Rescuing Greece means rescuing Europe too

Washington Post

July 3, 2015

After months of tense and drawn-out negotiations, bailout talks between Greece and its international creditors have apparently broken down. The (seemingly) final act came last weekend at an emergency meeting of euro-zone finance ministers who rejected Greek request for the extension of the financial assistance program. The breakdown in bailout talks triggered a sharp reaction on financial markets on Monday, as well as the imposition of capital controls and rising social tensions in Greece. On Wednesday, Greece became the first advanced economy to default on a loan from the International Monetary Fund.

To understand this Greek crisis, it’s important to understand the broader context of European Union responses to the challenges of managing a single currency in a multi-country political system. Previous rounds of Greek negotiations took place alongside interrelated negotiations among all the euro-zone members on “grand reforms” to Europe’s rules for economic and financial governance. These grand negotiations made the negotiations with Greece possible, because they linked reforms in Greece to the ongoing process of European integration. As soon as the bigger negotiations stopped, so did the incentives for E.U. creditors and debtors to cooperate.

The early negotiations on Greek debt

Since the crisis started in 2010, Greece has received nearly 240 billion euros in financial assistance from its official creditors: E.U. member countries, the European Central Bank (ECB) and the International Monetary Fund (IMF). Financing has come through two consecutive programs.

The first was agreed in May 2010. Under the program, euro-area countries provided bilateral loans for a total amount of 80 billion euros. The IMF contributed to the financial package with a 30 billion euro loan, amounting to the largest IMF program ever.

The bailout program had two key conditions: fiscal adjustment and structural reforms. That is to say, Greece had to reduce the size of its public deficit by reducing expenditures and raising tax revenues so that its debt didn’t continue increasing indefinitely and unsustainably. Greece was also required to liberalize its rigid product, service and labor markets, to improve competitiveness and boost exports.

Other conditions that might ordinarily be considered for a country trying to reduce its debt had to be ruled out for political reasons. For instance, Greece couldn’t devalue its currency, because part of the goal was to keep Greece within the euro zone. Restructuring Greek debts by inflicting losses on private bondholders was rejected, lest that lead to a panic about other euro-zone countries with high debts, and because it might have set a bad example for other countries hoping to shed their debts.

But as we know now, the bailout conditions didn’t work. Its fiscal targets were wildly over-optimistic for a country dealing with a sharp recession and plunging investor confidence.  Reforms to eliminate some rigidities in the labor market that prevented downward movement of wages were delayed. By the end of 2011, it became clear that the debt problem was getting worse.

Greece and euro-zone partners began negotiating a second bailout program, concluded in March 2012.  This new program, for which the Greek government recently requested an extension, provided Greece with additional 144.7 billion euros from euro-area countries and 28 billion euros from another IMF loan. While building on the 2010 program, the new plan slowed the pace of fiscal adjustment based on the recognition that the implementation of the other reforms to the Greek economy contained in the adjustment program, including the liberalization of labor market, would have depressed the economy deeper and longer than originally envisaged. The second program also tried to lower Greece’s debt, based on the offer made by Greece to its private bondholders for a reduction in the nominal value of Greek government bonds.

The second program had a bumpy start. Uncertain about who would win Greece’s spring 2012 elections, Greek citizens withdrew their money from Greek banks, severely weakening their solvency.  The program was thus renegotiated.  Greece was given a longer time to tighten its finances, and euro-area lenders lowered the interest rates they were charging on their loans.

Beyond the negotiations with Greece: securing the euro

E.U. member states have had to deal with other problems besides the Greek crisis since 2010. As the crisis started, E.U. leaders and finance ministers have also been frantically occupied with negotiating measures to fix the political and institutional weaknesses of the E.U. economic architecture, dramatically exposed by the repercussions of the crisis in Greece on such euro-area states as Italy and Spain, where interests rates rose. Negotiations on Greece economic future thus proceeded in lockstep with negotiations on how to save Europe’s economic and political union.

As the second program was being negotiated from the end of 2011 until the summer of 2012, member states negotiated and adopted measures that strengthen the coordination of economic policies. An intergovernmental treaty, also known as the fiscal compact, set out the principle that member states had to set their national budgets in coordination with each other, and allowed European institutions to monitor their budgetary behavior.

Europe also took important steps to develop an ability to manage crises that it had not previously had. Between 2010 and early 2012, E.U. leaders developed the European Stability Mechanism, which can provide financial help to European countries in trouble, albeit under very strict conditions. In July 2012, the European Central Bank’s president, Mario Draghi, announced that the ECB was ready to do “whatever it takes” to save the single currency.  By the same time, E.U. member states began negotiations to allow the European Union to supervise member states’ banks. This process was concluded last November, with the ECB assuming responsibility for supervising banks within the euro area.

These measures still fall far short of a full-fledged monetary and political union. For instance, member states were not able to agree on issuing common bonds. But had these additional negotiations not been underway, key negotiations over the extension and renegotiation of financial assistance to Greece might well have turned out differently.

These broader reforms to the E.U.’s economic and financial governance helped persuade opponents to support the second bailout of Greece. Some creditor states had been unwilling to lend to Greece because they feared that it would set a bad example for other equally unstable and indebted states. Those worries were mitigated as Europe reformed its economic governance by early 2012 in a way that strongly emphasized fiscal discipline, and introduced new tools that made it harder for states to overspend. Because of the efforts to create a E.U. firewall with the resources to lend euro-area countries in a crisis, the ECB was less worried about making a deal under which private creditors would not be repaid for some of their Greek debts.

E.U. reforms also helped negotiations with Greece in a more subtle way. Negotiations over E.U. integration is often described as like riding a bicycle. You have to keep pedaling or momentum collapses.  Between 2010 and 2012, E.U. member states were confronted with a crisis, in which creating greater fiscal authority and handling the Greek problem seemed closely interlinked. Under the dictum that “if we do not integrate further, we risk fragmentation,” they tried to rescue both Europe and Greece, since failure in Greece would have suggested a broader failure in the project of European integration. Once the E.U. prevented other countries from falling into similar crises, rescuing Greece from default and keeping it in the euro-zone became less critical.

With the euro zone secured, Greece may be on its own

Since 2010, negotiations on how to rescue Greece have been inextricably intertwined with negotiations on how to strengthen the political and institutional weaknesses of the E.U. economic and financial governance. The first two stages of Greek negotiations were easier to achieve, because they were seen as closely linked to broader negotiations about Europe’s future, which furthermore soothed the worries of some member states.

But the bicycle of European integration has stopped moving for the moment, not because it has collapsed, but because the rider has gotten tired. There is no political willingness to embark on any more grand projects, and Europe’s policy agenda involves completing the reforms agreed over the past five years. It remains an open question whether Europe can successfully get out of its own economic crisis and regain public support without climbing back on the bicycle. However, so long as Europe doesn’t want to get back on, the distance between creditors and Greece is likely to remain large. Greek problems are perceived by key member states as the product of Greece’s own particular faults, rather than reflecting any broader problem in the E.U..

Manuela Moschella is professor of international political economy at the Scuola Normale Superiore di Pisa and senior fellow at the Center for International Governance Innovation (CIGI). 

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.

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