What’s depressing is that we will likely see this drama play itself out again, as we have before, whether or not the actors on stage are Greece and the European Union or some other over-indebted nation and its creditors. There may be elements to this story that are particular to the dynamics of the Eurozone, to be sure, but there is a more fundamental, less discussed, problem that needs resolving: the excessive reliance of nations on debt as a means of financing their development.

The Greek debt crisis is so similar to other debt crises of the past it’s haunting. Developing countries load up on loans from over-eager banks and other creditors based on rosy growth projections that do not materialize. Unable to meet their repayment obligations, they default or seek debt forgiveness. If the crisis is big and systemic, other governments and multilateral financial institutions (in this case, the European Central Bank and the International Monetary Fund) bail out banks trying to prevent a financial crisis that may cause large economic disruption. Pundits on both sides make loud noises. There is a usually a “moral hazard” camp arguing against any bailouts, opposed by an “extraordinary times require extraordinary measures” faction eager to do what it takes to avoid ruinous financial contagion. Rewind, pause, repeat. The pattern is all too familiar and a bit too frequent.

The fundamental problem is an excessive reliance on debt as the method to finance public spending. Such inflexible IOU’s shouldn’t be the only means available for sovereign nations to raise capital to invest in their growth and development. Like enterprises in the private sector, sovereign states should also be able to raise equity funding, which involves selling a stake in their future to investors eager to participate in, and benefit from, their success. This would give these states more room to maneuver when times get tough, and give their creditors a better return when things go well.

Consider the differences between Greece and Uber. If Uber wants to raise money to finance its expansion, it can go to a bank to seek a loan, or it can sell that equity stake to investors willing to share both the upside and downside risk, aligning their interests with those of the company. Short of selling shares in individual state-owned enterprises, there are surprisingly few avenues for sovereign nations and investors to partner up, and there is no good reason for Uber and other start-ups to have more financing options than an emerging sovereign nation does.

A traditional loan requires a fixed repayment, regardless of circumstances. Sure, different borrowers, including governments, pay different interest rates depending on their track record and prospects, but essentially once a debt is contracted, they do not repay more if outcomes exceed expectations, and their liabilities aren’t diminished if things sour. Lenders have generally looked to government debt as a relatively safe, conservative investment, which is why so many pension funds and individual investors in this country choose to invest in municipal bonds and Treasury bills.

That’s the theory, of course, but as the Greek case shows, the international financial system has gone too far in privileging debt over other financing options, with utterly predictable results. Once again, creditors and borrowers—not to mention the people of Greece and elsewhere in Europe who weren’t in on the decision to enter into these agreements—are entangled in a messy, time-consuming, and destabilizing drama emanating from a supposedly unimaginable default. Equity-like deals, where investors fully become invested in a country’s fate, are often made only after a costly default process, when some investors acquire “bad debt.” The value of the bad debt can rise and fall dramatically, depending on a nation’s performance. For instance, after defaults by Latin American countries, such as Argentina, in the 1980s, these countries’ old debt obligations were swapped for what were called “Brady Bonds,” which allowed investors to trade the debt for other financial instruments at deep discounts from their contractual values. The market values of Brady Bonds rose and fell with the economic performance of these countries, which means investors and sovereign debtors’ interests became somewhat aligned.

It would be far better to design an equity-like, risk-sharing arrangement between sovereign states and creditors from the outset, in which the required repayment were automatically lowered in bad times and scaled up in good times. For example, the repayments could be linked GDP growth, or to market prices of commodities that a country exports.

Finding new ways to package and sell risk-sharing equity stakes in a nation’s future would better align the interests of sovereign borrowers and its foreign or domestic creditors. The concern that countries receiving equity capital might be tempted to minimize their resources or performance to lighten their obligations is likely not relevant for small, growing countries. The consequences for reporting bad outcomes frequently would cause investors to lower their expectations of countries’ potential for growth and thus lower the valuation of their assets when any future financing is being negotiated. The hit that a country’s reputation would take for inaccurate reporting would simply be too high.

We should think of small, growing countries such as Greece (whose performance was healthy prior to the financial crisis, recession, and austerity of recent years) the way we think of promising, but volatile, tech start-ups. They should be financed with less debt, and more equity, perhaps even with riskier options—like stock-call options that are worth zero when performance is poor, but deliver outsized returns when things go well. This more diversified approach to sovereign financing would provide growing nations with natural shock absorbers. Their creditors would profit handsomely in good years, but countries like Greece would conversely benefit from some relief in bad years, as opposed to forcing a crash of the international financial system on account of a debt straightjacket they have forced themselves into.

