Summary: Greece had its election. The pro-austerity party won, despite their policy’s lack of success — and lack of historical for theoretical foundation (it’s contrary to basic economics). Despite the applause in the banker-dominated news media, it’s unlikely to work, and every month of delay only makes Greece weaker — less able to well-manage an exit from the EMU. Today we ask why Greece’s leaders stay with a failed, perhaps terminal if continued, policy?
Contents
- Introduction
- The escalation of commitment
- Consequences of the vote in Greece
- Other articles about escalation of compliance
- For more information about the euro-crisis
(1) Introduction
The projected victory of the pro-austerity coalition in the Greek election represents a decision by a majority of the Greek people to continue with the failed policies that have so damaged their nation since joining the European Monetary Union (EMU), and the austerity policies that are destroying Greece since their first “adjustment package in early 2010.
These policies have little foundation in economic theory or history, are based on factually incorrect descriptions of events (monetary and competitiveness factors were the cause, excess debt the result), and have proven disastrous to the GIIPS nations (see the links at the end). Why the enthusiasm by so many of Greece’s leaders to stay the course? There are many reasons. Fear of the unknown if they leave the euro. Pressure to conform with the policies of their greater peers in Europe. And escalation of commitment, the subject of this post.
(2) The escalation of commitment
One major source of error in decision making is escalation of commitment — the human tendency to continue to follow a failing course of action. … There is a considerable amount of research that indicates that individuals and groups escalate commitment to a course of action in order to justify their original decision. … James G. March, put it this way: “Now that I have made my decision, I need to find good reasons for it.”
— “Escalation of Commitment: Patterns of Retrospective Rationality“, Fred C. Lunenburg, International Journal of Management, Business, and Administration, 2010 (references omitted)
For a summary of this research see this excerpt from “Escalation of Commitment” by Theresa F. Kelly and Katherine L. Milkman (Asst Prof, Wharton), in Encyclopedia of Management Theory, E.H. Kessler (Editor), in press.
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When a decision maker discovers that a previously selected course of action is failing, she is faced with a dilemma: Should she pull out her remaining resources and invest in a more promising alternative, or should she stick with her initial decision and hope that persistence will eventually pay off? Management scholars have documented a tendency of decision makers to escalate commitment to previously selected courses of action when objective evidence suggests that staying the course is unwise.
… While there are many situations where the best course of action is to commit further resources to a failing investment, the term “escalation of commitment” describes only those situations where objective evidence indicates that continuing with an investment is unwise, and yet an individual chooses to invest further in spite of this.
Explanations for Escalation of Commitment
Self-justification. {This} provides one explanation for why people escalate commitment to their past investments. Feeling personally responsible for an investment that turns sour intensifies the threat associated with failure and increases a decision maker’s motivation to justify the original choice to herself. Negative feedback on a past investment decision calls the validity of the original decision into question and is dissonant with a decision maker’s natural desire to see herself as competent. Many decision makers attempt to eliminate this conflict by convincing themselves that their failing ventures will turn around if they simply invest more resources. To do so and succeed would prove that the original choice was valid and eliminate the “cognitive dissonance” created by the initial negative feedback.
Confirmation Bias. Biased information processing is one way that decision makers reduce the dissonance that arises when their positive self-perceptions conflict with evidence that past investments are underperforming. After committing to a choice, people are far more likely to notice and overweight evidence that supports their decision and ignore and underweight evidence that does not. Furthermore, decision makers actively seek information that confirms the validity of their decisions. This means that decision makers may actually be less aware of problems with their current investments, or, when they are aware of such problems, they may underestimate their severity. “Confirmation bias” can therefore cause decision makers to escalate commitment to bad investments.
Impression Management. {This} focuses on a decision maker’s need to justify her past choices to others. The outcome of an investment is rarely free from external scrutiny, and a decision maker may escalate commitment to her original investment to avoid admitting to others that the venture was a failure or that her decision was flawed. Such admissions might cause others to doubt her competence. Furthermore, people tend to punish decision makers for inconsistency.
(3) Consequences of the vote in Greece
The austerity policies will continue in Greece and the other GIIPS. The GIIPS’ economies will grow weaker, month by month. Their societies will continue to suffer, and probably lose social cohesion. The combination will reduce their ability to adapt, to successfully change course.
The peoples of Europe must decide to unify — completing the long post-WWII process — or fragment (perhaps to try again in the future). The structure of the EMU is tilted to benefit the northern states (especially Germany) vs. the GIIPS. That means the north benefits from the current regime, and explains why they make loans to the GIIPS to remain in the EMU. It’s worth paying a little to keep the marks in the game.
