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LiU economist: Countries should be allowed to go bankrupt

Governments hungry for popularity and reckless finance markets have brought on the Euro crisis. Banks now need to be shown that taking risks that are too big won’t go unpunished. Individual countries should be allowed to go bankrupt, says a political economist at LiU.

Bo Sjö is a lecturer in political economy at Linköping University and a specialist in macroeconomics. He divides the blame for the Euro crisis among governments that could not hold on to their money, and banks and other lending institutions that were unable to assess the risks. Insolvent countries were able to borrow money far too cheaply.

“Governments in the most debt-ridden countries let the deficit grow even in good times. The combination of high government expenditures and low tax revenue won’t function in the long run.”

But banks are also at fault here. They loaned money to insolvent countries entirely too casually.

“They couldn’t assess the risks properly.”

The EU is now establishing funds that will take over the bad loans, and in that way save the most debt-ridden countries. This isn’t good, Sjö says. They’re strengthening the message to the banks that there is no risk in lending, even to countries that can’t pay. Stronger Euro countries (read: Germany) stand behind those making the guarantees.

“The support package is bad; it’s creating a seedbed for the crisis to return. The EU should let individual countries go bankrupt.”

But wouldn’t bankruptcy hit the citizens badly, with a drastically worsened economy?

“Yes,” Sjö says, “but that’s happening anyway. Even with the support package from the EU and the IMF, countries are being forced to cut back steeply on their expenditures. Whatever is done, citizens are going to suffer.”

The advantage of bankruptcy is that debts can be devalued, or even written off. This means that even the banks - the ones that loaned money - will lose out. And that’s just the message they need, Sjö says.

“The finance market needs better incentives. Lenders need to learn that taking risks that are too big won’t go unpunished. Now they know that stronger Euro countries stand behind the weaker ones and that it is practically risk-free to lend, even to completely insolvent states.”

Despite everything, he sees the risk of Euro collaboration cracking up as minimal, even if it is included in the discussion on whether countries can abandon the euro.

“In the short term, of course, it’s simpler to get state expenditures in order with the local currency. It can be devalued and thus a trade surplus can be created, which pays off foreign debt. Local currency increases freedom of action.”

Sweden will also manage well, even if several European countries are among our biggest trade partners.

“Sweden can benefit from the growth in Asia: we don’t need to be worried for our part. Moreover, we are now keeping tabs on our banks. A bank bubble, like the ones in Ireland or Iceland, can’t happen here.

“I’m very optimistic, despite everything. Greece and Ireland have a good change of putting their economies in order. And even if Portugal and Spain follow suit, we’ll get through that as well.


Page manager: therese.winder@liu.se
Last updated: 2011-02-09