Like most of the EU’s big announcements these days, the recent bailout of Greece didn’t really change anything. Greece will still default, and the eurozone is still in crisis. But the can has been kicked down the road.
The simple truth is that even if everything goes according to plan – even if Greece meets its austerity and reform targets, bondholders overwhelmingly accept the proposed haircuts and economic growth returns in 2013 – Greece will still be left with an unsustainable debt burden and will require more EU money to keep the show on the road.
In reality, of course, none of that is actually going to happen. Even when the proposed debt write-off was smaller, and European Central Bank (ECB) participation was on the table, the assumption that 90% of bondholders would voluntarily participate seemed optimistic. So it seems rather unlikely that 95% of bondholders (the participation rate assumed by the Greek debt sustainability analysis) will accept a bigger write-off without ECB involvement.
The prospect that Greece will meet its austerity and reform requirements is even slimmer. As a leaked briefing for eurozone finance ministers put it: “The Greek authorities may not be able to deliver structural reforms and policy adjustments at the pace envisioned in the baseline… Greater wage flexibility may in practice be resisted by economic agents; product and service market liberalisation may continue to be plagued by strong opposition from vested interests; and business environment reforms may also remain bogged down in bureaucratic delays.”
This is hardly idle speculation: many of the reforms agreed in 2010 as part of
Greece’s first bailout were blocked by unions, special interest groups, and Greek officials. Moreover, there’s a Greek election coming up in April, and parties opposed to the austerity programme are gaining support. In case it has escaped anybody’s notice, the Greek population does not seem to enjoy being ruled by the EU–ECB–IMF troika, and is unlikely to accept the scale and speed of the proposed reforms without an almighty fight.
As some commentators have speculated, it is almost as if Greece is being set up to fail.
Then there are the growth assumptions underlying the bailout deal, which economists at Lombard Street Research bluntly call “ludicrous”. The deal imagines that Greece’s economy will only shrink by four per cent this year, stabilize in 2013, and then grow by two per cent or more in 2014 and 2015. There is simply no reasonable chance of any of this coming to pass.
In other words, the latest Greek bailout is based on a fantasy.
If we make more reasonable assumptions – and the leaked EU briefing was kind enough to lay out a more pessimistic scenario: Greece’s debt-to-GDP ratio ends up closer to 180% by the end of the decade than to its 120% target. And that means one thing: without another huge bailout (which a smart man wouldn’t bet on) this sorry story stills ends in disorderly default.
In a rational world, bankruptcy would be an opportunity for Greece to purge its economy of bad debt, escape the euro, and engage in a radical process of restructuring and liberalization. This would dramatically strengthen its economic competitiveness and put it back on a sustainable path for the future.
But few anticipate such a rosy outcome. Political dynamics and entrenched special interests mean the results of a disorderly default could be pretty dire for the Greek population.
What of the rest of the eurozone? Will panic spread like a contagion, and bring Portugal, Spain, Italy and Ireland tumbling down like the proverbial house of cards? The answer to these questions depends entirely on the policies pursued in the intervening period. These countries must use the time this bailout has bought them to eliminate their budget deficits and stabilize their debt burdens.
They must roll back bureaucracy, free up entrepreneurs and reduce the burden of the welfare state, so that the private sector can begin to grow. Crucially, they must develop a credible plan for winding up failed financial institutions without threatening the system as a whole. Blank-cheque bank bailouts are a sure and certain route to fiscal ruin.
Regrettably, this is not the approach that has prevailed so far. Indeed, as things stand a whole host of European Union and European Central Bank policies are pushing things in precisely the opposite direction. Will policymakers realize their mistake and change course before it is too late? Well, stranger things have happened. I just won’t be holding my breath.