Wednesday, June 22, 2011

Default is neither inevitable nor desirable

I had a brief online debate with Ghassan Karam on Lebanon's debt sustainability (see comment section of Lebanese Sovereign Debt Default: An Inevitability) , which is worth highlighting for two reasons:

1. I think Ghassan Karam is a reasonably credible commentator on several issues.

2. I think his opinion on this particular issue is both wrong and reckless.

To start with, and to be very clear: I am in no way defending the fiscal policy of Hariri's last government.  As I argued in "When government by auto-pilot is better than active government"  Lebanon was "more lucky that good" in having a primary surplus. But I also argued in Lebanon's $18,000,000,000 question:

" a Hizbollah-inspired government will have to try harder than a Hariri-led government to instil ... confidence ... This is in part because they have no track record in government, and in part because their past pronouncements on economic issues are reckless"

I think that at this stage it is pointless to argue over how the debt was accumulated, unless you are planning to write a sequel to South Park's Captain Hindsight.  All that matters is that Lebanon has a ton of debt of short term maturities. The question is how to get out of this predicament, which is taking a big toll on public finances. There are only three options: cut spending, raise taxes or default.  Ghassan thinks  that cutting spending is impossible, raising taxes is difficult (he thinks that raising the VAT is wrong because it impacts the poor more than the rich) and so thinks that default is inevitable.

I think he is wrong on all three counts.

Cutting spending is not impossible. Subsidies to our dysfunctional electric utility alone (over $1.2 bn) are equivalent to more than half of the debt service payments. Cutting government staffing is also possible. Walk into any government office and all you will see is a hoard of navel-gazing underemployed. As an example, let's take the number of times your passport gets checked while leaving the airport (4): before check-in, after check-in and before passport control, at passport control, and then one last time before getting on the plane. One employee at passport control is enough for most countries. Firing the rest means a saving of three salaries.

I also don't think we exhausted the possibilities of raising revenue. VAT is not regressive. Higher income groups tend to spend more on higher value-added goods, lower income groups spend more on more basic goods. The VAT makes sense, its efficient, hard to avoid, and creates an incentive for saving over consumption. (Personally, I would rather go for a flat tax on all income, but I understand that most Lebanese tend to be too left-leaning for such a radical idea, preferring Byzantine loopholes).

We have not exhausted the possibility of raising revenue through privatisation either. How many countries still have government owned telecom operators, for example? It's a scandal that we have not privatised the obvious.

Default will be the most difficult and most damaging solution. Lebanese debt is held mostly by Lebanese banks, and so a default by the government will wipe out everyones savings. The examples of how this plays out are many, but for a short 1 page summary of potential implications, take a look at this article and insert the word Lebanon for Greece. Now ask the average Lebanese if they would they rather see  their life's savings wiped out, or a combination of higher electricity bills, a slightly higher VAT, a private telecom service and some government officials fired? I suspect the answer will be clear.


  1. Oussama,
    I just wrote a very lengthy response of about 8000 characters and I was told that my response was not accepted but what is worse it disappeared!!! I do not think that I am in the mood to do that again. Maybe later.

  2. Thanks Ghassan. Strange about the response. I just checked the spam folder to see if there is anything there, but there is nothing. Maybe there is was a glitch of sort? Anyway, reasonable people can disagree, and I'm sure there will be other opportunities for us to agree or disagree!

  3. It happened again. Another 30 minutes wasted. i wonder why.

  4. Strange. I can't figure it out either. Nothing in my spam folder. A friend of mine told me she had a similar problem a few months ago.

  5. This comment has been removed by the author.

  6. Oussama,
    IThe above was only a test. It worked!!!. I have no clue what the problem could have been .