ATHENS – Even as the European Union and the International Monetary Fund lay the groundwork for a giant first-round bailout, debate is swirling about whether Greece can avoid sovereign default.
Some view Greece as Argentina revisited, noting the stunning parallels with the country that in 2001 set the record for the world’s largest default (in dollar terms). Others, such as Greek Prime Minister George Papandreou, see the country’s problems as difficult but manageable, and complain of interference from ill-intentioned foreign speculators.
Avoiding default may be possible, but it will not be easy. One has only to look at official data, including Greece’s external debt, which amounts to 170% of national income, or its gaping government budget deficit (almost 13% of GDP).
But the problem is not only the numbers; it is one of credibility. Thanks to decades of low investment in statistical capacity, no one trusts the Greek government’s figures. Nor does Greece’s default history inspire confidence.
As demonstrated in my recent book with Carmen Reinhart This Time is Different: Eight Centuries of Financial Folly , Greece has been in default roughly one out of every two years since it first gained independence in the nineteenth century. Loss of credibility, if it comes, can bite hard and fast. Indeed, the historical evidence slams you over the head with the fact that, whereas government debt can drift upward inexorably for years, the end usually comes quite suddenly.
And it can happen to any country, although advanced countries can usually tighten fiscal policy with sufficient speed and credibility that the pain comes mainly in slower growth. Unfortunately, for emerging markets, adjustment is often impossible without help from the outside. That is the precipice on which Greece stands today.
A debt crisis is not inevitable. But the government urgently needs to implement credible fiscal adjustment, concentrating not only higher taxation, but also on rolling back some of the incredible growth in government spending – from 45% of GDP to 52% of GDP – that occurred between 2007 and 2009. The government must avoid relying too much on proposals for tax increases, which ultimately feed back on growth and sustainability. It would be far preferable to balance tax increases with some reversal of runaway government spending.
I have Greek friends who say that Greece is not alone. And they are right. Some countries are almost inevitably going to experience bailouts and defaults. One of the more striking regularities that Reinhart and I found is that after a wave of international banking crises, a wave of sovereign defaults and restructurings often follows within a few years.
This correlation is hardly surprising, given the massive build-up in public debts that countries typically experience after a banking crisis. We have certainly seen that this time, with crisis countries’ debt already having risen by more than 75% since 2007.
But, whereas we are likely to see a wave of defaults and IMF programs this time, too, fiscal meltdown does not have to hit every highly indebted country. Indeed, what a country like Greece should be doing is pulling out all the stops to stay clear of the first and second wave of restructurings and IMF programs. If it can, then perhaps watching other countries suffer will help convince the local political elite to consent to adjustment. If not, Greece will have less control over its adjustment and potentially experience far greater trauma, perhaps eventually outright default.
There is an old joke about two men who are trapped by a lion in the jungle after a plane crash. When the first of them starts putting on his sneakers, the other asks why. The first answers: “I am getting ready to make a run for it.” But you cannot outrun a lion, says the other man, to which the first replies: “I don’t have to outrun the lion. I just have to outrun you.”
Greece has yet to put on its sneakers, while other troubled countries, such as Ireland, race ahead with massive fiscal adjustments. Greece’s new Socialist government is hampered by campaign promises that suggested the money was there to solve the problems, when in fact things turned out to be far worse than anyone imagined. Unions and agricultural groups tie up traffic with protests every other day, hinting at possible escalation.
Most Greeks are taking whatever action they can to avoid the government’s likely insatiable thirst for higher tax revenues, with wealthy individuals shifting money abroad and ordinary people migrating to the underground economy. Greece’s underground economy, estimated to be as large as 30% of GDP, is already one of Europe’s biggest, and it is growing by the day.
In the case of Argentina, a pair of massive IMF loans in 2000 and 2001 ultimately only delayed the inevitable harsh adjustment, and made the country’s ultimate default even more traumatic. Like Argentina, Greece has a fixed exchange rate, a long history of fiscal deficits, and an even longer history of sovereign defaults. Nevertheless, Greece can avoid an Argentine-style meltdown, but it needs to engage in far more determined adjustment. It is time to put on the running shoes.