What Is A “Primary Surplus”? 

One crucial concept for understanding the Eurozone crisis or sovereign debt dynamics in general is the idea of a budget that’s in “primary surplus.” What does that mean? Simply put, it means that tax revenues exceed program spending — i.e., spending if you ignore interest on outstanding debt. But what’s the significance of that?

I don’t normally like to explain public finance in terms of analogies to household budgets, but in this case I think it’s illuminating. Imagine a household where current month-to-month expenses are lower than income. You have a salary, in other words. Then you deduct taxes and health insurance premiums and then you pay the rent and the utility bills and the groceries and the care insurance and gasoline and other basic expenses and you’ve got a positive number left over each and every month. You should be in good shape. Your income exceeds your expenses, so you’re prepared to save up for vacations or new purchases of durable goods or the occasional luxury. But you have a problem. Several years ago you wracked up a ton of credit card debt traveling to your friends’ destination weddings even though you really couldn’t afford it. So today in addition to all those basic expenses you have to pay interest on the outstanding debt. You’ve got a primary surplus, meaning that income > expenses but an overall deficit meaning that income < expenses + interest. What are your options? Well you can cut expenses to shift into overall surplus (austerity), you can declare bankrupty (default), or else you can try to refinance your debt (bailout).

Here I think it’s best to exit the analogy since the options look different for a household than for a country. A person declaring bankruptcy is quite different from a country defaulting, but the bottom line is that an entity (be it a household or a firm or a government) with a primary surplus is in pretty good shape. All you need to do to get fully into the black is to stop making payments on your debt. The biggest price you’ll pay for this is that you can’t borrow any more money. But with your primary surplus in place, you don’t need to borrow any more money. It’s your creditors who have a much more fundamental problem. Unless they can find a way to coerce you into austerity, they’re going to wind up eating a loss one way or the other. If the bankruptcy code is sufficiently favorable to the interests of creditors, they may be able to do this. In an international context, it may be possible to send in the navy to blockade ports and demand payment.