Now that the Greek elections are out of the way and the new government under Alexis Tsipras has taken office we are entering a phase in which the existing policy mix will be re-negotiated. This is good news and overdue as the old recipes have clearly not worked. The evidence from Greece and elsewhere is overwhelming so it is important for the creditor countries to accept that the current policy direction is, in fact, misguided.
As James Galbraith wrote yesterday, it is also important that everybody approaches the upcoming negotiations in good faith and realises what responsibility they have not just for their respective countries but for the Eurozone and the European Union as a whole.
That said, I am hopeful that there can be a compromise – a new deal for Greece and the Eurozone. There is certainly scope for one and here are the three elements that I consider necessary:
Dealing With The Debt Burden
Addressing the issue of the existing debt mountain, I think Paul Krugman hit the nail on the head when he made the crucial distinction between stocks and flows. The debt burden the new government has inherited is a stock and whether it is a problem or not really depends on how one deals with it:
the great bulk of the debt is now officially held, the interest rate bears little relationship to market prices, and the interest payments come in part out of funds lent by the creditors. In a sense the debt is an accounting fiction; it’s whatever the governments trying to dictate terms to Greece decide to say it is.
Greece’s primary budget surplus on the other hand is a flow which, together with aid funds, is used to service the debt. If I understand Syriza’s policy correctly their idea is to cut the debt burden (stock) in half in order to free up funds for extra spending and investment (alternative use of flows).
One key principle of negotiation is that you negotiate interests, not positions. The positions in this case are mutually exclusive: Syriza insists on a debt write-down, the creditor countries insist on repayment. As the sustainability of the debt depends on the cirucmstances (see Andrew Watt here), I think there is a solution if you move beyond positions and try to reconcile interests.
The creditor countries’ interest is effectively the same as their position: they don’t want to be seen rolling over and giving in. The interest of the Greek government, however, is to free up funds to kick-start growth again and deal with the humanitarian crisis in the country. The negotiation position of debt write-down is a means to that end.
This end can, however, also be achieved if there is a moratorium on debt service, a further reduction of interest rates and a linking of future debt service to growth rates. This would take the debt stock problem off the table for the foreseeable future without the need for a formal haircut or default. Both sides could claim victory as their interests would be reconciled.
Kickstarting Growth And Domestic Reform In Greece
Once the debt stock problem is under control there needs to be a clear departure from austerity. The Greek surplus should be invested in the country and there should also be a more extensive European investment push by making sure – probably through policy tweaking as Ronald Janssen suggested this morning – that the European level investment programme of the Commission ends up helping the countries most in need. The Troika conditionality needs to change and misguided policies of recent years should be reversed. Once a growth path is firmly re-established, the debt/GDP ratio will be significantly lower when debt service resumes at a later point and the old debt stock ceases to be a major problem.
In return for this change, Syriza needs to make good on its promise to fundamentally reform the flawed domestic structures in Greece itself. There is little doubt that corruption is a major problem and that the tax system and the civil service, amongst other institutions, need serious reform. It would be an important signal of commitment to the rest of Europe if the new government made serious progress in the areas its predecessors did not.They have to deliver in this area.
Linking Up Monetary And Fiscal Policy Across The Eurozone
The third element of a new deal is a task for the Eurozone as a whole. It is obvious that if you want to deal with sluggish growth and large debt burdens a deflationary economic environment is really the last thing you want. The ECB has, in the end, done its bit by starting QE. But as Mario Draghi said, QE alone won’t do the trick. We need a concerted investment push across the Eurozone that takes advantage of the new money created through QE and record low interest rates. If you don’t invest now, when would you ever do?
There are reliable calculations that coordinated investment would have a significant positive multiplier effect and help boost growth. If you want to leave behind the years of stagnation and make sure that high debt levels – by the way not just in Greece! – decline in the medium to long-term, you need to make sure that Eurozone inflation gets back to its 2% target as quickly as possible. If a real deflation takes hold the problems will become much harder to manage as the real debt burden increases.
This investment push should start in Germany with a large public investment programme. There is a significant private and public investment gap that is estimated at around 3% of GDP at a time when yields of German 10-year bonds are below 0.5%. There is a lot of catch-up investment to do and plenty of historically cheap funds around to get this done. It just takes the political will to get going.
A Lot Is At Stake!
We are at the beginning of a journey that will take a lot out of the negotiators and there is a clear danger that we end up in a blame game and thus create a toxic political situation that could easily spiral out of control. But if everybody approaches this process in good faith, acknowledges past mistakes (on both sides) and focuses on a sustainable solution there is a good chance that the Eurozone comes out stronger. If not we are in for a bumpy ride!
Have something to add to this story? Share it in the comments below.