Opinion

Greece: Lessons for Europe

It was inevitable that Greece would have to make cuts. Yet, if it is ever to pay back its debts, what the country needs most of all is a growth strategy.

By: Date: August 13, 2015 European Macroeconomics & Governance Tags & Topics

The dreadful stand-off is over, for the moment: Greece and its creditors have started work on a third rescue package. However, debate continues about what lessons can be drawn from the failure of the previous programmes.

The IMF’s Chief Economist, Olivier Blanchard, recently published an important paper about just this.  When he defends the IMF’s main decisions, one can agree with much of what he says. It was surely inevitable that Greece would have to undertake massive budgetary consolidation in the last five years. When the 2010 rescue package began, the budget deficit was at 15%. That was not sustainable.

Blanchard has sharply criticised European austerity policies. Yet even he admits that in the Greek case the need for financing would have been unrealistically high without such rigorous savings. The total that has been lent within the previous bailout packages already exceeds 40% of Greek GDP – and this just to finance the deficits of the last years. Surely, the willingness to fund higher deficits was not there.

On two important points, however, Blanchard’s analysis is unsatisfactory. The most important question for Greece is this: the economy must grow, but where should this growth come from? Politicians need to present a strategy, but the programmes have not really made it a priority. What is more, the debt issue was never dealt with properly – including by the IMF.

The economic policies of Greece since the introduction of the Euro have been reminiscent of a Ponzi scheme. Every year more money was borrowed, not just to pay previous creditors but also to finance new expenditure. State spending in Greece therefore grew rapidly. From 1999 to 2009 salaries in the public sector doubled – in comparison, across the euro area they increased by only 40% in the same period. The resulting wage pressures led to excessive salary increases in the private sector, and Greek firms became less and less competitive. All this caused a huge current account deficit and spiraling foreign debts.

For the Greek rescue packages to be successful it was therefore vital to get this competitiveness problem under control.  Yet the Troika, and especially the IMF, only made half-hearted attempts. For example, in official documents they discussed necessary salary cuts in great detail. At the beginning, however, they did not make these a firm condition of emergency loans. They did not have enough courage.

It was also well known that lower salaries alone would not be enough. At the same time, a far-reaching reform of product markets was necessary, in order to break-up antiquated systems and vested interests. Otherwise it was hardly going to be possible to develop new growth sectors. As a result of this mistaken leniency, unemployment in Greece rose more rapidly than necessary. It was largely unavoidable that domestic demand would collapse, but in Greece this was in no way balanced by an increase in exports – unlike in Portugal, for example.

This is an area where the new rescue package should act. Greece urgently requires a growth strategy which makes it possible to increase exports. Labour market reforms are not necessary for this: according to the OECD, the Greek labour market is already more flexible than Germany’s. It is instead vital to open up product markets, to reform competition policy and increase the efficiency of the public sector. Start-up financing for new businesses, funded from European resources, would also be helpful.

The second central point concerns the ability of Greece to pay back its debts. IMF officials and independent experts had doubts about this from the beginning. Nevertheless, the IMF agreed to the first programme, and even changed its internal rules to make this possible. To justify this, the risks to financial security were highlighted.

Whether these risks were really so great could be the subject of a long debate. Still, it is certainly true that worries about contagion and the stability of the financial system were substantial and very present at the time. In this respect the IMF’s decision should not be criticised. However, what really must be criticised is the fact that the very financial risks being stressed by the IMF did not result in a sustainable rescue programme. Even the eventual haircut came too late to solve the debt problem.

Investments require certainty: the Euro

The new programme should also act here. To support further growth Greece needs confidence and new investments. Yet these will only come if there is certainty that Greece will still be in the Euro in five years, and that its debts are sustainable.

Politics could bring this certainty if there were an agreement to link debt servicing to Greek economic growth. The current repayment plan would only apply if Greece achieved adequate growth; in other cases the creditors would have to accept a further postponement of payments and lower interest rates.

This would enable long-term planning in Greece, and create incentives to invest.  At the same time this solution would also be in the creditors’ interest: it is clear that Greece will not be able to repay its debts in full anyway if growth remains weak. If this economic reality is accepted now, then such a plan could actually increase the expected repayments.

With hindsight it is clear that massive mistakes were made in Greece: by the IMF, the Troika and especially Greece itself. The country now needs to finally implement far-reaching reforms that will allow the private sector to export more and grow. In return the creditors must declare themselves ready to guarantee debt sustainability and realistic primary surplus targets, so that investment can return to Greece. Reforms and debt sustainability are two sides of the same coin.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.

View comments
Read article More on this topic

Blog Post

dion bongaerts
Schoenmaker pic

A call for uniform sovereign exposure limits

Banks’ sovereign bond holdings were at the heart of the euro-sovereign crisis. The concentration of domestic bonds created a vicious cycle between governments and banks. There are several proposals to end this link, including concentration limits on southern European bonds. We argue for a uniform limit to reduce flight-to-quality effects on northern European bonds. Such a uniform limit would also be more acceptable politically.

