There are two competing narratives about the Greek financial crisis. The first line of thinking accuses Greeks of being lazy workers and lousy money managers, having essentially brought financial ruin on themselves. The other theory blames Greece’s creditors, who have profited from the country’s spectacular downfall and imposed austerity measures that have kept the economy underwater while rescuing the risky lenders who sank it in the first place.
So, how to reconcile two such divergent strands of thinking? As in any rhetorical tug of war, the truth lies somewhere in the middle.
“Who’s right? Well, both sides are right and that’s why there are dual narratives because it’s a glass-half-full, glass-half-empty [scenario],” said Sebastian Mallaby, a senior fellow for international economics at the Council on Foreign Relations. “You can point the finger at both sides because both sides have made mistakes.”
After joining the eurozone in 2001, Greece gorged on low interest rates and easy credit, embarking on a spending spree that German, French and U.S. banks eagerly financed. The bottom began to fall out in 2009 when it became clear to investors that Greece had hidden the extent of its debts and had failed to restructure its woefully inefficient economy. The subsequent crash’s cascading effects ravaged the Greek economy and threatened to shatter over 60 years of European unity.
So the European Commission, European Central Bank and International Monetary Fund — collectively known as the “troika” — stepped in to prevent a debt default and a “Grexit” from the 19-member eurozone, fearing the contagion could spread to other weak economies such as Spain and Italy (and, in the process, drain the French and German banks who held Greek debt).
In 2010, the troika extended a lifeline to Greece — the first of three rescue packages that now total over $350 billion. The bulk of these bailouts go to pay off Greece’s existing debt, the majority of which is now owned by the troika. In other words, the creditors are essentially paying themselves back, not chipping in to rebuild the Greek economy. But the hope is that if Greece can adopt long-overdue structural reforms, it can begin to regain competitiveness and win back investor confidence. In the meantime, the troika has injected Greek banks with badly needed liquidity and propped up the country’s ailing economy.
But the bailouts came at a steep price for Greece, which has endured severe punishment for its profligacy. Over the last six years, as investment fled the country and the government had no choice but to impose a slew of harsh austerity measures, the economy contracted by over 25 percent while unemployment tripled. One out of every four Greeks is now jobless (while youth unemployment stands at over 50 percent). Meanwhile, suicide rates and drug use have soared and standards of living have tumbled.
The austerity-centered prescription of spending cuts and tax hikes championed by Germany has stymied growth and exacerbated Greece’s chronic economic malaise, pushing a steady diet of shock therapy-like reforms that may improve the country’s competitiveness in the long run, but have done little to alleviate its immediate pain.
While Greece’s suffering is very real, so are the homegrown problems that fueled it — among them, bloated public spending, inefficient state-run monopolies, cooked books, rampant tax evasion and endemic corruption.
That’s why Mallaby says there’s plenty of blame to go around for the debacle: creditors for lending “foolishly” during the heady days of euro integration; Greeks for “flat out lying” about how shoddy their finances were; Germans for imposing an austerity approach that has radicalized Greek politics; and the anti-establishment Syriza party that promised to lift the country out of its misery, only to bring it to its knees — and to heel — after a dramatic summer showdown.
Meg Lundsager, a public policy fellow at the Wilson Center who focuses on economic, financial and regulatory issues, agrees that culpability lies on both sides of the divide: Greece for splurging once it joined the eurozone in 2001, and Europe for letting it in — and then looking the other way.
“I think the consensus now is, ‘Oh they weren’t really ready,’” Lundsager told The Diplomat, echoing the widely held view that it was a mistake to allow Greeks into the exclusive currency club. Lundsager said that once they joined, however, everyone — not just Athens — took advantage of the good times that followed.
“[A]nd that’s where I think the fault comes on both sides,” she said. “Once you’re in, what happened to interest rates? They plummeted. What a great time for all the members. Maybe they weren’t as low as Germany’s, but for all of them, they benefitted tremendously from that unity and then went on a bit of a borrowing binge.”
