There is something natural in the return of democracy to its European cradle. But Prime Minister Papandreou caught every one by surprise by announcing a referendum on the last programme that had just been negotiated a few days earlier in a marathon summit in Brussels. The eruption of politics in what was seen by the Europeans as a fairly technocratic process was bound to happen sooner or later. European democracies cannot be expected to make fundamental choices without the full legitimate backing of their own people. In this respect, the call of the Greek Prime Minister to seek legitimacy for its actions could be a blessing in disguise. In other countries, including in particular in Germany, leaders have sought broad political support of the financial assistance measures despite heavy criticism. However, the fact that it happens now is a major blow to the attempt to rebuild the credibility and the stability of the euro area. With this announcement, last week’s agreement is in limbo while it had achieved a substantial debt reduction for Greece.
But beyond the simple binary question asked to the Greek people, this referendum precipitates a new set of questions, not only for Greece but also for European governments, for the European Central Bank and for the IMF. For Greece, the result of a no vote is fairly straightforward and the history of default is a good guide of what would happen. In this instance, the Greek government will:
- Interrupt payments of coupons and principal to all bondholders, and renegotiate the terms of this debt deeply.
- Need to bring its primary deficit back to 0 immediately. The government would have to adjust its expenditures downward to match exactly the flow of revenue coming in from taxes and the like. This would imply a very significant cut in pensions and salaries, perhaps by an additional 20%. This will also force a more dedicated tax collection effort both domestically and abroad.
- The Greek banking system would be immediately bankrupt and we would observe a run on deposits. The Greek authorities will be unable to recapitalise their banks if the programmes are suspended and they may be forced to impose some form of capital controls to limit deposit attrition.
- Greece will then seek to rebalance its economy. The forced cut in wages together with the severe depression following the disorderly default will go some way in achieving the devaluation needed to get growth eventually going. Nevertheless, there may be a temptation to leave the euro area in order to achieve a nominal devaluation
For European governments, things will be more complex. There will inevitably be a bipolar split between the willingness to set an example, prevent moral hazard and therefore interrupt any form of financial assistance and the necessity to salvage the young monetary union and the integrity of the EU. This will be a difficult balance to strike but in practice it probably means that if Greece decides to end its adjustment programme, European governments will have to take very fundamental decisions about the future of the euro area and the European Union.
By setting an example, European governments would force a Paris Club negotiation on the financial assistance extended so far. More importantly, they will need to take a strong and credible view on the absolute integrity of the euro area and the steps necessary to enforce it or think of concrete ways to allow a smooth exit from the EU, which in fact, is legally possible under the Lisbon Treaty. Even more urgently, euro area governments will need to prepare very clear contingency plans to deal with a disorderly Greek default and possible exit. Ring-fencing the eurozone financial system is key. The stock market decline of yesterday confirms that banks/insurances will be most affected.
For the ECB, there will also be particularly daunting policy choices. For Greece, it will have to decide whether it changes its collateral framework to accept defaulted bonds in its open market operations or alternatively the extent to which it will let the Bank of Greece do it on its behalf via the Emergency Liquidity Assistance window. The ECB will also have to identify the key institutions necessary to salvage the payment system and be prepared to take full control of them. But more importantly, this event will force the ECB to update its stance on its securities market programme and the role it plays in stabilising government bond markets across the euro area.
The IMF is likely to remain a passive bystander in this process while it is an important stakeholder. It can give today some hope that this new programme is better than the previous ones by helping to shape a new Extended Fund Facility programme that gives more time to the Greek authorities to implement the necessary reforms and shows that there is some light at the end of the tunnel. But regardless of Greece, it will also have to decide whether it wants to play a role in Italy and Spain, possibly through precautionary arrangements to avoid other euro area countries to be impacted irredeemably by the unfolding Greek tragedy.
The opposite logic of continued and more favourable financial assistance despite a negative referendum would probably trigger calls for softer targets in other countries such as Portugal. It would embolden other countries to resist adjustments and more and extended fiscal solidarity would result. However, this policy wouldn’t be credible in and of itself. The distorted incentives would further delay real economic adjustment, which would increase divergences and lead to a two-tier eurozone with a periphery of low growth, weak employment and dependency on transfers. The only solution then would be to lay the grounds of a much stronger euro area enshrined in a form of fiscal federalism that would give rise to a mechanism for the issuance of jointly and severally guaranteed debt.
Ultimately, what PM Papandreou has called is much more than a Greek referendum. It is a moment of truth for the euro area and for the European Union as a whole.
