After the Storm
Teaching PIIGS to Fly
Nouriel Roubini
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NEW YORK – Greece’s fiscal problems are, as I have argued many times, but the tip of a global iceberg. For the next installment of the recent global financial crisis will be rising sovereign risk, especially in advanced economies that run massive budget deficits and accumulate large stocks of public debt as they socialize private financial losses in order to revive economic growth.
Indeed, history suggests that severe recession and socialization of private losses often lead to an unsustainable build-up of public debt. Moreover, financial crises triggered by excessive debt and leverage in the private sector are followed after a few years by sovereign defaults and/or high inflation to wipe out the real value of public debts.
Greece is also the canary in the coal mine for the euro zone, where all the PIIGS economies (Portugal, Italy, Ireland, Greece, and Spain) suffer from the twin problems of public-debt sustainability and external-debt sustainability. Euro accession and bull-market “convergence trades” pushed bond yields in these countries toward the level of German bunds, with the ensuing credit boom supporting excessive consumption growth.
Most of these economies were suffering a loss of their export markets to low-wage Asia. A decade of wage growth exceeding productivity gains led to real appreciation, loss of competitiveness, and large current-account deficits.
In Spain and Ireland, a housing boom exacerbated external imbalances by reducing national saving, pumping up consumption, and boosting residential investment. And the euro’s appreciation in recent years – driven in part by the European Central Bank’s excessively tight monetary policy – was the final nail in the competitiveness coffin.
Thus, restoring competitiveness, not just fiscal adjustment, is necessary to revive sustained growth. There are only three ways to accomplish this. A decade of deflation would work, but it would be accompanied by economic stagnation, thus becoming – as in Argentina earlier this decade – politically unsustainable, leading to devaluation (exit from the euro) and default. Accelerating structural reforms that increase productivity while keeping the growth of public and private wages in check is the right approach, but it is likewise politically difficult to implement.
Or a weaker euro could be had if the ECB were willing – quite unlikely – to ease monetary policy further to allow real depreciation. But a weaker euro would not eliminate the need for structural reforms; otherwise, the benefits would go mostly to countries like Germany that undertook painful reforms to restore competitiveness via a reduction in relative unit labor costs.
A shadow or actual International Monetary Fund program would vastly enhance the credibility of a policy of fiscal retrenchment and structural reforms. Under the former, the European Commission would impose fiscal and structural conditionality on Greece, while the EU and/or ECB would provide financing, which would be absolutely necessary, because announcing even the best conceived reform program would not be sufficient to restore lost policy credibility. Markets will remain skeptical, especially if implementation leads to street demonstrations, riots, strikes, and parliamentary foot-dragging. Until credibility is re-established, the risk of a speculative attack on public debt – reflected in the current rise in credit default swap spreads – would linger, given the ongoing budget deficit and the need to roll over maturing debt.
Since the European Union has no history of imposing conditionality, and ECB financing could be perceived as a form of bailout, a formal IMF program would be the better approach. The most successful programs undertaken in the presence of a risk of a fiscal and/or external debt financing crisis were those – as in Mexico, Turkey, and Brazil – where a large amount of liquidity/financing support by the IMF beefed up an increasingly credible commitment to adjustment and reform.
Loan guarantees from Germany and/or the EU are less desirable than an IMF program, as it is very hard to design and credibly implement conditionality in such guarantees. IMF support, on the other hand, is paid out in tranches and is conditional on achieving various policy targets over time.
The Greek authorities and the EU had until recently denied the need for financing, owing to concern that it would signal weakness and create a stigma. That was a grave mistake. Fiscal adjustment and structural reform without financing is more fragile and liable to fail without a war chest of liquidity to prevent a run on public debt while the appropriate policies are implemented and gradually gain credibility.
At the same time, if Greece does not fully adjust its policies to restore fiscal sustainability and competitiveness, a partial bailout by the EU and the ECB will still be likely in order to avoid the risk of contagion to the rest of the euro zone and the consequent threat to the monetary union’s survival. A default by Greece, after all, could have the same global systemic effects as the collapse of Lehman Brothers did in 2008.
