Finding Europe
Fears about Greece dropping out of the Eurozone have rattled stock markets worldwide, including in the United States. So, what does the US have to fear from events across the Atlantic. Quite a bit, as it happens. After all, this too is a country with a massive budget deficit that needs taming. Just don’t mention the word austerity.
In fact, as Amity Shlaes argues for Bloomberg View, there is much to commend in austerity — though perhaps not how it is practised in Europe. She sees spending cuts as beinf necessary to build trust with those holding government debt — a credible commitment, if you will, of a government’s willingness (and capacity) to pay back what it owes. Keep in mind that a large part of Greece’s troubles stems from the fact that it lied for so long about the true state of its finances, and since then has demonstrated an alarming propensity to squib on tough reforms.
But Shlaes also suggests a quid pro quo for curtailing spending: ‘austerity’ governments should cut taxes too, or at least outline a plan for doing so within the short to medium term. This may be a harder sell. On the face of it, if you cut both spending and taxes, the two cancel each other out — you still have a deficit. However, Shlaes argues that tax cuts provide greater economic stimulus than government spending, meaning you get better a bang for the buck. This ‘supply-side’ story suggests that tax cuts can in turn yield more, not less, tax revenue — a politically popular notion, even if the empirical evidence to justify this is contentious.
The bigger issue from Europe’s perspective is that, for some troubled economies, tax cuts may have a relatively smaller effect than you might expect. Tax evasion is rife in Greece. Lowering taxes on people who aren’t paying tax in the first place is not going to stimulate anything at all.
Ditch the Euro, ditch the EU?
As expected, Greek voters will be forced back to the polls next month to try again at electing a parliament. And by all accounts, the main beneficiary of this second-round vote will be a party that came from virtually nowhere to become the second largest party in this month’s election: the radical-left Syriza. Some now predict that Syriza will emerge as the largest party in the new parliament, giving it a strong mandate to pursue its plans to renounce the conditions of its bailout from the European Union and International Monetary Fund.
Syriza’s leader, Alexis Tsipras, reckons that Europe will be prepared to renegotiate — despite the fact that European leaders, particularly Germany’s Angela Merkel and her finance minister Wolfgang Schäuble, have insisted that there is no prospect of a better offer on the table. So, what happens? Well, Greece loses its bailout funds and will be forced to default. But that’s not all.
As Monash University’s Remy Davison (who, incidentally, once lectured yours truly) writes, without external funding sources (not just from foreign governments, but financial institutions as well), it would be untenable for Greece to remain in the Eurozone. But there is no provision for abandoning the single currency. Davison suggests the only ‘out’ clause is for Greece to withdraw from the European Union entirely. Consequently, other transfer payments to Greece — such as subsidies under the Common Agricultural Policy — would cease. Moreover, it would lose the trade benefits it enjoys within the EU, resulting in the remaining EU members slapping tariffs and other trade barriers on Greek exports. The EU’s customs union would no longer cover Greece either.
Of course, it’s also possible that some elegant fudge could be devised that would allow Greece to ditch the euro, but remain an EU member. But Davison’s point is that, as the rules currently stand, there is currently no provision for such a scenario. The only hope Greece might have is that it leaves the EU, and ditch the euro, only to be automatically readmitted to the club (but outside the Eurozone). However, how many would be willing to completely ignore the fact that Greece has become an economic basketcase when it comes to assessing it against the EU’s membership criteria?
[Syriza leader Alexis] Tsipras is merely expressing views that are already widespread within large segments of the Athens establishment, namely that the Europeans will ultimately give in and pay up, because they fear a Greek bankruptcy as much as people in the Middle Ages feared the Black Death.
Der Spiegel, German newsmagazine
Greece is almost certain to go back to the polls next month, after parliamentary elections this month proved inconclusive. What seems clear is that radical-left party Syriza looks set to play a dominant role in Greek politics in the near-term. Its young leader, Alexis Tsipras, rails against the austerity measures inflicted on Greece, and is vowing that any government his party supports will reject the conditions and call on Europe’s leaders to return to the negotiating table. Europe is unimpressed with that idea: Germany, in particular, insists that Greece must stick to its bailout agreement, or lose its only financial lifeline.
