Is There Any Hope for Greece?

The Greek debt crisis didn’t materialize overnight. It is the product of decades of mismanagement of the country’s finances, overspending, unrealistic promises to every possible interest group and an unwillingness to address issues before it was too late. Now Greece has to act to try to prevent being crushed by its mounting debt. What should Greece do?

In the 1980s, Ireland successfully restructured its debt by, among other things, devaluating its currency. This remedy is now being tossed about for Greece, but there are crucial differences.

First, even if Greece exited the euro zone, the Greek debt (public and private alike) would remain in euros. As George Mason University Professor of Economics Garett Jones, explains, “This was tried before in Asia in 1997. Devaluation when you owe money in a hard currency creates as many problems as it solves.”

Second, while there is little doubt that a weaker currency than the euro would be more appropriate for a relatively poor country like Greece, richer nations in Europe, like Germany, won’t accept such a move. They fear a bank run on other weakened countries like Portugal and Spain would follow. As a result, there are likely more bailouts in Greece’s future rather than a devaluation. The question, of course, is how long will the German people be willing to pay for the fiscally irresponsible behaviors of their neighbors.

Short of declaring bankruptcy, Greece should cut its spending and mainly reform its entitlement programs. Using a large data set covering over 20 O.E.C.D. countries and spanning nearly four decades, economists Andrew Biggs, Kevin Hassett and Matt Jensen identify more than 100 instances in which countries addressed their budget gaps. They find that “the typical unsuccessful fiscal consolidation consisted of 53 percent tax increases and 47 percent spending cuts. By contrast, the typical successful fiscal consolidation consisted of 85 percent spending cuts.” Their findings are consistent with the work of Harvard’s Alberto Alesina and Silvia Ardagna.

They also found that successful consolidations involve important reductions in social transfers and that “cuts to government wage expenditures, meaning the size and pay of the public sector work force, and cuts to subsidies are typical in both successful and unsuccessful consolidations.” Unfortunately, only a minority of countries chose to cut spending. Most relied on revenue increases, which were unsuccessful in reducing the debt ratio. Interestingly, the debate over whether successful fiscal consolidations may spur growth is far from settled.