Greece in Our Time

After a weekend of brinksmanship between Greece and its debtors, the European Union emerged on Monday morning with an agreement to muddle through. The choice, which occupied the negotiators until dawn, was stark: come up with an agreement for Greece or prepare for the first-ever departure of a country from a so-called irrevocable eurozone membership. For the moment, they’ve chosen the former.

It’s easy to understand the pressure for them to find some kind of deal. The potential harm from Greece abandoning the currency union was seen as immense, even by a German paper, Der Spiegel, which wrote:

[W]ere Greece to leave the euro, the consequences would be disastrous — for Europe, for Greece and indeed for Germany. … A Grexit would mark the end to the process of European integration; the euro would be destabilized as a currency; the EU would be geopolitically undermined.

Even so, according to the Financial Times, German Chancellor Angela Merkel and Greek Prime Minister Alexis Tsipras were ready to call it quits, until European Council President Donald Tusk forbade their departure.

So, back to muddling through.

I argued last week that such muddling would be particularly difficult now, given the disastrous state of Greece’s economy. An agreement has to work in three key dimensions:

1) It has to work politically.

2) It has to work economically.

3) It has to provide a viable precedent for the eurozone.

Take the politics first. This includes both politics in Greece and in the rest of the countries of the eurozone. In Greece, the voters first elected Syriza as a protest against austerity. Then, they voted “No!” in a July 5 referendum on a gentler, if expired, European bailout offer. Now the Greek parliament will have mere days to approve a package of measures that are being characterized as a complete capitulation. Greece’s Labor Minister said the deal called into question Syriza’s governing majority.

German leaders and other skeptics were quite open about how little trust they had in the Syriza government — hence the demand that the Greek parliament pass a raft of reform measures first. Money will flow second. It would be nice if economic reform were that simple. It would certainly have made IMF and World Bank conditionality much more effective than they have been. In reality, as Kenneth Rogoff, professor of economics and public policy at Harvard, argues, reforms tend to work only when there is a committed domestic reformer pushing them.

The politics outside of Greece look just as problematic. It was tempting to cast the standoff over the weekend as Merkel vs. Tsipras, or perhaps Merkel vs. French President François Hollande, who took up the Greek cause. In fact, the skepticism about Greece’s prospects within the eurozone was widespread within Germany and was reportedly shared by other countries, including Finland, Estonia, Lithuania, Slovakia, Slovenia, and the Netherlands — a rift within the eurozone. And even if the Greeks pass all the measures they are supposed to this week, a new bailout package will still need to make it past these skeptical parliaments.

What, then, of the economics? Will the third bailout be the charm for Greece? Here the situation looks even worse. Greece’s economy is failing at two levels: chronic bad and acute bad. Chronic bad consists of national output that has shrunk by more than 25 percent, a debt load that the IMF has declared unsustainable, and shocking levels of unemployment (25 percent overall, 50 percent youth). Acute bad consists of capital controls, limits on ATM withdrawals, and fears of bank failures. The package does not seem to address either of these challenges in a satisfactory way.

Passing a package of market-oriented reforms is a good thing, but it rarely suffices to tell a patient in cardiac arrest that they should eat better and get more exercise. The absolute minimum that would have been needed for a workable package would have been an infusion of funds sufficiently impressive so as to remove any doubts about the viability of Greek banks. That does not seem to have happened with the preliminary deal negotiated this weekend. Greek banks will remain closed at least until Wednesday. There is some talk of bridge financing and Greece is being instructed to sell assets to recapitalize its banks. This sounds like a recipe for a bank run. The Financial Times‘ Alphaville blog offers a more detailed analysis of the Greek banking situation and poses the question: “if you had a Greek bank account, would you rush to return your cash to it?” Any suggestion that the fix is temporary will likely encourage any Greek bank account holders to drain whatever funds have been stuck for the past couple weeks. When banks face fleeing deposits and non-performing loans, they fail quickly. When they fail, the economy fails.

Compared to the daunting political and economic obstacles, the question of precedent may seem picayune. But it has been at the heart of the Greek impasse. If the wealthier countries of Europe had offered Greece a blank check and forgiven Greek debt, it would have raised very difficult political questions in countries such as Portugal, Spain, and Ireland, where leaders backed painful measures to pay off debts. It also would have raised concerns in some of the countries of Eastern Europe who are poorer than Greece.

That was the fate Europe avoided by holding firm against Syriza. Instead, Europe explicitly raised the possibility of an exit mechanism from the eurozone. In its harsh approach, Financial Times columnist Wolfgang Munchau despairs, the creditors “have destroyed the eurozone as we know it and demolished the idea of a monetary union as a step towards a democratic political union.” He argues that when eurozone membership becomes a purely economic calculation, a number of members will conclude it is not in their interest and the edifice will crumble.

It is no great surprise that the eurozone opted for Door #2 rather than facing an immediate Grexit. After all, Europe has been deferring, rather than resolving, the Greek problem since 2010 (with strong U.S. encouragement). However, unless an unanticipated bout of creditor generosity pops up this week, the deferral of Grexit is not likely to last very long.

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