O QUE DIZ MARTIN WOLF

Bail-out for Greece is just the beginning

Martin Wolf

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Desperate times; desperate measures. After months of costly delay, the eurozone has come up with an enormous package of support for Greece. By bringing in the International Monetary Fund, at Germany’s behest, it has obtained some additional resources and a better programme. But is it going to work? Alas, I have huge doubts.
So what is the programme? In outline, it is a package of €110bn ($143bn) (equivalent to slightly more than a third of Greece’s outstanding debt), €30bn of which will come from the IMF (far more than normally permitted) and the rest from the eurozone. This would be enough to take Greece out of the market, if necessary, for more than two years. In return, Greece has promised a fiscal consolidation of 11 per cent of gross domestic product over three years, on top of the measures taken earlier, with the aim of reaching a 3 per cent deficit by 2014, down from 13.6 per cent in 2009. Government spending measures are to yield savings of 5¼ per cent of GDP over three years: pensions and wages will be reduced, and then frozen for three years, with payment of seasonal bonuses abolished. Tax measures are to yield 4 per cent of GDP. Even so, public debt is forecast to peak at 150 per cent of GDP.
In important respects, the programme is far less unrealistic than its intra-European predecessor. Gone is the fantasy that there would be a mild economic contraction this year, followed by a return to steady growth. The new programme apparently envisages a cumulative decline in GDP of about 8 per cent, though such forecasts are, of course, highly uncertain. Similarly, the old plan was founded on the assumption that Greece could slash its budget deficit to less than 3 per cent of GDP by the end of 2012. The new plan sets 2014 as the target year.

Two other features of what has been decided are noteworthy: first, there is to be no debt restructuring; and, second, the European Central Bank will suspend the minimum credit rating required for the Greek government-backed assets used in its liquidity operations, thereby offering a lifeline to vulnerable Greek banks.
So does this programme look sensible, either for Greece or the eurozone? Yes and no in both cases.
Let us start with Greece. It has now lost access to the markets (see chart). Thus, the alternative to agreeing to this package (whether or not it can be implemented) would be default. The country would then no longer pay debt interest, but it would have to close its primary fiscal deficit (the deficit before interest payments), of 9-10 per cent of GDP, at once. This would be a far more brutal tightening than Greece has now agreed. Moreover, with default, the banking system would collapse. Greece is right to promise the moon, to gain the time to eliminate its primary deficit more smoothly.

Yet it is hard to believe that Greece can avoid debt restructuring. First, assume, for the moment, that all goes to plan. Assume, too, that Greece’s average interest on long-term debt turns out to be as low as 5 per cent. The country must then run a primary surplus of 4.5 per cent of GDP, with revenue equal to 7.5 per cent of GDP devoted to interest payments. Will the Greek public bear that burden year after weary year? Second, even the IMF’s new forecasts look optimistic to me. Given the huge fiscal retrenchment now planned and the absence of exchange rate or monetary policy offsets, Greece is likely to find itself in a prolonged slump. Would structural reform do the trick? Not unless it delivers a huge fall in nominal unit labour costs, since Greece will need a prolonged surge in net exports to offset the fiscal tightening. The alternative would be a huge expansion in the financial deficit of the Greek private sector. That seems inconceivable. Moreover, if nominal wages did fall, the debt burden would become worse than forecast.
Willem Buiter, now chief economist at Citigroup, notes, in a fascinating new paper, that other high-income countries, notably Canada (1994-98), Sweden (1993-98) and New Zealand (1990-94), have succeeded with fiscal consolidation. But initial conditions were much more favourable in these cases. Greece is being asked to do what Latin America did in the 1980s. That led to a lost decade, the beneficiaries being foreign creditors. Moreover, as creditors are now paid to escape, who will replace them? This package will surely fail to return Greece to the market, on manageable terms, in a few years. More money will be needed if debt restructuring is unwisely ruled out.
For other eurozone members, the programme prevents an immediate shock to fragile financial systems: it is overtly a rescue of Greece, but covertly a bail-out of banks. But it is far from clear that it will help other members now in the firing line. Investors could well conclude that the scale of the package required for tiny Greece and the overwhelming difficulty of agreeing and ratifying it, particularly in Germany, suggest that further such packages are going to be elusive. Other eurozone members might well end up on their own. None is in as bad a condition as Greece and none has shown the same malfeasance. But several have unsustainable fiscal deficits and rapidly rising debt ratios (see chart). In this, their situation does not differ from that of the UK and US. But they lack the same policy options.
This story, in short, is not over.
For the eurozone, two lessons are clear: first, it has a choice – either it allows sovereign defaults, however messy, or it creates a true fiscal union, with strong discipline and funds sufficient to cushion adjustment in crushed economies – Mr Buiter recommends a European Monetary Fund of €2,000bn; and, second, adjustment in the eurozone is not going to work without offsetting adjustments in core countries. If the eurozone is willing to live with close to stagnant overall demand, it will become an arena for beggar-my-neighbour competitive disinflation, with growing reliance on world markets as a vent for surplus. Few are going to like this outcome.
The crises now unfolding confirm the wisdom of those who saw the euro as a highly risky venture. These shocks are not that surprising. On the contrary, they could have been expected. The fear that yoking together such diverse countries would increase tension, rather than reduce it, also appears vindicated: look at the surge of anti-European sentiment inside Germany. Yet, now that the eurozone has been created, it must work. The attempted rescue of Greece is just the beginning of the story. Much more still needs to be done, in responding to the immediate crisis and in reforming the eurozone itself, in the not too distant future.