Following five years of imperfect yet noticeable economic progress Greece is once again at the epicentre of the financial world’s attention. The country is due to repay €1.6 billion to the IMF in four steps between now and June 19. The first payment of €300m is due on Friday June 5.
But the Greek, Syriza-led government is at loggerheads with its international creditors over making these payments. To pay them, they require access to more loans – specifically €7.2 billion – which have been held up for months.
Greece’s creditors refuse to release the bail-out before Syriza agrees to economic policies that confirm fiscal discipline and further reforms in Greece’s civil administration and goods, services and labour markets. Syriza, on the other hand, refuses to adopt policies that are contrary to its election mandate to stop austerity and reverse many of the structural reforms completed over the past three years.
The present situation is clearly unsustainable, so what is likely to happen next? Making predictions within the current environment of complicated politics is of course very difficult. But, assuming Greece’s top priority is to remain in the eurozone, the most likely outcome is a compromise deal closer to the lenders’ positions rather than the Greek government’s.
Syriza’s pre-election promises were unrealistic. To start with, the cash necessary to deliver them is not available. Raising taxes on an already highly taxed population is politically very difficult, reducing the widespread tax evasion will take time and political will that the new government has not yet shown and Greek government yields have returned to levels that forbid Greece’s access to international financial markets.
The only realistic source of financing any expenditure beyond the state’s receipts in the foreseeable future is the bail-out programme provided to Greece by its international partners. Syriza’s plan seems to have been to force Greece’s creditors into accepting its pre-electoral programme by threatening contagion from a renewed Greek crisis, a kind of mutually-assured-destruction strategy. From the very beginning, however, that strategy was clearly misguided.
Although nobody wishes Greece to leave the eurozone and a Grexit would certainly not be costless, 2015 is not 2012, and it would hurt Greece more than it would the eurozone. The European Monetary Union has put in place significant institutional firewalls since 2012 to protect other members from a new Greek crisis. Plus the credibility cost that would follow Greece returning to unsustainable economic policies would be even greater for the long-term sustainability of the euro. In short, Greece needs Europe more than Europe needs Greece. So the latter will have to compromise more than the former.
The economic argument
The economics underlying the new Greek government’s negotiating positions have been fundamentally wrong. The emphasis of the Greek negotiating team is on the demand side. They argue that the Greek economy is in recession due to reduced demand and to overcome the recession a boost in demand – or, in other words, an end to austerity – is necessary.
There is little doubt that Greece indeed faces a problem of reduced demand relative to its production capacity – a fact reflected in the very high Greek unemployment rate. And indeed, a number of very prominent economists have argued that austerity in Greece in particular, and Europe in general, may have gone too far
But there is no mainstream economist, including the most vocal opponents of austerity, who does not acknowledge that the supply side of the Greek economy suffers from serious deficiencies, namely excessively low levels of productivity, competitiveness, private investment and institutional performance. The new Greek government has not presented any credible plan to address these.
On the contrary, Syriza is committed to reversing most of the reforms that have taken place since 2012, largely because they go against the interests of those pressure groups that constitute its main voter pool. As a result, from the perspective of mainstream macroeconomics, the present Greek position appears outdated and unsuitable to address the main causes of the Greek crisis – namely the weaknesses in the Greek supply side.
There is little chance that a demand-oriented policy, with ever-increasing borrowing, will be acceptable to Greece’s lenders and international financial markets. More importantly, such a policy is not in the best interests of Greece and its citizens.
Perhaps ironically, the Greek negotiating positions have so far reinforced the demand problem which it emphasises. By not adjusting their position, the Greek authorities maintain and intensify the climate of uncertainty and have cut the country off from the demand-boosting quantitative easing programme initiated by the ECB earlier this year. This results in conditions of credit crunch and postponement of investment and consumption decision. It will also cause capital flight, hitting demand from the monetary sector.
At the same time, and as the economy slides into a deepening recession, the fiscal deficit widens creating further pressure for raising tax and more expenditure cuts. Given the present fiscal dynamics, Greek authorities will eventually have to increase taxes and cut expenditure at levels significantly higher than planned a year ago to achieve a lower surplus than previously projected. Greece at the moment faces economic uncertainty, political uncertainty, a liquidity squeeze and deteriorating fiscal outlook. It is hard to define a more recessionary profile than the one created in Greece since January 2015.
The democratic argument
Eurozone countries are all run by democratically elected governments which, ultimately, answer to their voters. Public opinion polls in almost all of them show decreasing support for further financial assistance for Greece without conditions. This raises a two-way democracy-related argument.
On the one hand it is argued – and with some justification – that if Greek voters decided that they wish an end to austerity, their choice should be respected. On the other hand, an equally plausible argument is that if an end to Greek austerity presupposes increased financing by other European countries, it is the democratic right of the voters of those other countries to refuse this, if Greece does not observe mutually agreed conditions.
This brings us back to the internal contradictions of the pre-electoral promises given to Greek voters. It is not possible for Greece to maintain its participation in the eurozone without financing form their fellow eurozone members – which brings with it certain conditions. That is why the most likely outcome of the current negotiations is a deal closer to the lenders’ rather than the Greek government’s positions.
Question of priorities
There is a caveat in my prediction, namely the assumption that the overriding objective of the Greek government is to maintain Greece’s status as a euro-member. The assumption is based on public statements of top Greek officials, including the Greek prime minister, Alexis Tsipras, and is affirmed by Greek public opinion polls showing overwhelming support (in the order of 65% to 80%) for continued participation. Syriza, however, includes a substantial number of far-left members, known as the Left Platform, who openly argue that Greece should leave the euro if staying in it comes with any conditions.
As I have explained elsewhere, this will be a calamity for Greece and its citizens. To avoid it, Tsipras should not let this minority view hijack policy. At the same time, Greece’s international partners should show the highest possible degree of flexibility, both now as well as during future negotiations for a third Greek financial rescue package, which looks almost inevitable.
The best deal in my view will be one reviving the momentum on reforms in exchange for the minimum possible extra taxation measures – this will allow each party to claim some degree of success. Nobody will gain anything from prolonging the current stand-off – it is time for all parties to contribute towards a pragmatic agreement.