A more difficult question: why do the GIIPS stay in the EMU? Fear of war, with unification as the cure. Unification as a means to retain major power status in the 21st century. Fear of change.
But the EMU, a half-way house on the way to unification, cannot last much longer. Decisions will be made. Delay only guarantees that the choice gets made under disorderly conditions, reducing the odds of wise actions.
For a look at the future see
- “Greece Must Exit“, Nouriel Roubini, 17 May 2012
- “Berlin Is Ignoring the Lessons of the 1930s“, Niall Ferguson & Nouriel Roubini, 11 June 012
- “Greek Elections: Returning to the Unsustainable Status Quo“, Megan Greene, 18 June 2012
(4) Other articles about escalation of compliance
- “Knee-Deep in the Big Muddy: A Study of Escalating Commitment to a Chosen Course of Action“, Barry M. Staw, Organizational Behavior and Human Performance, 1976
- “The Escalation of Commitment To a Course of Action“, Barry M. Staw, Academy of Management Review, October 1981
(5) For more information about the euro-crisis
(a) Posts about Greece:
- A great speech by the PM of Greece. How soon until an American President says similar words?, 3 March 2010
- The EU does Kabuki for Greece. Is it the next domino to fall?, 14 April 2010
- Important: Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
- Hot news! The Wehrmacht failed to take Greece. Now Germany tries again, with a different method., 28 January 2012
- Europe has chosen a harsh future. All the paths for Greece lead into darkness., 24 February 2012
- A note from Athens: Feeling on the ground has palpably changed, 1 March 2012 — A clear sign that the Greek people are ready for change
(b) Analysis and forecasts about the crisis in Europe, reporting their slow march to the cliff:
- The periphery of Europe – a flashpoint to the global economy, 8 February 2010
- Governments cannot go bankrupt, 2 April 2010 — But they can default.
- About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
- The Fate of Europe, nearing the point of decision, 13 September 2011
- Europe drifts towards the brink of a cataclysm, 26 September 2011
- Delusions about easy fixes for Europe, dreaming during the calm before the storm, 30 September 2011
- Is Europe primed for chaos, as it was in July 1914?, 7 October 2011
- Today Europe’s leaders took another step towards the edge of the cliff, 27 October 2011
- Where to from here, Europe? Some experts share their views., 8 November 2011
- Status report on Europe’s slow re-birth (first, the current system must die), 10 November 2011
- Looking ahead to see the new shape of Europe, 22 November 2011
- Europe passes the last exit. A great crisis lies ahead., 21 February 2012
- The Fate of Europe has become visible. Only how and when the break comes remains uncertain., 6 June 2012
Expect a very short-lived rally, as investors see a silver lining, that isn’t there. Time to play with triple inverse, JAZ, if you have the stomach for a spike and fall early this week in NYSE prices. I won’t risk it myself!
There are thousand websites about investments. This is not one of them. Additional comments about trading will be deleted, as they tend to take over the thread.
OK – understood; I will avoid specific to market, in future; however, the lemming-like rush for the cliff’s edge seems to be contrary to a reasoned approach encouraged by you in your material. I find your approach to be very refreshing. Thanks for this.
Why do so many commentators try to paint this as being all about the money – either keep dumping money into Greece or force them out and back to the Drachma? Neither will result in a Greek rescue because neither addresses the root cause.
Greece has been receiving bucketloads of ‘support’ money from the EU since it joined. This money should have been used to increase their competetiveness – it wasn’t, it just went into lining people’s pockets The Greek graft system has stifled the necessary changes and corruption is endemic in all levels of Greek society – they’re beyond saving no matter which currency they use.
The EMU set interest rates at levels that worked for Germany (not the GIIPS), and allowed massive capital flows (investment capital, not “support money”). That hot capital was wasted, as it so often is when money is mispriced, in the GIIPS — as it was in Japan 1985-1990, during the sunbelt housing boom in the US (unlike Greece, Texas was rescued), and throughout much of the US in 2000-2007.
Greece has had high levels of graft for generations, but survived nonetheless — until it joined the EMU (see details here). It will survive once it leaves the EMU — the trauma of adjustment will grow the longer they wait to do so.
The GIIPS and EMU saga is not a morality play. It’s a public policy failure. Like building the plumbing wrong in a new building.
“Greece as Victim“, Paul Krugman, op-ed in the New York TImes, 17 June 2012 00 Excerpt:
Ever since Greece hit the skids, we’ve heard a lot about what’s wrong with everything Greek. Some of the accusations are true, some are false — but all of them are beside the point. Yes, there are big failings in Greece’s economy, its politics and no doubt its society. But those failings aren’t what caused the crisis that is tearing Greece apart, and threatens to spread across Europe.
