By Thanasis Bakos for Global Risk Insights
After 5 years of hardship, Greece has lost the battle against default.
The Greek government has missed its IMF payment on the 30th June, the Treasury’s coffers are empty, the banking system is on the brink of collapse and no mechanism is in place to provide the country with the necessary financial support that will allow it to remain in the common currency.
When the Greek debt crisis erupted in 2010, Greece’s European partners provided it with a massive loan to cover the country’s financing needs. This was accompanied by a programme of fiscal austerity to allow that debt to eventually be repaid, and a set of structural reforms to prevent the economy from creating similar trade and current account deficits in the future. Greece gladly accepted the loan and (not so gladly) the strings attached to it, and vowed to implement the programme.
After 5 years and one of the most prolonged crises in European history, Greece’s economy has shrunk by over a quarter, unemployment has reached 27%, and the basic premise and aim of the programme, to make Greece a sustainable and solvent economy, lies in tatters. Greece’s exit from the Eurozone is now seen as more likely than ever before, caused this time by a backlash to the failed policies of the last few but long years.
One might wonder: Where did it all go so horribly wrong?
The answer is very complex, albeit quite simple: trying to solve Greece’s debt crisis has always been seen very differently in Europe and Greece. European Union leaders led by Germany saw the Greek debt crisis as the “hangover” from a party Greece has been having since joining the euro. They saw austerity and – their version of – structural reforms as the only way to “discipline” Greece, bring balance to the economy and justify the bailout programmes to their electorates, despite warnings by economists that the adjustment programme was too severe for an already depressed economy.
To the contrary, the Greek political elite reacted to the crisis by ignoring the mistakes of the past. They avoided owning responsibility for any hard decisions, and blamed creditors for their obligation to impose spending cuts and tax hikes. Necessary reforms have been delayed and influential groups protected, while the burden of the crisis was placed on the most vulnerable and tax evasion remained widespread.
While in opposition, politicians have constantly argued that the poor state of the economy was due to the government’s failure to properly negotiate the severity of cuts and its unwillingness to oppose the creditors’ demands. This radical but deceitful stance has led both Mr Samaras and Mr Tsipras to become Prime Minister with the false promise of ending austerity.
Both strategies have been utterly ineffective and counterproductive. Europe’s obsession with austerity and a set of reforms that ignored the peculiarities of the Greek political economy has been as near as it gets to a complete failure. Greece’s own obsession with renegotiating an externally imposed programme and restructuring its debt failed miserably to provide a credible plan on how to distribute the burden of fiscal consolidation evenly, distribute the scarce resources available for growth and reform the economy in order to increase competitiveness and exports, even within the narrow confines of the programme.
There couldn’t be a clearer example of this failure from the current government’s strategy, which turned a fragile but slowly recovering economy with big reform potential to a bankrupt state with an insolvent banking system.
How can Greece rise again?
Greece and its European partners must finally learn from the mistakes of the past.
European bailout programmes have failed to achieve their GDP forecasts by suppressing the demand side of the economy, without achieving the expansion needed on the supply side. This has led to an unsustainable 180% debt to GDP ratio, which all major economists agree cannot be met simply through fiscal adjustments. European institutions will need to provide Greece with some breathing space.
Greece’s creditors also need to realise that the structural reforms imposed were equally inadequate. Product and labour market deregulation has been proven politically costly and with questionable benefits so far, while increasing competitiveness through reducing wages did not bear the expected results. The reason is the limited number of export facing industries that benefited from having lower wages.
Even if lower wages are one way of supporting export led growth it cannot be the only one, as it leads to a global race to the bottom. German export industries face intense competition from China, but the German government never argued that it needs to set Chinese level of wages to remain competitive.
What needs to be set is a goal to compete in quality and comparative advantage. To accompany that, investment in R&D and support to start and run a business would be the key in creating a favourable environment for skilled Greek workers and researchers and increase the country’s export potential.
Greek governments need to show real determination to implement the reforms the country needs. The first priority should be creating a leaner and vastly more meritocratic civil service, independent from clientelism and political interference. Second, the government must reform the inefficient and slow legal system and simplifying and enforcing tax rules and regulations. Third is to tackle cartels, oligopolies, and influential groups that have been profiting from privileged access to the political class.
To be able to implement all these reforms, the government should pursue stability at all costs to save its broken banking system, allow businesses to operate, and enable inward investment. It cannot be easily dismissed that the record of the current Greek government in all the above areas has been abysmally poor.
Instead of facing these challenges, Greece now has a choice between remaining in the Euro or sliding back to its national currency. This is clearly the implied question of the Greek referendum, as in the absence of a bailout programme within the next few weeks, the need to establish a national currency will be necessary in order for Greece to recapitalise its banks.
It has been widely argued that the benefits of Greece returning to its own currency would be minimal, while the dangers to the economy and social cohesion would be dramatic. The large scale fall in wages as a result of devaluation will not be enough to restore competitiveness and production amidst a recessionary environment of bankrupt banks, hyperinflation and dramatic cuts in savings and pensions.
Most importantly, a Eurozone and potential EU exit will make the above reforms, which can lead the country back to growth, even more necessary but will create an environment very hostile to implementing them.
Greek and European leaders need to rise up to these historic challenges and accept the risk coming with making difficult political decisions and agreeing mutual concessions. A “yes” vote in the upcoming referendum could provide a fresh start towards finding an agreement by showing the determination of the Greek people to remain in the common currency, despite having bared the burden of the failures of the past.
The damage done in the past week has been severe, but there is still time for Greece to turn the page and reject a future of poverty and isolation.