In the meantime, regardless of what happens in Greece, a continued overreliance on debt to finance the expansion of developing economies will only mean that the next time—and there will be a next time—will be no different.

The post Greece Doesn’t Need a Bailout—It Needs Investors appeared first on Zócalo Public Square.

Greek Referendum
Noun. An act of intense self-destruction. A suicidal act. Usually harms many people, not just the person committing the act. Often causes those witnessing the act to facepalm or exclaim in a loud voice, “Why?”

The average Greek citizen is not a political economist or an expert in international finance, which means most eligible voters aren’t nearly knowledgeable enough on the technical financial issues involved to make an informed decision—certainly not as informed as the government they elected to make these decisions. Nevertheless, the mere fact that Greek citizens are being given a choice means that the Greek referendum might actually be good for the country in the long run.

Greece is facing two very bad options. On the one hand, it could turn down Europe’s bailout proposal, reject the attached austerity measures, and face the wrath of its creditors. This would destroy Greece’s credit rating for years and probably lead to the country’s exit from the European Union, which would in all likelihood trigger massive capital flight, inflation, and all sorts of other economic horrors. On the other hand, Tsipras and his team could accept yet another round of harsh and unpopular austerity measures, further cutting salaries and pensions and raising taxes, under the hope that this austerity package (unlike the last several) would finally lead to an improvement in the Greek economy. But with unemployment already at record highs, this would put severe financial strain on Greek families, and potentially cause the economy to collapse further.

In other words, it doesn’t matter which decision the Greeks make; the ramifications are going to be pretty bad. It’s pick-your-poison time. And that is true whether the decision is made by bureaucrats or voters.

One might say that the biggest threat to Greece right now, however, isn’t austerity, nor is it leaving the Euro. The biggest threat to Greece right now may be the political instability that could result from citizens’ frustrations regarding the inevitable fallout from either of those two unenviable paths. Disruptive protests, rioting, constitutional change, or (at worst) an unconstitutional change in government or regime would only make Greece’s economic situation worse—and could have ripple effects on every aspect of Greek life for years to come.

It’s hard enough to get the economy back on track with a bad credit rating or under the burden of austerity measures or hyperinflation. That becomes much, much harder if strikes shut down public transit and industry, violent protests require the government to use its already scarce funding to hire additional police and security, or the tourist industry collapses because civil unrest gives the impression that the country isn’t safe to visit.

So how does the government in Athens prevent such unrest? Bringing its citizens into the decision-making process may make them more likely to accept the ultimate outcome, whatever that outcome may be. As discussed in our book, Democracy Despite Itself, there is a strong psychological principal which tells us that people are much more at peace with a decision—even one they disagree with—if they are given a voice in the decision-making process. This so-called “procedural justice” also reduces corruption and makes people more willing to follow rules and get along (all things Greece needs from its citizenry if it is going to get out of its fiscal crisis).

There’s plenty of research that captures these effects. During the 1991 California drought, the amount of water residents rationed wasn’t influenced by their beliefs about the drought’s severity, but instead was driven by how fair they thought water pricing and allocating polices were. Other studies have shown that people are more likely to pay taxes when they get to vote on where the tax money goes, even when they aren’t on the winning side of the vote. If the goal is to get Greek citizens to conserve scarce resources (which would reduce government costs) and pay taxes on time (a perennial problem in the country), the government needs to be sure that the electorate perceives that decisions were made fairly.

A referendum, by its nature, is a stabilizing measure, meant to forestall the social and political turmoil that a tough decision can incite. Yes, representative government has its merits, but especially in a country like Greece, where political parties and state institutions don’t enjoy the highest levels of public trust (and there is a widespread perception that foreign creditors control the government to the exclusion of the electorate), putting existential questions directly to the people can help create legitimacy for the actions the government takes.

The referendum isn’t likely to help Greece make a better decision, but it very well could help Greece nonetheless. Whichever path the Greek voters decide, given how bad both of the options are, the mere fact that the voters themselves are deciding could make all the difference in the world.

The post Why Greece’s ‘Suicidal’ Referendum Is Still a Good Idea appeared first on Zócalo Public Square.