Mallaby said that foreign banks were “clearly excessive and no prudent lender should have extended so much credit,” noting that many private-sector lenders had to eat losses on those loans.
“On the other hand it’s also true that the Greeks have behaved with astonishing irresponsibility,” he added, pointing out that the Greek government was running “insane budget deficits” long before it adopted any austerity measures.
“They were irresponsible before the crisis and they’ve been irresponsible since the crisis because of the pattern of pretending to [enact] reforms and then not delivering on them.”
Those days may finally be coming to an end. Since 2009, Greece has cycled through six different governments, three of which have collapsed in the face of widespread public discontent.
The latest incarnation of Greek anger is Alexis Tsipras, the charismatic young prime minister elected in January on an anti-austerity platform. Over the summer, Tsipras engaged in a dangerous game of brinkmanship with Greece’s creditors in a bid to secure debt relief for his beleaguered citizens. But Europe called Tsipras’s bluff and he blinked — big time.
After weeks of contentious and chaotic negotiations, Athens missed a critical debt repayment to the International Monetary Fund and had to institute capital controls to prevent a run on Greek banks. Seeking leverage in his talks with the troika, Tsipras called a last-minute referendum on the terms of a future bailout in July. The move backfired. Even though Greeks overwhelmingly voted to reject the tough conditions imposed by creditors, European Union officials — fed up with Tsipras’s erratic tactics — shrugged off the results.
With his government teetering on the verge of bankruptcy, Tsipras was forced to concede defeat and accept a three-year bailout worth up to 86 billion euro (on top of two previous bailouts totaling 240 billion euro since 2010). In return, Greece had to swallow a raft of punishing reforms such as pension cuts, tax increases, a privatization overhaul and intense outside monitoring. Creditors have been demanding the unpopular measures for years, among them: raising the retirement age, dismantling labor protections, slashing pension benefits, increasing VAT and consumption taxes, and selling off state assets to create a 50 billion euro fund, the bulk of which would go to pay off debts.
Tsipras and his left-wing Syriza party didn’t get much for their surrender — just a vague promise that creditors would revisit the country’s staggering debt burden, which now stands at 177 percent of GDP, and might relax certain loan terms, but not grant Greece the outright debt write-down it wants.
It was a humiliating about-face. Not only did Tsipras have to embrace the very policies he was elected to oppose, he had to stomach concessions that were worse than what was on the table before his hastily called referendum.
The fiery populist admitted it was a “hard deal” that will lead to recession, saying he had no choice but to capitulate in order to keep Greece inside the common currency.
To bolster his mandate, the prime minister then called a snap election in September, winning by an unexpectedly comfortable margin. Now shorn of the far-left fringe in his own party, Tsipras is free to build an amenable coalition that guarantees passage of the reforms demanded under the so-called European Stability Mechanism (ESM), the vehicle through which Greece gets its bailout.
In the meantime, Europe will be watching to see if Greece makes headway on thorny economic challenges such as revamping pensions and stabilizing banks ahead of a major ESM review in mid-November. Tsipras hopes to eventually restructure the country’s debt load, but the troika has said it will not consider any relief until the review is completed.
Berlin vs. Athens
Moving forward, Mallaby said Greece and Germany, which for all intents and purposes represents the creditors, need to be realistic and flexible — traits that have been sorely lacking on both sides in recent years.
“[T]he blame could fairly be ascribed to one party over another and that responsibility has varied over time,” said Mallaby, who has written for the Financial Times, Wall Street Journal and New York Times. “I do think that this year has been a period when the fault was much more on the Greek side because they’ve gone through this period of wild gyrations of Tsipras changing directions every few weeks. When he was first elected, his first moves were basically to not reform, but undo reform.”
Tsipras, he noted, “was elected on a mandate of saying no to austerity, but the mandate also said that he would say yes to the euro. And that’s why zigzagged thereafter because the two parts of the mandate were directly contradictory. Saying no to austerity meant undoing the reforms, but saying yes to the euro meant sustaining the reforms.”
