The dreadful stand-off is over, for the moment: Greece and its creditors have started work on a third rescue package. However, debate continues about what lessons can be drawn from the failure of the previous programmes.
The IMF’s Chief Economist, Olivier Blanchard, recently published an important paper about just this. When he defends the IMF’s main decisions, one can agree with much of what he says. It was surely inevitable that Greece would have to undertake massive budgetary consolidation in the last five years. When the 2010 rescue package began, the budget deficit was at 15%. That was not sustainable.
Blanchard has sharply criticised European austerity policies. Yet even he admits that in the Greek case the need for financing would have been unrealistically high without such rigorous savings. The total that has been lent within the previous bailout packages already exceeds 40% of Greek GDP – and this just to finance the deficits of the last years. Surely, the willingness to fund higher deficits was not there.
On two important points, however, Blanchard’s analysis is unsatisfactory. The most important question for Greece is this: the economy must grow, but where should this growth come from? Politicians need to present a strategy, but the programmes have not really made it a priority. What is more, the debt issue was never dealt with properly – including by the IMF.
The economic policies of Greece since the introduction of the Euro have been reminiscent of a Ponzi scheme. Every year more money was borrowed, not just to pay previous creditors but also to finance new expenditure. State spending in Greece therefore grew rapidly. From 1999 to 2009 salaries in the public sector doubled – in comparison, across the euro area they increased by only 40% in the same period. The resulting wage pressures led to excessive salary increases in the private sector, and Greek firms became less and less competitive. All this caused a huge current account deficit and spiraling foreign debts.
For the Greek rescue packages to be successful it was therefore vital to get this competitiveness problem under control. Yet the Troika, and especially the IMF, only made half-hearted attempts. For example, in official documents they discussed necessary salary cuts in great detail. At the beginning, however, they did not make these a firm condition of emergency loans. They did not have enough courage.
It was also well known that lower salaries alone would not be enough. At the same time, a far-reaching reform of product markets was necessary, in order to break-up antiquated systems and vested interests. Otherwise it was hardly going to be possible to develop new growth sectors. As a result of this mistaken leniency, unemployment in Greece rose more rapidly than necessary. It was largely unavoidable that domestic demand would collapse, but in Greece this was in no way balanced by an increase in exports – unlike in Portugal, for example.
This is an area where the new rescue package should act. Greece urgently requires a growth strategy which makes it possible to increase exports. Labour market reforms are not necessary for this: according to the OECD, the Greek labour market is already more flexible than Germany’s. It is instead vital to open up product markets, to reform competition policy and increase the efficiency of the public sector. Start-up financing for new businesses, funded from European resources, would also be helpful.
The second central point concerns the ability of Greece to pay back its debts. IMF officials and independent experts had doubts about this from the beginning. Nevertheless, the IMF agreed to the first programme, and even changed its internal rules to make this possible. To justify this, the risks to financial security were highlighted.
Whether these risks were really so great could be the subject of a long debate. Still, it is certainly true that worries about contagion and the stability of the financial system were substantial and very present at the time. In this respect the IMF’s decision should not be criticised. However, what really must be criticised is the fact that the very financial risks being stressed by the IMF did not result in a sustainable rescue programme. Even the eventual haircut came too late to solve the debt problem.
Investments require certainty: the Euro
The new programme should also act here. To support further growth Greece needs confidence and new investments. Yet these will only come if there is certainty that Greece will still be in the Euro in five years, and that its debts are sustainable.
Politics could bring this certainty if there were an agreement to link debt servicing to Greek economic growth. The current repayment plan would only apply if Greece achieved adequate growth; in other cases the creditors would have to accept a further postponement of payments and lower interest rates.
This would enable long-term planning in Greece, and create incentives to invest. At the same time this solution would also be in the creditors’ interest: it is clear that Greece will not be able to repay its debts in full anyway if growth remains weak. If this economic reality is accepted now, then such a plan could actually increase the expected repayments.
With hindsight it is clear that massive mistakes were made in Greece: by the IMF, the Troika and especially Greece itself. The country now needs to finally implement far-reaching reforms that will allow the private sector to export more and grow. In return the creditors must declare themselves ready to guarantee debt sustainability and realistic primary surplus targets, so that investment can return to Greece. Reforms and debt sustainability are two sides of the same coin.
This article is published in collaboration with Bruegal. Publication does not imply endorsement of views by the World Economic Forum.
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Author: Guntram B. Wolff is the Director of Bruegel since June 2013. His research focuses on the European economy and governance, on fiscal and monetary policy and global finance.