Moving into a New Era?

In 2012 a study by the Bertelsmann Stiftung warned that a Greek withdrawal from the Eurozone might not only hurt Europe by triggering a domino effect, but could also "cause a global economic crisis". The report's authors warned that the situation "could totally run out of control". European policy-makers shared this opinion and the so-called "Grexit" was eventually avoided. Six years later, however, another Grexit is in the news, but not in a negative way.

Aug. 21, 2018 will be an important date. The European Commission and the Eurozone members hope that it will mark the end of Greece's third bail-out program, wrapping up nine years of international support - amounting to 260 billion euros in external loans. It should also demonstrate that the recipe has at last borne fruit, sending a strong message to other countries resisting reform.

 The Greek government, meanwhile, hopes that it will end extreme austerity. With the opposition New Democracy Party enjoying a ten point lead in the polls, the SYRIZA-ANEL government is keen to regain control of the economy before the September 2019 election. However, like Portugal and Cyprus after their bailouts ended, Greece will also undergo post-program surveillance linked to balanced budgets and further reforms.

Painful Reforms and Social Costs  

Now the Greek economy is growing again, although at a pace below the Eurozone's average. Unemployment is slowly falling but is still above 20 percent. And the government has achieved a spectacular 3.5 percent primary surplus in the 2017 budget versus a target of 1.75 percent - mainly by raising taxes for the middle classes.

These successes are the result of extremely painful reforms. The adjustment program had heavy and largely unexpected economic and social costs. The Greek economy has undergone a severe depression, and one which has few historical parallels: since 2009 the country has lost more than quarter of its real economic output with dire social consequences. A study by the Athens-based think tank DiaNeosis found that the earnings of 15 percent of the population put them below the extreme poverty threshold. In 2009 that number was below 2.2 percent. According to the Bank of Greece, the net wealth of Greek households fell by a precipitous 40 percent during the same period.

Probably no other country in recent history has made such an impressive economic adjustment. Unit labour costs have been reduced by 16 percent, tax revenues have risen, pension reforms have been implemented and privatizations of public assets have multiplied.  

Fragile Economic Improvement

Greece's reforms have been much heftier than those of its ‘peer' Eurozone countries, such as Ireland, Italy, Portugal, Spain and Cyprus, but the benefits it has accrued have been much smaller. This is largely due to the fact that the Greek economy was relatively ‘closed'. Ireland, which recovered much more quickly, had, in 2009, an exports-to-GDP ratio four times higher than that of Greece. Thus, the internal devaluation imposed by Greece's creditors did not have an immediate positive impact: since exports started from a low base, even a high growth rate would mean that they had no chance in offsetting the declining domestic demand.

The Greek economy's uptick is both evident and fragile. Serious challenges remain. Real investment has dropped by 60 percent since pre-crisis levels and remains depressed mainly due to tight financial conditions. The reduction of non-performing loans in the banking sector is also a serious challenge.  

Greece's debt currently stands at close to 330 billion euros, over 180 percent of GDP. Almost 70 percent of this debt is owed to European official creditors, with some 70 percent to the European Financial Stability Facility. The IMF, along with most international observers, believe that this debt mountain is unsustainable and demands deep relief in return for continuing participation in the Greek program.  Germany and other northern European countries have ruled out a ‘haircut' but seem willing to consider a further extension of maturities and possibly a growth-adjustment mechanism that would link repayment to the rise of GDP. The IMF projects that Greece's debt to GDP ratio would fall to around 150 percent of GDP by 2030 but then it would rise substantially.

And the IMF's involvement in the Greek program is crucial, not in monetary terms but rather to reassure investors that Greece's public finances are on a sound footing. Many economists argue that without generous debt relief, Greece's fiscal policy will remain tight and the country will continue to suffer from anaemic growth and high unemployment.

Investor Anxiety

Volatility continues to be the key feature of the Greek government bond market.  This in turn makes investors jittery. Negative international developments lead to a sharp widening of yield spreads translating into significant losses. Greece raised 3 billion euro in a five-year bond issue in July 2017, around half of which involved swapping existing debt for longer-dated paper. That debt sale marked its first bond issue since 2014. However, Italy's recent financial turmoil raised interest rates again, putting hopes of Greece's "clean exit" on the back burner.

The tone in the latest Bertelsmann Stiftung Sustainable Governance Report is cautiously optimistic: "Overcoming the crisis is possible despite the imposed austerity measures, but [much] will depend on the pace with which structural reforms are adopted and implemented".

However these reforms are not only the responsibility of Greece. The European Union also needs to take steps to avoid similar disasters in the future: it should re-consider the unequal distribution of gains arising from freer trade. The European leaders should find the political will to adopt and implement the necessary institutional arrangements for the next steps of European integration, including a banking union and more resources for the development of countries lying behind. Without them, Greece's and other countries' painful adjustments will remain deficient and fragile.