Even so, Mallaby added, “Germany refused to recognize that demanding too much austerity would push Greek politics into a radicalized posture and would lead to the election of Syriza and Tsipras. A lot of people at the time said, ‘Look, these guys have crashing GDP, unemployment at 25 percent, youth unemployment much higher than that and there’s only so much austerity a country can take, and if you don’t cut them more slack and allow them to adjust toward stability in a more gentle fashion, there will be a political upheaval’ — and that’s exactly what happened.
“The Germans were deaf to that,” Mallaby argued, “so I think they were culpable last year, they reaped the whirlwind this year, and the whirlwind was Tsipras and he indeed was as radical and as irresponsible as people expected given Germany’s policies before.”
In particular, German Finance Minister Wolfgang Schäuble drew criticism for suggesting that Greece might be better off leaving the euro — a sign that Berlin was more interested in coercion than compromise in its effort to make an example out of Greece.
German taxpayers generally supported Chancellor Angela Merkel for taking a hard line in the negotiations. But Tsipras’s camp accused Berlin of taking Greece hostage without considering the human repercussions of its unyielding stance — or the economic data showing that austerity alone, without any concomitant stimulus or debt write-off, perpetuates a vicious cycle of recession.
Between the seemingly dismissive signals coming out of Berlin and the schizophrenic negotiating strategy employed by Athens, trust between both governments quickly eroded.
Despite the lingering bad blood, Mallaby said the Germans “dodged a bullet” by keeping Greece in the eurozone — on their terms — and that their position may soften in the future.
At the same time, he warned, the underlying economic principles that drove Germany’s response are unlikely to budge — and run counter to the prevailing wisdom in Washington that the way to climb out of recessions is to ratchet up spending, pump easy money into the system and take bad debts of banks’ balance sheets.
But that type of monetary stimulus is antithetical to the German intellectual tradition, which puts “more emphasis on rules, on stability of law, not messing around with debt contracts,” Mallaby said, “and that’s why they don’t want to restructure debt, they don’t want to do funny tricks…. It’s a much less improvisational and much more disciplined approach to policy.”
Some economists, however, have pointed out that by racking up large trade surpluses, spendthrift Germans accumulate excessive savings and inadvertently contribute to the EU’s anemic growth because their savings are then used to finance other countries’ trade deficits.
But Lundsager praised the Germans’ insistence on fiscal discipline, saying it stood in sharp contrast to the EU’s lax data collection and fiscal enforcement. She said that while euro candidate countries adopt stringent standards to enter the currency club, once they’re in, the EU tends to let its guard down. For example, she pointed out that the bloc often turns a blind eye when France and even Germany don’t hit the agreed-upon threshold to keep deficits at 3 percent of GDP.
“If the two big guys can’t do it, it’s very difficult to enforce it with the smaller countries,” said Lundsager, a former U.S. executive director on the IMF Executive Board. “And the Europeans have not been effective enforcers so that’s why I believe they do share the blame.”
“With that said, I think Germany deserves a lot of credit for being so focused on holding Europe together,” Lundsager added, though she conceded that “frankly, I think it would’ve been nice if Europe could’ve done an outright haircut as a signal to incentivize the Greeks on their economic reforms and performance, but that just wasn’t in the cards. The Germans were not going to accept that.”
Deconstructing the Debt
The troika has ruled out a face-value write-off of Greece’s debts, fearing it could trigger a Pandora’s box if other heavily indebted governments such as Spain and Portugal demand the same treatment.
Mallaby pointed out that while public-sector lenders haven’t deducted any principal from Greece’s loans, “the terms on which it’s repaid have been greatly relaxed so that they can pay it back at lower interest rates, over a much longer period, which basically is the same as reducing what is going to be repaid.”
Lundsager said Europe refused to consider an outright haircut or direct transfers to Greece, like United States did during its recent recession, when the federal government provided grants to tide state and local governments through the lean years. That left Europe with a third option: offer low interest rates and much longer maturities and grace periods, which make Greek debt relatively manageable — for now.
“So for the next [20 to 30 years], payments are still going to be very low, on interest and principle,” she said.
