Greece after the elections

The Greek elections on 17 June 2012 brought some relief. There is a realistic chance that a government can be formed shortly with the participation of three parties, which will sit to the table with European partners and the IMF to discuss, and perhaps revise, the conditions of the current financial assistance programme. The immediate risk of a Greek exit from the euro-area is abated.

But this is just a temporary relief and much needs to be done for Greece, in Greece, and for the rest of the euro area as well.

As I argued earlier, Europe must offer a prospect for Greece after the elections if a cooperative government is elected. The reasons for this are simple.

First, Greece’s economic outlook is hopeless: see for example a chart comparing the output and employment developments of Greece with other euro-area periphery countries and Germany. Greek GDP and employment are in free-falls. The more they fall further, the more likely that social tensions escalate, which could bring down the soon-to-be formed new government. That would make the Greek exit from the euro area be imminent, hurting Greece further and, through contagion, the rest of the euro area.

Second, Greece’s public debt is still too high. Even if the austerity programme is implemented as planned some months ago it is very unlikely that Greece will be able to pay back all public debt. Prolonging the recognition of this issue just prolongs the uncertainty about Greece’s future, thereby negatively impacting the economy as well.

One difficulty in treating Greece a special way is that fairness would require treating other countries similarly. Yet the Greek case is special in the sense that it was a major mistake of the official lenders to start the first Greek programme without debt reduction and afterward for insisting too long that no debt reduction is needed. While certain aspects of the Irish and Portuguese programmes can also be criticised, public debt of these two countries were not so obviously unsustainable as in Greece and they still have a good chance of paying back, especially if certain conditions are revised.

Unfortunately, the most likely outcome will be a limited renegotiation of the current Greek programme without significant growth initiatives and debt relief. Let me say that while fiscal targets can and should be revised, structural reforms should continue, since the Greek public sector is so inefficient and the private sector is so overregulated.

Anyhow, the EU’s muddling-through strategy for Greece is set to continue and the temporary relief given by the Greek elections also reduce the pressure for wide-ranging reforms for the euro area. Yet following a brief Monday-morning market rally after the Greek elections, the mood in the markets has changed, which must remind European policymakers that they must act now. We shall see on 29 June after the European Summit if our policymakers are up to the job.