
One possible solution to overcome such deficit is to make a genuine deal with the Greek voters. This will enable social support and backing. Any public wage cuts, or welfare benefits reduction could be securitized by the government e.g using 10-year maturity bond. Securitization of the austerity cuts will function as a forced saving in its simplest form, as a way to carry income to the future, if the public debt problem is temporal as I assume and hope. Make the commitment to the people and give them the right to be in the position of a principal monitoring their agent, the government.
The German proposal to impose a borrowing limit clause in the national constitutions could be made more flexible by allowing governments to exceed the limit if they borrow directly from their citizens, making a commitment that can bind them as agents. The direct borrowing can serve as a fiscal transfer of the intertemporal kind, binding national governments to their citizens/voters, who in the case of default would be the ones with whom the government should negotiate any hair cut.

The feasibility of this proposal has to be worked out, and it assumes that the budgetary effort for the government is only temporary. Furthermore, it has the major flaw of not addressing the short run contractionary effects of wage and purchasing power reduction. I do wholeheartedly believe that wage cuts are not effective, and unjust. But if wage cuts need to be imposed, then Sezgin’s proposal has a few appealing features.

  • First, it gives substance to the typical argument that we hear when sacrifice is imposed to the people. We hear a lot the sentence “We need to impose hard times today in exchange for a brighter future”. Wage cut securization would transform this generic engagement in a binding commitment.
  • Second, it would at least partially free the government from foreign holding of domestic bonds, and from speculation. This is an interesting aspect of the proposal, that is shared with an article calling for forced borrowing (imposed on the wealthier) that was published on the Financial Times a few months ago.
  • Third, but this is harder to demonstrate, if workers have some sort of permanent income approach, the fact that the wage cut is in the end temporary could impact less their consumption today, and hence be less contractionary. This last argument actually implies that workers have savings to use to smooth consumption; any newscast on Greece shows how implausible this is…

So why not discuss this further? This is what public debate is for.

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  1. February 17, 2012 at 3:27 pm | #1

    Wow, this is a cool idea. Just to be clear on the mechanics of securitizing wage cuts, I think Sezgin is proposing the following. The Greek government will issue 10-year debt to the public. Greek investors will consider the debt subject to the credit-worthiness of the issuer. Austerity measures will signal credibility to bondholders, and may thus increase demand for the notes. Holders of the debt will then receive coupon payments on some regular schedule. The gain in income from the coupon payments will presumably offset some of the loss in income due to austerity measures. Is that right?

    I think the idea is a nice one. Designing a mechanism that would give Greek voters an incentive to monitor their own government makes a lot of sense. Even so, I have some doubts. I don’t get the feeling that Greek voters or people in general trust their government at all. They seem genuinely suspicious of their political system. The admittedly lopsided picture I’ve gotten of Greeks as a nation gives me the feeling that they were all somehow “in” on the party that led to this mess. If so, they would normally be the last people who would agree to lending to their own government.

    A second reservation comes from the probability that this entire issue, to the extent that it is placed at all, will end up in the hands of people who will probably not be loved by the voting majority. They will be described in elections as rich Athenians who store Greek debt and unpaid taxes on their yachts. I don’t believe that these folks will be protected in any way by the political system that seems to govern Greece.

    The above reservation could probably be addressed if Greeks were somehow forced to opt-into the debt issue. Mandating pensions and other national institutions to hold some of the debt could effectively force Greeks to care about what their government does. To me, this doesn’t seem very fair. To say that something is unfair, however, is hardly the same as saying it is impossible. I dunno. I guess there are ways to make this idea work. But, as long as Greek voters can pass the costs onto Europe, I don’t see why they would line up behind this idea. Just a thought.

    • Sezgin Polat
      February 17, 2012 at 7:36 pm | #2

      I am not quite sure whether Javaad has got my first point right. My first suggestion directly targets the ongoing wage cutting or benefit reduction issues. More plainly, I am saying that the Greek government must make a commitment to the voters by issuing a long-term debt contract if it demands even more wage or benefit reductions from people. The deal is simple though maybe hardly implementable. Simply the Greek authorities can offer a debt contract (preferably a long-term bond ) in exchange for any austerity measures like wage or benefit cuts. The reduction of wage say, 20% should be securitized by that debt contract to be paid in the future. This is what the ordinary people face now. To reply to my friend Javaad, my first proposal targets the ordinary Greek citizens, not only the riches people of Athens.

      For other concern of Javaad, I think it is feasible to design a more democratic way to finance a deficit in case of a deep recession. Naturally, I am skipping harder questions like monitoring who, whom and by which means, really, OK. But, if an EU government should exceed the borrowing limit, it must very plainly make a commitment to voters, but surely not a cheap one. The commitment must be solid commitment, a debt contract saying that we borrow in bad times and pay in good times. If a government succeeds in getting most of the citizens involved and sells its recession bonds (upper limit on each bond would solve the “only rich people save” problem if it would be more democratic), then ok, any EU government can do that. That was my second point.

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