The challenge, according to Lundsager, will be maintaining investor confidence once those grace periods expire — specifically the confidence to know that tax rates won’t abruptly change and profits won’t be confiscated because the Greeks have to pay off outstanding debts that have come due.
Yet enacting the structural changes needed to restore that confidence will take time — and a seismic shift in how Greeks view the role of the public versus private sector.
Indeed, the recent bargain struck in Brussels seeks no less than to upend a deeply ingrained culture of dependency on the government, which Lundsager says is paradoxically seen as both caretaker and adversary.
“People love the government; they hate the government,” she said. “On the one hand, they love the security it affords. Parents say, ‘Well, my son’s going to get a job in government, and it’ll be a lifetime job and he’ll have a nice pension, and he can retire at 55.’ Well, all that’s changing now. On the other hand, they all hate the government because the government can be very fickle, very uneven in terms of how they impose taxes and fees, [and] it drives the private sector nuts.”
Lundsager, who visited Greece in August, said a sense of “resignation” has crept in among an austerity-weary public, as evidenced by the lackluster voter turnout that ushered Syriza back to power. After years of belt-tightening, Greeks seemed to have begrudgingly accepted their lot. That could change, of course, once protected groups such as labor unions and farmers feel the pinch of reforms.
On that note, Lundsager was dismayed that Tsipras didn’t capitalize on his re-election victory to fundamentally reset the debate — framing austerity not as something Greeks are being forced to do, but as something they should do. “I still haven’t heard Tsipras say, ‘But we need to do this for ourselves, to help enliven our economy and create jobs for our young people.’”
Yet the prime minister, while having consolidated power, still faces deeply entrenched skepticism in his own party, and among his constituents, that austerity is the best path forward.
And if Greece’s political leaders and business oligarchs aren’t fully committed to instituting reform, Lundsager doubts the grassroots-level bureaucrats charged with executing those reforms will be motivated to break old habits and carry out the changes.
The sheer enormity of those changes — and the top-to-bottom approach it requires — is why she believes the devil of the latest rescue package will be in implementing the details.
“This program is so ambitious,” Lundsager said. “And that makes it very tough — a lot of fiscal reforms, changes that are going to be fundamental to how people do business, how they pay taxes, how they engage with the government.
“But a lot of these changes, while they’re good for long-run sustainability — making the economy more flexible, getting people to understand the government is not going to be the main source of jobs; the private sector will be — all that really takes time to work.”
So what can be done in the meantime to boost jobs and show the disillusioned Greek populace some tangible benefits? Mallaby and Lundsager say rebuilding investor confidence is key.
“It would be really helpful to get some high-profile investment commitments to Greece,” Lundsager said, noting that the European Commission has been exploring ways to accelerate investment in areas such as agriculture, infrastructure, transport and other “visible job-creating projects.”
“That’s the problem…. Right now Greece is not going to be a big manufacturing hub. It’s not going to have a bunch of automobile plants or rebuilding jet engines there. Other countries in Europe do that sort of thing very well. What Greece has is a wonderful location. It can be a huge transport corridor,” she said, noting that there’s been talk of a German company taking over a string of Greek regional airports as part of the first wave of privatization under the recent bailout.
“Between transportation, agriculture and tourism — there’s huge potential to develop all those further. I would hope European investors would want to do that, but you can’t tell the private sector where to invest.”
Mallaby said investment might trickle back in now that the election is over and the dust has settled.
“[Y]ou get a return of confidence because the craziness of Syriza has calmed down and there’s a sense that stability is returning. The real tragedy of the first half of this year was that actually in late 2014, the Greek economy was showing modest signs of stability and even slight growth,” he told us. “There was so little confidence in the first half of 2015 that you can recover from the very low base.”
Yet Greece cannot rely on the one tool that countries like the United States fall back on in hard fiscal times: They devalue their currency to make their exports cheaper and regain competitiveness. The fact that different nations with widely divergent tax-and-spending policies share a single currency has long been considered the Achilles’ heel of the eurozone project.
