Syriza, Greek Debt and the eurozone

by George Hatjoullis

Everyone, it seems, has an opinion but no one actually knows how this new Greek government will work out. Some are convinced Greece will exit the eurozone others equally convinced that a compromise will be found that will also allow Syriza to claim to have fulfilled its mandate. None however can clearly delineate a path for either event. There many possibilities and it is impossible to attach probabilities to any of these paths. Anyone speaking with confidence on the subject at the moment has an agenda. What can be said with some confidence?

First, the Greeks have no one to blame but themselves for the situation. They got into debt, like other eurozone states, and took troika assistance on dictated terms. Greece was given fairly generous terms and allowed to restructure private holdings of Greek government debt. A coalition government accepted the terms. It was obvious at the time (as my professional writing stated) that despite the generous terms, Greece could not grow and reform its way out of the debt and that the suffering of the Greek people would be disproportionate to that experienced anywhere else in the eurozone. I expressed grave doubts that Greece’s fragile democracy would survive the economic and social onslaught. It may yet fail. Others compare Tsipras to Lula and Chavez. My fear has always been he might end up as another Allende.

Second, the Berlin emphasis on moral hazard was not unreasonable. To simply bail Greece out with fiscal transfers would not have reformed Greece and would have left open the risk of a repeat event. This would have been in no ones interest. However, reform is not the same thing as austerity. In its eagerness to teach Greece a lesson Berlin overdid the austerity. I argued at the time that Greece should be allowed to trade-off reform for austerity. It should be rewarded for reform with some easing of budget restrictions, and debt relief. The purpose of the exercise should have been to reform Greece not punish it. A little punishment was necessary to elicit the reforms but the Berlin position was quite vindictive (I speak from direct experience of the Berlin position). The outcome was somewhat better than I feared. Syriza is in power but democracy is still intact. However, the can that was kicked repeatedly down the road from 2010 until the present has disintegrated. The same issues need to be faced today by Greece and the eurozone that presented themselves in 2010.

The situation is a little better than it was in 2010. Greece has implemented many reforms and some privatisations. The country is on course for a primary surplus and the decline in GDP has stopped and started to reverse. The debt however has grown as a % of GDP and it will take some spectacular growth to get the ratio (presently circa 177% of GDP) down to the target 120%. More important much of this growth will not accrue to the Greek people during the process. Given that social and economic conditions in Greece as seriously bad, this could lead to problems. The election is evidence that the Greek people have had enough and many feel they have little left to lose. Desperate people do desperate things.

Syriza speak of debt forgiveness and this is guaranteed to raise the hackles of the troika, Berlin and the eurozone partners. Why should Greece be so favoured? Cyprus has been punished far more severely than Greece (see my blogs on the Cyprus crisis if interested) or indeed anyone else in the eurozone. What Greece needs is some slack. It needs a little less austerity to allow some respite for the people. It needs to allocate a little more of the growth to ‘welfare’ and a little less to debt service and repayment. Lengthening debt maturities and interest deferral would normally suffice. However, the eurozone deflation means that this will not reduce the real burden of the debt. The future still looks bleak even if the present becomes less painful.

I have argued repeatedly in these blogs that the deflation is in part a global phenomenon arising from widening inequality but particularly intense in the eurozone because of Germany’s pathological fear of inflation. In an optimal currency area high productivity regions (Germany) should experience above average inflation and low productivity regions (Greece) below average inflation in order to effect a relative price adjustment to offset the productivity differences. In a symmetric adjustment Germany would now be experiencing inflation over 2%. It is experiencing inflation barely above zero which is forcing the whole burden of adjustment on Greek prices and hence the Greek economy. The resistance of Berlin to any inflation in Germany has been evident in its fiscal policy and the intense pressure it has placed on the ECB (compromising ECB independence). The result has been that the ECB has been slow to deploy all its tools and even now has deployed a fragmented, if sizeable, quantitative easing programme.

If the ECB QE can return inflation in the eurozone to just below 2%, quickly, then extending maturities and deferring interest may be enough to allow Greece some breathing room. However, this seems unlikely (for too many reasons to develop here). The rational solution would be to trade reform in Greece for debt relief. Unfortunately, Berlin wants instant reform without debt relief and Syriza will be seeking debt relief without increasing the pace of reform. It will be up to other eurozone partners to steer the two into the compromise path (if it can be done).

Other considerations also play a part. How would Greece exit the eurozone and remain in the EU? What would happen in Greece after exit and how would this affect a volatile global geopolitical context? How would this impact Cyprus and thus other volatile geopolitical considerations. If Greece is offered a compromise how will other indebted, eurozone members respond? If you think it is simple it is because you are not thinking. You have an agenda.