21 September 2015

CEPS: The Greek elections and the third bailout programme - Why it could work this time round

Whereas most observers argue that the third bailout for Greece cannot work because it merely represents a continuation of an approach that has manifestly failed, the authors argue that a closer inspection of the conditions today give grounds for cautious optimism.

[...] The two adjustment programmes that Greece accepted in 2010 and 2012 went off-track for one main reason: the recession was much deeper than anticipated. The exceptional downturn of the Greek economy was attributable to two main reasons: the extraordinary fall in investment and the lack of export recovery.

The fall in investment was of course also due to the political uncertainty, resulting inter alia from the strong opposition to the bailout programmes. This factor should be much less strong going forward after these elections results.

But the key problem for Greece was that it started the adjustment with an outsized fiscal deficit, which had to be reduced. Many have argued that austerity was overdone and might have been self-defeating, but this was not the case in the other programme countries. The reason was that in a small, open economy the impact of a large fiscal adjustment can be contained if strong external demand compensates for the weakness of internal demand. This is what was expected in the first two adjustment programmes, which were predicated on the following logic: reduce the fiscal deficit; its impact will in any event be offset by a surge in exports (driven by lower wages).

[...]

So, the natural question now is: Can it work this time round?

The answer should be ‘possibly yes’. The current situation is completely different from 2010 and 2012. The economy is in worse shape, given the GDP losses, yet fundamentals have adjusted. Most of the fiscal and external imbalances have been corrected.

Despite a lack of control over public finances during the first half of this year, the primary balance is not that far away from balance, whereas it had been in deficit for over 10% of GDP in 2009. The primary-balance targets contained in the new programme will not require much of an effort if the economy recovers, as should be the case given the considerable drop in wages already achieved.

The task of structural reform should also be easier. Implementation has always been the main problem, with only a small fraction of the reforms really implemented. But if another small fraction, say a further 25%, is implemented over the next few years, the Greek economic context may look completely different compared to four years ago.

The banking system which had been frozen by political uncertainty over Grexit for a long time should now also be able to function better once it has been recapitalised.

And finally, the political context is changed. There is now bipartisan support for the programme. The political uncertainty that held back investment and exports should thus also abate. In 2014, the Greek economy had already shown some signs of recovery, which was nipped in the bud by the political drama that seized the country in the first half of this year. The same forces behind that change should now become even stronger allowing for sustainable growth. 

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