international analysis and commentary

The wrong therapy for Greece and Europe’s troubles


Reading most newspapers on the negotiations between Greece and the European institutions, the message one gets is that the latter are generous, but tired of helping an undisciplined country. “People feel like they have been helping this country for the past five years,declared French Finance Minister Michel Sapin last month. But one could legitimately wonder if this widespread, yet simple, narration corresponds to the actual picture.

Indeed, we have at least four main reasons to be doubtful. First, the actions of the European institutions were based on a missed diagnosis and therapy and, even worse, they were a major determinant of the Greek recession that is now the core problem.

At the heart of the problem was low productive investment, despite the great indebtedness of the private sector (prior to the crisis, the debt boom in Greece was first of all private), that generated low labor productivity and low competitiveness. The therapy imposed by the “Troika” was lowering wages that, far from making investment rise, produced a huge fall in consumption. Moreover, the bailout programs transferred the debt burden from private banks to the state, and thus to Greek citizens; on the lenders’ side, the risk of default was shifted from banks to states, and thus taxpayers.

The second pillar of the therapy was restrictive to fiscal policies. The fiscal surplus, that was 1.5% of GDP in 2014 (to be raised to 4.5% in 2016, according to EU demands), had a far higher impact on GDP than expected: IMF plans predicted that real GDP would have shrunk just temporarily and by no more than 5% with respect to 2009. Instead, the decline may have not been “temporary”, and in any case the Greek GDP reached less than 80% of the 2009 value. This fall in GDP and the deflationary context made the debt burden unsustainable. This came together with cuts in social security and health that are seriously harming standards of living (according to Eurostat, 35.7% of the population is at risk of poverty and social exclusion) and justify the alarm of an ongoing “humanitarian crisis” that the current government has been emphasizing.

Third, Greece has been the symptom of structural problems within the Eurozone that are still underestimated by European decision-makers, such as the excessive constraint on demand-side policies. The Eurozone is not showing the willingness to bear the responsibilities of a monetary union that would imply internal redistributive mechanisms, common fiscal policies and centralized investment on growth. In that respect, Greece is more the “canary in the mine” – as defined by its Finance Minister Yanis Varoufakis – than the guilty undisciplined son.

Fourth, creditor countries acted in their own interest, not for the sake of generosity. As also pointed out by several analysts, Europe’s choices appear to have been mainly driven by the willingness of French and German governments to protect their own banks. Moreover, core European countries are benefiting from extremely low interest rates: an estimate by Jens Boysen-Hogrefe from the Kiel Institute for the World Economy shows German savings due to decreased interest rates on their bonds amount to 80 billion euros between 2009 and 2013.

Which are the core issues at stake in the ongoing negotiations? First and foremost, the fiscal surplus (the amount of public resources that exceed expenditures, and thus go to creditors): what Greece is asking is a relaxation of the request to increase the fiscal surplus from today’s 1.5% to 4.5% in 2016. Greece is not asking to stop repaying. It is asking to lower the pace of this repayment, since such a fiscal surplus is unbearable for an economy that has to start growing again. “I can’t think of what basis Germany can use to reject this proposal,” wrote Paul Krugman on his New York Times blog.

The positive effect of lowering the primary surplus can be quite high in terms of growth and employment, since it would be amplified by the fiscal multiplier (the coefficient that transfers a change in public expenditure into a change in GDP) that seems, according to IMF estimates, to be around 1.3. Unfortunately, the multiplier effect works also the other way around: an increase in the fiscal surplus actually produces a more-than-proportionate contraction in GDP that negatively affects taxes and imposes an even a greater reduction in public expenditure to reach the surplus goal. The February agreement with the Eurogroup is vague on the topic, which made some observers say that there may be room to moderate the target.

Second, the liquidity crisis and bank run that Greece is facing: it is the subject matter of the four-month agreement with the Eurogroup, but mostly concerns the relationship with the European Central Bank. In the current situation, the ECB seems to act to increase pressure on Greece. The first very controversial decision was to eliminate the waiver that allowed Greece to use its bonds as collateral towards the ECB itself (February 4th). But it is unclear what conditions changed in order for that action to be taken or what “technical” reason (as it has been claimed) might have justified it. At the same time, the European Central Bank increased another financing instrument, the ELA (Emergency Liquidity Assistance) that is allowing Greece to access liquidity, but at the same time is subjected to ECB approval on a regular basis. The last episode that risks worsening the current liquidity shortage is a recommendation towards Greek lenders to stop buying Greek bonds. This is very risky because of the expectations it may generate in investors, which may in turn amplify the bank run.

Third, the long-term plan. The government in Athens proposes that the debt issue be treated at the European level, not through the loan-for-program system. On this plan the counterparts did not provide significant answers. A recent proposal formulated by the Greek Finance Minister is a European growth plan, financed by the European Investment Bank (EIB), with the ECB backing the EIB bonds. This can be more effective than quantitative easing since it would immediately translate into investments, without risking getting stuck in the banks that do not necessarily turn it into credit to firms. The idea can be an important catalyst of consensus in Europe, as suggested for instance by the “Marshall Plan for Europe” proposed by the German trade union DGB last year.

For the time being, Greece seems quite isolated in the negotiations, even though some intermediating roles can be identified. Among the strongest opponents to the Greek request is, of course, Germany. Yet, even within the German government different positions have emerged on the “Grexit” scenario: the CDU considers it possible, using it as a way to define the crisis as a “Greek problem”, while the SPD is openly opposed to it. To complicate matters, however, other indebted countries (e.g. Spain and Slovakia) are very rigid against Greece, since they built up their internal political consensus exactly by complying with the demands by the “troika”. The position of the European Commission is quite ambiguous, as it has been evident in the case of the vote on the anti-poverty bill in Greece (March 18th): the first reaction has been hard (Greece has been accused of taking a “unilateral” measure, even though the impact is planned to be “fiscally-neutral”), but it was followed by more conciliating voices.   

Big questions are open for the entire EU: will European decision-makers understand that this is not a “Greek” problem, but a “European” one? Will they see that Grexit is the worse option especially for Europe itself, since it would leave us with the failed economic policies that are responsible for the deep crisis we are in?