Monash Association of Debaters

Harish Natarajan

The Global Financial Crisis: Debating Debt, Austerity and Bailouts

Introduction


The economic crisis that started in 2008 is still ongoing. The crisis has affected
economic and political systems across the globe. Currencies like the Euro have
been destabilized. Violent protests have broken out throughout the world. Scenes
of chaos in Athens and Rome suggest that the economic crisis has profound
political implications. Protestors have not only opposed particular policy, but
often critique the capitalist dominated political system.


It is unsurprising that the financial crisis has lead to an increased focus on
macroeconomics in debating. One indication is the incidence of topics on the
subject. For example the motion This house believes that central banks should
set limits on government spending was set at Botswana Worlds 2011; This House
would Abolish the Euro was set at WUPID 2010; This house believes Eurozone
countries should bail out other Eurozone countries who would otherwise default on
their sovereign debt was set at the LSE Open in 2010; and This house believes that
Barack Obama should have vetoed any debt deal that did not increase taxation at
EUDC 2011.


Debating is ill-suited to discussing economics. Theories can be used to justify both
sides of most debates. Instead economics requires empirical evidence to justify
which theory is correct, and the complexity of the conditioning variable involved
is not accessible to the majority of participants. Only basic observations can be
made, and complex theories must be relegated to a few sentences. Nonetheless,
the topicality of macroeconomics makes it hard for most Adjudications teams to
avoid.


Any debater preparing to speak at a major competition would be advised to
research the financial crisis and the issues it has created. This article does not
provide an academic look at the crisis. Plenty of other sources and academics
have written in depth about the problems, and potential solutions. This article
focuses on providing a background to the crisis and ways of thinking about
macroeconomics in debates. It focuses on ways of effectively deploying economic
theory to a debating audience.


Why Economics Matters?


In political discourse benefits to the economy is often considered an overriding
good in itself. Showing that a particular policy helps economic growth is often
a silver-bullet in justifying a particular policy. Not so in competitive debates.
Competitive debating forces its participants to consider why economic growth is
good. This is one of the strengths and weaknesses of the activity. It is a strength as
it forces us to explain what we often take as a premise. It is a weakness in that it
divorces debating further from the political process.


Take the example of ceding control of fiscal policy to a Central Bank. It is possible
that an opposition team could concede that a Central Bank setting fiscal policy
could lead to better decision making, yet still successfully claim that the principles
of democracy are sacrosanct and determine that such fiscal decisions should not
be taken away from elected representatives. Similarly financial cost and economic
gain is often a dominated argument. The financial cost of a policy is regularly
considered unimportant against any other benefit or costs claimed.


It is useful that teams try to explain why the economy gains or losses are important.
Even if an entire debate assumes that economics matters, elevating the importance
of economic claims can strengthen arguments against indirect attacks.


One way of explaining why the economic system matters is by transforming claims
from the economic to the emotive. The language of economics is dispassionate.
It is often hard for an audience to appreciate why negative economic growth
matters in itself. For example, you could describe a recession as two negative
quarters of economic growth. While accurate, that has little power in front of
an audience. Former US President Roland Reagan expressed a recession more
emotively: ‘Recession is when your neighbour loses his job. Depression is when
you lose yours.’ Describing a recession in this way makes it seem more important
and far easier for an (intelligent) audience to understand.


Another way of expressing the human impact of a crisis is to take a global approach.
The World Bank predicted that the 2001 economic downturn would push 10
million people below the $1 a day poverty line. Up to 40,000 children died of
malnutrition. A single country crisis still leads to hundreds of thousands of people
without jobs and income. Areas of unemployment can grow, and unemployment
can last a generation.


On a more general level, one of the most important skills in any economics debate
is the ability to explain why economic concepts matter. Experts in economics will
often find themselves speaking with the assumption that it is obvious as to why
their arguments matter, yet it will often need to be argued rather than assumed.


Debt Crises


One of the more popular debates on macroeconomics focuses on high levels of
government debt. Debt Crises have spread throughout the Western World. The
US has unprecedented levels of government debt, forcing it to increase the debt
ceiling. Many Eurozone countries face high levels of government debt, resulting
in measures to reduce spending and thus debt in the long run (these are known
as ‘austerity measures’).


Debt crises exist when governments have borrowed heavily for years and are
struggling to pay the interest on what they have borrowed. Greece, for example,
has faced a debt crisis - as it struggles to pay interest on its new debt. Other
countries fear that they will struggle to pay the interest on their debt (or that
financial markets will believe that), and respond by cutting spending. The UK,
for example, is not facing an immediate debt crisis, but has acted to reduce the
rest through austerity cuts.


Debates on the topic focus on how countries can institute reforms to prevent
future debt crises, how to reverse the buildup of debt and how to manage a debt
crisis. Non-economists cannot be expected to fully understand the economics of
debt crisis, but a few of the points below should help understand how to make the
most of what knowledge you do have.


