Sunday, November 23, 2014
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Will more Europe or less Europe solve the Eurozone crisis?

Despite dozens of summits, the European economic crisis continues to drag on. Greece remains the crux of the matter. Mired in both an economic depression and a political crisis, progress on reform has been difficult. Social unrest and uncertain prospects of future growth has undermined commitment to economic adjustment, raising concerns over how much longer Greece can even remain in the Eurozone.

It has been difficult for others to agree on how best to help Greece because there are political divisions here as well. These were underscored last week in a public spat between IMF Managing Director Christine Lagarde and Chair of the Eurozone Finance Minsters Jean-Claude Juncker. They debated whether the end goal for Greece should be to reduce its level of debt to 120% of GDP by 2020 or 2022. The potential for this disagreement was present from the beginning. The Eurozone’s contribution to the Greek bailout was 2/3 of the total, with the IMF supplying the rest. The Lagarde/Juncker debate, then, resembles two restaurant goers arguing over the size of the check.

In a sense, debating what Greece’s debt ratio should be almost a decade from now is trivial. Greece needs the next tranche of aid now, and the dangers of inaction are indeed real. The deepening divisions within the troika (comprised of the IMF, the EU, and the European Central Bank) have given rise to a range of different proposals. Christopher T. Mahoney offered one such solution last week, arguing that the imperatives of the crisis necessitate kicking the IMF out of the troika and preparing for an orderly departure from the Euro (known as a “Grexit”). I’d offer two comments on the first part of Mahoney’s proposal, and conclude with an observation on the second part.

It’s not apparent that an all-European solution would address the crisis more efficiently. Greece’s economy continues to shrink and its unemployment is now over 25%. In this setting, raising additional tax revenue is difficult and it is also hard to get support to cut government spending further. It is no wonder that there is increasing pressure for some sort of debt relief, but Eurozone countries have little interest in granting this. This official debt relief would follow on the heels of private debt restructuring concluded earlier this year, making it appear that these countries are throwing money away. Eurozone politicians such as Angela Merkel that face elections next year have no desire to give their opponents a ready-made campaign issue. Since the economy across the Eurozone is in poor shape, the needs of voters at home will take priority over the needs of Greek citizens.

This is part of the rationale for why international organizations are valuable. IMF conditionality has often been used as a ‘scapegoat’ by reform-minded governments to justify economic austerity. In this light, then, the IMF plays an essential role in the Eurozone in helping make agreements possible. European politicians can gain some political cover by framing debt relief as necessitated by the Fund. If anything, the IMF’s most recent statement that the 120%/2020 guideline was a necessary condition for the Fund to support the Greek program was intended to press the European governments to reach a deal on its terms.

It is also the case that an all-European solution would be less fair to Greece. The debate between Juncker and Lagarde typifies this, as the Europeans are willing to fund a Greek program that concludes with a higher overall level of debt. The debate between the two positions is one of a preference for financing a balance of payments problem or adjusting to it. The difference between these two positions is an important one, especially since the political turmoil in Greece (as witnessed by two elections to produce a coalition government with slender support) makes further austerity politically difficult. More tough talk is not likely to produce more reform.

Mahoney is absolutely correct that it is difficult to look at the rhetoric and question how serious the Europeans are about keeping Greece in the Eurozone. If anything, Greece might leave because her leaders have concluded that additional help is unlikely, and that not supporting a Grexit would be tantamount to political suicide. To prevent this from happening, IMF involvement in the Eurozone crisis is essential. This is not a case of “too many cooks spoiling the pot.” Without the IMF as a voice of moderation, one fewer cook will surely result in a recipe that few European politicians would be willing to stomach.

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