Saturday, June 18, 2011

Greece after a Cabinet Reshuffle

What started as a free-fall ended up as a bungee jump, and a government that seemed one the verge of collapse, regrouped, reconciled and may even survive. But besides the sheer entertainment value of seeing this roller coaster, what exactly happened over the past few days, and what does it mean? Before thinking about this reshuffle, let us review where Greece stands.

First, Greece’s agreement with the troika was premised on the country returning to the markets in 2012. That premise is effectively dead (see here). Unless Greece can secure more official aid or miraculously reverse market sentiment, it will default by March 2012. This fact cannot be changed by any revenue or tax measures unless those measures either (a) massively change market sentiment or (b) help Greece secure further official aid.

Second, Europe is very keen to help Greece avoid default, but the structure of the help is extremely contentious. German support is particularly conditional, and German Chancellor Angela Merkel faces a number of political and even legal challenges in forging a new agreement. Her plan to make a new bailout plan contingent on involving the private sector (i.e. forcing a haircut) has been fiercely resisted by the European Central Bank. She has since softened her stance, but her problems within Germany are not going away.

Third, getting further official aid is premised on presenting a coherent and credible plan, which is what the medium term strategy was meant to accomplish. The pillars of the strategy were three: (a) grow government revenues in line with GDP; (b) freeze spending at stable nominal terms such that increased interest payments are offset by a reduction in real expenditures; and (c) engage in a very extensive (though not unprecedented) privatization campaign to both raise revenue and accomplish the task of shrinking the role of the state. Together with growth at historical levels, Greece’s debt could be somehow manageable, reaching 100% of GDP by 2024, assuming historical growth rates and the maintenance of fiscal discipline.

Four, the popularity of the Greek government has been falling. The prime minister’s approval ratings continue to tumble (23% think him most suitable for this job), while frustration is growing in the streets of the country. Finding a unifying theme that frustration is difficult, but broadly speaking, it comes from three sources: (a) the frustration of insiders: the people, mostly in the public sector but sometimes in the private sector as well, who stand to lose from reforms; (b) the frustration of those who believe that this crisis was generated by cheating politicians and who are more or less repudiating the political class; and (c) the frustration of those who think that the ruling cabinet, and the prime minister in particular government, have been spineless in passing through reforms and that change is not coming rapidly enough.

Five, social tension is rising. Greece’s recession is greater than anticipated and unemployment hit 15.9% in Q1 2011, versus 10.3% when this government took office in Q4 2009 and much above the forecasted 14.5% for 2011. Violent incidents are rising and a growing disconnect – that runs two ways – between Greeks and immigrants is further threatening social cohesion. There is a growing sense that the government cannot impose order.

Six, the unity of the cabinet and the ruling party has disintegrated. There is a growing number of very public disputes between ministers and, more recently, an open mutiny against the prime minister, which included the resignation of two members of parliament. This challenge was effectively put out by the PM appointing his chief rival as the number two in the government (in reality number 3 but de facto number given a portfolio that includes the ministry of finance).

Seven, the reform agenda has reached its most crucial phase. If 2010 was the year of easier choices, then 2011 was the year when the PASOK government had to basically implement an agenda that would, for the most part, radically unsettle its own power base. This agenda revolved chiefly around shrinking the public sector both directly and through privatizing state-owned enterprises, of which some (e.g. the Public Power Corporation) boast extremely powerful unions. In effect, PASOK needed to move past being PASOK if its agenda could succeed.

Greece thus faces a deep political, economic and social crisis, and it is being navigated through that crisis by a government that is increasingly unpopular and divided, and which is failing to convince either Greeks or foreigners that it means business. As a result of this dynamic – and the extremely unfavorable math, the choices that are open to the Greek government are fairly limited, and frankly have to conform more or less to the medium strategy.

Now bring in a cabinet reshuffle. By way of disclaimer let me say that I was a big fan of the sacked finance minister. I found it sensible and component, given the circumstances. His chief offense, it seems to me, was that he did not play well with others in the government and that power was too concentrated in his hands. His offense was thus more political than anything. Given Greece’s structural and mathematical realities, the substance of future policy has little room to change.

The question is then whether the style of policy will change. In theory, this reshuffle, by closing ranks, restores some governability. But it does not resolve the underlying tension that what Greece needs is for PASOK to not be PASOK; in fact, by pulling in a major old PASOK figure, that goal is not only nullified but perhaps reversed. From the PM’s perspective, party cohesion is better than no party cohesion, and given his blunders, he may have had no other choice. From the country’s perspective, however, the challenge for PASOK is to believe there is electoral hope in a policy that challenges so much of its constituency base, and it is not clear that this will happen.

In theory, the party that is so wedded into the establishment could more easily sway its own supporters. But in practice, this is a zero sum game, and the hope rests on the government’s ability to articulate a broad message for the country’s direction that will galvanize support outside the party while maintaining a parliamentary majority. So far, no politician has been able to articulate this message, provide an honest account of how Greece got into this mess and what awaits the country on the other side. Without that, Greece’s hopes are dim, cabinet reshuffle or not.

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