Saturday, November 29, 2014

Lessons of a Greek Tragedy

ATHENS – A visit to Greece leaves many vivid impressions. There are, of course, the country’s rich history, abundance of archeological sites, azure skies, and crystalline seas. But there is also the intense pressure under which Greek society is now functioning – and the extraordinary courage with which ordinary citizens are coping with economic disaster.

Inevitably, a visit also leaves questions. In particular, what should policymakers have done differently in confronting the country’s financial crisis?

The critical policy mistakes were those committed at the outset of the crisis. It was already clear in the first half of 2010, when Greece lost access to financial markets, that the public debt was unsustainable. The country’s sovereign debt should have been restructured without delay.

Had Greece quickly written down its debt burden by two-thirds, it would have been able to shed its crushing debt overhang. It could have used a portion of the interest savings to recapitalize the banks. It could have cut taxes, rather than raising them. It could have jump-started investment and gotten its economy moving again, if not in a matter of months, then, with luck, in no more than a year.

In its official post-mortem on the crisis, the International Monetary Fund now agrees that debt restructuring should have been undertaken earlier. But this was not its view at the time. Under the leadership of Dominique Strauss-Kahn, the Fund was in thrall to the French and German governments, which adamantly opposed debt relief.

The European Commission, for its part, has rejected the IMF’s mea culpa. Preoccupied by the state of the French and German banks, it continues to argue that delaying debt restructuring was the right thing to do. It has no regrets about throwing Greece to the wolves.

Given this opposition, the Greek government would have had to move unilaterally. Hindsight suggests that the authorities should have done just that. Faced with foreign opposition, the government should have announced its decision to restructure as a fait accompli.

Clearly, there would have been risks. The “troika” – the IMF, the European Commission, and the European Central Bank – might have refused to provide an aid package, forcing Greece to compress imports even more sharply. The ECB might have cut off emergency liquidity assistance, forcing the government to impose capital controls and even consider abandoning the euro.

But, by acting preemptively, Greek leaders could have shaped the dialogue. They could have said to their EU colleagues, “Look, we have no choice but to restructure what is clearly an unsustainable debt. But make no mistake: our preference is to remain in the eurozone. We are committed to reforms. Given this, don’t you agree that we are deserving of your support?”

Making a compelling case would have required Greece to get serious about those reforms. The government could have started by bringing together employers and unions to negotiate an equitable burden-sharing agreement, including an across-the-board reduction in wages and pensions, thereby getting a jump on internal devaluation. This could then have been complemented by a simultaneous agreement to restructure private debts. With everyone accepting sacrifices, it might have been possible to reach an accord on liberalizing closed professions and on comprehensive tax reform.

But, instead of working together with its social partners, the government, heeding the troika’s advice, dismantled the country’s collective-bargaining system, leaving workers unrepresented. Greece thus lacked a mechanism to negotiate a social compact to cut wages, pensions, and other obligations in an equitable way. With every vested interest fighting for itself, closed professions proved impossible to pry open. Doubting that there would be shared sacrifice, those same interest groups were unable to negotiate meaningful tax reform.

With the Greek government thus failing to push through structural reforms, it was unable to earn the trust of its creditors; and, skeptical that the government was committed to reform, the troika demanded a pound of flesh, in the form of front-loaded austerity, as the price of assistance. Those front-loaded tax increases and government-spending cuts plunged the economy deeper into recession, making a farce of claims that the public debt was sustainable – and forcing the inevitable debt restructuring after two more agonizing years.

Greece is now seeking to make the best of a difficult situation. It is attempting to breathe life into the campaign for structural reform. It is lobbying the troika for further debt relief. But the damage will not be easily undone. Past mistakes, committed not just by Greece, but also by its international partners, make a difficult short-term future unavoidable.

It is important that other countries draw the right lessons. If they do, Greece’s brave, beleaguered citizens can at least take comfort in knowing that many people elsewhere will be spared the same unnecessary sacrifices.

