Global Trends by Martin Khor

Star, Monday, 2 February 2015

Crisis or opportunity for Greece and Europe?

Blurb:  A political earthquake in Greece opens new roads either to a resolution to its economic crisis or a very messy situation for Europe and the world economy


Last week a political earthquake took place in Greece when the new party Syriza won the national election on an anti-austerity platform. 

The new prime minister, Alexis Tsipras, appointed prominent critics of the creditor-imposed austerity policies to the Cabinet and indicated the new government intends to re-negotiate the bailout loan conditions and also seek debt relief.

The new government looks ready to take on its troika of main creditors (the European Central Bank, the IMF and the Eurozone countries).  Some European leaders have called on the government to stick to the obligations linked to the bailout loans.

The big fights ahead have great significance not only for Greece but the whole of Europe and indeed the world.

It is a climax of the clash of ideas and policies that has taken place since the start of the global financial crisis in 2008 on how countries facing debt and recession should get out of their dire situation.

On one hand are the economists and politicians who argue that the focus should be to tackle debt and deficits by reducing government spending and channeling the saved money to service the old and new debts, so that growth can resume.

On the other are those who claim that this austerity strategy is counter-productive as the reduction in spending will worsen the recession, cause social dislocation and higher unemployment without solving the debt problem.

The debt-ridden Greece has obtained agreement for 240 billion euro in bail-out loans in recent years with very strict austerity conditions, with the assumption that its economy would improve.

However the opposite took place.  Unemployment has shot to 26% with youth unemployment at over 50%, the GDP is 26% below the pre-crisis peak level, and national debt has jumped to 175% of GDP. 

A large part of the population are suffering from reduced income, lack of access to food, health care and heating as public social spending was slashed. 

Greece, a proud nation with a glorious history of civilization, culture and science, was becoming a Third World country, and most people were disillusioned by the austerity strategy.

It was this economic and social collapse and loss of hope that led to the loss of the traditional parties and the election of Syriza which campaigned for a  rejection of austerity and re-negotiating with the creditors.

The new government’s policy platform has the support of some prominent economists and commentators.

The economist Paul Krugman notes that Greece has been running a primary surplus (government revenue minus government spending other than interest on debt) since 2013 and according to its agreement with the troika, it is supposed to run and use a primary surplus of 4.5% of GNP to pay its creditors for years to come.

The new government wants to use at least some of the surplus for government spending. This is expected to be a key bone of contention with the troika.         

According to Krugman, a relaxation of austerity and extra spending would mean a stronger economy, which means more government revenue, which means the primary surplus would not fall as much.

He estimates that an additional billion euros in spending should generate 0.5 billion euros in revenue, reducing the primary surplus by only 0.5 billion euros.

If the requirement that Greece runs a primary surplus of 4% of GDP is dropped, this would allow spending to rise by 9% of GDP and this would raise GDP by 12% relative to otherwise, and unemployment would fall by 10 percentage points.

If, more realistically, the surplus requirement is not cancelled but only relaxed, this would still have significant positive effects on Greek welfare, argues Krugman.

The fight will also be on debt relief, or debt write-down of a part of Greece’s debt, which the new government will ask for.

This will face fierce resistance from the creditors.  But it is receiving quite a lot of support from those who realise that Greece can never repay its debt in full and the sooner debt relief is provided the better, rather than prolonging and worsening the crisis by giving new bailout loans to repay old ones.

The Financial Times’ Martin Wolf points out that most of the bailout loans did not benefit Greeks; only 11% directly financed government activities.

He supports the proposal by Reza Maghadam, former head of IMF’s European department and now vice-chairman of Morgan Stanley, for substantial debt relief by halving Greece’s debt and halving the required primary fiscal surplus.

Maghadam acknowledges debt relief will be difficult as creditor European governments are constrained by their own politics, yet Greece has made huge sacrifices with too little to show, and official debt relief is not a new idea.

It is clear that if there is no negotiated settlement of the issue, there will be a very messy situation ahead.

Alternatives to a relaxation of austerity and debt relief is continuation of the status quo (which the Greek election result has proclaimed is impossible) or a Greek debt default and followed by unilateral debt restructuring, which will be chaotic at least in the short term, and a possible exit from the Euro.

The Greek situation again exposes the absence of, and the need for, an international sovereign debt resolution mechanism, to which a country with a severe debt crisis can have recourse to for an orderly and fair debt workout with their creditors, and with a panel of judges and experts objectively suggesting the terms.   

The next few weeks will be crucial for Greece, which has new hopes and plans for solutions to its severe crisis, but which will face a messy situation, whichever route it chooses.

Crucial too for Europe, which has to weigh accommodating Greek concerns with its countries’ domestic aversion to providing debt relief, and the future of the Euro and of the European Union.

And also crucial for the world, because a new crisis in Europe will have negative repercussions for the global economy, while an orderly solution will contribute to stability.

Moreover, the evolution (and eventual resolution) of the Greek crisis will have many important lessons for other countries, including on how not to get into such a debt situation in the first place, and how to get out of it, with less pain or at least without unbearable pain.