Despite this limitation, Mallaby said Greece can cushion the fall by employing two specific mechanisms.
“One is that although their currency cannot devalue because it’s a shared currency, they can have a so-called internal devaluation whereby it adjusts in a real sense, not in a nominal sense. So basically what happens is that Greek wages fall and Greek prices fall, and so the cost of producing things goes down. Without the exchange rate moving, you get a gain of competitiveness compared to other members of the euro currency area.”
While depressed wages aggravate an already-dismal employment picture, Mallaby says the silver lining is that they also attract investment. “If there’s unemployment in Arkansas, wages in Arkansas will tend to stagnate and land will be cheap, and then some businesses will notice that and set up a factory in Arkansas to take advantage of their production costs, and Arkansas’s exports to New York state will go up. And so this is a normal adjustment mechanism which can apply to the Greeks as well.
“There’s also the question of the external environment,” he added, “so things can happen outside Greece that help Greece if you’re lucky. They may not, but those things include stronger growth in the countries that Greece normally exports to…. Unfortunately that’s not happening, but it’s possible that it can happen.
“What is happening right now is that the euro as a whole is falling against the dollar, and that of course helps Greece export to non-eurozone countries, whether it’s the U.S. or Britain or the Middle East or whatever. They have a competitiveness advantage. They can’t devalue within the eurozone but they can devalue against the rest of the world.”
Exhaustion Seeps In
World events, however, have conspired to put Greece on the backburner. The migrant crisis spilling onto Europe’s shores has both sidelined Greece and compounded its misery. Ill-equipped to handle an influx of refugees fleeing Syria, Iraq and other war-torn nations, Greece’s cash-strapped government has nevertheless been forced to absorb a record 400,000 migrants in 2015. Tsipras has warned that the crisis could derail hopes for economic reform. Even if the government manages to pass the slate of laws the troika demands by year’s end, once the measures begin to bite, a fresh round of protests and upheaval could grip the country.
For now, however, it appears that everyone wants a breather from the six-year roller-coaster ride of economic turmoil. Lundsager says that with the Greeks exhausted and Europeans distracted, both sides will slog through the next chapter of the Greek drama. “Everybody wants this to work out and move on. There are just too many other challenges in Europe right now — let’s just keep Greece on an even keel.”
She found it striking that Tsipras, when he reluctantly accepted the third bailout, admitted that Greece would have needed to embrace reforms, regardless whether it stayed in the eurozone or not. “Finally it got through that even if Greece were to drop out, and the Germans were ready to let them go … they would have to undertake a lot of these reforms. You drop out and you have huge inflation. You’re going to be in a worse mess.”
On that note, neither Lundsager nor Mallaby support the doomsday scenario of Greece returning to the drachma, thereby becoming the first country to leave the euro.
Such a step is theoretically plausible. A return to the drachma would let Greece devalue its currency, though it wouldn’t reap the benefits for an untold number of years. On the flip side, Europe may survive a Grexit intact. Greece represents less than 2 percent of the eurozone, and since 2010, the EU has erected a firewall to prevent any panic from infecting other members.
But leaving the euro would be a step into the unknown, both for Greece and world financial markets. Beyond the inherent uncertainty and potential chaos, nothing guarantees that going back to the drachma could pull Greece out of its economic woes.
“A lot of countries succeed at doing this over the years, but that’s because they couple devaluation or a big depreciation with domestic reforms, tightening economic policy and then going through admittedly lean times for a few years before the growth,” said Lundsager, who questions whether Greece’s dysfunctional government could steer it through a devaluation.
Mallaby speculated that a return to the drachma isn’t out of the realm of fiscal possibility, but politically it may be a nonstarter.
“You could go through an absolutely hellish five years and maybe come out the other end with a flexible currency, but the problem is, it’s all very good to have a flexible currency if you manage it well,” he said. “And there’s not much in Greek economic history to suggest that they would manage it well. If they were the kind of political culture that did manage it properly, they wouldn’t have had the deficit in the first place.”
About the Author
Anna Gawel is managing editor of The Washington Diplomat.