Complex Short-sightedness – The Non-performing Greece

In the following, we apply complexity science to better understand the Greek situation. In doing so we first address the issue of what is the relationship between innovation activity and non-performing loans. Non-performing loans offer us a springboard to discuss the concept of short-sightedness or short termism. We argue that in an innovation ecosystem we live in, three properties should be addressed (feedbacks; self-influence; and the arrow of time as history) to understand and describe what is really going on, for example, in Greece.

Innovation and non-performing loans

Innovation-related literature suggests that 1) flexibility of financing and access to capital are crucial to the realisation of innovations; 2) innovation is often a series of trial and error mechanism therefore the innovator has to be able to bear the situation (i.e. financial burden) when innovation fails to be economically feasible and viable. Consequently, although there will always be non-performing loans in the financial system; a relatively big share of non-performing loans does not necessarily mean that the given country offers a fertile ground for trial and errors, so to pro-active innovation activity.
The relatively surpassing level of non-performing loans in a society, all the more, signals the people’s short-sightedness both from the demand (companies, households) and supply sides (banks, financial intermediaries). Short-sightedness or short-termism mean that people are more likely to prefer the present over the future (present bias) by pursuing the excessive fulfilment of their desires today without having the sufficient capacity to perform the loans in the future.
Short-termism from the supply side means that financial sector exhibits a rather irresponsible nature, a more risk-taking behaviour by lending more to the private sector stakeholders (households, firms) who are willing to file for loans even though their capacity to payback is questionable. The latter may imply at least two interrelated things: 1) the financial sector is underdeveloped by not having risk-minimising rules (e.g. Azerbaijan); 2) the economy itself does not promise a variety of investment opportunities in a wide spectrum of sectors that would absorb liquidity (e.g. mono-cultural one with the dominance of oil and gas industry like Azerbaijan; Greece where the tourism and agriculture dominate). Notice that more or less the most competitive economies are found to be at the other side of the spectrum (United States, Finland, Switzerland for example, according to various ranking services like IMD World Competitiveness Yearbook, World Economic Forum Competitiveness Yearbook etc.). Of course, the performance of innovation ecosystem matters: whether private sector’s innovation can become success with a more vigorous way. In this respect, Estonia is an outsider since it is regularly seen as a moderate innovator according to the Innovation Union Scoreboards. The small share of non-performing loans in Estonia is therefore mainly due to its more developed and cautious banking system relative to other post-socialist countries.
Chart 1. The share of bank non-performing loans to total gross loans in selected countries
(%, average of 1997-2014)

ottoman_chart1Source: World Bank Development Indicators (2015)

Short-sightedness creates processes (e.g. fluctuation of non-performing loans), while its own existence is also a manifestation of the evolution of processes. Complexity science showed us that macroscopic form could depend strongly upon the history of microscopic fluctuations that have impinged upon a system while it had been in a dynamically metastable state. As a corollary, the increasing share of such non-performing loans indicates that instabilities are going to be encoded into the financial system. A myriad of econometric studies dealt with this issue with the aim at identifying the tipping point precisely when the systemic risk has to be decisively addressed otherwise the economy falls short with a juggernaut effect. None of these studies could identify such a threshold, simply because of the fact that social life is a complex evolution of processes featuring with non-linearities, therefore fluctuations and thus with indeterminism. Notice that socio-economic system exhibits: feedbacks; self-influence; and the arrow of time as history.

Feedbacks and self-influence

Let’s take an example of the evolution of processes that builds present bias. By collecting and monitoring the non-performing loans related dataset, the financial sector itself creates events and influences its own behaviour. Increasing share of non-performing loans has therefore a non-linear negative effect on bank lending which also has a non-linear effect in the society through limiting the access to finance for innovation. Since access to finance becomes more limited, especially for more risky and thus more promising innovations that would otherwise have longer term positive effect, the interests of innovators as well as financial sector tend to turn to innovations promising shorter term positive effect. The likelyhood of establishing critical states (bubbles, indebtedness) may thus increase.
As far as the government’s role is concerned in the evolution of processes that builds present bias, short termism can also be cultivated at the level of governance. Insofar as the government has not been being able to initiate, refine and implement structural reforms over decades, this systemic inaction conveys us that it is not without purpose, but with the aim at concentrating just on the redistributor function of governcance to treat the clientelism and to underpin power. This drives the behaviour to prefer obtaining short term gains with longer term pains (myopie). This is a vicious circle since increasing redistibution over coordination tends to result in unsustainable public finances requiring painful measures leading to evaporating trust (See for instance Edelman Trust Barometer, which shows that trust has been decreasing mostly in governments).

