If I have seen further it is by standing on the shoulders of giants.

Monday, July 4, 2011

Once Greece goes…

The economic crisis in Greece is the most consequential thing to have happened in Europe since the Balkan wars. That isn’t because Greece is economically central to the European order: at barely 3 per cent of Eurozone GDP, the Greek economy could vanish without trace and scarcely be missed by anyone else. The dangers posed by the imminent Greek default are all to do with how it happens.

I speak of the Greek default as a sure thing because it is: the markets are pricing Greek government debt as if it has already defaulted. This in itself is a huge deal, because the euro was built on the assumption that no country in it would ever default, and as a result there is no precedent and, more important still, no mechanism for what is about to happen. The prospective default could come in any one of several different flavours. From everybody’s perspective, the best of them would be what is known as a ‘voluntary rollover’. In that scenario, the institutions that are owed money by the Greek government will swallow heavily and, when their loan is due to be repaid, will permit their borrowings to be rolled over into another long loan. There is a gun-to-the-side-of-the-head aspect to this ‘voluntary’ deal, since the relevant institutions are under enormous governmental pressure to comply and are also faced with the fact that if they say no, they will have triggered a proper default, which means their loans will plummet in value and they’ll end up worse off. The deal on offer is: lend us more money, or lose most of the money you’ve already lent.

This is, at the moment, the best-case scenario and the current plan A. It reflects the failure of the original plan A, which involved lending the government of George Papandreou €110 billion in May last year in return for a promise to cut government spending and increase tax revenue, both by unprecedented amounts. The joint European Central Bank-EU-IMF loan was necessary because, in the aftermath of the financial crisis of 2008, Greece was exposed as having an economy based on phoney data and cheap credit. The cheap credit had now dried up, and Greece was faced by the simplest and worst economic predicament of any government: it couldn’t pay its debts.

There is a good moment in one of the otherwise terrible Star Trek movies, in which Spock quotes an ancient Vulcan proverb: ‘Only Nixon could go to China.’ Similarly, it is probably true that only George Papandreou could confront the fundamental economic structure of the modern Greek state, since his father Andreas did more than anyone else to build it. Andreas Papandreou took Greece into the EEC in 1981, and subsequently the Greek government created a client state in which direct subsidies and transfers from the EEC were supplemented by easy loans from Western European banks. Money poured into Greece, and was used to fund a huge boom in public-sector jobs, most of them linked to political patronage. Various forms of corruption permeated the system, where cash gifts in fakelaki or ‘little envelopes’ were a fact of life, and where, crucially, the rich regarded paying tax as something that only the poor and stupid would ever choose to do. This latter fact meant that Greece was in certain vital respects a country without a functioning version of the social contract. To outside observers, all this was largely familiar, but the younger Papandreou, on becoming prime minister in 2009, was the first prominent Greek politician to admit it and promise to challenge it head-on. ‘Corruption, cronyism, clientelistic politics; a lot of money was wasted basically through these types of practices.’ Papandreou’s admission was jaw-dropping: everyone knew it was true, but since when do prominent politicians say very unpopular things which everyone knows to be true? The EU lent Greece the money to fund Papandreou through his programme of cuts and crossed its fingers that this would buy enough time for the deficit to narrow – the deficit being the gap between what Greece was spending and what it was raising in tax.

That was the old plan A, and it didn’t work. Papandreou made deep cuts across public-sector spending, but two things went wrong. One, the Greek economy kept crashing. Economists have varying theories about the practical effects of ‘austerity’, meaning sharp cuts in public spending. To an outsider, it’s a little alarming how they differ about something so big and basic as the effect of large public spending cuts. But if you ignore the economics and look at the history, it seems to be the case that you can’t simply cut your way to growth. (There are a couple of contentious counter-examples, but this is the broad rule.) Holding public spending flat while other parts of the economy grow is historically a more valid model – and, by the way, holding public spending flat is in itself a huge struggle, being roughly what Mrs Thatcher did in the UK. So the first problem was that the Greek cuts led to a worsening of the Greek predicament: the economy kept contracting, and unemployment hit a record high of 16.2 per cent. The second problem was that those richer Greeks who had never fancied paying their taxes showed no increased desire to do so, and, much worse, the state showed no new ability or desire to make them. Without the ability to raise more tax, the old plan A was invalid.

So this is the new plan A: the Greeks borrow another €120 billion, the bondholders allow their debt to be rolled over, Papandreou’s government introduces further austerity measures and privatisations, rich Greeks start paying their taxes, the Greek economy recovers, and by the time the next huge chunks of debt repayment are due – from mid-2012 – Greece can afford to pay back its lenders and the crisis is over.

Continue reading - John Lanchester - Once Greece goes…

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