Greece's debt Economic Growth at the Stroke of a Pen

According to a group of Anglo-American economists, debt relief contributed to Germany’s economic miracle after World War II and could be a recipe for helping Greece today.
Quelle: dpa
The signing of the London Debt Agreement on February 27, 1953.
(Source: dpa)

The International Monetary Fund (IMF) does not believe Greece can survive under its mountain of debt and is insisting on debt relief. But Germany’s Finance Minister Wolfgang Schäuble is resisting any moves to ease Greece's debt burden by deferring interest payments.

“If we simply forgive Athens’ debt, we will change nothing of the country’s problems,” Mr. Schäuble said.

International economists like France’s Thomas Piketty and U.S. economist Jeffrey Sachs like to point to the London Debt Agreement of 1953, which cancelled nearly half of the Federal Republic of Germany’s foreign debt. Ironically, Greece was one of the nations that signed the agreement. Greek Prime Minister Alexis Tsipras has been calling for a similar cancellation of debt for his country since 2012.

The London Debt Agreement restructured Germany’s debt from both before and after the war. The original debt sum of 30 billion D-Mark ($16.34 billion) was reduced to 14 billion D-Mark ($7.6 billion) during negotiations and the annual debt service limited to three percent of Germany’s export revenues.

“By settling our debts, the Federal Republic not only became credit-worthy again, the world also began to trust this nation once again,” said the Head of Germany’s delegation in 1953, Hermann Josef Abs.

Is the situation in Greece similar? Most Anglo-American economists agree with the IMF that Greece is insolvent. “Anyone who does the arithmetic of Greek’s debt knows that the country cannot pay back its foreign debt, which is currently 170 percent of its gross domestic product (GDP),” said Jeffrey Sachs, for whom the current situation is similar to Germany’s after the war.

03 p8 Greece's Debt and Her Debtors-01

Economic historians are convinced that the cancellation of some of Germany’s debt in 1953 was decisive in how Germany’s economy, which was at rock bottom, soon outperformed other European countries, even though these other countries often received more assistance from the Marshall Plan.

“Germany can thank massive debt cancellation for its economic miracle, the stability of the D-Mark and the favorable position of its public finances,” wrote Albrecht Ritschl, professor of economic history at the London School of Economics. After researching 45 major debt cancellations beginning in 1920, economists Carmen Reinhart and Ken Rogoff determined that the GDP rose on average by 20 percent in the five following years.

How exactly this growth effect came about, is what a team consisting of Gregori Galofré-Vilà, Martin McKee, Christopher M. Meissner and David Stuckler wanted to find out in a first empirical study of the effects the debt cancellation had on Germany. They gave their paper a title which is a direct reference to Keynes’ famous work on the consequences of the reparation demands of Versailles after WWI: “The Economic Consequences of the 1953 London Debt Agreement.”

Initially, they examined how the agreement influenced government spending and discovered that spending increased dramatically. This effect, however, did not occur due to reduced debt servicing, because Germany already enjoyed a temporary moratorium on debt repayment. When debt was cancelled, the credit standing of Germany improved dramatically. The government was able to increase the scope for public spending through new loans at low rates of interest. From the start of negotiations about debt relief mid-1951 until their completion, 10-year government bond yields fell from over three percent to 1.8 percent.

Also contributing to this was that debt relief stabilized Germany’s currency. Private companies profited from lower interest rates in form of lower borrowing costs.

What Germany did successfully back then – namely using its restored credit standing to take out new loans – is cited today by the German side as a main argument against debt relief for Greece – apparently because they do not believe Athens will do anything sensible with the money. Back in 1953, critics of the agreement also expressed these same fears: that debt relief would only seduce the German government into unsound fiscal policies.

The authors of the study did find one fundamental difference between then and now. Back then, the performance of Germany’s economy was put at the forefront, while today servicing the debt and compliance with budget cuts and reforms dominates the Greek situation. They attribute this to the fact that Germany was an important ally to the U.S. during the Cold War, while today Greece is far less important strategically. For Mr. Sachs, the most important question is not if Greece has earned debt relief. It is not crucial, he says, whether or not a country has earned debt relief, but whether it needs it, like Germany did back then.

The Anglo-American research team also identified benefits from the agreement for creditors, which eventually could be carried over to today. “Because they coupled debt repayment to Germany’s ability to meet its financial obligations, they also received substantial value as well,” they write. Higher value than if creditors back then had simply let West Germany slide into insolvency and economic collapse.

Mr. Sachs and his research team do agree with Mr. Schäuble that debt relief alone will not solve Greece’s problems. We should not forget, however, that the London Debt Agreement of 1953 was also part of a series of other economic reforms and restructuring, primarily the currency reform of 1948 and the creation of the European Payments Union in 1950, which liberalized the movement of capital.


Julia Balk is a Handelsblatt reporter based in Frankfurt. Norbert Häring reports on economics and finance for Handelsblatt from Frankfurt. To contact the authors: [email protected][email protected]