Greece: A Tale Of Toil

Includes: GREK
by: Yale Economic Review

Since 2009, Greece has struggled to pay its debts. Already burdened with a high debt to GDP ratio, the Great Recession of 2008 exposed structural weakness in the Greek economy. Together, these problems led Greece to the brink of default. Fearful of the repercussions of a default, various European governments along with the European Central Bank and the International Monetary Fund (IMF) loaned money to Greece. While this bailout provided temporary relief, it now looks that Greece will be unable to repay its debt in its current state. The country is struggling to maintain a 1.5% primary budget surplus (its surplus before interest payments), and the 3 and 4.5% primary surpluses expected in the next two years respectively, are impractical and impossible. As it stands, Greece's debt burden currently is at a staggering 175% of GDP. As Paul Krugman noted, holding Greece to its current agreement could lead to a nearly 8% decline in the country's GDP. Moreover, while the adverse effects of austerity can often be counteracted through monetary policy, Greece's inability to issue its own currency prevents it from undertaking the requisite stimulus measures.

Although Greece's creditors - namely, Germany - rightfully demand that they receive sufficient compensation for their loans, they must also recognize that their interests are directly tied to the health of the Greek economy. The resulting decline in GDP from continued austerity will only make it more difficult for the Greek government to collect revenue and will in turn, decrease the likelihood that the government will pay off their debts.

Yet the Greek government must also make sacrifices. The bold, populist claims made by Alex Tsipras, Greece's new prime minister, were understandable prior to the election, but many believed that he would be more willing to compromise his extreme anti-austerity platform after entering office. Unfortunately, these beliefs have proved false. The new Syriza government, led by Mr. Tsipras, seems worryingly close to reversing many of the positive reforms enacted by the previous government, by raising the minimum wage and scrapping privatization plans. These goals are worrisome not only for a recovering Greek economy, but also for its creditors.

Altogether, it is clear that the status quo can only lead to another default. Yet this is not to say that there does not exist a solution. It is in all parties' best interests to restructure Greek debt. In other words, Greece's creditors are better off accepting lower returns on their loans in order to increase the probability that Greece is able to repay its debt. However, this must come with a guarantee that Greece is able to maintain economic growth.

In short, Greece must be willing to accept conditions with any restructure of its debt. While this may seem harsh, it is not without precedent. The IMF established the Heavily Indebted Poor Countries (HIPC) initiative in 1996. This program, generally targeted at African nations, allows for countries to issue debt in exchange for promised policy changes. Although Mr. Tsipras has maintained a stubborn resistance towards proposed restructurings involving policy conditions, he must and will eventually realize that such conditions are a necessity as Greece cannot maintain its current debt levels.

While this may give Greece's creditors an advantage in negotiations, it seems likely that Greece's creditors realize the importance of providing a feasible path forward. As a result, it is likely that a restructured plan with limited but important conditions will constitute the much-needed compromise between Greece's government and its creditors.