No, the origins of this disaster lie farther north, in Brussels, Frankfurt and Berlin, where officials created a deeply — perhaps fatally — flawed monetary system, then compounded the problems of that system by substituting moralizing for analysis. And the solution to the crisis, if there is one, will have to come from the same places.
So, about those Greek failings: Greece does indeed have a lot of corruption and a lot of tax evasion, and the Greek government has had a habit of living beyond its means. Beyond that, Greek labor productivity is low by European standards — about 25 percent below the European Union average. It’s worth noting, however, that labor productivity in, say, Mississippi is similarly low by American standards — and by about the same margin.
On the other hand, many things you hear about Greece just aren’t true. The Greeks aren’t lazy — on the contrary, they work longer hours than almost anyone else in Europe, and much longer hours than the Germans in particular. Nor does Greece have a runaway welfare state, as conservatives like to claim; social expenditure as a percentage of G.D.P., the standard measure of the size of the welfare state, is substantially lower in Greece than in, say, Sweden or Germany, countries that have so far weathered the European crisis pretty well.
So how did Greece get into so much trouble? Blame the euro. Fifteen years ago Greece was no paradise, but it wasn’t in crisis either. Unemployment was high but not catastrophic, and the nation more or less paid its way on world markets, earning enough from exports, tourism, shipping and other sources to more or less pay for its imports.
Then Greece joined the euro, and a terrible thing happened: people started believing that it was a safe place to invest. Foreign money poured into Greece, some but not all of it financing government deficits; the economy boomed; inflation rose; and Greece became increasingly uncompetitive. To be sure, the Greeks squandered much if not most of the money that came flooding in, but then so did everyone else who got caught up in the euro bubble.
And then the bubble burst, at which point the fundamental flaws in the whole euro system became all too apparent.
Ask yourself, why does the dollar area — also known as the United States of America — more or less work, without the kind of severe regional crises now afflicting Europe? The answer is that we have a strong central government, and the activities of this government in effect provide automatic bailouts to states that get in trouble. …
Doesn’t assuming some kind of irrational thinking on their part fall into the same trap FM recommends against when thinking of US politicians as ‘stupid’ or ‘ineffectual’?
Should we not assume the Greek politicians are rational? That whatever mess they get into was intentional or a by-product of their intention?
A massive and growing body of research shows that logical fallacies and cognitive biasis are omnipresent and powerful drivers of human thought and social dynamics. Assuming “rationality” is unwarranted, against the evidence, perhaps even illogical. One might as well, like Homer, assume everything results from the Gods intervention.
I believe that the concept of agency (see Wikipedia) has replaced the assumption of rationality. We make choices. Society and history results from our choices.
What Greece does or doesn’t do will of course have zero impact on American perceptions of them, and the EU in general – they must fufill roles in the American morality tale (Two legs bad, four legs good), and we are impervious to learning any actual real life lessons from them.
I’m always looking for symmetry between the fundamental forces that brought us here, and the mirror image of those same forces that will take us forward. I find that what brought us, and Europe, here to the present was a naive and unjustified high level of trust. This includes trust in our institutions, trust that assets would always appreciate, trust in the rule of law, trust in our military, trust in counter-parties we do business with, and ultimately trust in ourselves, our own resilience, and in the durability of our culture.
Path forward, I predict, by symmetry, a loss of trust. We will now begin losing trust in our institutions (banks will go first and they mostly deserve it), the foolish notion that assets always appreciate, (continuing with housing and beginning with equities), our legal framework (right down to our constitution), our military (its effectiveness, justification, even its morality), our financial and economic counter-parties (which will manifest as a freeze on pricing risk and an ensuing dramatic reduction in economic activity), and ultimately a loss of trust in ourselves, our resilience, and in the durability of our culture.
I am a believer in the utility of finding and studying symmetries. And that’s a powerful one. Thanks for posting it!
Or more briefly:
(Trust in) hardware, ideas, and people, in that order. Got us in.
(Trust in) people, ideas, and hardware, in that order! Will get us out.
FM: “Why do the GIIPS stay in the EMU?”
This article I read at ZeroHedge puts it in perspective: “If Greece Was California…“, 27 May 2012
It seems they just don’t want to make enemies, especially with their neighbors.
Zero Hedge reposts good material, including some from A-team sources that’s difficult to get (eg, research from JP Morgan and Goldman). It’s original content ranges from excellent to delusional, in a manner difficult for non-experts to distinguish.
