The discussion about the fiscal multipliers used to gauge the course of the Greek economy is very interesting. If nothing else, it has taken the debate to a more serious level. We are no longer looking for the grand conspiracy that brought the country to its knees, but, rather, at whether and what mistakes were made in the first memorandum. This debate is already under way at the International Monetary Fund as well at various, mostly American, think tanks.
The handling of the Greek crisis stirred a good deal of controversy in the IMF from the start. There were those, for example, who insisted that the model of internal devaluation would not work or solve the country’s problems. This is why they argued in favor of a “temporary” eurozone exit as the more sensible solution. Another subject of debate was whether there needed to be a write down of Greek debt from the start of the first fiscal adjustment program. The side that prevailed, strongly, was that of German Chancellor Angela Merkel, who argued that debt haircuts need to be granted gradually, as a reward for applying agreed measures and reforms.
There are, however, other factors that contributed to the deepening of the Greek recession as well. The massive outflow of capital from Greek banks was not foreseen even though it eventually created major problems in local lenders’ liquidity and in the economy. The troika also failed to predict and stem skyrocketing state debts to individuals and enterprises, which dealt a catastrophic blow to the market. Every country facing bankruptcy has to deal with state arrears, but in Greece the phenomenon grew to frightening dimensions.
The basic recipe for internal devaluation also contained a lethal flaw. Imports declined significantly, as the model predicted, but the growth that was supposed to come from exports never did, because becoming competitive does not just mean slashing labor costs. The biggest problem that everyone overlooked was the inability of the Greek political system to tear down the obstacles to growth and entrepreneurship, and to attract investment.
In my humble opinion, the Europeans, and our northern European friends especially, made another major mistake: when they saw the donkey dig in its heels and make no progress on reforms, they threatened it with the euro exit whip. It made sense from their end, but the over-use of the threat created a vicious cycle that dogs Greece to this day. The feeling that there is a danger of returning to the drachma has not disappeared completely, and the result has been to make foreign investors very wary, especially when it comes to the country’s drive to privatize state assets.