First, the buildup of debt has a strong political logic to it. A rising debt ratio is
caused by persistent government deficits. Governments have incentives to spend
now through borrowing. High spending and low taxes are popular, as the costs of
current spending can be differed to future governments.


Debt buildup is thus often caused because of politics rather than economics.
Attempts to overcome this political logic include ceding control of total spending
to bodies that do not apply to same political calculus. For example, Central Banks’
decisions may be less politically determined. Further, external bodies can formally
limit the deficits countries run. While all these measures reduce the power of
democratic bodies, they can be justified as reducing the chance of crisis.


Second, while the underlying amount of debt a country has is important,
financial markets confidence matters. The interest rate that countries have to
pay depends on the apparent risk of lending to that country. If markets believe
there is an increased chance of default, then they demand an increase the interest
rate associated with holding that currency. The irony is that the loss in market
confidence can vindicate itself. If market participants feel that there is an increased
risk of default, they can cause that very default that they feared. Thus policies
that signal to financial markets that they are likely to be repaid often are more
important than actually repaying debt. For example, UK austerity measures have
showed markets that the government is willing to take tough political decisions to
repay debt. This increases the credibility that the government will pay back debt.


Third, the total amount of debt matters far less than the debt to gross domestic
product (GDP) ratio. GDP is the amount a country produces, and most debt
figures you read will be expressed as a percentage of GDP. It stands to sense that
a country with a higher GDP should be able to pay a greater amount of interest
and correspondingly have a high absolute amount of debt. As a country grows
richer (its GDP increases), it can service greater absolute amounts of debt. This is
important to recognize as it suggests that one way of getting out of a debt crisis
is economic growth. Thus policies that aim to reduce spending (or increase taxes)
to overcome debt problems can be self-defeating. These policies can harm total
growth, and in doing so make debt harder to service.


There is, of course, a lot more that is relevant to the debates on debt buildup and
debt crises (see Eichengreen’s Towards a New Financial Architecture for example) -
however understanding the basics is sufficient for most debates.


Bailouts


Bailouts have become an increasingly topical issue. Banking bailouts have generated
political backlash (see the Occupy Walls Street Protests). Sovereign bailouts have
received similar negative attention. Packages to bailout Greece (providing Greece
funds to pay off some of its existing debt), has led to the German public in
particular (the majority funders of any such deal) to question their support of
such measures.


In many debates the question of whether a country should default arises. Bailouts
are an alternative to defaulting on debt. The relative benefits and costs of defaulting
on debt (compared to bailouts) are complex and economically technical. Yet
again, a few comments on the relative merits of defaulting on debt are worth
considering.


First, defaulting on debt passes costs on to lenders. Lenders face substantial losses
when they cannot get repaid. These lenders are often domestic banks. Losses to
these banks risks that these banks will collapse and general depositors (those who
lend to banks) potentially suffer a loss of their entire savings. Second, defaulting
often means that it becomes harder to borrow in future. In the immediate term a
country will still (likely) need to borrow to cover its immediate spending needs.
However, few can trust that a country that has just defaulted will pay back
future debt - and will thus only be willing to lend at very high interest rates.
Hence, following a default, countries are forced into rapidly cutting spending
(or increasing taxes). This explains why countries that default often have sharp
economic downturns in the immediate aftermath. While both of the previous
costs may be preferable to having to pay back billions in debt (and pay the service
costs for years to come), it should suggest that defaulting is not a simple option.


Bailouts are often necessary to prevent harsher economic contractions. They are
often also necessary to prevent a crisis from spreading. For example, the collapse
of Italy would likely hit banks worldwide. Banks everywhere hold Italian debt, or
debt from other financial firms that hold Italian debt. This provides a rationale for
other countries to bailout failing economies.


However, bailouts are only stopgaps. Bailouts will rarely allow a country to retire
all of its debt. They tend to provide funds at lower interest rates for the immediate
term. They also help convince the markets that debt will be repaid, and thus
reduces the cost of private borrowing. Measures will still be required to prevent
debt from increasing. Greece, for example, still needs to cut spending in order to
remain solvent even after it has received bailout packages. If a bailout is not met
with the political will to cut the deficit, it will do little but delay the eventual
crisis.


Further, bailouts lead to moral hazard problems. A country may be more likely to
engage in risky and imprudent behavior if it knows that others will shield itself
from the worst excesses of its financial profligacy. A bailout is that shield from
the worst consequences. While any government that accepts a bailout is likely to
suffer political damage and conditions associated with the bailout will mitigate
the effect of moral hazard further, it still remains possible that bailouts increase
the chance of debt crises reoccurring.


Conclusions


This article has provided some of the basics that all debaters need when debating
macroeconomic issues. It has not provided a full academic discussion of the topic.
Competitive debating requires that experts temper their knowledge for their
audience - failing to do so could result in losing debates to those who are just
better able to explain why their arguments are correct and why they are important.