How to undo the damage in Greece
Today Greece faces calamity. Banks have been closed for more than a week and the economy is deteriorating at an accelerating rate. Citizens and businesses can’t easily carry on with their normal lives; the tourism industry is plagued by cancellations; companies are postponing paying their workers. Yet the infusion of cash from the European Central Bank that is desperately needed to resuscitate the Greek banking system and jumpstart the economy is missing. It will arrive only after Greeks and their lenders come to a final agreement on the details of a new assistance program.
The “no” vote in Sunday’s referendum, by a margin of 61 to 39 per cent, has increased the probability of Greece exiting the European Monetary Union because it has put the burden on the Greek government to deliver a better outcome in its negotiations with the lenders.
Prime Minister Alexis Tsipras seems to believe that the referendum’s overwhelming outcome will give the government additional negotiating power and has dismissed the possibility of a euro exit. Based on the experience of the last six months, it is hard to see how its negotiating power would increase; instead, it will restrict the choices of the Greek government.
What could not be achieved by the Greek government in the past five months must now be achieved in only a few days — and in an environment of mistrust and acrimony. To make matters worse, hardliners among the lenders have been emboldened by the fact that Greece’s crisis has not led to contagion in the rest of Europe.
How did we reach this point? Back in November 2014, and after six years of depression that had shaved 26 per cent off Greece’s real GDP, the economy was finally starting to show signs of growth, foreign direct investment had picked up and unemployment was declining.
Back then, Greece had secured a credit line from its euro-area partners for 2015. At the Eurogroup meeting of Dec. 8, 2014, the European Union commissioner for economic affairs, Pierre Moscovici, stated that Greece had done more than was required to fulfil the obligations for completing the so-called fifth review of the second adjustment program. Doing so would have unlocked €7.2 billion ($10.1 billion) of funding, or four per cent of Greece’s GDP, and about onethird of that was not a loan.
But in late summer 2014, the previous government, in which I served, became excessively anxious to have one of the lenders, the International Monetary Fund, cease its program at the end of 2014, more than a year earlier than had been previously planned. Since European lending programs were also ending, this would have allowed the government to claim it had finished with austerity and lenders’ strict rules. Yet this move prompted a reaction by the IMF, which became tougher in its demands during the second half of 2014.
A presidential election was due in early 2015. At that time, polls were showing that Syr- iza, a leftist party, would win. I believe that this prospect led the IMF to prevent cash from flowing into the Greek government’s coffers in order to ensure there was enough leverage on the side of the lenders to force a potentially new and untested government to behave rationally.
At the December 2014 Eurogroup meeting, the IMF and the European Central Bank did not agree with the European Commission that Greece had done enough to receive the next stage of funding and halted the program. This, in my view, was a blunder.
The lenders could have instead distributed their money gradually in response to the fulfilment of a set of milestones that stretched beyond the elections and thus met all the IMF benchmarks.
The negative consequences of this decision remain with us today. It hurt the previous government’s image during the January 2015 elections, because we were not able to claim success in ending the program on time and improving relations with Europe. And the lack of cash flowing into the Greek economy wiped out all the initial signs of growth that had appeared early that year.
The new government, led by Syriza, was animated by a grudge against the lenders. First, instead of worrying about the economy, the government focused on the issue of debt and disregarded the fact that the Greek public debt is not an issue of immediate importance. (It has an average maturity of 16.5 years and carries low interest rates, so it is easily serviceable.) While there is room for getting a better deal in a way that is acceptable to the lenders’ parliaments, the debt issue can wait.
Second, Tsipras’s government behaved as if the flow of cash into the economy didn’t matter. The newly appointed finance minister, Yanis Varoufakis (who resigned on Monday), went so far as to say, “we do not need the cash inflow of the 7.2 billion euros.” The Syriza government also postponed payments and accumulated arrears, drying up liquidity from the private sector.
Third, Tsipras’s government ignored the need for credibility and trust in Greece’s private sector and instead let it drift in anxiety. Worse still, many ministers attempted to renege on the reforms that had passed with great difficulty during the previous five years. As a result, uncertainty reigned, business contracts were postponed and people began withdrawing their savings from banks.
Finally, Tsipras’s government misread the European point of view. Based on my experience negotiating with them, European officials tend to work by building consensus and in small steps. They dislike extreme solutions. Being lenient on Greece was seen as an extreme solution because it created a moral hazard that might allow future copycats to disobey established rules. Being extremely strict toward Greece and letting it drift outside the monetary union was also seen as an extreme solution, as it might create a precedent that could unravel the European Monetary Union during any future crisis.
The Syriza government forgot the moral hazard issue and overplayed European fears of an unravelling of the euro area. As a result, it alienated almost all its potential friends and became isolated. Instead of trying to extract the maximum flexibility from the lenders, it pushed its own point of view that the eurozone couldn’t survive without it.
The next few days will be crucial.
The lenders must compromise without sacrificing their principles. They can easily give a clearer signal on their long-term plans for Greece’s debt and extend the maturities of the loans without alienating their own constituencies. This is a win-win solution for Greece and Europe.
Domestically, reforms that seek to level the playing field, minimize bureaucracy, fight oligopolies and give more power to the people are badly needed.
Tsipras has called for a united front and seems to have sidelined ministers who took extreme positions. This is a good start that provides hope that an agreement can be reached before it is too late.
Otherwise, the future of Greece will be bleak and the damage will take decades to undo. Exiting the euro and issuing a new currency would unleash inflation, destroy institutions and bring poverty. The Greek government has gambled with the livelihood of future generations. It must now stop and work constructively.
The Greek government has gambled with the livelihood of future generations. It must now stop and work constructively