Retaking the Greek Test

By Ashoka Mody

For about five years now, Greece has been giving the euro area authorities a test in economics and politics. The test must be retaken until the authorities produce the right answers.

For about five years now, Greece has been giving the euro area authorities a test in economics and politics. The test must be retaken until the authorities produce the right answers.

The economics question is simple. How should Europe deal with a country that has lived beyond its means and cannot repay its debts? The answers have evolved. Greece has no problem. Greece can manage with loans from the European authorities and the IMF. Privately-held Greek debt does, after all, need to be restructured. The repayment terms of the debt owed to European authorities need to be eased some—and a bit more.

“I will think of some way…. After all, tomorrow is another day.” This Scarlett O’Hara dictum rarely works in conditions of distress. Delays are costly and the distress deepens. The then French Finance Minister Christine Lagarde, now the IMF’s managing director, said of the delays in the original Greek bailout, “If we had been able to address it right from the start, say in February [2010], I think we would have been able to prevent it from snowballing the way that it did.”

Predictably, and despite concessional terms, the Greek debt levels remain unmanageable. The unending fiscal austerity caused GDP to collapse and is steadily reducing the price level, making the debt burden more onerous. The debt ratio has continued to rise faster than forecast and the current projections of a decline are not credible.

The “radical-left” party Syriza, which led the polls in the election run-up, has given voice to a sharper economic question: Is it time to make a clean break with the past and forgive Greek debt?

And then there is the political question on the test: how should the European democratic process treat a country that does not live by the rules? The Lisbon Treaty requires that official loans be repaid, and not repaying them incurs the wrath of the German taxpayers.

European leaders have, therefore, sought to influence the Greek elections. European Commission President Jean-Claude Juncker advised Greek citizens to not vote the “wrong” way. “Extremist forces,” he said, should not “take the wheel.” The grown-ups must continue because they understand that Greece has obligations, which flow from “the necessity of the European processes.”

As with the economics, the political strategy has backfired. The same Mr. Juncker earlier lamented: “We are increasingly sliding down the slope towards reflexive regionalism and nationalism.” But could it be that the honoured European processes are feeding the nationalism? The Greeks feel aggrieved and the Germans see unending bills.

Angry German politicians want Greece to leave the euro area. But the exit would cause global financial mayhem and the costs to Germany would be much greater than from a write down of Greek debt.

No matter who now governs the country, forgiving Greek debt would give Greece a real opportunity to restart its economy. Official debts forgiven in the aftermath of World War I led to: “higher income levels and growth, lower debt servicing burdens and lower government debt.”

Those who worry that Greece will create a new burden for Europe should use this opportunity to fundamentally change the European architecture. Official monitoring of Greece has not worked—and will not work. Instead, under a new “no bailout” regime, private creditors must unambiguously bear the burden of future defaults, ideally through contracts that require debt restructuring at pre-agreed thresholds. Making creditors and debtors beware will create greater discipline. Continued reliance on discredited European processes will cause legitimate distress to spread. Extremism will grow.

The wrong answers to the Greek test have escalated the stalemate. The dilemmas intensify, raising the stakes in resolving them. Greek debt will eventually be written down. Doing so in driblets will only drag the process out while the Greeks hurt and European political divisions deepen. Till then, the Greek test will need to be taken again—and again.

Ashoka Mody is Charles and Marie Robertson Visiting Professor in International Economic Policy at the Woodrow Wilson School, Princeton University. Previously, he was Deputy Director in the International Monetary Fund’s Research and European Departments.


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Bruegel is an independent European think tank specializing in economics. Established in 2005, Bruegel is independent and non-doctrinal. Its mission is to improve the quality of economic policy with open and fact-based research, analysis and debate. Bruegel was ranked first in 2012 and second in 2013 among all international economic policy think tanks worldwide by the Think Tanks and Civil Societies Program at the University of Pennsylvania. Among all think tanks worldwide, it was ranked eighth in 2012 and sixth in 2013.

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