The leaders of Greece’s Syriza government are clever people. They include university academics, well versed in modern economics, including game theory and the theory of negotiations. After yesterday’s decisive No vote in the referendum on settlement terms, these negotiators now feel they have a strong hand. I don’t share their optimism.
Unless you believe the conspiracy theories that Syriza’s real aim is to create a Venezuela in the Mediterranean, they appear to think that their EU counterparts and the IMF will be forced to negotiate because the consequences of not doing so are dire. What they seek are two things. First is that the level of government debt be reduced through forgiveness. The second is that the Greek government has a free, or freer, hand to follow an economic policy of its choosing, supported by fresh funding, primarily in the form of support for the Greek banking system by the European central Bank (ECB).
On the face of it neither of these requests is all that unreasonable. The moral case for debt forgiveness is a sound one. In the modern age more responsibility needs to be pinned on creditors to lend responsibly, and to suffer losses otherwise. The lending made to Greece before the crisis was not responsible, although misinformation from the Greek government contributed. This moral case is softened but still stands after two things. The Greek debt has already been substantially restructured so that the country’s interest rate burden is proportionately less than even Germany’s; the net present value of Greece’s debt is not nearly as high as you might assume for its nominal size. And now the debt has been taken over mostly by government agencies; the private sector banks that originally lent the money have mostly been paid off, after significant losses were forced on them.
And as for economic policy, the nominal Greek aim is to set up a virtuous circle of increasing demand that will help the economy to recover, so that its banks can repay the ECB, and that other lending becomes more sustainable. There is a familiar, Keynesian demand management logic to this. I think this is why so many respectable economists (especially based far away in the US) support the Greek government’s standpoint. There is also a powerful argument about democracy – surely a democratic Greek government should choose its own path to a sustainable economy? The sight of so many unelected functionaries dictating terms to the Greek government has angered not just Greek citizens. I have seen many comments this morning about how the Greek referendum vote was a blow for democracy. The People have spoken!
So what’s the problem? International leaders are masters of fudge and pragmatism. Surely some kind of face-saving formula can be found that will be better than the consequences of a collapse of the Greek banking system? This is now a clear and present danger. Greeks having been withdrawing deposits from their banks, making the system insolvent. Since this looks like a temporary problem, the ECB has been prepared to prop the system up with emergency funding, awaiting the return of those deposits once a new deal has been struck. But last week this support was cut off, as the confidence of European governments was shaken about the ability to do any deal, when the Greek government called the referendum. With the referendum done the outgoing Greek Finance Minister, Yanis Varoufakis, suggested that this funding would return while a new and more reasonable deal was in prospect. Mr Varoufakis, who had taken to lecturing his European colleagues on basic economics, even resigned to make such a deal easier to negotiate.
But all negotiations are built on trust. You have to believe that your counterpart will stick to their side of the deal. And this has always been the problem with Greece and its creditors. What these creditors fear is that the Greek government do not put their economy on the path to true sustainability, and that it and the country’s banks will continue to need injections of foreign money without any real prospect of these being repaid. And this further support will have to supplied or underwritten by fellow European governments. There is little feeling of solidarity with the Greeks from other European electorates. Better off countries, like Germany, Finland and the Netherlands are outraged about the prospect of more taxpayers’ money being sent to countries that they see as feckless. Many east European governments, like Slovakia or Lithuania, are poorer than the Greeks overall, and see no reason to let the Greeks off; in some cases they have been forced to endure harsher austerity regimes than the Greeks were. Governments in other countries that have been subject to bailouts, Spain and Portugal in particular, do not want to give an easy victory to Syriza, lest it encourage similar movements in their own countries.
And why isn’t the Greek economy sustainable? This is a familiar combination of corruption, clientalism and ineffective government. Tax collection is inefficient; many benefits are too generous; there are too many meaningless publicly funded jobs. Many Greeks are entrepreneurial and hard working, but overall the economy does not pay its way – consumption is sustained by net imports. To create something more sustainable would require a programme of reforms, most of which would be politically unpopular. They would also suck demand out of the economy in the short term, i.e. they involve what has become known as “austerity”. Some theoretical economists, like Joe Stiglitz and Paul Krugman, seem to think that economic reform programmes can be designed without austerity. But this requires a favourable context and an efficient government – which does not apply here. The commonest way for such reforms to be imposed is through the government following a programme designed by outsiders, such as the IMF. Or else it is the threat of such an intervention that forces governments to act. These outsiders become convenient scapegoats, but in the longer term the reforms may be popular, as they deliver a healthier economy.
But the hidden background to the current crisis is that the Syriza government has not offered any convincing programme of reforms, while reversing reforms enacted by its predecessor. You wouldn’t guess this from listening to their smooth-talking spokespeople on the international media. But the Syriza movement contains many with more extreme, anti-foreigner views, limiting the government’s ability to act. The IMF in particular have found their plans utterly unconvincing. Politically they seem happy to go after rich people to tax them more. But rich people’s money is a notoriously elusive quarry; and the government is unwilling to take on any other reform with a political cost.
So what are the European governments to do? They are the critical parties on whom a deal depends. They have been humiliated by the referendum. Their electorates are telling them to not throw good money after bad. Their expert advisers suggest the Greek offers of reform are unconvincing, which means that the crisis will simply repeat itself. Over the years they have increasingly embraced an idea that had been unthinkable: that countries may be able to drop out of the Eurozone. The political costs of a negotiating failure have never been lower.
So what might happen? This depends in some measure on how well-prepared the Greek government is for this moment. If they have in their back pocket a credible compromise deal that saves some face for the European governments, we might pull back from the brink. Mr Varoufakis’s resignation is a good start, it has to be said.
What are the ingredients of such a deal? The Greek banking system must be at its heart. The banks must be recapitalised using external capital. They need to be insulated from the Greek government – in other words the money supplied by outsiders shouldn’t be simply channelled into government debt. Something needs to be offered to reduce the principal of older debts – though perhaps the interest bill can be kept intact. The Greek government can then be left to work its own way out of its short-term economic problems.
Such a deal would point towards the sort of reforms that might make the Euro more sustainable. Separating the banking system from government, with a more centralised regulatory and ultimately deposit insurance scheme. A resolution system for insolvent governments that means debts can get written down quickly. More nominal freedom for government fiscal policy – with discipline forced by bond markets, not EU agencies.
Such a deal would be a way forward. But it still needs trust. Alternatively the Greeks will have to create a quasi-currency of their own to keep their banks afloat – a first step towards the Euro exit. I am not optimistic.