Grexiting: why you should not (only) blame the big bad creditors

The Greek situation is continuously evolving. The deadline for Greece to repay a €1.5 billion (A$2.2 billion) loan to the IMF has now officially expired and with the referendum on creditors’ proposals on Sunday, Greek Prime Minister Alexis Tsipras seems prepared to make some last minute concessions.

In a letter dated 30 June 2015 and addressed to the representatives of European Commission (EC), European Central Bank (ECB), and International Monetary Fund (IMF), Tsipras indicates the willingness of the Greek government to accept at least some of the conditions set out in the document known as “Reforms for the completion of the current programme and beyond”.

It is however unclear whether this will be enough to convince creditors to close the deal. In particular, the German government has already made clear that those proposals are no longer on the table and that no new negotiations will occur before the referendum.

In the current situation, the temptation to blame the “big bad creditors” is strong. Certainly, the group formerly known as troika (EC, ECB, IMF) has made several mistakes since the eruption of European debt crisis.

Yet, a story that only blames the troika for the ongoing drama would be badly incomplete.

A tale of odious debt

In a recent interview to an Italian newspaper, French economist Jean-Paul Fitoussi argued that Greek’s debt should be cancelled in the same way as the Allies cancelled the German (and Italian) debt at the end of World War II.

In practice, what Fitoussi proposes is to treat Greek’s debt as “odious debt”; that is, debt incurred by non-democratic regimes for purposes other than increasing the welfare of their citizens. It is largely accepted that odious debt should not be enforced.

However, Greek debt hardly fits the definition of odious debt. On the contrary, debt in Greece has been specifically used by democratically elected governments to finance per-capita income growth.

A banner reading ‘No to blackmail and austerity’ on an Athens buildingAAP/EPA/Igor Talayevich

According to IMF data, in the 20 years from 1989 to 2009, Greek general government debt as a percentage of GDP increased from 56% to 126%. Over that period of time, per-capita GDP increased from €14,741 to €21,380. This is a 45% per-capita GDP growth compared to a 28% growth in Germany over the same period.

One might argue that the choice to boost growth via debt was hazardous, if not plain wrong, because clearly unsustainable in the long term. But this does not make Greek debt odious.

Moreover, the post-war cancellation of German and Italian debt was attached to rather stringent political and economic conditions. In general, whenever debt has been cancelled, conditions have always been imposed to prevent moral hazard.

The proposals advanced by creditors aim exactly at that: establishing conditions to pave the road to debt cancellation (because in the end this is where the process is going). Demanding creditors to cancel the debt of Greece without conditions would be an unjustified pretence.

The austerity that isn’t

The goal of the proposals put forward by creditors is to achieve fiscal consolidation in the form of budget surpluses. Is this austerity? Well, the answer is no.

Austerity is when taxes on incomes are increased by several percentage points, when public sector jobs are cut, when pensions are cut, when expenditures on health and education are cut, when bank deposits are taxed.

Greece and other European countries experienced this austerity in 2011-2013. But the conditions that are now requested by creditors are significantly different.

The reform of the pensions that creditors are proposing is about discouraging early retirement and extending retirement age, which is a reasonable thing to ask given that in Greece pensions amount to 17.5% of GDP (source: Eurostat) and 75% of pensioners secure their early retirement before the age of 61.

Greek pensioners queue outside a bank branch after capital controls are put in place.EPA/Yannis Kolesidis

In creditors’ proposal there is no mention of increasing taxes on household income. There is a request for increasing the corporate tax rate (two percentage points). More importantly, there is a provision to standardise the VAT rate at 23%, but with discounted rates on necessary goods like basic food, energy, water, and pharmaceuticals. Probably the hardest request in this sense is to eliminate the 30% VAT discount on islands.

On the expenditure side, there is no proposal of cutting public employment. Instead, creditors ask for a reform of public administration to: a) ensure that the wage grid aligns with the wage bill target and b) wages are more closely linked to skills, performance, and responsibility of staff.

Finally, still on the expenditure side, the request is to reduce the military spending ceiling.

All in all, these proposals can hardly be regarded as a new wave of austerity.

Power to the people

Tspiras has justified the referendum as a way to give people the power to decide their own future. In fact, a counterargument is that in a representative democracy, the government is elected to take care of technical decisions like the reform of pensions, of the public administration and of the tax code.

Greek citizens are actually asked to vote on the technical document submitted by creditors and this does not seem like material for a referendum. The document is not necessarily easy to digest and the risk is that people will end up voting based on biased summaries – one way or the other – presented in the media.

But there is another potentially disturbing aspect in the decision to go to a referendum.

The view that Greece has been strangled by interest payments since 2010 is not entirely correct. Certainly, interest payments have been, and still are, very large. But at least until 2013-14, the inflow of financial support provided by the troika to Greece actually exceeded the interest paid, as recently noted by economists Jeremy Bulow and Kenneth Rogoff.

This financial support provided to Greece is essentially coming from the budget of European partners; that is, from European taxpayers, including taxpayers from countries that have been in very troubled waters, like Italy and France.

Suppose then that Tspiras is successful in his call for Greek citizens to choose no and make default happen. Then, by reciprocity, shouldn’t citizens in other European countries be asked if they are still willing to provide financial support to Greece?

Exiting from the eurozone would not necessarily mean a return to prosperity for Greece.AAP/EPA/Fotis Plegas G.

Grexiting would not fix a thing

If the “no” wins on Sunday, Greece will be dangerously close to a Grexit; that is, a disorderly exit from the eurozone. Those who see the eurozone as the source of all evil will rejoice: without the eurozone, Greece will return to prosperity.

The problem here is that the eurozone is not the main reason for the Greek crisis. Austerity in 2011-13 has made the crisis worse, but the crisis itself has been generated by Greek’s own fiscal profligacy and structural weaknesses. Removing itself from the eurozone will not create a long-term boost, which is ultimately what Greece needs to exit the tunnel.

Greece would have to go back to printing its own currency (drachma) and running its own monetary policy. The drachma will quickly devalue. Greek exports will become cheaper on international makers, but imports will cost more to Greek producers and consumers. The net effect of the devaluation will not necessarily be a boost in net exports, and even if it is, empirical evidence suggest that this would be short-lived and with relatively little effect on long-term growth.

On the other hand, a Greece that is no longer part of the eurozone will find it difficult and costly to borrow on international capital markets while private investors will most likely flee the country (scared by uncertainty and expectations of continued currency devaluation). As a result, Greece would find itself under an even tighter budget constraint than today.

The only way to ensure a minimum of government expenditure would be for the central bank to monetise spending by printing more and more of the new drachmas. This would induce an inflation spiral that can easily get out of control.

At that point, the future of Greece would look very gloomy, to say the least.

Fabrizio Carmignani receives funding from the Australian Research Council for a project on the estimation of the piecewise linear continuous model and its macroeconomic applications.