Jean Pisany-Ferry is director of the Brussels-based economics think-tank Bruegel, a professor of economics at Paris-Dauphine University, and a member of the French Prime Minister's Council of Economic Analysis.
"For months now, a fight over sovereign-debt restructuring has been raging between those who insist that Greece must continue to honour its signature and those for whom the country's debt should be partly cancelled. As is often the case in Europe, the crossfire of contradictory official and non-official statements has been throwing markets into turmoil. Confusion abounds; clarity is needed.
The first question is whether Greece is still solvent. This is harder to judge than is the solvency of a firm, because a sovereign state possesses the power to tax. In theory, all that is needed in order to get out of debt is to increase taxes and cut spending.
But the power to tax is not limitless. A government determined to honour its debts at any cost often ends up imposing a tax burden that is disproportionate to the level of services that it supplies; at a certain point, this discrepancy becomes socially and politically unsustainable.
Even if the Greek government were to succeed shortly in stabilising its debt ratio (soon to reach 150% of GDP), it would be at too high a level to convince creditors to continue lending. Greece will need to reduce its debt ratio considerably before it can return to the capital markets, which implies – even under an optimistic scenario – creating a primary surplus in excess of eight percentage points of GDP. Among advanced-country governments, none (except oil-rich Norway) has managed to achieve a durable primary budget surplus (revenue less non-interest expenditure) exceeding 6% of GDP.
This is too much for a democratic country, especially one where the tax burden is very unequally shared. Greece is, in fact, insolvent.
The second question is how serious a problem it is not to repay one's debts. One camp notes that, for decades, no advanced country has dared to do this, and that is why these countries still enjoy a positive reputation. If just one member of the euro zone embarked on the debt-default path, all the rest would immediately come under suspicion. In any case, according to this view, contracts simply must be respected, whatever the cost."
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Published in partnership with Project Syndicate.