It was wrong from the start. Going on the incorrect assumption that the Eurozone crisis could only be overcome with the help of the crisis-proven IMF, it was the German government above all that insisted on embedding the Fund as an equal partner in the Troika meant to draw up and monitor the rescue programme for Greece. Behind this may have lurked some lack of trust in the resoluteness of the other two Troika members, the European Commission and European Central Bank, as regards pushing through the spending cuts seen as de rigueur in Berlin. But the federal government was obviously pretty unclear about the consequences of its action.
In a dilemma
The easily identifiable error from the start was political in nature: By drawing in the IMF as an equal partner the EU admitted de facto that it saw itself as unable to solve the Eurozone crisis on its own. This sent a signal of political bankruptcy. Finally, this conceded a clear right to co-determination in solving an intra-European problem to other IMF members, especially the influential USA or emerging countries such as Brazil and India. This weakened Europe’s political weight.
From the German government’s point of view it’s clearly surprising that its economic speculation didn’t work out. The IMF actually turned out not to be the hoped-for hawk over retrenchment but, to the horror of the economic hardliners in Germany, a dove. And here lies the heart of the problem: the contradictory nature of the so-called rescue plan for Greece.
Even today the German government believes that the core problems of Europe are down to excessive public borrowing and a lack of competitiveness. And these can only be overcome through tough spending cuts combined with structural reforms primarily in the labour market. It thought the IMF would be firmly on its side in this analysis and this, from the beginning, was wrong both as regards the analysis and the IMF’s “loyalty to the alliance.”
Whatever its origins, the problem of Greece like that of the rest of the Eurozone is a lack of economic demand. This is lacking because the combination of harsh spending cuts and labour market reforms have hugely reduced incomes for the broad mass of people through wage-cuts and high unemployment. Anybody who, like the Commission, expected that growth would spark back into action via improved competitiveness has fallen at this hurdle of deficient demand. This is particularly true of Greece. The result was that, with diminishing economic output, debt levels could not be reduced despite the huge support from the ESM and the IMF.
The IMF recognised this problem quite a few years ago and has again and again declared its readiness to pursue a softer cuts programme that would not so strongly impact upon gross domestic demand. But the German government in particular – since it laid the blame for the economic disaster at the door of faltering Greek efforts to cut spending – rejected this.
The IMF has been pointing to the logical consequence of this inflexibility for ages: Should there be no change of course towards Greece, the levels of government debt will become intolerable and debt relief unavoidable. This assessment has a severe consequence: the IMF may constitutionally no longer hand over funds to Greece and must quit the Troika.
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This has put the German government in a triple dilemma of its own making. Either it weakens the programme of retrenchment or it agrees to debt relief or simply accepts the IMF’s departure. Berlin doesn’t like any of these three options. But the federal government has the power to block only two of them. So it’s going to have to grasp the nettle. As we can gather from the leaked conversations the IMF itself is already considering putting this result into effect consequentially.
The best thing for Europe and Greece would be if options one and three were adopted. It would make sense politically for the IMF to quit. Even so, it could still carry on giving aid in the form of technical advice. Just as sensible would be a softer cuts programme that helps breathe new life into gross domestic demand. But harsh debt relief would be problematic. It would overwhelmingly hit the budgets of other European countries and raise their own levels of debt. It would be even worse if uncertainty about government debt arose anew. In any event, a debt moratorium in the form of longer payback times and even lower interest rates would be sustainable and helpful.
But there’s one fact that can’t be ignored: The German government will have to move economically. Its course was always unsustainable – right from the start.
Gustav A Horn is professor of economics at the University of Duisburg-Essen, a member of the executive board of the SPD and chair of its Council of Economic Advisers. He is also chair of the Keynes Society.