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    1. CommentedCarol Maczinsky

      Of course delaying debt restructuring was the right thing to do, and any other options would have cratered market confidence at this stage. But Greece undertook no effort to restore trust.

    2. Portrait of Pingfan Hong

      CommentedPingfan Hong

      If the government could have brought together employers and unions to negotiate an equitable burden-sharing agreement, including an across-the-board reduction in wages and pensions, say 20%, would it be the same as GDP declines by 20%, equivalent to the same recession as Greece has experienced?

    3. Portrait of Pingfan Hong

      CommentedPingfan Hong

      A more important and more pertinent question we should ask is not "what should policymakers have done differently in confronting the country’s financial crisis?", but what should policymakers have done differently before the country fell into financial crisis?

    4. Commenteddonna jorgo

      PEOPLE CONTINUED TO PAY ..(but i think they like to pay)

    5. CommentedGeorge J. Georganas

      A brief account of the Greek crisis here :
      Hard truths told well.

    6. CommentedAurelian Dochia

      A good example of wishful thinking! In an ideal world, where all parties - governments, creditors, debtors, trade unions, employees etc. - do have the same view of a "common interest", many alternative solutions may be envisaged. In the real world however, it is hard to believe the Greek government would have been able to design, negotiate and implement a superior solution. First, Greece had no means to impose a debt restructuring on all its creditors without being declared bankrupt. Second, Greece needed urgent fresh money that it could not get on the financial markets - so the Troika funds were critical. And third, it is really hard to imagine anyone in Greece would have accepted any kind of sacrifices in terms of salaries, pensions or jobs cuts if somehow by miracle the public debt was written off from the beginning. Yes, earlier debt restructuring would have avoided a lot of pain, but would have delayed or annulled the necessary adjustment efforts. Because in the end Greece, like everybody else, should learn to live within its means and to a large degree this is what the current crisis is about.

    7. Portrait of Christopher T. Mahoney

      CommentedChristopher T. Mahoney

      If an EZ member is going to default, it should also repudiate and redenominate. That ends the whole problem. It's easy to stay in the EZ when the net flow of funds is in your direction. But when that reverses, as it is about to for Greece, it makes sense to get out.

    8. CommentedJules Pierre

      « It could have jump-started investment and gotten its economy moving again (...) in no more than a year. »
      « The government could have started by bringing together employers and unions to negotiate an equitable burden-sharing agreement »
      This is crazy.

    9. CommentedGeorge J. Georganas

      Eichengreen fails to mention that the Greek government deficit was running at over 15% of GDP and the balance of payments deficit at over 10% of GDP at the time that the crisis broke. So, Greece was not having a "financial crisis", but a full-blown production crisis. The financial crisis was a symptom of the deeper malinvestment crisis. Greece had invested in educating many hundred thousand people to sit in public sector offices and set stamps on documents, while manual and menial jobs were left to be done by immigrant labour at sub-minimum wages, also depriving social security funds of social security contributions. Presumably Eichengreen expected taxpayers in Germany and the rest of the EU to continue financing deficits generated in that manner, while the Greek government was dicussing ways to smoothly cut those same huge deficits. Now, what incentive did the Greek government and unions to hurry ? None whatsoever !
      The article is inaccurate in another respect. The interest burden on the unsustainable debt was not a factor in the deep reduction in the Greek standard of living. The rescue package only asked Greece to take care of its running deficits, while the rescuers were taking care of the debt. Thus, the fall in Greek living standards was the result of Greece having to live within its means.

    10. CommentedAdam Harper

      Prof Eichengreen is spot on when he lays responsibility on the Greek policy makers first. Austerity was inevitable, whether it came from the Greeks themselves, the international investing community or the Troika. The Greeks had an opportunity to impose austerity measures on their own terms, but foolishly and childishly "played dumb" until the situation became extremely dire, indeed. Naturally, IMF imposed austerity would not, and could not consider the specifics and nuances of Greek policy as well as Greek-imposed austerity, but that ship has sailed. What the Greek people are left with were measures not tailored to their specific needs, and thus not as helpful to the situation at hand.