Why the Greek deal will work

Financial Mirror (Cyprus) - - FRONT PAGE -

Now that Greek banks have re­opened and the gov­ern­ment has made sched­uled pay­ments to the Euro­pean Cen­tral Bank and the In­ter­na­tional Mon­e­tary Fund, does Greece’s near-death ex­pe­ri­ence mark the end of the euro cri­sis? The con­ven­tional an­swer is a clear no.

Ac­cord­ing to most econ­o­mists and po­lit­i­cal com­men­ta­tors, the latest Greek bailout was lit­tle more than an anal­gesic. It will dull the pain for a short pe­riod, but the euro’s deep-seated prob­lems will metas­ta­sise, with a dis­mal prog­no­sis for the sin­gle cur­rency and per­haps even the Euro­pean Union as a whole.

But the con­ven­tional wis­dom is likely to be proved wrong. The deal be­tween Greece and the Euro­pean author­i­ties is ac­tu­ally a good one for both sides. Rather than mark­ing the be­gin­ning of a new phase of the euro cri­sis, the agree­ment may be re­mem­bered as the cul­mi­na­tion of a long se­ries of po­lit­i­cal com­pro­mises that, by cor­rect­ing some of the euro’s worst de­sign flaws, cre­ated the con­di­tions for a Euro­pean eco­nomic re­cov­ery.

To ex­press guarded op­ti­mism about the Greek deal is not to con­done the provoca­tive ar­ro­gance of for­mer Greek Fi­nance Min­is­ter Yanis Varoufakis or the point­less vin­dic­tive­ness of Ger­man Fi­nance Min­is­ter Wolf­gang Schäu­ble. Nei­ther is it to deny the eco­nomic crit­i­cism of the bailout pro­vi­sions pre­sented by pro­gres­sives like Joseph Stiglitz and con­ser­va­tives like Hans-Werner Sinn.

The ar­gu­ments against cre­at­ing a Euro­pean sin­gle cur­rency and then al­low­ing Greece to cheat its way into mem­ber­ship were valid back in the 1990s – and, in the­ory, they still are. But this does not mean that break­ing up the euro would be de­sir­able, or even tol­er­a­ble. Join­ing the euro was cer­tainly ru­inous for Greece, but there is al­ways “a great deal of ruin in a na­tion,” as Adam Smith re­marked 250 years ago, when los­ing the Amer­i­can colonies seemed to threaten Bri­tain with fi­nan­cial dev­as­ta­tion.

The great virtue of cap­i­tal­ism is that it adapts to ru­inous con­di­tions and even finds ways of turn­ing them to ad­van­tage. The United States in the mid-nine­teenth cen­tury was badly suited for a sin­gle cur­rency and a sin­gle eco­nomic struc­ture, as ev­i­denced by the Civil War, which was pro­voked as much by sin­gle-cur­rency ten­sions as by moral ab­hor­rence to slav­ery. Italy would prob­a­bly be bet­ter off to­day if Garibaldi had never launched uni­fi­ca­tion.

But once uni­fi­ca­tion has hap­pened, the pain of dis­man­tling the po­lit­i­cal and eco­nomic set­tle­ment usu­ally over­whelms the ap­par­ent gains from a break-up. This seems to be the case in Europe, as clear ma­jori­ties of vot­ers are say­ing in all eu­ro­zone coun­tries, in­clud­ing Ger­many and Greece.

Thus, the ques­tion was never whether the sin­gle cur­rency would break up, but what po­lit­i­cal re­ver­sals, eco­nomic sac­ri­fices, and le­gal sub­terfuges would oc­cur to hold it to­gether. The good news is that Europe now has some per­sua­sive an­swers.