Sovereign spreads are already pricing the risk of a domino effect from Greece to Spain, Portugal, and other euro-zone members. The EU and the ECB are worried about the moral hazard of any “bailout.” But that is precisely why a credible IMF program that ties financial support to the progressive achievement of fiscal and structural reform goals is the right way to teach Greece and the other PIIGS how to fly.
Nouriel Roubini is Professor of Economics at the Stern School of Business at New York University and Chairman of Roubini Global Economics (www.roubini.com), a global macroeconomic consultancy.
Copyright: Project Syndicate, 2010.
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belgradetokyo 09:56 16 Feb 10
The main factors driving the growth of the Brazilian, and to a lesser extent the Turkish economies are their size, comparative advantage in regards to natural resources and labour costs, and political stability. The same can be said of Russia and China. The Mexican economy, in real terms, is not a success story. Social issues, such as wealth distribution and law and order, amongst others, must be factored in when gauging economic growth.
The varied nature of E.U. economies, based on their cultural and historical differences, cannot be neutralized simply through monetary union and the ECB. European values unite the continent, unfortunately the currency isn't. Simply put, people refuse to accept that the price of an espresso should be the same in Thessaloniki as it is in Paris.
Comprahensive long term E.U.policy directives, based on a "difference in unity" approach to consensus building are the only way to prevent further European disunity. The blunt, and self-serving I.M.F. intervention (support) programs only threaten to Caribbeanize the latin economies of the E.U. I hope that the decision makers in Athens, and Brussels, make the wise choice.
alexferro 12:36 25 Feb 10
If some do not like part of your list of successes, of countries that appealed to the IMF try S. Korea.
sceptic 08:10 25 Feb 10
IMF conditionality may be a necessary but not a sufficient condition for restoring competitiveness & recovery of the Greek economy.
Sufficiency (and success) requires a devaluation mediated by a currency shift to a newly issued (and devalued) drachma and a temporary suspension of debt service until exports recover. Strikes & civil unrest, would be averted (but not the decline in living standards and consumption) due to the "monetary illusion".
A similar currency switch reportedly required only an afternoon to be sorted out by the Czech and Slovak governments according to Vaclav Klaus in Today's FT (02/25). This time around it would be much quicker than teaching the PIIGS to fly
jnuetzel 09:20 27 Mar 10
Relative to northern and middle europe, wages and pensions in southern europe, especially Greece, have been increased recklessly over the last few years to 15 to 30 % above productivity, in clear violation, and downright criminal fudging numbers, of signed Euro contracts. It would be criminal to punish even more the folks in N and M EUROPE, accepting significant real wage and pension losses, for the continued free spending of those, who did not.
All Euro members have signed a contract to keep public deficits and therefore inflation under control. The northern and middle europe countries have fulfilled the contract. The appropriate thing to do is that the violators, and in the case of greece (government), downright criminals, cheating the creditors about the real state of deficits, just renormalizes all pensions, salaries, wages back to year 2003 levels (german tax payers have not seen increases since then), increase immediately retirement age to 65, as everywhere else, and slap a one time tax on all greek property, as needed to cover the rest.
The first 2 rangs of the former criminal greek government should be extradited to Den Haag, all greeks living abroad become just subject to the same rules equivalent to the US, paying on their global income or loosing all local property and nationality.
Why should any US (via IMF) or DE (via EU) tax payer toil even harder to support a continued spending spree beyond their own means? That would be not just a "moral hazard" but a deeply immoral crime, intentionally destroying the moral and functional core of Europe and the Euro.
davie1003 07:55 16 Feb 10
This is excellent advice; but is not the use of the IMF simply another stage in the socialization of country (EU)financial losses leading to further accumulation of debt? IMF tranche payments are based on moveable conditions. I do not believe that wishing will make it so, nor that pushing to another level will avpid the reality. Do you?