Opinion

Greece: Lessons for Europe

It was inevitable that Greece would have to make cuts. Yet, if it is ever to pay back its debts, what the country needs most of all is a growth strategy.

By: and Date: August 13, 2015 Topic: Macroeconomic policy

The dreadful stand-off is over, for the moment: Greece and its creditors have started work on a third rescue package. However, debate continues about what lessons can be drawn from the failure of the previous programmes.

The IMF’s Chief Economist, Olivier Blanchard, recently published an important paper about just this.  When he defends the IMF’s main decisions, one can agree with much of what he says. It was surely inevitable that Greece would have to undertake massive budgetary consolidation in the last five years. When the 2010 rescue package began, the budget deficit was at 15%. That was not sustainable.

Blanchard has sharply criticised European austerity policies. Yet even he admits that in the Greek case the need for financing would have been unrealistically high without such rigorous savings. The total that has been lent within the previous bailout packages already exceeds 40% of Greek GDP – and this just to finance the deficits of the last years. Surely, the willingness to fund higher deficits was not there.

On two important points, however, Blanchard’s analysis is unsatisfactory. The most important question for Greece is this: the economy must grow, but where should this growth come from? Politicians need to present a strategy, but the programmes have not really made it a priority. What is more, the debt issue was never dealt with properly – including by the IMF.

The economic policies of Greece since the introduction of the Euro have been reminiscent of a Ponzi scheme. Every year more money was borrowed, not just to pay previous creditors but also to finance new expenditure. State spending in Greece therefore grew rapidly. From 1999 to 2009 salaries in the public sector doubled – in comparison, across the euro area they increased by only 40% in the same period. The resulting wage pressures led to excessive salary increases in the private sector, and Greek firms became less and less competitive. All this caused a huge current account deficit and spiraling foreign debts.

For the Greek rescue packages to be successful it was therefore vital to get this competitiveness problem under control.  Yet the Troika, and especially the IMF, only made half-hearted attempts. For example, in official documents they discussed necessary salary cuts in great detail. At the beginning, however, they did not make these a firm condition of emergency loans. They did not have enough courage.

It was also well known that lower salaries alone would not be enough. At the same time, a far-reaching reform of product markets was necessary, in order to break-up antiquated systems and vested interests. Otherwise it was hardly going to be possible to develop new growth sectors. As a result of this mistaken leniency, unemployment in Greece rose more rapidly than necessary. It was largely unavoidable that domestic demand would collapse, but in Greece this was in no way balanced by an increase in exports – unlike in Portugal, for example.

This is an area where the new rescue package should act. Greece urgently requires a growth strategy which makes it possible to increase exports. Labour market reforms are not necessary for this: according to the OECD, the Greek labour market is already more flexible than Germany’s. It is instead vital to open up product markets, to reform competition policy and increase the efficiency of the public sector. Start-up financing for new businesses, funded from European resources, would also be helpful.

The second central point concerns the ability of Greece to pay back its debts. IMF officials and independent experts had doubts about this from the beginning. Nevertheless, the IMF agreed to the first programme, and even changed its internal rules to make this possible. To justify this, the risks to financial security were highlighted.

Whether these risks were really so great could be the subject of a long debate. Still, it is certainly true that worries about contagion and the stability of the financial system were substantial and very present at the time. In this respect the IMF’s decision should not be criticised. However, what really must be criticised is the fact that the very financial risks being stressed by the IMF did not result in a sustainable rescue programme. Even the eventual haircut came too late to solve the debt problem.

Investments require certainty: the Euro

The new programme should also act here. To support further growth Greece needs confidence and new investments. Yet these will only come if there is certainty that Greece will still be in the Euro in five years, and that its debts are sustainable.

Politics could bring this certainty if there were an agreement to link debt servicing to Greek economic growth. The current repayment plan would only apply if Greece achieved adequate growth; in other cases the creditors would have to accept a further postponement of payments and lower interest rates.

This would enable long-term planning in Greece, and create incentives to invest.  At the same time this solution would also be in the creditors’ interest: it is clear that Greece will not be able to repay its debts in full anyway if growth remains weak. If this economic reality is accepted now, then such a plan could actually increase the expected repayments.