“It seems they just don’t want to make enemies, especially with their neighbors.”
Totally crackers. Suffering depressionary conditions for years to keep the neighbors happy? If you find that likely, then you must have an unusual neighborhood.
“What Part of ‘Austerity Isn’t Working’ Don’t People Get?“, Jared Bernstein, Rolling Stone, 18 June 2012:
As I prepared for a talk on austerity last week, I found myself a bit stuck. What can you say other than that it’s very clearly not working, nor should we expect it to, nor has it ever? And then I hit upon what I think is the key question: Why do governments stick with the austerity approach when all the evidence suggests it’s a total failure?
First, some facts. By austerity I mean attacking recession by cutting spending and raising taxes – the opposite of Keynesianism, which dictates that if the private sector isn’t spending enough money to get the economy moving, the government needs to temporarily step in and supply the juice (aka “stimulus”). Europe and the UK are committed to austerity, and – not coincidentally – they’ve seen growth deteriorate and unemployment jump (to over 20 percent in Greece and Spain). The figure below, from this excellent – and pretty readable – paper by economist Jay Shambaugh reveals the expected positive correlation between governments that cut spending and slower GDP growth.
Too bad for Europe, right? But, wait – we’re doing the austerity thing too, cutting spending as stimulus fades and failing to enact jobs measures, such as fiscal relief to cash-strapped state and local governments or public infrastructure investment – measures that appear more necessary with each new, disappointing economic report.
In a way, our austerity policies are actually less defensible than those in some European countries. With the price of borrowing so extremely low here, capital markets are basically pleading for our government to borrow and get busy with temporary growth measures. That’s not happening in Spain, Italy, Portugal, and Greece, and for good reason: government debt in those countries is highly risky, and priced accordingly.
How is it that policy makers keep getting this so wrong? Sure, there are countries – above all Greece, with its record of government overspending and widespread culture of tax evasion – where some measure of austerity might be in order.
But that doesn’t explain the U.S., the U.K., and most others who continue to blithely go down this bumpy road. For that, I think we need to reflect on what the great economist Joe Stiglitz refers to in his new book on inequality (I recently interviewed Joe for these pages – should be up soon) as deficit fetishism, the prime symptom of which is the inability to distinguish between good and bad deficit spending.
I’ve identified four viruses that have led to this illness:
(1) For Democrats, deficit reduction was a tactic that morphed into an intractable policy position.
Back in the G.W. Bush years, many Democrats (I was one!) argued that cutting taxes as deeply as he did would lead to the bad kind of budget deficits: structural ones that starve government of needed revenues and increase even when the economy is growing. We were right, but too many Democrats now fail to distinguish between structural deficits and Keynesian ones. They just think they’re all bad.
(2) For Republicans, deficit reduction is a cudgel to bash government.
They are ideologically opposed to social insurance, stimulus, infrastructure investment, and everything else, but they gussy this up as an economic argument about markets and debt burdens on future generations. Worse, for them it’s mostly rhetoric. Since Reagan, it’s the Republicans who’ve run structural deficits (Obama’s deficits are largely cyclical—very much a function of the recession).
(3) Drawing the wrong lessons from the Clinton surpluses:
The last time the federal budget was in surplus was at the end of the Clinton years. Economic growth was strong, unemployment very low (below 4% for a few months in 2000!), and financial markets were booming (due, in no small part, to the dot.com bubble, but that’s a different story). These were the years of the alleged bond vigilantes, bond traders who would punish governments by dumping their bonds if they thought their fiscal policy was irresponsible. I’m not sure there ever was such a menace—what led to the late 90s surpluses were a reasonable set of tax rates and strong (albeit bubbly) growth. But whatever…the main point is that fiscal policy during the Clinton years made sense: deficits fell as the recovery gained strength. By no measure does that imply that austerity makes sense in recession.
(4) In Europe, there’s another dimension to this, something unique to their currency union: anti-bailout sentiment.
You think the TARP and the auto bailouts were unpopular here, imagine if they were for Mexico. As a prominent German economist told me, “we know what we have to do, we just can’t let anyone see us doing it.” Good luck with that.
We’d better get straight on all this if we’re going to fix it, not just for this go-round but for the next recession. Imagine arguing for Keynesian jobs measures—another big stimulus—the next time the economy heads south. With all this misunderstanding in the air, there’s just no oxygen for such arguments.
The time for austerity is when the economy is strong and growing. When it’s stuck in the mud, austerity just digs it in deeper.