In search of a Greek hero

Published in Business Spectator (Melbourne), 15 February 2012

More violence in the streets, more political acrimony in parliament, more austerity measures demanded by the international community. It’s Groundhog Day again for Greece, or rather – and in keeping with its mythology – it is a Sisyphus experience. Greece, just like the fabled king, has to pay the price for its past sins. And just like Sisyphus, it is caught in an endless sequence of mindless and eventually futile tasks.

Sisyphus was forced to roll a stone up a hill, which shortly before reaching the top always rolled back downhill. Modern Greeks are locked in a similar trap. They are condemned to relentless austerity measures with no end in sight. But before the spending cuts even have a chance to reduce the budget deficit, let alone the country’s debt burden, a shrinking economy rolls Greece’s debt and deficit position back to where it was before.

It is at that stage when the troika of EU, ECB and IMF (not just Germany, as many Greeks believe) come in. The experts then look at the data and conclude that Greece now really needs to get serious with its budget cuts.

So new austerity measures are demanded, Athens experiences more civil war-like nights; parliament goes through more rancorous debates; and under the threat of default budget cuts are passed, public servants fired, and taxes increased. Not that it would help, at least not in the short term, and so Sisyphus’ stone again rolls back down the hill.

The Greek tragedy has been going on for more than two years now with no relief from the vicious circle of deficits, cuts, economic decline, and yet higher deficits. Even the EU’s plan to give Greece some breathing space by allowing a partial default on its debt does not change the big picture.

It hardly matters whether Greek debt is reduced to 120 per cent debt-to-GDP, which the EU hopes to achieve by 2020, or whether it increases beyond the current 160 per cent mark. Within the eurozone, Greece cannot generate the economic growth needed to solve its debt crisis in the long run.

Economists David Bencek and Henning Klodt of the Kiel Institute for the World Economy recently found Greece cannot conceivably consolidate its public finances, despite the proposed debt reduction to 120 per cent. They based their examination on the primary balance concept. Put simply, a primary balance is the government’s net borrowing (deficit) or net lending position (surplus) corrected for interest payments on its debt.

Even if the Greek economy suddenly started to grow at 4 per cent per year (at the moment it is shrinking) and if yields on its public debt returned to much lower levels (current 10-year yields are 33 per cent), Greece would require a primary budget surplus of 5.2 per cent in perpetuity to stabilise its debt level (Greece is currently running a primary deficit). By the way, this calculation assumes the success of EU’s debt reduction plan.

If even such a Goldilocks scenario requires substantial primary surpluses, it is easy to imagine what a worse economic outlook would mean. Bencek and Klodt calculated this too. Under the assumption of bond yields remaining high and growth only running at 2 per cent, the required primary surplus would be 14.8 per cent of Greek GDP. However, their pessimistic assumption of 2 per cent growth may still turn out to be too optimistic for the troubled economy.

In any case, it is virtually impossible that Greece will ever be able to achieve the required primary surpluses, whether they are at 5 or at 15 per cent. No country in the history of the OECD has ever sustained such levels for more than a few years. The austerity measures to achieve them are so tough that after some time they become politically impossible. And yet this is exactly what the EU is demanding from Greece.

The figures from the Kiel Institute cannot be refuted since they are not a forecast but a simple calculation of fiscal needs based on different assumptions. But if the outcome of even the most optimistic of such calculations is that Greece will not be able to carry its debt burden, it ought to be clear that the current focus on austerity measures alone is misguided.

So what would work for Greece? Realistically, Greece can only be saved if two things come together. First, Greece must default on most of its debt. A default in homeopathic doses, which seems to be the EU preference for now, will not suffice. Second, to carry its remaining debt burden Greece needs economic growth, which the country cannot achieve as long as it remains in monetary union with countries like Germany. In the long term, Greece needs to raise its productivity substantially. In the short term, a depreciation of its new currency is the best way to boost its external competitiveness. This is why Greece must leave the eurozone as soon as possible.

A ‘default and devalue’ strategy is the only realistic way for Greece to get out of its sad predicament. Without these two policies in place, Greece will be going through the same vicious policy circle for years to come.

To escape from its current mess, Greece does not need more Sisyphus work. It needs someone to tackle the Herculean task of cutting the country loose from Europe’s monetary union.

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