Arrow of time, history matters

Let us assume that there is a country with a historical indebtedness with structural problem of extensive and unsustainable public sector. The risk of insolvency might be mitigated by reducing the unproductive expenditures like public sector wages and salaries, while fostering innovation in the public sector to have more efficient public service with less costs, and supporting innovation milieu in the private sector to transform the economy in a more competitive and innovation-driven one. Let us underscore that this supermarket of ideas are failing as soon as one also considers that the given country suffers from the heritage of the Ottoman Empire which cannot be easily deduced from the Greek socio-economic system with a configuration of processes making the birth of any attempt to reduce the public sector cumbersome. There is such a country, it is unsurprisingly: Greece.
The Greek economy did not live through the renaissance, the reformation, then the counter-reformation, the rationalism, the process of Enlightenment and the bourgeois revolutions. Instead, the country has been being built on the expansion of the public sector to serve and build widespread clientelism. The culture of clientelism originated in the Ottoman Empire and this specific feature was transferred to the era of independent Greek state with 1974 and its aftermath. Let us also note that the current development of the Greek governance is also disquieting in this regard, which is reflected in the crisis management which does not address clientelism at all. It is hardly by chance that the so-called fiscal illusion (Chart 2) is hard to be reduced in Greece (i.e. Fiscal illusion relates to a wrong perception of government budget aggregates from the voters’ and taxpayers’ perspectives. It suggests that when government revenues are not completely transparent or are not fully perceived by taxpayers, then the cost of government is seen to be less expensive than it actually is. Since some or all taxpayers benefit from government expenditures from these unobserved or hidden revenues, the public’s appetite for government expenditures increases, thus providing politicians incentive to expand the size of government.).
Chart 2. The evolution of fiscal illusion in selected European countries

ottoman_chart2Source: fiscal illusion index data stem from Mourao (2008)

Clientelism implies that public sector leaders are more likely to have a solid present bias since their current position depends a lot on those influential clients. This is why the sustainability of public finance got impaired by driving the financial sector to replace to some extent the public sector’s role in supporting private sector’s stakeholders by extending the loans in an unsafe and risky way. Let us underscore immediately, complexity science tells us that the same sort of ‘economic law’ can be the end result of entire different causes and vica versa: same causes do not necessarily lead to similar economic development. There is no such determinism. Concretely, the Ottoman past with its clientelism-prone feature had, presumably, survived in Greece because of the more mono-cultural feature of the economy, and had not survived in other countries also having the legacy of the Ottoman empire (e.g Turkey, where the economy exhibits a strong and seemingly successful economic policy). The Greek economy, which is a more agricultur-based one neglected the need to modernise its most important sector resulting in huge trade deficits in agricultural products.
Of course, history is continuously created by us, what is more, it is exposed to be interpreted differently because of what once Immanuel Kant clearly emphasised: mind-dependent reality. In all of this, politics play a fundamental role. In a complex system like an economy, especially an integration such as the European Union, there is always the chance for parallel phenomena resulting in an outcome that might have been seen positive, but encoded the instabilities in a broader context.
It was mainly the case when it came to further EU integraton. There was an original sin: letting Greece to join the EC and then Eurozone, simply because its mainly monocultural economy suffers from shortcomings in terms of international competitveness. The process of the European integration encoded the instability since further expansions beared the stamp of political interest in a more vigorous way rather than socio-economic aspects. Of course, there was also the driving role of asymmetric interdependence: EMU-framework could not work as an efficient external enforcing mechanism of discipline, and, to be honest, it was the interest of core countries to soften Stability and Growth Pact as well to maneouvre out from the years of stagnation (think of German GDP of 2003). This triggered the financing of the Greek economy without requiring structural steps in return.
And because of complexity, there are always lots of ‘Ifs’, because many narrative (mind-dependent reality) can be elaborated by interpreting slightly else a particular event with the benefit of hindsight. Concretely, if the Troica did not lend to Greece and did not impose so gargantuan requirements in return on Greece, that would have presumably been interpreted as ‘there is no sovereignty in the EU‘. If the Troica did lend and considered the debt relief somehow too (by the way there was a restructuring 3 years earlier, but the agreement was badly elaborated), the message would have been that: ‘We are a fate community, we are fulfilling the ethos of binding brotherhood, the sovereignty is above all‘ and it is hardly by chance that Schiller’s symphony sings “Alle Menschen werden Brüder”.

But, precisely because of the politics and particulars, this would lead to moral hazard in a more dedicated way. This is why the godfathers of the European integration did not consider to emphasise sovereignty so much, rather welfare and peace, because they were aware of that future integration of rather different countries will make sovereignty unrealistic to be pursued at the harmful expenses of others driving the union more rigorously.

Potential implication for Greece

The implication of the Greek situation is at least threefold.
First, a complexity approach, a more systemic is needed which deals not only with the direct effects of the Greek situation but also with the potential bifurcations and nonlinearities within the EU of tackling the Greek crisis. We have to admint that the EU integration did not prove to be a developmental integration and the homework has to be done in all member states. All time governance, let it be of a member state or that of the European Union, always functionate as a coordinator, redistributor and stabilisator in the economy; however, what is often omitted from the discussions is that: governance always have to play a sort of pedagocial function as well to deal with the mind of citizens. Unfortunately, bailing a country out would not necessarily direct citizens’ mind and thus their behavior (including that of the public sector workers and politicians) towards pursuing more sustainable structures.
Second, politicians have a predilection to want certainty and measurable objectives to demonstrate and legitimise their role. This corresponds to what Adam Frank famously stated: “We hunger for certainty. That is a big problem. It might even be THE problem”. The problem, because in the meantime our world economy became ever-more complex, interspersed with interconnections, spillover effects, psychological soft factors are also in place (contagion effect) etc. and the pattern and course of a policy intervention carries big unknowns. Additionally, no one really knows what shall such a quasy monocultural economy do (i.e. tourism exposure). Of course, the ‘do structural reforms’ is in order at an abstract level of thinking, but by going beyond this sonorous voices. The term should be filled with real content.
Third, and related to the second one, there will be no viable consolidation and aid programme until the cofiguration of the underlying processes are not taken into account. Namely, any moratorium, any debt restructuring will not be able to consolidate the Greek economy unless the clientelism is broken down. This would presumably open a window for longer term interventions in pursuing stability and innovation dynamism.