12 March 2012

Yannos Papantoniou: Greece’s crisis - Testing the viability of the euro project

In his prepared remarks delivered at the Peterson Institute for International Economics, the former Minister of Economy and Finance of Greece writes that saving Greece is doable, provided that both the country and the euro area get their act together.

The adjustment programme imposed on Greece by the troika (European Commission, ECB, IMF) in May 2010 was seriously flawed. It placed too much emphasis on austerity, through tax rises and income cuts, and too little on reform. Its implementation, punctuated by delays, omissions, and outright failures, instead of correcting the planning defects, further accentuated them. The government, lacking a cohesive plan of its own, found it politically more expedient to apply horizontal austerity measures, hitting the less affluent social strata, than confronting the special interests (suppliers of state-owned enterprises, public-sector trade unions, closed professions) that are affected by—and, therefore, opposed to—reforms. A deep and prolonged recession, leading to a cumulative fall of GDP by 13 per cent, prevented, through consistent undershooting of tax receipts, a substantial fall in the budget deficit.

In the absence of the devaluation weapon, the reverse should be the case: less austerity and a longer time profile for deficit reduction, alongside an aggressive, and tightly monitored, pursuit of reforms so as to accelerate productivity growth and bring down domestic costs. These defects are now addressed in the new adjustment programme agreed in the context of the second bailout loan and the associated debt reduction deal reached with private sector lenders.

The future course of Greece hinges on the capacity of the next government to rise up to the challenge of lifting the economy out of the present mess, which increasingly looks like a cul-de-sac. The challenge is twofold. First, reforms must be effectively pursued and confidence in Greece’s growth potential must be restored. The recent record does not augur well. The two previous  governments failed on this score, despite enjoying stronger positions, partly out of fear of the political cost but also because they lacked the required skills. It is uncertain whether the new political setup can—or will—do better than the preceding one. Moreover, a Monti-type government, supported by the two main pro-euro parties, does not seem to be an option.

Neither the country’s history nor its political culture sustain such experiments while the civil society does not produce politically-minded technocrats in sufficient numbers so as to engage credibly on this course. Professional politicians will continue to have the upper hand. Critical factors that will determine the effectiveness of the new government in rescuing the economy are thus its political strength and will to push forward with reforms and the skills it can master for implementing them. In this context it would be advisable to “outsource” the conduct of economic policy to a handful of extraparliamentary ministers who will commit themselves to stay out of politics after they complete their mandate.

Second, the euro area should support Greece’s reform effort. Reversing the economy’s free fall over the next two critical years of continued austerity and wage cuts requires countervailing action in the shape of pro-growth policies at the euro area level. This comprises reinforced economic policy coordination, easier monetary conditions, progress in fiscal unification (eurobonds, beefing up the European Stability Mechanism), as well as a European Marshall Plan to finance—through grants and ECB loans—investment in the austerity-stricken countries. Helping Greece and other weaker economies addresses the euro area’s structural problem, namely the core periphery competitiveness divide. It will thus contribute to establishing longer-term economic stability. However important the contagion risks from a Greek default and eventual euro exit are judged to be, letting Greece go under will be a severe blow to the credibility and viability of the euro project, notwithstanding the considerable security concerns it will raise in a critical geopolitical space.

Saving Greece is doable, provided that both the country and the euro area get their act together. Failure will inevitably pose the question “who’s next?” Success, combined with a leap forward in European unification, will lay the basis for sustainable growth and a dynamic presence in the globalised world.

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© Peter G Peterson Institute for International Economics