If You Want to Save Greece, Stop Lending It Money
The Greek rescue program is seriously derailed. By the end of this year, the economy will be a fifth smaller than it was five years ago, and the government is forecasting another 4.5 percent decline in 2013. This figure may once again prove overly optimistic.
The collapse helps to explain the high drama involved this week, as the Greek government tries to drive through parliament a double dose of austerity in the teeth of recession, and the country’s international creditors worry over whether to give the country its next 31 billion euros ($40 billion) of life support, rather than let it default on debt repayments later this month and crash out of the euro.
Given such a desperate situation, it’s all the more surprising that Greece continues to borrow abroad at a stunning rate. The current account deficit, a measure of external borrowing for the country as a whole, was 21 billion euros in 2011, or about 10 percent of gross domestic product. While it slowed somewhat in 2012, Greek borrowing still ran at an annualized rate of 14 billion euros in the first half of the year.
The continued borrowing is often overlooked in the debates over how to rescue Greece, and it indicates that the effort to avoid default is doomed.
Heavy foreign borrowing is sensible when a country is faced with a temporary fall in growth. It can help to cushion the effects on domestic consumption. But Greece is not suffering from a temporary slowdown in the economic cycle. In a situation where the decline in activity is more permanent, large-scale borrowing to sustain consumption only increases the pain down the road. It requires cutting back consumption to fall in line with lower production levels, as well as additional reductions to service the accumulated external debt.
The paradox of a simultaneous plunge in economic activity and increased external borrowing raises the question of why Greece is borrowing at the rate it is. The answer appears to be that the Greek political system is seriously dysfunctional. There simply is no credible plan for the long term and, certainly, none that would envisage repaying external debt.
The past weeks have shown that the ruling parties in Greece are more focused on fighting each other than on reforms that could support economic growth and real change in the country. Prime Minister Antonis Samaras and his New Democracy party are aware of the once-in-a-lifetime opportunity they now have to marginalize their long-standing political rivals from the moderate left and to establish a new bipolar political system, in which the extreme left Syriza party features as their main opponent. Aware of this tactic, the moderate-left parties decided to oppose sensible measures from the so-called troika -- the International Monetary Fund, the European Commission and the European Central Bank -- such as liberalizing the labor market and reducing public sector employment, thereby turning themselves into a threat to New Democracy. The result is political deadlock and a rate of increase in debt levels that even the biggest rescue packages can’t keep up with.
Policy makers have slowly begun to recognize the unsustainability of these debt and borrowing dynamics. The IMF has been pushing the euro area to find ways to reduce Greece’s debt, but governments and the ECB, which holds about 45 billion euros of Greek bonds, have resisted any suggestion they should forgive the debt that’s owed to them.
Eventually international lenders will have to come to terms with the fact that Greece will simply not be able to repay its debt. It is quite possible that further measures, such as misguided plans to buy back Greek debt, can temporarily push back this moment of truth. They are unlikely to buy much time so long as Greece is borrowing abroad at a rate of 14 billion to 20 billion euros a year.
Greece will only be truly “saved” once it manages to get along without additional borrowing. Achieving this requires that official creditors stop lending money to the current Greek elites, that official and private creditors write off the country’s debt, and that domestic economic competitiveness increases to a point where it gives a strong boost to exports.
A Greek debt default and a simultaneous euro area exit would achieve all of these goals, virtually overnight. Obviously, the adjustment would be rough and turmoil would probably prevail for a number of months, but the adjustment would take place.
The current soft approach, in which international money is channeled to the ruling elites with the aim of smoothing transition to a sustainable position within the euro area, has yielded close to nothing in terms of structural economic adjustments. Instead of a smooth transition, Greece is in the midst of a disastrous collapse in output.
This unfortunate outcome must be blamed on the inability of the Greek political elites to deliver the structural economic changes that are needed. Salary cuts and tax increases alone simply cannot re-establish the competitiveness of the economy. And if true economic reform cannot be delivered, then a euro- area exit remains the only other available option. This is a sad and unavoidable conclusion, and it follows from the simple fact that Greece cannot go on borrowing forever.
(Klaus Adam is a professor of economics at the University of Mannheim, and a research professor at the Deutsche Bundesbank. The opinions expressed are his own.)
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