Greece’s economy and society are imploding.
Gross domestic product has declined more than 20 percent since 2008. The unemployment rate has tripled, and now stands at 25 per cent, with joblessness among youth at twice that level. Crime is on the rise, as are racist incidents, and ideologies of the extreme right and left are gaining significant support.
Worse, current policies aren’t stemming the economic decline. The new three-party government elected in June has focused its energies on negotiating a new package of austerity measures to meet the conditions set by the so-called troika (the European Central Bank, the European Commission and the International Monetary Fund) for the disbursement of the next tranche of the bailout loan.
The reforms that are the only pathways to growth, such as building a well-functioning public administration and liberalizing markets, are resisted by Greek politicians and vested interests. They are also greatly underemphasized by the troika’s push for austerity.
Unless there is a change of course, Greece is headed for disaster: further declines in GDP, a possible chaotic default on its debt, extremist political parties in power, and isolation from Europe. The European Union also stands to lose because a Greek meltdown would reverse the decades-long process of integration and undermine the credibility of the single currency. And Greece’s creditors won’t get any of their money back.
To avoid such an outcome, which could occur soon, Greece’s European partners should devise a long-term strategy with two mutually reinforcing objectives: a drastic reduction of Greece’s debt and a thorough overhaul of the country’s dysfunctional economy.
Greece’s debt is projected to rise to 189 per cent of GDP next year, from 129 per cent in 2009. This is despite the restructuring of privately held debt and severe austerity measures that have almost wiped out the government’s primary deficit.
Most of the increase in the debt-to-GDP ratio can be attributed to the large decline in GDP. Further austerity measures, designed to generate the large primary surplus necessary to begin reducing the debt, will cause GDP to fall further, making the debt-to-GDP ratio even larger. This will make it impossible for Greece to ever repay its debt in full. Its European partners should recognize this state of affairs and write off a significant fraction of the debt. This would allow Greece to grow and repay the rest.
Writing off Greece’s debt can be done in a way that preserves, and even promotes, incentives for reform. A portion of the officially held debt — 50 per cent or more — should be set aside to be written off gradually over the next five years or so, on the condition that Greece completes a set of institutional and market changes. The steps include making the public administration more efficient, speeding judicial proceedings, reducing corruption and liberalizing markets.
Achievement of these milestones could be monitored using existing indexes designed by institutions such as the World Bank and the IMF. Such a system would not only promote reform, but would put Greece’s debt, which cannot be repaid in full in any case, to good use.
More generally, the troika should emphasize structural changes rather than the rapid accumulation of a primary surplus. The initial emphasis on reducing the deficit was appropriate given the unsustainably large budget shortfall.
However, continued austerity will be counterproductive because it undermines reform. For example, deep salary cuts in the public administration are causing talented personnel to leave, thus impairing an already weak system and worsening the core problem of low public-sector productivity. The agencies in charge of essential tasks such as tackling tax evasion, supervising financial markets and prosecuting white-collar criminals, are often short of funds, equipment and the ability to attract talent. The troika should ensure that those funding needs are met, regardless of the effect on the deficit.
And it is hard to imagine how the Greek politicians and vested interests who have successfully resisted reform could continue to block institutional changes that are the condition for writing off a large part of the debt and averting disaster.
An emphasis on transformation and debt reduction would be welcomed by the Greek population, whose support is necessary for these efforts to succeed. Giving voters the chance to back debt relief in exchange for reforms will dim the appeal of the extremist parties.
The only way forward is to overhaul the Greek economy. For the population, that means recognizing that resisting structural reforms would be suicidal. For its part, the troika should acknowledge that further budget cuts would be catastrophic, and could only lead to a continuing deterioration of the economy and to the severing of Greece’s links with Europe.
Costas Meghir is a professor of economics at Yale University; Dimitri Vayanos is a professor of finance at the London School of Economics; and Nikos Vettas is a professor of economics at the Athens University of Economics and Business.