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This week’s deal extending a third bailout to debt-racked Greece in exchange for further austerity measures averted the country’s having to abandon the euro, and the possibly devastating consequences that would have brought. But Vivien Schmidt says it’s a Pyrrhic victory.
Schmidt, Jean Monnet Professor of European Integration and a professor at the Frederick S. Pardee School of Global Studies, agrees with critics who say that far from solving the debt crisis, more austerity will merely prolong Greece’s 1930s-type depression. That depression prevents economic growth and the resources it would bring to pay debts, she says—a problem evident on her last visit two years ago, when “you could see lots of stores closed in Athens.”
Yet several members of the 19-nation Eurozone, having undergone austerity themselves in the past in exchange for help, are loathe to spare the Greeks what they had to endure, Schmidt says. “It’s like belonging to a fraternity in which everyone gets hazed. You’re not going to let one young freshman who says I’m going to die…get out of being hazed.”
She also agrees with opponents who say the bargain infringes on Greek sovereignty, stripping the country’s ruling party, the leftist Syriza party, of control over the nation’s economic destiny. The quandary for Greece, she says, is that “if it stays in the Eurozone, it’s subject to a massive loss of sovereignty.…If it doesn’t accept this, it’s in much worse shape if it leaves.”
Schmidt, also a College of Arts & Sciences professor of international relations and of political science, directs the Center for the Study of Europe.
Schmidt: Greece has had debt problems for a very long time, although they came out only in late 2009, when the newly elected socialist prime minister found a much larger deficit than expected, way out of line with that expected under the Eurozone’s Stability and Growth Pact. Once the markets began pricing up interest rates on Greek debt to unsustainable levels in response to European Union (EU) leaders’ seeming unwillingness to back a euro member’s sovereign debt, Eurozone members at the last minute agreed to a first bailout.
But the bailout was more about saving the euro, and thus stopping market attacks and contagion effects on other member states, than about Greece. Although the rescue plan provided a loan to save Greece from bankruptcy, it did not provide for any debt restructuring, as is normal under International Monetary Fund (IMF) rules. And because Greece was in the euro, the equivalent of a fixed exchange rate, it could not rapidly devalue its currency and thereby return to growth via cheap exports. Instead, it had to engage in reducing wages. The bailout plan also demanded austerity, which the Greek government carried out through across-the-board cuts in public sector wages (up to 30 percent) and pensions. In consequence, the economy shrank massively, up to 25 percent over time, with the ratio of debt to gross domestic product thereby increasing exponentially. Moreover, unemployment increased to record levels, up to 25 percent generally and 50 percent for youth. Structural reforms were also demanded, but were for the most part not achieved.
Austerity in the Greek case did nothing to solve its problems. Debt forgiveness from the very start was needed. Austerity has only deepened the Greek recession, as expected by Depression-era economist John Maynard Keynes. As the IMF itself later stated, it had miscalculated the “multiplier effects” of austerity, and the original bailout package could not have produced the desired effects, i.e., successful exit from the program. Instead, a second bailout was required, this time with a “haircut” for private creditors. And even a third will also be required.
However, the main creditors—German and French banks—have sold their debt, and the main holders of Greek debt are German and French, but also Italian, taxpayers, and the European Central Bank, as well as the IMF. All of this makes it more difficult to agree to debt forgiveness for Greece. But ultimately, as the IMF itself has lately argued, debt forgiveness is necessary. Bankruptcy would be highly problematic, since it would mean that Greece would have left the Eurozone, with all the unforeseen circumstances surrounding that.
The Greek government has been problematic from the start. One of the main reasons the EU took the austerity course it did is that the framing of the crisis—as one of public debt, rather than private resulting from the banking crisis—was all about Greece, which was then incorrectly generalized to other member-states. Greek governments had been lying for a long time about the numbers, helped in the early 2000s by investment banking firm Goldman Sachs, which disguised its debt through a derivatives scheme that also massively increased it. For the past five years, governments did indeed impose austerity, but they did little with regard to structural reform. As for the recent negotiations, Syriza did not do itself any favors by taking a tough negotiating stance, ultimately alienating the member states rather than seeking to build a relationship of trust. That said, the level of distrust was so high that this was likely impossible anyway for both sides.
As for whether Greece needs regulatory reform, the answer is an unquestionable yes. Tax evasion is widespread, in particular among the wealthiest Greeks, as is corruption and trading in favors. Moreover, the economy is one of the most difficult in Europe in which to do business, given rigid rules, strong labor market rigidities, protected “closed” professions, and a broken pension system.
But it is very hard to do structural reforms when there are all sticks (austerity) and no carrots (investments for growth, or delaying cuts if reform). And what worker would agree to more “labor market flexibility” if that means easier firing and fewer labor protections when there are no jobs out there to begin with?
The EU and Eurozone members have not been very helpful. Their view has been that providing the loan bailout constituted “economic solidarity.” But there is little sense that providing money to Greece to repay its debt—which at first meant to the German and French banks—in exchange for austerity did nothing to help the country grow.