Two years ago, most European policymakers still believed that Greece would pull through. They lacked experience in managing financial crises. They did not even consult with policymakers in other parts of the world who had dealt with crises in previous decades. Armed with ignorance and arrogance, they ended up repeating everyone else’s mistakes. They thought they were clever when they came up with the idea of an expansionary fiscal contraction. And they thought that a voluntary private sector involvement (PSI) could really help.
Having failed to learn from the mistakes of others, some of them are now beginning to learn from their own. In some northern European capitals, policymakers are beginning to understand that the Greek programme has been an unmitigated failure. They have lost trust in Greek politics. As we enter year five of a depression, and the certainty that Greek gross domestic product will fall further under the influence of austerity, they are on the verge of giving up on Greece.
But they are also inherently risk-averse, and prone to stick to procedure. They feel they must pretend to take the latest Greek austerity programme seriously, while simultaneously giving the impression that they will safeguard their own taxpayers’ interests. The Greek coalition parties have reached an agreement that should, at least formally, satisfy the demands of European finance ministers. The Greek parliament will accept it. The eurogroup will also accept it. Separately, the Greek bondholders will reach an agreement on PSI.
The Bundestag could still derail it, as public opinion in Germany is currently turning extremely nervous at the prospect of a futile €130bn programme. But my central expectation, however, is that the programme will happen. A period of calm will set in, but after a few months it will become clear the cuts in Greek wages and pensions will have worsened the depression. Europe’s policymakers will also find out that, in such a desolate environment, even a reduced target for privatisations is unrealistic. Greek GDP fell 6 per cent in 2011, and continues to decelerate at a similar rate this year. And before long, another round of haircuts beckons.
This is not even the most pessimistic scenario. It still assumes that Greek politics remains broadly supportive. But with fresh strikes and ministerial resignations greeting the latest programme, do we really know whether Antonis Samaras, the leader of New Democracy and most likely winner in the April elections, will co-operate with the current strategy? I cannot see how this is going to work politically. For a new prime minister who contemplates a full term of four years, the temptation must be big to pull the plug and blame the mess on his predecessors. He will then have four years to rebuild the country from the rubble of a eurozone exit. It would be politically much riskier for him to stick to a programme that he himself says does not work, and that will keep his country in a depression for the length of his mandate, and possibly beyond.
But for argument’s sake, let us assume that Mr Samaras will stick to the programme and that a debt trap can be avoided. Everything works as officially planned. Would that be the end of the Greek crisis? In that case the Greek debt-to-GDP ratio would fall from over 160 per cent today to about 120 per cent of GDP by the end of the decade.
But this will still be far too much. We should remember that 120 per cent is a political number that lacks economic justification. It is no coincidence that this happens to be the current Italian debt-to-GDP ratio. If one admitted that 120 per cent was not sustainable for Greece, one might create a presumption that the same was true for Italy.
But the two economies are very different. Greece has seen its economy collapse. To rebuild itself, Greece needs a functioning economic infrastructure, a modern labour market and a less tribal political system. Only after all that is in place will the financial markets start to trust Greece again. But that may be decades away.
So even in this unlikely case where everything works out according to plan, debt sustainability is far from assured. I believe that the Greek debt-to-GDP ratio would have to come down to a much lower level – something like 60 per cent of GDP – before the country has a chance to escape from the crisis. That would wipe out most of the country’s foreign-held debt, including the debt held by the official sector.
Some say it would be better to force Greece out of the eurozone right now, and use the funds to save Portugal. I disagree. I personally believe it would be best to recognise the desolate state of both countries, let both default inside the monetary union, and then use a sufficiently increased rescue fund to help them to rebuild themselves, and to ringfence the rest at the same time.
This will be very expensive. But to ignore reality for another two years will be ruinous.