Sovereign Debt, Migration Pressure, and Government Survival

• Author: David Leblang,William T. Bernhard
• Published date: 01 June 2016
• Date: 01 June 2016
• DOI: http://doi.org/10.1177/0010414015621079
• Subject Matter: Articles

Comparative Political Studies

2016, Vol. 49(7) 907 –938

© The Author(s) 2015

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DOI: 10.1177/0010414015621079

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Article

Sovereign Debt,

Migration Pressure, and

Government Survival

William T. Bernhard1 and David Leblang2

Abstract

As soon as the sovereign debt crisis began, it was widely understood that

Germany’s response would dictate its ultimate resolution. Whereas the

initial round of bailouts stabilized markets and preserved the Euro, the

purpose of the second Greek bailout is less clear. We argue that the German

government’s decision to support a second Greek bailout reflected domestic

political calculations. While a bailout would involve short-term political costs,

Merkel’s government also recognized the social and economic consequences

of potential Greek default. In particular, a default entailed the prospect of

a massive inflow of migrants from Southern Europe into Germany, which

would have hurt labor markets and, in turn, could have cost Merkel’s coalition

electoral support. To evaluate the political, economic, and social costs of the

second Greek bailout, we use models of credit default swap spreads, studies

of international migration, and research on vote intention.

Keywords

political economy, EU politics and policy, migration, sovereign debt, financial

crises

As soon as the sovereign debt crisis began, it was widely understood that

Germany’s response would dictate its ultimate resolution. If Germany chose

to provide assistance to shore up other economies or to support bailouts, then

1University of Illinois, Urbana, IL, USA

2University of Virginia, Charlottesville, VA, USA

Corresponding Author:

William T. Bernhard, University of Illinois, 420 David Kinley Hall, 1407 W Gregory, Urbana,

IL 61821, USA.

Email: bernhard@illinois.edu

621079CPSXXX10.1177/0010414015621079Comparative Political StudiesBernhard and Leblang

research-article2015

908 Comparative Political Studies 49(7)

it was possible that Portugal, Ireland, Italy, Greece, and Spain (PIIGS) would

be able to survive within the Eurozone. If Germany chose not to support any

sort of assistance or if it insisted on excessive conditionality, it would force

costs of adjustment on the PIIGS that would create enormous hardships for

those economies and likely result in a larger wave of financial sector failures.

Ultimately, this may have led countries to default and, possibly, to exit the

Eurozone.

German policy makers weighed the costs and benefits of action carefully.

A bailout would entail costs—both in terms of taxes and credibility. Germany

would have to provide taxpayer money to cover the bad habits of govern-

ments that did not manage their economic policies with Teutonic fastidious-

ness. Almost as importantly, bailouts would require the German government

to go back on historic pledges to not bailout profligate Euro member states,

reducing its credibility and, hence, its ability to prevent future abuses.

However, failure to support these economies could plunge the periphery

into a severe depression that could spread to northern Europe. Default would

have also endangered German banks and bondholders with exposure to gov-

ernment debt from the PIIGS. Depression in southern Europe could also trigger

massive immigration into Germany as people would move north looking for

employment. These immigrants could adversely affect German labor markets,

provoke social unrest and conflict, and place pressures on social insurance.

Failure to support a bailout might also endanger the broader European

project, the cornerstone of Germany’s foreign policy since the 1950s. Without

a bailout, some countries were likely to leave the Euro, dealing a blow to the

ideal of European solidarity. This was not merely a symbolic cost as, for

Germans, the European Union (EU) is more than just an economic club. It

represents an invaluable security commitment, the fundamental institutional

mechanism to prevent the outbreak of war and hostility on the European

continent.

These stark policy choices created tension within the governing parties as

German policy makers grappled to find the best response to a rapidly evolv-

ing situation. The prospect of a bailout aroused a passionate response from

German voters. Indeed, a new anti-government and anti-Euro party—the

Alternative for Deutschland (AfD)—quickly developed, calling for Germany

to rid itself of the single currency. Other voters recognized the value of the

European commitment and, though annoyed at the profligacy of southern

governments, accepted the costs of a bailout as the price of solidarity.

During the early months of the crisis, Chancellor Merkel walked a fine line

between support for Euro and demanding accountability from Eurozone mem-

ber states. Ultimately, Merkel worked with the European Central Bank (ECB)

and the International Monetary Fund to arrange bailouts for Greece, Ireland,

Bernhard and Leblang 909

and Portugal, thus ensuring the survival of the Euro. As part of the bailout, the

ECB and other solvent governments assumed the debt held by private banks,

transferring the associated risk from the private sphere to the balance sheets of

public institutions. Although the initial bailout of Greece did little to stabilize

that market, by late 2011, bailouts of Ireland and Portugal led to calmer mar-

kets across the Eurozone, saving the Euro from a total collapse.

As financial markets calmed, however, the domestic position of the Greek

government weakened. The Greek populace rebelled against budget cuts and

higher taxes. This domestic political turmoil in Greece, which resulted in the

resignation of Prime Minister Papandreau in November 2011, threatened the

ability of the Greek government to maintain its fiscal promises even as mar-

kets appeared to become more confident in the Euro (see Figure 1).1 Greek

bond spreads began to increase, even as the spreads of other government

bonds were falling. And, as shown in Figure 2, the risk of contagion within the

Eurozone—that is, the risk of financial market volatility spilling over from

Greece to other countries—was negligible by the fourth quarter of 2012.2

Moreover, the fact that German banks had become less exposed to Greek

debt meant that the financial and economic consequences of a potential Greek

default would be limited (see Figure 3).3 It seemed as if the markets had

decided that the Euro would survive, even if Greece would have to default.

Indeed, the Eurozone—its currency as well as its banking system—might

even be stronger and more viable without Greece.

Figure 1. Euro/dollar volatility.