By: Dion Bongaerts and Dirk Schoenmaker Topic: Finance & Financial Regulation Date: March 28, 2017
Read article More on this topic More by this author

Blog Post

DSC_0794

Why was the last TLTRO take-up unexpectedly high?

The final round of TLTRO financing was an unexpected hit with euro area banks. The aim of the programme is to encourage banks to increase lending to the real economy. However, with many now expecting a hike in deposit rates, banks’ enthusiasm might be driven largely by the chance to make a profit from the cheap loans.

By: Justine Feliu Topic: European Macroeconomics & Governance Date: March 27, 2017
Read about event

Upcoming Event

Apr
5
09:30

Micro- and macro-based methods in assessing the impact of investment

This workshop will discuss methods for accurately evaluating the performance of public and private investment initiatives.

Speakers: Sabine Bernabe, Francesco Di Comite, Grégory Claeys, Zsolt Darvas, Helmut Kraemer- Eis, Aron Gereben, Simon Mizrahi, Amine Ouazad, Debora Revoltella, John K. Swales, Simone Signore, Natacha Valla, Georg Weiers, Marcin Wolski and Guntram B. Wolff Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Silvia Merler

The inflation basket case

Inflation in the euro area has finally reached 2%. But Draghi is right to warn that the underlying dynamics do not point to this being a self-sustaining trend. Breaking down the numbers shows that many inflation basket items are still showing weak price growth or even deflation.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: March 17, 2017
Read about event More on this topic

Upcoming Event

Apr
12
11:00

Global outlook and policy priorities

At this event the Managing Director of the International Monetary Fund, Christine Lagarde, will speak about the global outlook and policy priorities, ahead of the 2017 IMF Spring Meetings

Speakers: Christine Lagarde, Jean-Claude Trichet and Guntram B. Wolff Topic: Global Economics & Governance Location: Brussels
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

What future for Europe?

The Commission's White Paper on the future of the EU sets out five scenarios, but misses the fundamental questions facing Europe. How should the EU interact with its neighbourhood? How can we manage the tensions created by multi-speed integration? And above all how can the Euro be made sustainable in the absence of a major step towards fiscal union?

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: March 16, 2017
Read about event More on this topic

Past Event

Past Event

Intellectual Property and Competition Policy in Europe and Japan

Intellectual property (IP) is a cornerstone for incentivising innovation initiatives. It defines a framework within which firms and individuals can produce creations of intellect.

Speakers: Peter Alexiadis, Reiko Aoki, Michael Koenig, Kai-Uwe Kühn and Georgios Petropoulos Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 14, 2017
Read article More on this topic More by this author

Blog Post

Grégory Claeys

Debunking 5 myths about Frexit

French elections are fast approaching and the debate on euro membership is now in full swing. ‘Frexit’ supporters promise that the benefits of leaving the euro would be substantial for the French economy, that economic policy would be greatly improved, and most importantly that the exit process would be a piece of cake. This blog post shows that these claims are greatly exaggerated if not outright lies.

By: Grégory Claeys Topic: European Macroeconomics & Governance Date: March 10, 2017
Read article Download PDF More on this topic

Working Paper

WP_01_17 cover

Fundamental uncertainty and unconventional monetary policy: an info-gap approach

This paper applies the info-gap approach to the unconventional monetary policy of the Eurosystem and so takes into account the fundamental uncertainty on inflation shocks and the transmission mechanism.

By: Yakov Ben-Haim, Maria Demertzis and Jan Willem van den End Topic: European Macroeconomics & Governance Date: February 28, 2017
Read article More on this topic

Blog Post

Zsolt Darvas
DSC_0798
dsc_1000

The Brexit bill: uncertainties in the estimate of EU pension and sickness insurance liabilities

Pension and sickness insurance liabilities for EU staff could be an especially contentious part of negotiations on an EU-UK financial settlement: the “Brexit bill”. This post looks behind the calculation of the alleged cost of pension benefits and concludes that it may be less than half of what it seems.

By: Zsolt Darvas, Konstantinos Efstathiou and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: February 17, 2017
Read article More on this topic

Blog Post

Zsolt Darvas
DSC_0798
dsc_1000

The UK’s Brexit bill: could EU assets partially offset liabilities?

The ‘Brexit bill’ is likely to be one of the most contentious aspects of the upcoming negotiations. But estimates so far focus largely on the EU costs and liabilities that the UK will have to buy its way out of. What about the EU’s assets? The UK will surely get a share of those, and they could total €153.7bn.

By: Zsolt Darvas, Konstantinos Efstathiou and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: February 14, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Is Germany a currency manipulator?

What’s at stake: the Financial Times reports that Peter Navarro, head of the US’s National Trade Council, has accused Germany of currency manipulation. He claims that the country uses a 'grossly undervalued' Euro to 'exploit' its trading partners. Angela Merkel replied that the Euro is managed by the European Central Bank, on which Germany does not exert influence. We review what the economic blogosphere thinks of this.

By: Silvia Merler Topic: Global Economics & Governance Date: February 6, 2017
Load more posts