At this point, Greece’s suffering is so severe that neo-Nazi parties have a legitimate chance at seizing power. However, the core idea on debt restructuring remains very much valid.
As additional reading, Martin Sandbu’s book, Europe’s Orphan, offers an excellent elaboration of the thoughts expressed below.
Let’s be blunt: Greece has been in a dark hole for a while now and cannot feasibly get out for a while as long as it shoulders its current debt. This article from Foreign Affairs states that it would take years, if not decades, to produce a balanced budget, let alone start reducing the debt at a sustainable rate. It quips:
To achieve a sustainable path, Greece must start reducing the ratio of its national debt to GDP. This will be virtually impossible as long as Greece’s real GDP is declining. Basic budget arithmetic implies that even if Greece’s real GDP starts growing at two percent (up from the current seven percent real rate of decline) and inflation is at the ECB target of two percent, the deficit must still not exceed six percent of GDP if the debt ratio is to stop increasing. Since the interest alone on the debt is now about six percent of GDP, the rest of the Greek budget must be brought into balance from its current three percent deficit.
Cutting the interest bill in half and simultaneously balancing the rest of the budget would reduce the ratio only very slowly, from 150 percent now to 145 percent after a year, even if no payments to bank depositors and other creditors were required. It is not clear that financial markets will wait while Greece walks along this fiscal tightrope to a sustainable debt ratio well below 100 percent.
However, it would take even longer to resume economic growth and reach a level of unemployment that is anywhere close to normal because austerity severely depresses economic growth, which also depresses tax revenues. This creates a vicious cycle that risks making the government too small to function efficiently.
Ironically, Greece has been in default for half of its history as an independent state. It may be time to let it partially default yet again. Here is my premise: after default, if Greeks were presented a choice between a HUGE carrot and a HUGE stick, then they will use their common sense.
My proposal has three prongs:
1. Restructure all Greek debt over 80% of GDP. Given the small size of Greece’s economy relative to the Eurozone, this is bearable and more efficient than endless bailouts that won’t be paid back for at least a decade. The ECB and the IMF should be first in forgiving their holdings of Greek debt; any remainder should fall towards private creditors, who were well aware of the risks of investing in Greek bonds. To avoid financial contagion, the ECB should stand ready to allow banks breathing room and help construct firewalls.
2. Allow the Greeks to borrow cheaply from the ECB (at AAA levels) under two conditions. First, Greece must aggressively pursue long-term structural reforms and crack down on tax evasion. This would simultaneously increase international competitiveness and open up an important source of revenue.
Second, Greece should be allowed to follow short-term stimulus in infrastructure and other productive spending. What exactly that entails is unclear, but some form of debt relief would be desirable to increase demand and consumption. This would be combined with medium-term moderate austerity through cutting the bloated public sector and privatizing inefficient public services whilst continuing efficient infrastructure spending (this is important!). Finally, in the long-term, moderate cuts in more important parts of the budget will be made to help achieve a balanced budget.
The timeline is debatable, but here’s a guideline: the short term would encompass 1–2 years; the medium term would extend across 3–5 years; and the long term would be any point when unemployment falls below a tolerant level. Considering current economic weakness, let’s set that at 10%.
While Greece is indeed the only country that borrowed beyond its means for the past decade (unlike the rest of the demeaning term “PIIGS,”) austerity will still have adverse effects on economic growth. The key is to turn around the deep economic recession and restore economic growth, which would by itself increase governmental revenues.
3. You might wonder if a moral hazard might occur if Greece were suddenly relieved of pressure. It’s a valid concern, and this is where the third part kicks in: should the Greeks refuse to do enough, the debt held by the ECB and IMF will be “unforgiven” and all external support will be withdrawn until the Greeks relents. If they miraculously limp on without defaulting after two months, they should be kicked out of euro and not let in until they agree to the conditions set above!
You might be skeptical that Greece would cooperate because motivation and incentives often defy carrots and sticks. Sadly, that’s probably true. Many things can go wrong with this particular plan, and the moral hazard might not be sufficiently eliminated.
However, I believe that when Greece is presented with vastly different approaches depending on its behavior rather than a bad choice and a worse choice, it would be more likely to cooperate. Moreover, Greece is in such a deep hole right now that this is an impossible problem with virtually no practical solutions.