voxeu: Two lessons from the Greek crisis

More generally, though, there are two lessons we can learn from the way the EU has dealt with Greece.

• Delay is costly. The logic behind “debt forgiveness” is that investors may realise that the debtor country will not be able and/or willing to repay, because at such a level of indebtedness, the benefits from the debtor’s painful adjustment will only marginally accrue to him. Thus, by forgiving part of the debt, creditors may actually enhance repayments by providing the right incentives to debtors. Clearly, a restructuring agreement should be reached as soon as possible, not after the debtor’s economy has been shattered by the measures imposed by creditors. With Greece, it took about four years to reach the agreement: the sluggish adjustment led to a sharp contraction in the economy’s growth (red line, left scale in Figure 1 below) and to the explosion of the debt burden (blue line, right scale), while the ambitious targets were never fully met. So why wasn’t an agreement reached at the outset? In short, it was Europe’s fault.

Figure 1. Greece: GDP growth and the debt-GDP ratio

• “More Europe” is (not) the solution. We have heard the story over and over - “since the crisis is European, the solution must be ‘more Europe’”. The consequences of this ill-conceived idea are for everyone to see. Instead of choosing a realistic option of increasing the IMF’s endowment and letting it deal with troubled EU countries, Europeans decided to create new ad hoc institutions (EFSF, the ESM). With insufficient funding, clumsy voting rules (requiring, in some cases, unanimity), and a payment system “by instalments” possibly propagating contagion (see my article on this site, Manasse 2011), the new institutions achieved the following unenviable results.
  • They made technical decisions the hostage of national politics (German state and French general elections, German Constitutional Court pronouncements, Finnish government coalitions, approvals of national parliaments, a referendum in Ireland);
  • They introduced dangerous conflicts of interest within countries, between European taxpayers and European banks on the one hand, and between European countries, the creditors and debtors, on the other. This made national governments’ positions erratic and uncertain (see Germany). The result was a much-delayed restructuring and heightened contagion risk.
  
  
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