DESMOND LACHMAN *

Greece’s Pyrrhic victory

COMMENT

One has to pity Greece’s battered citizenry, since this week’s European finance ministers’ deal to provide the country with a much-needed loan disbursement came with the most onerous of budget austerity strings attached.

If Greece’s own past experience with budget austerity in a euro straitjacket is any guide, those strings are likely to ensure that Greece will not emerge anytime soon from its six-year economic depression. That has to be regretted since the depression is now on a scale of that experienced by the United States in the 1930s. It has also seen Greek unemployment rise to its present 24 percent level.

To its credit, the IMF has finally, if belatedly, come around to the view that excessive budget austerity within a euro straitjacket was a principal contributor to the Greek economic implosion over the past six years. For that reason, the IMF has been forcefully arguing that Europe should offer Greece substantial debt reduction.

The IMF has done so with the hope that this might limit the amount of budget adjustment that might be required of Greece to ensure debt sustainability. In that context, the IMF has been suggesting that the most that should be reasonably required of Greece on a long-term basis is a 1.5 percent of GDP primary budget surplus (a surplus excluding interest payments). That is to be compared with the 3.5 percentage points of GDP primary budget surplus still being demanded by Greece’s European partners.

Sadly, this week’s European finance ministers’ meeting chose to largely ignore the IMF’s counsel. While agreeing to release Greece a much-needed US$10 billion loan tranche, it insisted that any notion of Greek debt restructuring be deferred until 2018. Though of course not explicitly stated, that latter date would conveniently be after the German elections were safely out of the way and would thereby ensure that Greek debt reduction did not become an issue in those elections.

In the meantime, the Greeks are now expected to deliver on their original commitment of attaining a 3.5 percent primary budget surplus by 2018. They are to do so even though the IMF estimates that delivery of such a budget surplus would require as much as 4.5 percentage points of budget adjustment over the next two years.

To make sure that the Greeks deliver on this primary budget surplus target, the European finance ministers not only required of Greece painful upfront tax increases as a precondition for releasing the latest loan disbursement. They also required a firm commitment to contingency budget measures amounting to close to 2 percentage points of GDP. Those measures are to be implemented in the event that the primary budget surplus target appeared to be going off track.

The very scale of the budget austerity measures now still being required of Greece must raise two basic questions. First, why if excessive budget austerity in the past within a euro straitjacket has brought Greece to its dreadful current economic and social pass, will more budget austerity within that same euro straitjacket now produce any better a result? This question would seem to be of special relevance when the Greek government is in an even weaker position now than before to undertake structural economic reforms. Second, if Greece fails to have meaningful economic growth, why will Greece’s debt become any less unsustainable than the IMF thinks it is today?

This is not to suggest that these questions are not being seriously asked by the European finance ministers. Rather, it is to suggest that Greece is once again being cynically sacrificed for the political convenience of its European taskmasters. This is all too likely to prove shortsighted, as this latest round of austerity runs the real risk of ensuring that Greece becomes a failed state as its economic depression only deepens.


* Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

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