If Tsipras does find himself, eventually, in a position to call Europe’s bluff — and Germany holds its ground — Greece would likely withdraw from the European monetary union. The writers at German newsmagazine Der Spiegel recognise the pain this would inflict, but also consider it the best option for Europe, and for Greece itself.
From Europe’s perspective, the dangers associated with renegotiating the bailout term are simply too great. If Greece gets a better deal, other recipient states would surely demand greater leeway as well. As it is, Der Spiegel considers that Greece has failed in its current reform program. Meanwhile, public anger in those countries footing the bill — chiefly Germany — would increase. Instead of weaker countries potentially leaving the Eurozone, instead the pressure on stronger countries to depart would grow.
If Greece were to return to the drachma, it could instantly devalue its currency — helping to restore the international competitiveness it has lost within the Eurozone. This isn’t just about consumer purchasing power (that is, raising the relative price of imports into Greece and lowering the relative price of Greek exports abroad). Foreigners could buy up Greek companies for a song, and transform their operations — a chance for the sort of private sector growth that Greece has been sorely lacking in.
Of course, devaluation on its own will not be sufficient. Greece still needs to restructure its welfare system, reduce barriers to industry, and reform its labour laws. These are the measures that will provide the long-term incentives for economic prosperity — and precisely the sorts of things that Greece has struggled with even under the current pressure from investors and foreign governments. And the rest of Europe will have challenges of its own. As Der Spiegel concludes, ‘if Greece returns to the drachma, that will be the point when Europe’s work really begins’.
All roads lead to ruin
Post-election negotiations to form a new government in Greece appear deadlocked, with no prospect of a workable coalition being forged to run the country. So, within days, it seems likely that a new election will be called — sending Greek voters back to the polling stations in June. Such political uncertainty is not helping the country’s economic position either, with markets now expecting Greece to completely default on its debts.
Wolfgang Münchau sees four options for Greece. One, it could persist with the status quo — sticking to the terms of its current bailout from Europe and the International Monetary Fund — inevitably leading to greater domestic political opposition that will undermine any government. Two, it could meet the terms of the agreement until it balances its budget (excluding interest repayments), and then renegotiate the terms of it bailout or unilaterally default. Three, it could pursue Syriza’s preferred path — call Europe’s bluff, reject the terms of the bailout, and wait for Europe to come back to the bargaining table. Four, it could withdraw immediately from the European monetary union, and wear the massive turmoil that would unfold.
Whichever course it takes, Münchau believes Greece will end up defaulting on its loans. Option four is obvious in this regard. But Münchau considers option one as having no long-term future given the country’s political dynamics. And option three would probably backfire, considering German opposition to renegotiation (and the risks it would entail in terms of the bailout conditions imposed on other embattled recipients in the Eurozone). Münchau’s preference is option two, which would give Greece a more stable footing — but this might not be achievable, given how long and painful it will take for Greece to prune back its deficit. Indeed, the public anger today has all but destroyed the main centre-left party, Pasok; a second election could likewise critically weaken the main centre-right party, New Democracy.
Defaulting later is better than defaulting now, says Münchau. But there is no other option but default.
Into the fire
In this Olympic year, attention on Greece will turn briefly today away from the country’s political and economic woes to the lighting of the Olympic flame and the commencement of the torch relay for the London games later this year. But investors will not likely be distracted for long. Political gridlock threatens to bring Greece, finally, to the point of default and eventual exit from the Eurozone. European leaders have warned Greece’s politicians that they must honour their bailout commitments. As it is, while a further €3 billion loan to Greece has been approved, €1 billion has been withheld pending the formation of a government. It is now clear that the ball is firmly in Greece’s court: if it wants to stay within the monetary union, it will have to take the highly unpalatable medicine prescribed to it.
And, as we’ve so often seen throughout Europe’s debt crisis, Greece isn’t the only country on the hook either. Attention is also focused on Spain, where one of its financial institutions — Bankia — has been partly nationalised. Madrid has pledged to save the country’s banks, which could cause a blowout in the government’s finances: at a time when there are doubts about Spain’s ability to balance its books. Yields on Spanish bonds are climbing upwards again, increasing the likelihood that Spain will be forced to seek a bailout from its European neighbours. A clear resolution to the region’s economic turmoil remains as distant as ever.
