ATHENS – Sunday’s election in Greece will decide whether confrontation or negotiation will be used to change the terms of Greece’s refinancing agreement with the eurozone. Rather than helping Greece to overcome its crisis, the austerity policies pursued since May 2010 have plunged it into a deep recession that perpetuates fiscal deficits and aggravates financial uncertainty.
It is becoming increasingly clear that if Greece proceeds to unilateral action – whether by repealing unpopular austerity laws or renouncing the loan agreement itself – the eurozone will suspend disbursement of the loan. The government will find it impossible to fulfill basic obligations, such as paying salaries and pensions, and the country will formally default. International banks will cease to finance Greek enterprises, including imports, creating shortages of fuel, food, and medicines. As confidence that Greece will remain in the eurozone plummets, a run on deposits will cause the banking system – and, eventually, the real economy – to collapse.
The next step will be forced exit from the euro and reintroduction of the drachma, implying a dramatic drop in living standards, owing in part to immediate devaluation of the new currency and high inflation. Meanwhile, the benefits in terms of competitiveness will be very limited, owing to the country’s narrow export base, and will evaporate in a vicious circle of devaluations and rising interest rates.
Long-term stagnation and high unemployment are the likely result of confrontation with the eurozone, which leaves only the path of renegotiation. The new political balance emerging in Europe after the Socialists’ victory in France’s presidential election creates scope for changes in the terms of the loan agreement that would help to boost economic growth.
Opting for renegotiation assumes the victory of pro-euro political forces in Sunday’s elections. New Democracy, Pasok, and Democratic Left belong to this group, as opposed to Syriza and some smaller parties on the extreme right and left, which support a confrontational stance vis-à-vis the eurozone, eventually leading to the euro exit. If a pro-euro majority emerges on June 17, the new government’s main challenge will be to propose a new policy agenda, and then to negotiate a revised deal with the eurozone.
The key to growth is increased competitiveness through higher productivity and lower production costs. In the 1990’s, in the run-up to joining the eurozone, Greece achieved substantial gains on this front. With inflation falling sharply, real incomes increased. Fiscal deficits were reduced. Important structural reforms were implemented, particularly privatization. Investment accelerated, and major infrastructure projects were realized. High growth rates were achieved in conditions of stability.
Unfortunately, that effort ceased over the last decade. Selfish interests prevailed. Business groups attempted to capture specific markets. Public-sector trade unions fought for preserving privileges. Tax discipline was further weakened. The welfare state was transformed into a system of endemic waste. A gap emerged between the economy’s productive base, which remained stagnant, and Greeks’ expectations (and demands), which were rising fast.
The agreement with the eurozone attempted to close the gap in a clumsy and misguided way. Instead of focusing on structural reforms to liberate the economy’s productive forces, it relied on income cuts and tax increases. The incompetence of the governments that implemented the agreement exacerbates that defect by sidelining structural reforms and enacting only the terms concerning austerity.
The renegotiation should aim at changing the policy mix in the following directions:
- Extending the timetable of fiscal-deficit reduction in order to limit the depth of the recession.
- Avoiding any new cut in incomes or new taxes, with reduction in indirect taxation to start immediately.
- Social-protection measures, particularly for the unemployed.
- A European Marshall Plan, through grants from the European Union’s structural funds and loans from the European Investment Bank, in order to sustain economic activity and create new jobs.
Achieving these targets presupposes that Greece’s new government implements all of the structural changes agreed with the eurozone. Privatization, opening up closed markets and professions, promoting entrepreneurship, and eliminating public-sector waste should proceed at a fast pace over the next few months.
The European Marshall Plan would offer a unique opportunity to reorient growth policies. Greece should move beyond its traditional focus on sectors such as tourism, shipping, and construction, and search for new areas of comparative advantage in renewable energy, high-value-added services, and selected lines of manufacturing that benefit from the country’s research potential.
If Greece succeeds in fulfilling the requirements of a revised financing agreement with the eurozone, it may win the confidence bet by convincing financial markets that it is determined to achieve the targets.
Confidence will unlock the door to economic recovery. The fear of a return to the drachma will recede. Consumption levels will begin to recover. Deposit outflows will cease. The banking system will be reinforced. Investors will reevaluate opportunities for undertaking new initiatives. A virtuous circle may be set in motion, leading the country, eventually, to escape the crisis zone.
The outcome of Sunday’s election will determine which way Greece goes – and, also, of course, how the unfolding Greek drama affects the eurozone’s future.