Published on All About Finance

Decision day for Greece?

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There have been many days over the past five years characterized as the final decision day, climax in a drawn-out attempt to resolve the Greek debt crisis and lead the country back onto a sustainable growth path. Today’s emergency summit of eurozone’s heads of government seems to be yet another of these days. Will Greece exit the euro or will there be another short-term respite? Are we really in the endgame? In the following, I will argue that whatever outcome, Greece will be on fiscal life support from the European Union for many years to come and that, ultimately, growth can only be restarted in Greece and not with externally imposed adjustment programs.

It is no longer about economics, but politics
The last few weeks have seen almost an explosion in suggestions by different economists on how to solve the crisis – ranging from further debt relief over a long-term growth programme to the introduction of a parallel currency (see a series of columns on and At the same time, the relationship between the Greek government and the creditors (Eurozone, IMF and ECB) has reached one low after another. The question on the table is no longer what the best would be for the Greek economy and society, but rather what is politically feasible, what can both sides (Eurozone creditors and Greece) sell to their respective electorates back home. The risk of this approach is that there will be another compromise with a short-term respite for Greece, with the can being kicked down the road, into the months after the summer break. This will certainly not help the Greek economy and will increase stakes and animosities in future negotiations even further.

A deep-seated crisis — beyond fiscal targets and debt relief
The future long-term growth path (think decades, not months and years) will not be directly determined by the decision to exit the euro or not, but rather by the willingness of substantial and deep institutional reform in Greece. There has been lots of criticisms against the design of the reform program — having focused on the wrong aspects (labor rather than product markets) and the impossibility of introducing such reforms while going through an austerity program. There have been discussions on whether leaving the euro and the consequent devaluation would help the Greek economy become more competitive (though this argument ignores the fact that compared to economies of similar size, Greece is a rather closed economy). Critical in the long term, however, will not be individual laws or regulations, but deep structural reforms that turn Greece into a competitive, export-oriented economy, which in turn will require a break with clientele-focused political model of the past 40 years.

One way to illustrate and quantify these deep-seated problems are the Doing Business Indicators, compiled on an annual basis by the World Bank Group. According to these indicators, Greece has made some progress, but is still behind other Eurozone countries on many dimensions. In the indicator of “Overall ease of doing business”, its distance to the best practice, has somewhat reduced between 2009 and 2014, from 62.15 to 66.7 (where 100 is best practice). This improvement has been driven by improvements in business licensing and property transfer. However, in other areas, the business environment lags far behind other European countries, including in the areas of creditor rights, credit information sharing and contract enforcement. Both the business environment and the speed of reform do not compare favorably with other periphery countries that have gone through adjustment programs, including Ireland, which stands at 80.07, Spain, which improved from 70.75 to 73.17 and Portugal, which improved from 71.42 to 76.03. If at all, Greece has caught up to neighbouring Cyprus, which stands at 66.6. Critically, de jure reforms (i.e. changes in laws and regulations) do not necessarily correspond to de facto reforms, which might be impeded by resistance in civil service, corruption or simply lack of proper implementation. Comparing institutional development indicators across Eurozone countries shows similarly significant differences between Greece and the other 18 Eurozone countries.  Comparing countries’ rank in control of corruption for 2013 from the Kraay, Kaufman and Mastruzzi World Governance Indicators database shows that Greece is not only the country with the lowest rank, its rank is also significantly lower than all other countries, except for Italy, Latvia and Slovakia (for these cases, the significance bands overlap with Greece’s significance band, although the ranks for these countries is higher). Using indicators for other dimensions of the institutional framework, such as rule of law or government effectiveness, show similar rankings.

More important than pointing to these indicators and the lack of reform progress, it has become clear that the ownership for such reforms has been missing over the past five years in Greece. And this refusal of the Greek political class to “own” any serious reform agenda, as it might undermine special interests, is ultimately behind the failure of five years of the Greek programme, not the design of the program or too much austerity.

Time for European policy makers to face reality
If there has been one thread going through the crisis response in Europe, it can be summarized in the verb “pretend”. For the first two years after the outbreak of the crisis in 2010, Europe pretended that Greece was facing a liquidity not a solvency crisis.  After the 2012 sovereign debt restructuring, there was the pretence that the problem was solved, Greece was on good way to recovery, and taxpayers in the other Eurozone countries were safe from further bail-out demands. The reality is that the high exposure of the Eurozone countries to Greece is a classical hold-up problem — refuse further funding and Greece might default on its existing debt; let Greece leave the Eurozone and not only will the current debt pile become even less sustainable, but the country would require additional emergency funding from the European Union. Either way, the path of crisis resolution over the past five years has led to a long-term dependency of the Greek government and society on taxpayers in the rest of the Eurozone.  Recognizing the losses and this dependency, however, is politically not feasible.   These political constraints, in turn make a long-term solution that helps Greece return to a long-term growth path and maximizes repayment to its creditors ever more difficult if not impossible.

Banking union to the rescue?
There seems one possible way to cut the Gordian know. If the recently established banking union arrangements can be used to take over the Greek banks and put them under European management, this might reduce the risk of an accelerated bank run. It would ultimately cut the deadly embrace between fragile government debt and a fragile banking sector, which has been at the core of the Eurozone crisis. This would not solve the Greek debt crisis, but it might prevent a Graccident and collapse of the Greek financial system. The Greek government might still be forced to issue IOUs to finance itself (which the banks could discount in exchange for Euros), with ultimately two currencies being used in Greece. While Gresham’s law predicts that the weaker of the two currencies, i.e. the new Drachma, might ultimately crowd out the stronger one, i.e. the Euro, this might not hold here, as the Greek government would issue only one of the two currencies; so Greece might rather turn into a dollarized or rather: eurorized economy.

Ultimately, the decisions will be taken in Athens, not Brussels, Washington or Frankfurt
It has become clear that the clientele-focused political system is at the core of the socio-economic crisis in Greece. Only a change in that system and substantial institutional changes can return Greece on a long-term sustainable growth path. Analyses of the necessary steps towards such structural changes are plenty, and international willingness to help seems still forthcoming, the impetus to implement them, however, has to come from inside the Greek society.


Thorsten Beck

Professor of Banking and Finance, Cass Business School

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