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WikiLeaks Controversy Strengthens Case for Greek Debt Forgiveness

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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The release this weekend by WikiLeaks of the purported transcript of discussions among International Monetary Fund officials about the best way to compel Greece's creditors to accept debt restructuring led to much finger pointing and seeming indignation.

QuickTake Greece's Financial Odyssey

Yet the economic case for forgiving that country's debt is straightforward: Without relief within a comprehensive reform program, Greece will struggle to grow, unemployment will remain high, and the turmoil will continue to periodically challenge the functioning of the euro zone.

The political calculus is a lot harder, however. Even the window opened by Europe’s refugee crisis is failing to provide a sufficient catalyst for change. If that continues, Greece could end up an element of a much larger threat to the integrity and performance of both the euro zone and the European Union. 

Debt forgiveness is never granted easily, and with good reason. Even when it is a financially viable solution, the concept raises fundamental issues of fairness and incentive-compatibility.

Why should a deadbeat debtor be granted relief when others have labored to pay off their debt? What about the creditors who worked hard to earn the money that they lent; why should they be punished? And doesn't the granting of debt forgiveness encourage other debtors to be less diligent, potentially undermining the overall flow of credit that supports economic growth and broader opportunities for well-being and prosperity?

These are legitimate economic questions. Over time, such considerations have rightly made debt forgiveness rare, subject to protracted negotiations or dependent on the outcome of other truly exceptional events. But the economic analysis also suggests that there are a few cases when debt forgiveness is in fact the better option when a "first best" solution isn’t available.

Here is the economic argument:

Beyond a certain point, high indebtedness does more than crush directly the recovery efforts of the debtor. It also inhibits new capital from coming in as fresh providers rightly worry about being contaminated by what is already an excessive existing liability. Without the much-needed oxygen provided by capital inflows, the debtor suffers even more, rendering growth almost impossible and making the debt trap even deeper.

Historical examples include the hard lessons of Latin America's "lost decade" of the 1980s. During this particularly sad episode, many countries struggled to overcome crushing debt burdens and ended up with prolonged economic stagnation, high long-term unemployment and rising poverty levels. The comprehensive debt relief that finally came at the end of the decade and in the early 1990s was too late to avoid misery, especially for the poorest citizens. There also is the example of poor countries in Africa, which benefited from a cooperative global Debt Initiative for Heavily Indebted Poor Countries in the mid-1990s that allowed a notable pickup in their growth, investment and poverty alleviation.

Most economists agree that Greece will not be able to grow without debt forgiveness. It is a necessary, though not sufficient, component of almost any approach to restoring the country to a sustainable growth path, reducing alarming levels of joblessness and avoiding a lost generation of unemployed and disenfranchised youth. Granted in the context of a comprehensive reform effort, such relief also would help restore Greece's status as a full working member of the euro zone, whose objectives extend beyond economics to important social and political achievements.

But even if the case is straightforward in economic terms, it also is politically complicated.

Primarily because of decisions made in the earlier bailout programs for Greece, the bulk of the country's debt is now owed to other European countries and their official institutions. Accordingly, the debt relief decision only can result from a political process that involves national parliaments, including those of Germany, Finland and the Netherlands, which tend to be averse to any softening of the terms on past loans.

Many had thought that the refugee crisis would make easier the political approval of this economically necessary, though difficult decision. After all, Greece has been in the forefront of the crisis, hosting -- under extremely difficult conditions -- hundreds of thousands of refugees who are looking to settle elsewhere on the continent.

But this window has proven hard to exploit given the deep divisions within the EU that have been exposed by the crisis. Moreover, as the leader on this and many other European issues, Chancellor Angela Merkel of Germany is finding that her courageous approach to the refugee crisis now faces growing internal opposition.

WikiLeaks's publication of the transcript of internal deliberations at the IMF, an important provider of funds and technical assistance to Greece, makes the politics even more complicated. The document details the thinking of fund technocrats as they attempt to predict how the complex EU politics of the next few months could affect a strategy to obtain the debt forgiveness for Greece that they have long regarded as necessary and are now suggesting could be a prerequisite for further aid.

It turns out that the start of the summer could be an even more challenging period for both the EU and the euro zone. By then, Greece could be running out of money to run its economy and meet debt service payments. The U.K. will vote on whether it should remain in the EU. And Europe is likely to have found out, the difficult way, that the recent regional agreement on refugee flows is hard to implement.

Europe should be taking actions now to avoid a potential confluence of problems this summer that, badly managed, would not just seriously test the region's resolve and problem-solving capabilities, but also its political credibility. In this context, the seemingly hard decision on Greek debt forgiveness takes on a pragmatic necessity that reinforces its economic justification.

It is the one decision that is in the hands of European governments and parliaments that, though they are challenged by anti-establishment nationalistic movements, are still dominated by those who believe in the historic project of an ever-closer European union.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Mohamed A. El-Erian at melerian@bloomberg.net

To contact the editor responsible for this story:
Max Berley at mberley@bloomberg.net