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Seattle Observer 3rd November 2011
"European democracies cannot be expected to make fundamental choices without the full legitimate backing of their own people." But when it comes to the EU, don't the political leaders make these choices without that direct backing? After the French and Dutch rejections of the 2005 "constitution", didn't European leaders make sure that wouldn't happen again with the Lisbon Treaty. Was there anyone else besides the Irish who had a direct vote on that treaty (and the Irish have to because their constitution requires it)? The only direct EU elections are for the European Parliament - also interesting that as the EP gets more power the percentage of eligible voters who actually vote in EP elections continues to drop?
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alex 5th November 2011
Finally just one remark on the federalism. If fear that this a good idea for 2 reasons. 1) As I told above the European institutions are not visible enough, giving them more budget without proper vision is actually anti democratic. 2) Belgium is a federal country with different people and different culture (North and South). Look at what is happening, the country is slowly splitting up!! The North do not want to pay for the south in part because they are not the same people, they do not speak the same language nor do they have the same culture thus why should they help them. In a federal Europe the same will happen on a bigger scale that is all. Democracy means 2 things, Demos: a common denominator to which you refer when you say WE and a cratos a set of law to enforce decision. Demos without cratos = weak state, Cratos without demos = dictatur. A federal Europe will be similar to the last one. The elite may not see it but the people (the 99 percent who has no Phd) they understand it.
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alex 5th November 2011
your comment is actually right. Furthermore the biggest problem with the european parliament is it visibility. I lived in Belgium for many year, and there was no way one can get accurate information on the European parliament or on the commission. Of course the expert knew. But the people, those who work 10 hours per day and have only 40 minutes to gather information they do not. Following the Belgian politics was actually much easier. Well sorry by the EU is not democratic with this respect. Democracy is not only being allowed to vote, it is also being able to easily gather enough information in order to make a choice. By the way EU has a president now. Thus I guess it is some sort of Republic, would be good to have DIRECT election for this guy!!
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Dionigio Vergallo 3rd November 2011
It's always good to ask people about their opinion, but provided that they are informed accurately enough on the issues at stake before voting. this is the problem and the French and Dutch Refs of 2005 show exactly this. Because of this problem refs are often hijacked. If we add the fact that, apparently, the truth has always been concealed to Greeks, then all the ingredients are there for a suicide caused by an unexpected, sudden and out-of-the-blue decision to ask people for their opinion (which, I repeat, in absolute terms it's a good thing). In this respect, I agree with the opinion of the gentleman before who wonders how come this decision right now. If Greek poeple had to be asked the correct question, then this would be: "do you want to be in the euro (in the EU, actually, given the fact that the only way out, and that thanks to the Lisbon treaty, is to leave the EU and consequently the euro) by knowing that this implies the measures taken by your governement, or not?" The problem is that at themoment the answer would most probably be no for the simple reason that they can only see the immediate negative impacts of the euro without seeing the advantages (which in another context, they could have seen). So I am afraid that, as often the case, a ref transforms itself into a plebiscit. Anyway the problem for the greek is that even if they go back to the dracma, they will again have to bear enourmous sacrifices (almost the same as remaining in the euro) as the others also describe. So I would tell them that whatevet their decision is things would not change much and what appears to be a moment of truth for them is a fake one. The moment of truth, on the other hand, is for the euro, the EU and I 101% subscribe the stance taken by Sarko-Merkel in saying that finally conditionality is going to be respected!!! The big mistake made in the past was exactly this lassist attitude towards the PIGS. The biggest pig of all, I am not at all ashamed to admit it, has been my country, Italy, which has received billions in structural funds since 1957 without doing much in exchange.
Finally, it would be interesting to know why F-D are doing this: is it a genuine European integration spirit or is it becasue D wants to safeguard its exports to the Eurozone and F its banks?
Dionigio Vergallo
Italy and EU.
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Elemer Tertak 3rd November 2011
I agree it is a good article, and recognises perfectly that in a democracy it is not possible to implement strict and painful austerity programs without political endorsement. (Something similar happened in Iceland too, people have refused to accept debts which were approved by the government - ex post.) Germany demonstrated that not only adjustments, but also taking contingent liabilities need legitimacy and political approval.
The mistake of PM Papandreou was the way as he acted: he had not consulted neither his party, nor other EU leaders about his intention, moreover he offered a referendum instead of brought forward elections, where most likely all serious parties would have committed themselves rather for the painful measures, as to risk an unorderly default with all the costs of that. Thus the choice would not be - as in a referendum - whether to approve or reject all the obligations, but whom the people trust more to implement the surgery. Last but not least: he could have done all this long ago.
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de Brouwer 3rd November 2011
Very good article . But the key question is why the Greek PM waited so long before calling such referendum . He could have done it long ago .
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Fayette Jacques 3rd November 2011
It looks like the 1931 story,. May be a referendum will ask the King to come back. Since the king is a representative of God on earth it could be an appropriate outcome.
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