Debt Deal Provides Wrong Incentives

by Irwin Stelzer

Wall Street Journal
March 14, 2011

With money markets so nervous about the condition of the euro zone's periphery that interest rates on Portugal's debt seemed headed towards 8%, the leaders of the 17-nation zone finally cut a deal on Saturday morning. Serious students of government know that it is important to get the incentives right if the desired behavior is to be induced. The euro-zone leaders got them wrong.

In the week before the meeting:

• Moody's again downgraded Greek debt and Greece sacked its chief tax collector for failing to boost tax receipts to levels it needs if it is to close its budget gap. Net revenue fell from €3.15 billion ($4.38 billion) in February of last year to €2.85 billion this year, making it almost certain that Greece will not hit its revenue target;

• China's rating agency, Dagong, downgraded Portuguese debt, driving interest rates on that nation's 10-year bonds close to 8%. "These levels of interest rates are not sustainable over time," says Carlos Costa Pina, Portugal's secretary of state for treasury and finance, who nevertheless says Portugal, with an economy that has grown at a rate of under 1% in the past decade, does not need a bailout. Never mind that its central bank predicts the economy will shrink by 1.3% this year;

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