With hindsight it is clear that massive mistakes were made in Greece: by the IMF, the Troika and especially Greece itself. The country now needs to finally implement far-reaching reforms that will allow the private sector to export more and grow. In return the creditors must declare themselves ready to guarantee debt sustainability and realistic primary surplus targets, so that investment can return to Greece. Reforms and debt sustainability are two sides of the same coin.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read about event More on this topic
 

Upcoming Event

Jun
23
14:00

BRI 2.0: How has the pandemic influenced China’s landmark Belt and Road Initiative?

China's Belt and Road Initiative is undergoing a transformation after two years of pandemic. How is it changing and what are the consequences for Europe.

Speakers: Alessia Amighini, Eyck Freymann, Alicia García-Herrero and Zhang Xiaotong Topic: Global economy and trade Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF
 

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read article More by this author
 

Blog Post

Owning up to sustainability risks: the EU should champion international standards

To keep European Union capital markets open and integrated, new international standards should be reflected in future European law and accounting practice to provide further incentives for a reallocation of capital, reflecting in particular climate risks.

By: Alexander Lehmann Topic: Banking and capital markets, Green economy Date: April 26, 2022
Read article Download PDF More on this topic
 

Working Paper

The low productivity of European firms: how can policies enhance the allocation of resources?

A summary of the most important policy lessons from research undertaken in the MICROPROD project work package 4, related to the allocation of the factors of production, with a special focus on the weak dynamism of European small and medium-sized enterprises (SMEs).

By: Grégory Claeys, Marie Le Mouel and Giovanni Sgaravatti Topic: Macroeconomic policy Date: April 25, 2022
Read article Download PDF More on this topic
 

Working Paper

Knowledge flows and global value chains

Trade and industrial policy can support productivity growth through global value chains by providing the right legal environment that supports the formation of longterm business relationships.

By: Marta Bisztray and Niclas Poitiers Topic: Global economy and trade Date: April 13, 2022
Read article More on this topic
 

Blog Post

Is the private sector retreating in China? Not among its largest companies

Though private ownership does not free companies from the pervasive influence of the Communist Party, China’s private and state sectors are not equivalent; China’s largest firms are growing faster than their state-owned counterparts.

By: Tianlei Huang and Nicolas Véron Topic: Global economy and trade Date: April 5, 2022
Read article Download PDF More on this topic
 

Working Paper

The private sector advances in China: The evolving ownership structures of the largest companies in the Xi Jinping era

This paper documents recent structural changes in China’s corporate landscape, based on company level data, providing a complementary perspective to that of official Chinese statistics.

By: Tianlei Huang and Nicolas Véron Topic: Global economy and trade Date: April 5, 2022
Read article More on this topic More by this author
 

Parliamentary Testimony

House of Lords

UK energy supply and investment

Testimony before the Economic Affairs Committee at the House of Lords, UK Parliament.

By: Simone Tagliapietra Topic: House of Lords Date: March 23, 2022
Read article
 

Opinion

European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read about event More on this topic
 

Past Event

Past Event

Greening Europe’s post-Covid-19 recovery

At this event Bruegel launches a new Blueprint that collects voices of policymakers and academics on the crucial topic of how to make sure Europe will recover from the pandemic crisis while keeping their commitments to the Paris Agreement.

Speakers: Ian Parry, Simone Tagliapietra, Laurence Tubiana and Guntram B. Wolff Topic: Green economy Date: February 24, 2022
Read article More on this topic More by this author
 

Opinion

Will this be the century of youthful Asia?

Youthful Asia offers immense opportunities for investors, but this potential can only be realised if their infrastructure and energy needs are fulfilled.

By: Alicia García-Herrero Topic: Global economy and trade Date: February 18, 2022
Read about event More on this topic
 

Past Event

Past Event

A debate on fiscal rules and the new monetary strategy

Presentation of the Yearbook of the Euro 2022.

Speakers: Maria Demertzis, Fernando Fernández, Gonzalo García Andrés, José Carlos García de Quevedo, Pablo Hernández de Cos and Jorge Yzaguirre Topic: European governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 17, 2022
Load more posts