BRUSSELS – The first de facto default of a country classified as “developed” has now taken place, with private international creditors “voluntarily” accepting a “haircut” of more than 50% on their claims on the Greek government. As a result, Greece now owes very little to private foreign creditors.
Greece also agreed to even more stringent budget targets and, in return, received financial support of more than €100 billion ($134 billion). The purpose of the entire package is to avoid a full-scale default and allow the country to complete its financial adjustments without overly unsettling financial markets. But this approach (a haircut on private-sector debt plus fiscal adjustment) is unlikely to work on its own.
The real problem in Greece is no longer the fiscal deficit, but a combination of deposit flight and continuing excessive consumption in the private sector, which for more than a decade now has been accustomed to spending much more than it earns. This over-consumption had been financed (at least until now) by the government, and, as a consequence, most of the foreign debt comprised public-sector liabilities. The official line is that Greek over-consumption will cease once the government reins in expenditure and increases taxes.
But this might not turn out to be the case. The Greek population has become accustomed to consuming above its means; and it can continue to do so because it effectively faces what the Hungarian economist János Kornai, analyzing the failings of socialism, called “a soft budget constraint.” When Greek households have to pay higher taxes, they can simply withdraw the funds from their savings accounts and continue spending much as before. That is why, despite the strong fiscal adjustment, Greece’s current-account deficit remains close to 10% of GDP.