Europe is exhausted with Greece. Greece is exhausted period. It is time to let go? Not quite.
The case for letting go is simple. The results of first €110 bn bailout have been mixed. After a strong start in 2010, progress slowed, and 2011 was abysmal. The economy continues to shrink, finances are not improving, unemployment keeps rising, social tensions are mounting and public health is deteriorating. There is no longer a sincere dialogue between Greece and troika. Greece no longer claims any ownership over this program (if it ever did). Politicians have zero credibility to promise, much less implement, reforms. If the Europeans don’t trust the Greeks, and if the Greek government can’t deliver, what’s the point of keeping down this path?
A default and even a Eurozone exit would not be the end of the world, although a Eurozone exit carries more contagion risk than a mere debt write-off. So many countries have defaulted and launched new currencies without collapsing. A default would allow the government to offer tax breaks or increase spending to prop up growth. A new currency would make goods and services more competitive, and it would prompt an export boom. Trade may be hampered for a while as finance becomes scare, but it will ultimately be restored. Provided that Europe can contain this exit, Greece would plunge into a deeper crisis but at least it would see a clearer way out. Much of the pain facing Greek society would become deeper for a short period but would be alleviated later on.
If that is so, why not just default? Odd as it may seem, default is the easy way out. It alleviates pain but does not correct the underlying problems from which pain emerged. Europe is rightly frustrated that Greek governments cannot seem to implement reform. But this is a supply problem. At the same time, the demand for reforms is changing, and in that sense, first bailout did much good. A default in 2012 is not the same as a default in 2010. If Greece defaulted in 2010, as many economists advocated it should have, the default would have been devastating but not cathartic. Greeks would have blamed various villains such as politicians, domestic and foreign banks, speculators and the European Union. Answers to the question “what went wrong” would have been too broad, and the crisis would have laid no seeds for regeneration.
Instead, the national conversation is different today and, in many ways, it favors reform. After a big demonstration at the time when Greece signed the first bailout agreement, public opposition was subdued in 2010. Partly, it was a grace period – any young government gets a break during a major initiative. But more broadly, there were two forces at work. First, the reforms of 2010 were narrow, and it was easy to beat one interest group at a time. Second, there was genuine hope that chronic ills – tax evasion, restrictive regulations and exorbitant benefits in the public sector – would be corrected.
Both forces changed in 2011. As the reform agenda widened, the government’s commitment waned and the ruling party hedged its bets. This equivocation alienated the people who consented to pain only as long as it led to meaningful reforms. By mid 2011, the state had pushed for just enough reform to anger those who stood to lose from it but not enough to win over those who stood to gain from it. Now, the state keeps trying to raise taxes to pay for its unwillingness to shrink the public sector, to reform the private sector and to curb tax evasion.
And yet the past 18 months have also empowered the reform movement. First, the bailout bred hope. It did for Greece what the Tunisian man who set himself on fire did for Arab world: it broke a psychological barrier and awakened all those who had given up on the prospect of Greece ever changing to regain some; it empowered people and forced them to reengage. For the first time in a generation, the bailout offered an alternative future for all those people who were sick and tired of “old Greece.” Second, the bailout forced Greek society to debate taboos by placing issues such as public sector employment and privatizations at the center of the national dialogue where they could no longer hide.
This was welcome but, in certain ways, not enough. There was certainly an ownership issue: Greeks people saw foreigners calling all the shots and were frustrated at their incapacity to impact their future. More broadly, however, the reform advocates were too afraid and politically narrow-minded to argue for reform. And so the debate soon became “memorandum or the drachma” or even, “memorandum or the tanks.” In some ways, these were indeed the dilemmas facing Greece. But they also misrepresented what was going on. Yes, Greece was forced to change certain things at gunpoint. But did we really need bureaucrats from Brussels, Frankfurt and Washington, DC to tell us that collecting taxes is a good thing? That people who should be paid relative to what they do? That we should have honest statistics? That we cannot spend more than we earn with impunity? Did we really foreigners to tell us those things?
So where are we now? The overwhelming feeling in the country is one of frustration. That leaves five paths open. One is to allow a massive default and a new drachma – the premise being that only when the country hits rock bottom will it reform. But not everyone who hits bottom recovers, and certainly not quickly – this is risky and may push Greece on the edge and leave it there for a long time. Even though it may turn out to be the only path, it is indeed a last resort option as it would wipe out any short to near-term prospect for a liberal reform agenda to take hold.
The other four courses depend on how frustration is mobilized politically. One option is for the country to become apolitical, where people are so frustrated and disillusioned that they disengage. Such an outcome would mean that we have weak governments with limited mandates and where little gets done. Another path is for the country to fall for populism, look inward and blame outsiders. Yet another path is for the country to demand “law and order” and accept a quasi-police state that pledges to restore order and some modicum of decision-making. And a final path is for frustration to generate momentum for a bottom-up restructuring of the country along the lines of a leaner but more efficient state and a bigger and more productive private sector.
Europe needs to understand that its investment in Greece has nothing to do with paying back debt. Rather, it’s about to providing an environment where reforms can gain momentum – where that fifth path becomes more likely. Europe is too focused on the supply of reforms (and lack thereof) – it ought to focus on the demand instead. That demand has generally risen over the past 18 months – but it has also reached a wall. Absent any careful nurturing, it will dissipate. And the fallout from that failure will far exceed the economic havoc from a disorderly default and currency re-launch. What Europe needs is to reassure reform minded Greeks that reforms are possible and that any government elected by the people to carry them out will have enormous support in its efforts.