Mohamed A. El-Erian
Once again, Greece is at an inflection point. With its cash balances severely stressed, it seems unlikely to be able to pay the cascading debt payments that are falling due over the next few months. So yet another round of contentious and protracted discussions with its creditors is underway – one that may well produce yet another short-term solution. Yet kicking the can down the road is hardly the negotiators’ only option. Indeed, it is the wrong approach.
When facing severe payment problems, a country has five basic maneuvers at its disposal. It can, first, draw down the monetary reserves and wealth it has built up during better times and, second, borrow externally to meet payments falling due in the short term. Third, it can simultaneously or subsequently implement domestic austerity measures (such as higher taxes or spending cuts) that free up resources to make debt payments.
Fourth, a cash-strapped country can also implement strategies to spur economic growth, thereby generating incremental income that can then be used for part of the payments. And, if none of this works, it can pursue a fifth option: allow market forces to implement the bulk of the adjustment, whether through very large movements in prices (including the exchange rate) or by forcing a default.
Most economists agree on the ideal mix and sequencing of such maneuvers. A so-called “beautiful de-leveraging” entails a combination of internal reforms, financing, and judicious use of the market pricing mechanism.
But what looks good in theory has proved difficult to implement in practice. For one thing, politicians are more likely to continue increasing their countries’ reliance on financing, thereby heightening the risk of disorderly market adjustments, than they are to implement difficult structural reforms and fiscal adjustments. For this reason, many countries have endured painful disruptions that have aggravated possibly avoidable falls in output, caused unemployment to surge, and, in the worst cases, eroded potential growth.
In any case, if a country is already too deeply indebted, it may find that no amount of realistic adjustment and financing is enough – the curse of what economists call the “debt overhang.” Under these circumstances, reliance on austerity to free up internal resources to service the debt chokes off economic growth. And pro-growth supply-side reforms cannot yield results fast enough to offset this impact.
External creditors, for their part, balk at the prospect of providing the financing the country needs to get back on track, with those that provided financing earlier often unwilling to accept losses. This leaves only one real option: a disorderly market adjustment.
Because such an adjustment is not much more appealing for creditors than it is for debtors, both parties engage in time-consuming rounds of “extend and pretend” negotiations, in the hope that some magical solution will emerge. Of course it doesn’t. On the contrary, during the time they waste, the debt grows heavier, not only weakening the debtor’s short-term prospects, but also discouraging inflows of new capital and investments that are critical to future growth.
That, in a nutshell, is the story of Greece. By avoiding decisive action to address the debt overhang, the country and its creditors have contributed to a situation that is disappointing for everyone. Greece’s European partners have nothing substantive to show for the billions of euros they have lent the country. The International Monetary Fund and the European Central Bank, which have gone along with the extend-and-pretend approach, have placed their credibility at risk.
But the biggest losers have been Greek citizens, who suffered through one of history’s most severe austerity programs but still cannot see light at the end of the tunnel. Indeed, Greece’s debt-to-GDP ratio today is considerably higher than it was when its austerity efforts began. And youth and long-term unemployment have remained at extremely high levels for an alarmingly long time.
Greece’s dismal growth performance over the last eight years contrasts sharply with the performance of the other eurozone members that faced crippling payment pressures. Not having fallen as hard as Greece, Ireland and Portugal have bounced back to positive growth. Even Cyprus has performed better, avoiding economic collapse and recapturing growth in the last two years, whereas Greece relapsed into recession.
The Greek economy’s performance also looks weak relative to that of Iceland, a country that, lacking the external support that Greece received, endured a vicious market adjustment. While it faced a broadly similar economic contraction for a couple of years, growth has recovered robustly, and now far outpaces that of Greece.
As Greece and its creditors (now mainly sovereign lenders and multilateral institutions) deliberate about how to address the country’s looming cash crunch, they should recognize these differences and learn from the mistakes of their past approach. The longer they deny reality, the greater the damage will be – and the more it will cost to repair it.
Kicking the can down the road is politically easier than reaching comprehensive and lasting solutions. But it seldom works. Greece can overcome its economic troubles only if it modifies its approach. Specifically, Greece and its creditors must agree to a credible debt-reduction program that would support the domestic reforms needed to re-invigorate Greece’s growth engines and place its internal obligations in line with its capabilities. Such an approach, which is already favored by the IMF, would boost Greece’s future growth prospects considerably.
If clear economic logic somehow does not provide sufficient motivation for Greece’s European partners to support debt reduction, surely Greece’s frontline role in Europe’s historic refugee crisis does. After eight long years, it is time to give Greece the help it needs, in the form of a proper growth-oriented round of debt reduction.
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