The Greek crisis: prejudices can be lethal

The struggle in the eurozone about how to proceed with Greece was largely determined by prejudices on every side. This is amazing as well as dangerous. A column by Charles Wyplosz.

Charles Wyplosz
«By considering that commitments must be respected at all cost, Europe has simply demonstrated that it is unable to work for all its members.»

The negotiations between Greece and its European partners are amazing. They concentrate a huge number of huge issues, including the wisdom of a shared currency, the choice between fiscal discipline and economic depression, the rationale for structural reforms, the role of central banks and even democratic principles, not to mention European politics and sovereignty in an economically integrated country. It is no surprise that everyone draws sharp conclusions that clash with opposed views held by otherwise like-minded friends and colleagues.

One particularly intriguing aspect is how our views are shaped by possible prejudices regarding countries. Some see the Greeks as perennial defaulters while others lament Germany’s passion for the rule of law at the expense of economic well-being. Some note that Greece is unable to export much else than its sunshine (tourism and agriculture), others denounce Germany’s rigid economy that includes protected professions, heavy labor market bargaining procedures and incestuous relationships between banks and corporations. «Greek laziness» is pitted against Germany’s troubled history.

It is always difficult to escape prejudices. Facts help, but will not dissipate strongly held views. For instance, according to the massive and authoritative work of Reinhart and Rogoff (This Time is Different, Eight Centuries of Financial Folly, MIT Press, 2009) Greece has been in external debt default or rescheduling for one year out of two since 1880, the third worst world performance after Honduras and Ecuador. Yet, if we count the number of defaults or debt rescheduling over the same period, we find only 5 events for Greece, to be compared with 13 for Spain, 8 for France and Germany and 7 for Austria. This goes on to say that Greece does not default very often but, when it does, it fails to find an agreement with its creditors or does not benefit from debt relief as easily as, say, Germany, does. On nearly every issue, no country ever appears as absolute evil or perfect angel. Prejudices are just that, strongly held views comforted by carefully selected facts.

Schäuble vs. IMF

A better approach would seem to be guided by solid principles. Unfortunately, even principles tend to be relative and there are many principles that contradict each other. A spectacular example is the opposition between the German Finance Minister, Wolfgang Schäuble and, say, the IMF, meant to represent mainstream economic thinking. Wolfgang Schäuble, a lawyer by training, considers that commitments have to be respected, at all costs. Greece has accepted in writing to close its budget deficit and to enact a slew of economic reforms. It has not delivered. In his view, shared by an overwhelming majority of the German population, this disqualifies Greece from Eurozone membership. How can the common currency be safe, he asks, if member countries cannot be trusted to live up to their commitments?

The IMF operates in a different planet. It notes that, from the start of the bailout programs in 2010, the Greek debt was probably unsustainable. Indeed, the IMF staff formally stated this assessment back then. It forced the Fund to introduce a new clause according to which exceptionally large loans can be authorized if there is a systemic risk to global financial stability. This «systemic exemption» clause, hastily and discretely invented at the time, was vigorously criticized by the IMF’s Executive Board, after the Swiss delegate discovered it. It meant that more loans were going to be provided to a country that was already unlikely to pay back previous loans. Put differently, Greece was requested to enormously increase its debt to protect global financial stability, in this case French and German banks that had lent unreasonable amounts. These loans did not come for free and they were granted subject to exacting economic conditions that were impossible to meet. Indeed, three years later, the IMF issued a paper recognizing that its own forecasts, which made the programs look reasonable, were wrong. The implication is that the programs never had a chance of succeed.

Much the same can be said about the structural conditions then required of Greece. The list was long and detailed. Greece slashed wages by close to 30%, reduced the size of its administration, cut into pensions, redesigned wage negotiations, and much more. No country ever did so much in so little time. But it did not do everything that was in the list. Moreover, many laws were adopted but not implemented because the administration was unable, or unwilling, to implement them. How do we judge a glass half full? Do we admire Greece for what it delivered or do we blame it for not having delivered everything? Wolfgang Schäuble, finance minister for six years with no significant economic reform under his belt, considers that the glass must be full. The IMF, which has a long experience of conditionality all over the world, considers that it is a good strategy to ask for too much to obtain a lot.

The new program will fail

All agree that Greece has much more work to do to become a model economy. Yet, reforms are highly disruptive as they always hurt some minorities to benefit the collectivity. A key lesson learned by the IMF is that reforms can only succeed if they are owned by the country. In practice, however, a country that asks for emergency assistance has little choice but to accept the conditions attached to loans by the creditors. Indeed, as with all IMF assistance programs, the memorandums of agreement signed by Greece were written entirely by the European Commission and the IMF, and signed by the Greek government.

Country ownership has always been a dubious concept, but over the last few weeks Greece has been fully disowned of its policies. The even deeper structural reforms and more fiscal austerity are a promise of deep hardship for the Greek people, at least those at the lower income levels. Whether this is acceptable is a deeply political question. Putting this decision to the people in a referendum is an exercise of direct democracy that Swiss readers should find legitimate. Not everyone agreed. It was noted that the question was far too complicated and technocratic and that the campaign was far too short for voters to be duly informed. It was seen as a manipulation by a famously provocative government. The government was even accused of blackmailing its European partners. This is probably all true, but how can a government elected on a mandate to reject these conditions respond?

Wolfgang Shäuble considered the referendum as the ultimate provocation, which deserved the harshest possible punishment. He prevailed. From his legal vantage point, justice has been served. From an economic viewpoint, the new program will fail, for many reasons. It is a continuation of the previous ones, which failed. The economic depression will become deeper, the public debt now at close to 180% of GDP will pass the 200% mark and the extraordinarily intrusive conditions cannot be fulfilled. What will happen when it is recognized as a failure? Greece will leave the Eurozone, but will order be restored? Not in Greece, which will plunge in economic and political chaos. Not in the Eurozone, which will have been weakened once it has been demonstrated that a country that does no toe the line can de dispatched out.

The law is meant to preserve fairness and stability. If its enforcement implies economic disruption, the law is wrong. By considering that commitments must be respected at all cost, Europe has simply demonstrated that it is unable to work for all its members, beyond existing prejudices. I thought that this was its fundamental purpose, to which laws are subservient.