Greece: Policy Overhang, Debt Overhang and Growth–A Quick Reaction

Angel Ubide of the Peterson Institute recently wrote a piece entitled “A Political and Intellectual Proxy War over Greece”. Angel has been an insightful, clear and constructive voice throughout the European crisis. This piece is no different. I urge you to read it.

But we are on the opposite sides of the Greek dilemma. I think Greece needs to return to the drachma to clear the clouds of policy and debt uncertainty and quickly finish repricing their factors of production. And tourism responds quickly. The pain would be great, and there is no cheating good governance, but the proverbial light at the end of the tunnel would no longer be Minister Schauble’s searchlight. You can’t fit a square peg into a round hole no matter how much money you pour into the hole.

Angel asserts Greece was on the verge of growth last summer and would be again if the right policies of generous debt relief and aggressive structural reform were enacted.  I have my doubts, but he makes some compelling points.

There were two areas, however, where I felt the case was overstated:

  1. Growth: Asserting last summer’s upturn was the beginning of a trend is far too strong.
    • The defining characteristics of post-crisis growth forecasts in developed economies have been serial GDP overestimation and false starts. Others’ forecasts of Greek growth don’t give me comfort either.
    • Unit labor costs have gotten much better, but the enabling environment is much worse.
    • The policy overhang (slippage risk, serial negotiations) would continue for as far as the eye can see under a new program—especially if insolvency relief is back loaded, as it most certainly would be. Trapdoor downside while creditors have exercisable warrants on the upside lowers the equilibrating unit labor cost.
    • It’s possible Greece was on the verge of sustained growth, but it’s as least as likely that it wasn’t. And the debt overhang is at least a growth dampener, and at most a counter-cyclical destabilizer.
  2. Characterization of the “no” camp was too harsh, too black or white
    • No one thinks a de-pegging would solve everything; Nor would it be painless.
    • In a de-pegging, there would likely be a final burst of pain, and it would be sharp. But it would also be followed by hope. The serial bloodletting of Troika programs would be over. And the debt overhang’s status would be relegated from urgent to important, giving Greece relief from living payment to payment.
    • The euro didn’t fail in Greece because it prevents devaluation. It failed because it allowed imbalances to build to where we still have to argue if Greece might be competitive enough to grow after a 25 percent GDP contraction. It failed because Europe was too ambitious in including a country as dissimilar as Greece in the first place. And it failed because it had a negative effect on disciplining policy, rather than the positive one that had been envisaged.
    • Many critics of austerity think it has been an exacerbating factor, not a decisive one. Most understand that there were limits to Europe’s ability to respond with fiscal stimulus from the outset. In brief, some austerity was inevitable.
    • But the defense of ‘expansionary austerity’–especially after reality disagreed—assassinated the hope of a more reasoned debate. Sure, there may be a few left wing types trying to sneak fiscal expansion into every back-door, but most austerity critics would have simply liked a little more fiscal space to cushion, financially and politically, the implementation of transformational structural reforms.
    • The heavily propagated idea that most austerity critics ignore structural reform is false. But the notion that most austerity proponents believe structural reform alone is enough—but only if you beat yourself hard enough with it—continues, sadly, to be true. (Angel, for the record, is not in this later camp.)

Like others, I am of the view that Greece is the extreme case and even pristine fiscal and monetary policy wouldn’t have spared it this disaster. It never should have been in in the first place. Greece has a deep tradition of poor governance at home, while milking partners abroad at every possible turn. Even the least charitable interpretation of Syriza doesn’t suggest it’s a break with the past.

Lastly, the black and white exposition also plays into the hands of the many who believe—at some conscious or subconscious level—that American and/or British economists somehow want to undermine in some zero-sum way the whole EU project. Yes, their ‘distance’ can lead to less empathy. But behavioral science also tells us that distance also has its virtues: greater objectivity.

What is unsustainable will, ultimately, not be sustained. Greece needs to stop clinging to the anvil disguised as a lifeboat and get past its fear of floating. Europe should get over the sunk cost fallacy, swallow its pride and take the hit.