In­deed, Europe has over­come what could be de­scribed as the “orig­i­nal sin” of the sin­gle-cur­rency pro­ject: the Maas­tricht Treaty’s pro­hi­bi­tion of “mon­e­tary fi­nanc­ing” of gov­ern­ment deficits by the ECB and the re­lated ban on mu­tual sup­port by na­tional gov­ern­ments of one another’s debt bur­dens. In Jan­uary, ECB Pres­i­dent Mario Draghi ef­fec­tively sidestepped both ob­sta­cles by launch­ing a pro­gramme of quan­ti­ta­tive eas­ing so enor­mous that it will fi­nance the en­tire deficits of all eu­ro­zone gov­ern­ments (now in­clud­ing Greece) and mu­tu­alise a sig­nif­i­cant pro­por­tion of their out­stand­ing bonds.

More­over, Euro­pean gov­ern­ments have be­lat­edly un­der­stood the most ba­sic prin­ci­ple of public fi­nance. Gov­ern­ment debts never have to be re­paid, pro­vided they can be ex­tended in a co­op­er­a­tive man­ner or bought up with newly cre­ated money, is­sued by a cred­i­ble cen­tral bank.

But for this to be pos­si­ble, in­ter­est pay­ments must al­ways be made on time, and the sanc­tity of debt con­tracts must al­ways take prece­dence over elec­toral prom­ises re­gard­ing pen­sions, wages, and public spend­ing. Now that Prime Min­is­ter Alexis Tsipras’s gov­ern­ment has been forced to ac­knowl­edge the un­qual­i­fied pri­or­ity of debt ser­vic­ing, and can now ben­e­fit from un­lim­ited mon­e­tary sup­port from the ECB, Greece should have lit­tle prob­lem sup­port­ing its debt bur­den, which is no heav­ier than Ja­pan’s or Italy’s.

Fi­nally, Ger­many, Spain, Italy, and sev­eral north­ern Euro­pean coun­tries re­quired, for do­mes­tic po­lit­i­cal rea­sons, a rit­ual hu­mil­i­a­tion of rad­i­cal Greek politi­cians and vot­ers who openly de­fied EU in­sti­tu­tions and aus­ter­ity de­mands. Hav­ing achieved this, EU lead­ers have no fur­ther rea­son to im­pose aus­ter­ity on Greece or strictly en­force the terms of the latest bailout. In­stead, they have ev­ery in­cen­tive to demon­strate the suc­cess of their “tough love” poli­cies by eas­ing aus­ter­ity to ac­cel­er­ate eco­nomic growth, not only in Greece but through­out the eu­ro­zone.

This raises a key is­sue that the Tsipras gov­ern­ment and many oth­ers mis­un­der­stood through­out the Greek cri­sis: the role of con­struc­tive hypocrisy in Europe’s po­lit­i­cal econ­omy. Gaps be­tween public state­ments and pri­vate in­ten­tions open up in all po­lit­i­cal sys­tems, but these be­come huge in a com­plex multi­na­tional struc­ture like the EU. On pa­per, the Greek bailout will i mpose a fis­cal tight­en­ing, thereby ag­gra­vat­ing the coun­try’s eco­nomic slump. In prac­tice, how­ever, the bud­get tar­gets will surely be al­lowed to slip, pro­vided the gov­ern­ment car­ries out its prom­ises on pri­vati­sa­tion, labour mar­kets, and pen­sion re­form.

These struc­tural re­forms are much more im­por­tant than fis­cal tar­gets, both in sym­bolic terms for the rest of Europe and for the Greek econ­omy. More­over, the ex­ten­sion of ECB mon­e­tary sup­port to Greece will trans­form fi­nan­cial con­di­tions: in­ter­est rates will plum­met, banks will re­cap­i­talise, and pri­vate credit will grad­u­ally be­come avail­able for the first time since 2010. If bud­get tar­gets were strictly en­forced by bailout mon­i­tors, which seems un­likely, this im­prove­ment in con­di­tions for pri­vate bor­row­ers could easily com­pen­sate for any mod­est tight­en­ing of fis­cal pol­icy.

In short, the main con­di­tions now seem to be in place for a sus­tain­able re­cov­ery in Greece. Con­ven­tional wis­dom among econ­o­mists and in­vestors has a long record of fail­ing to spot ma­jor turn­ing points; so the near-uni­ver­sal belief to­day that Greece faces per­ma­nent de­pres­sion is no rea­son to de­spair.

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