The modern Greek tragedy
A European nation with a proud heritage, Greece is nevertheless still an emerging market in many respects, and its economy has suffered the kind of epic depression that entrenched high-income countries have managed to avoid, even in the Great Contraction. Greece’s per capita GDP (in dollars), which had risen from 41% of German levels in 1995 to 71% in 2009, was back to 47% by 2014. On a purchasing power basis the decline was nearly as significant, from 77% of German levels in 2008 to 57% in 2013.
The conventional wisdom, certainly in Greece, is that the country has suffered through five years of excessive austerity, imposed by the IMF and the EU (primarily led by Germany), in a misguided effort to repay the country’s private creditors and to suck cash out of Greece. This view, although often reinforced by some academic commentators, is wrong. The aim of this note is to lay out the facts as best as we can ascertain them. In doing so, we hope to help illuminate some of the underlying strategic bargaining issues in a way we hope will be of interest to both academics and to observers of Eurozone debt negotiations. (We look more directly at the theory of sovereign debt contracts, and how the Greece case might be illuminating, in a separate companion piece more narrowly directed at researchers.)
Early motivations for lending to Greece
It is true that a major early motivation for the EU to lend to Greece was to subsidise its banks, but it is not true that Greece’s creditors were taking money out of the country, at least until the Greeks chose to postpone or stop meeting the terms of its second bailout deal in the second half of 2014. Europe continued to provide cash inflows to Greece until that time, on top of the banking system support it still provides, and arguably does not really expect to be a net receiver of very much if any money over the next few years (at the very least). The bailout deals negotiated with Greece were meant to provide it with the cash needed to ease the transition from running primary deficits in its heavy borrowing years and to help keep its banks running and its private creditors at bay. The problems that Greece faces are due to a loss of confidence in the state, not only by foreign private investors but also by Greece’s own citizens. Indeed, the latter have withdrawn over a hundred billion euros from the banking system since the onset of the crisis in early 2010. While Europe has replaced much of this money through Target2 loans (now primarily ‘Emergency Liquidity Assistance’) the Greek banks have also been weakened by the 33.5% of their private loans that are non-performing, reducing their capacity to take on new risky loans. It is partly for this reason, as well as because of the losses Greek banks suffered in 2012 on their holdings of Greek Government Bonds, that a significant part of the new money that Greece received over the past five years had to be used to recapitalise Greek banks.
Whereas the EU has actually been a net provider of funds to Greece since the beginning of the crisis, this is not to say that its motivation has been entirely charitable. Greece has been able to combine the threat of default (which would create an unknown and potentially massive risk for the EU), a promised commitment to economic reforms that would put it on the road to self-sufficiency, and its ‘too small to fail’ status to gain extraordinary financial support. Over time, the risks of ‘Grexit’ – Greece leaving the euro – while still unknown, appear to have lessened for most observers. At the same time, the Greeks have recently elected a party seemingly intent on rolling back some of the country’s hard-won economic reforms, negotiations have become harder. Nevertheless it seems unlikely that in any deal Greece would be asked to pay back as much cash as it receives in net subsidies from the EU, at least for a long time to come.
Read more: http://www.voxeu.org/article/modern-greek-tragedy