Financial Times, By Martin Wolf
Two and a half thousand years ago, Greece shaped the western mind. More recently, it shaped the response to the financial crisis. Greece suffered a calamity – and others' fear of following it justified the shift to austerity. The result has been a feeble recovery from the post-crisis recession, notably in the eurozone and the UK. Greece, alas, had the wrong crisis, at the wrong time.
Simon Wren-Lewis of Oxford university tells the story in an excellent blog post. He draws on a critical evaluation by the International Monetary Fund of the programme for Greece agreed in May 2010. Here is the report's summary of the failings: "Market confidence was not restored, the banking system lost 30 per cent of its deposits, and the economy encountered a much-deeper-than-expected recession with exceptionally high unemployment. Public debt remained too high and eventually had to be restructured, with collateral damage for bank balance sheets that were also weakened by the recession. Competitiveness improved somewhat on the back of falling wages, but structural reforms stalled and productivity gains proved elusive."
While the programme forecast a 5½ per cent decline in real gross domestic product between 2009 and 2012, the outcome was a fall of 17 per cent. According to the OECD, the association of high-income countries, real private demand fell by 33 per cent between the first quarters of 2008 and 2013, while unemployment rose to 27 per cent of the labour force. The only justification for such a depression is that a huge fall in output and a parallel rise in unemployment is necessary to force needed reductions in relative costs on to a country that is part of a currency union. Since the Greeks want to remain inside the eurozone, they have to bear the resultant pain.
Yet even this cannot justify one aspect of the programme. The International Monetary Fund is supposed to lend to a country only if its debt has been made sustainable. But it was not, in the least, as a host of commentators pointed out at the time. Instead of making debt sustainable, the programme merely let many private creditors escape unscathed. In the end, a reduction in debt to private creditors was imposed. Yet Greek public debt remains, arguably, too high: the IMF forecasts it at close to 120 per cent of GDP in 2020. This debt overhang will make it hard for Greece to return to the markets and to economic health. Deeper debt reduction is still needed.
All this tells us depressing things about the politicisation of the IMF and the inability of the eurozone to act in the best interests of its weaker members. But the Greek crisis, alas, also had two global results.
First, inside the eurozone, the fact that Greece was the first country to fall into trouble cemented the view of northern Europeans that the crisis was fiscal. For Greece was, indeed, a case of remarkable fiscal profligacy, with net public debt at more than 100 per cent of GDP even before the crisis. But elsewhere the position was quite different: private borrowing was the root cause of the crisis in Ireland and Spain and, to a lesser extent, in Portugal. Italy's public debt was high, but not because of recent profligacy. By deciding that the crisis was largely fiscal, policy makers could ignore the truth that the underlying cause of the disarray was irresponsible cross-border lending, for which suppliers of credit are surely as responsible as users. If the culpability of both sides – lenders and borrowers – had been understood, the moral case for debt write-offs would have been clearer.
Second, the Greek crisis frightened policy makers everywhere. Instead of focusing efforts on remedying the collapse of the financial sector and reducing the overhang of private debt, which were the causes of the crisis, they focused on fiscal deficits. But these were largely a symptom of the crisis, though also, in part, an appropriate policy response to it. As I have noted, in June 2010, shortly after the first Greek programme, leaders of the Group of 20 leading countries, meeting in Toronto, decided to reverse the stimulus, declaring that "advanced economies have committed to fiscal plans that will at least halve deficits by 2013". A sharp tightening followed (see charts). Policy makers justified the shift with supportive academic research: the view that fiscal contraction could be expansionary was an encouragement; the view that growth would fall if public debt grew too high was a warning.
What looked, until mid-2010, to be a burgeoning recovery from the nightmare of the "Great Recession" was aborted, notably so in the UK and eurozone. The greater success of the US in surviving austerity was probably due to its more aggressive clean-up of the financial sector, greater acceptance of deleveraging by households and its more aggressive monetary policy, particularly relative to the eurozone's. If the latest forecasts from the OECD are right, eurozone GDP will be lower in the fourth quarter of 2014 than it was in the first quarter of 2008 and a mere 0.7 per cent higher than in the first quarter of 2011. Did fiscal tightening cause such a weak recovery on its own? Certainly not. But it removed a still desperately needed offset to the contractionary forces emanating from crisis-hit private sectors.
What makes this story depressing is that it was unnecessary. At first, it might have made sense to fear the Greek crisis was the first outbreak of a fiscal-crisis pandemic. Yet it soon became clear that countries with their own floating currencies could still sell public debt at ultra-low interest rates. This was partly due to "quantitative easing" by their central banks. Possessing a central bank of your own gives a government a degree of freedom in managing its response to a financial crisis. For such countries, the time for rapid structural fiscal tightening comes only after the private sector starts to eliminate its structural financial surpluses. That would not be so soon after the crisis. It would also require prior restructuring of the financial sector and writedowns of excessive private debt.
In brief, the Greek crisis proved a triple calamity: a calamity for the Greeks themselves; a calamity for the popular view of the crisis inside the eurozone; and a calamity for fiscal policy everywhere. The result has been stagnation, or worse, particularly in Europe. Today, we have to recognise that the huge falls in output relative to pre-crisis trends may well never be recouped. Yet the reaction of policy makers has not been to admit the mistakes, but to redefine acceptable performance at a new, lower level. It is a sad story.
