If some pundits are right, the impact of a Greek sovereign default on the eurozone economy and the world markets could be equivalent to Lehman Brothers multiplied by a factor of five or 10. Unfortunately, Greece and the EU are not run by an efficient administration and an effective central bank as is the United States, which acted quickly and effectively to deal with the crisis after Lehman Brothers crashed. So, a disorderly Greek default becomes more probable and much more undesirable.
It is clear by now, even to its staunch supporters, that the Memorandum Greece agreed to on May 3, 2010 with the European Commission, the IMF and the ECB (European Central Bank) has not worked. The fact that it has to be revamped and that Greece has to be given an additional loan to make it until mid-2014 proves just that. Whether this occurred because it was not implemented properly by the Greek government or/and because of its own shortcomings is a matter of debate.
In our view, it was due to both factors. The Greek government willingly implemented the agreed fiscal measures but was unable or perhaps unwilling to do the same with the structural reforms that often pitted it against its own party members in trade unions and elsewhere.
In addition, the economic program did not make privatizations and other asset sales a priority because it wrongly assumed that Greece faced a liquidity crisis and not a solvency crisis requiring a reduction in the amount of public debt upfront.
The midterm fiscal strategy program unveiled by the government last week tries to correct some of the shortcomings of the Memorandum by placing greater emphasis on privatizations and proceeds from the development of public property as a means of lowering the state?s debt by 50 billion euros by 2015 and reinvigorating the economy by a more efficient allocation of capital and investments.
However, valuable time has been wasted and the rate at which some of the privatizations will have to be implemented points to fire sales, increasing the stakes for the politicians who will take the responsibility and sign, losing crucial support.
Even worse, the government has decided to hit the private economy with a new wave of taxes because it either does not want to or cannot cut state spending deeper to meet the budget deficit goals. In doing so, it repeats the same mistake it made in the economic policy program signed in May 2010, where it tried to slash the budget deficit by relying equally on tax hikes and spending cuts.
It is obvious that the government faces tremendous opposition from within its party ranks to do the right thing and overhaul the public sector, the source of Greece?s economic crisis. Meanwhile, calling on the conservative opposition New Democracy party for consensus, namely to support the new restrictive measures and help share the political cost, will not make the hardline trade unionists of any party change their mind.
Moreover, put aside the push for structural reforms, especially the privatizations and the liberalization of the so-called closed professions, the fiscal side of the midterm fiscal strategy appears to aim to cut the budget deficit by hurting more the engine of the Greek economy, that is, the private sector, rather than taking care of the big sick man, that is, the public sector.
This means it risks hurting the growth prospects of the Greek economy and protracting the vicious cycle of recession and ever-rising public debt.
It is therefore imperative that the government listens to the proposal of Antonis Samaras, the leader of the conservative party, and joins forces in a bid to change the means of attaining the goals of the midterm economic program in consultation with Greece?s EU partners and the IMF. In so doing, it will hold a major card in its hand — the threat of contagion — but to play it, the country needs strong leadership.
The two leaders will have to convince Greece?s partners of the country?s commitment to reforms and fiscal discipline by laying out a simple plan.
First they need to rely primarily on spending cuts to meet the budget deficit goals, even if it means layoffs in the public sector, and proceed with selective tax cuts but not consumption taxes. If this is not done, tens of thousands of jobs in the private sector will be lost and finally even more jobs will be lost in the public sector since the economy is likely to collapse.
Second, the two leaders should make a commitment to carry out the privatization plan within the agreed timeframe.
Third, they should ask that the EU frontloads the structural funds earmarked for Greece for the next few years to have a greater impact on economic activity and seek greater financing from the EIB for infrastructure projects.
Fourth, they should convince their counterparts that new EU and IMF loans will not do the economy much good if they do not help the liquidity of the banking sector. This means going for a Brady type bond solution now instead of going for straight loans to the public sector that leave the private sector cash-starved. The Brady bonds could be used by local banks as collateral to fund themselves in the repo markets and get the economy back on its feet.
Undoubtedly, Greeks bear the responsibility for their fiscal mess and high public debt, and should be the first to pay for cleaning up their house. However, it is highly probable that Greece may indeed turn out to be worse than Lehman Brothers to the eurozone and to the world economy, and some of the leaders of the eurozone may be blamed for failing to live up to the task.
It is, therefore, in everyone?s interest to help Greece. Perhaps the biggest help will come if eurozone leaders understand why US President Barack Obama has urged them repeatedly to help Greece so that it does not go belly-up.