Portents of the Greek Rescue

By: Barry Eichengreen

The curtain has finally been raised on the Greek rescue, and the reviews are good.  There will be €30 billion of EU money to be topped up by at least €15 billion from the IMF.  There will be even more later.  This is the Powell Doctrine as applied to financial economics: if you go in, go in with overwhelming force. 

 

Germany has also climbed down from its earlier position on the interest rate.  It has agreed to a rate of 5 per cent, midway between the kind of concessional interest rate typically offered by the IMF and the market rates previously insisted upon by the German government.  This concession creates a sliver of hope that Greece will be able to pay back what it borrows.

 

Indeed, the big news is that Germany climbed down more generally.  With regional elections looming, Mrs. Merkel will continue to claim that she got everything she asked for.  But the reality is different.  There is the matter of the interest rate, which as much as 200 basis points below market levels.  There is the fact that the rescue is being led in reality by the EU, and not the IMF as Germany previously demanded.  The critical decisions were those taken by eurozone finance ministers in their teleconference last weekend.  They were not taken by IMF staff in their mission to Athens.

 

            Then there is the fact that the draconian consequences for Greece, on which German officials had insisted, are nowhere to be found.  Greece is not being stripped of its EU voting rights.  It is not being threatened that the Lisbon Treaty will be amended to provide for mandatory ejection from the euro of countries exhibiting this kind of bad behavior.  Germany, for its part, is not threatening to withdraw from the eurozone.

 

            That’s the good news.  If the crisis was going to be contained, Germany had to come to its senses.  There was anger, not all of it unjustified, about having to come to Greece’s rescue.  No one likes to bail out sprendthrift family members.  But sometimes it’s necessary to swallow hard and do just that to avoid an inter-familial rift.  Avoiding the worst required providing Greece financial help.  The alternative of sovereign default, with uncertain consequences for banks holding Greek bonds, not just in that country but elsewhere, would have been many times worse.  It was the responsibility of German leaders to acknowledge this, whether doing so was politically expedient or not.

 

            This recognition creates an opportunity for Europe to now take steps to prevent similar messes in the future.  Member states can reform their fiscal institutions with the goal of producing better budgetary outcomes.  Regulation can be strengthened to prevent Goldman Sachs from again colluding with a government to disguise its true fiscal position.  Another attempt has to be made to strengthen the surveillance and sanctions of the Stability Pact.  The EU can create a European Monetary Fund, as recommended by Daniel Gros and Thomas Mayer, to regularize the kind of emergency operations organized on behalf of Greece.

 

            Whether meaningful reforms now occur, only time will tell.  But with German leaders having signaled their continuing commitment to the European project, there is at least a chance.  We have seen lots of posturing in recent weeks.  We have heard how younger Germans are no longer burdened by the guilt that shaped the actions of the postwar generation.  We have heard much talk of how a reunified, 21^st century Germany is no longer committed to European integration.  It is reassuring that the reality differs from this alarmist rhetoric.

 

            But if German politics reassure, Greek politics do not.  There is no sign yet of a commitment to the fundamental reforms that Greece still has to undertake.  The country still has to cut its public spending by something approaching 13 per cent of GDP, an all but unprecedented amount.  Now that it will be stretching out the process over four or five years, courtesy of the loan, the eventual adjustment will have to be even larger.  Athens will be borrowing from its EU partners in the meantime.  It will be incurring more interest obligations.  So it will ultimately have to make even deeper spending cuts in order to put its finances back onto a stable footing.

 

            For this to be possible, there will have to be a fundamental restructuring of the Greek economy.  The ten per cent cut in public sector salaries now on the table is just the start.  Greece has the most overregulated product market of any OECD country.  State control of the economy is greater than anywhere else in Europe.  Greece has the most rigid and distorted national economy in the so-called advanced-country world.

 

            But this terrible starting point creates an opportunity.  Marrying salary cuts with product market deregulation can reduce the pain for Greek workers.  Their pay packets will be smaller, but with more efficient product markets they will buy more.  Product market deregulation will be difficult for previously-sheltered producers, but salary cuts will prevent the less efficient from immediately going out of business.  One can see here the beginnings of a “grand bargain.” 

 

            Some will say that the idea of a grand bargain is apocryphal.  Greece is too polarized, too corrupt.  Maybe so, but then there is no way out. 

 

 

Barry Eichengreen is George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley.

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