Greece in 2015 Turning challenges into Opportunities

Global Centre Stage

If Greek Prime Minister Alexis Tsipras wants to offer a fresh opportunity to Greece, he needs to resist the temptation to take dangerous shortcuts and commit his government to tackle deep-seated economic and institutional problems that necessitated the intervention of the Troika in the first place. However, for him to succeed, the Greek public must follow his lead and give him their support. If signals emerge suggesting that this is occurring, Tsipras might also succeed in gaining support from the EU, suggest Dr Cinzia Alcidi and Alessandro Giovannini

The outcome of the Greek elections on January 25 did not present any great surprises: the victory of Alexis Tsipras’ party was well expected. Indeed, in the days running up to the polls, the European debate was driven by a seemingly sincere desire to formulate policy options that would be both suitable for the EU and compatible with existing commitments, but also acceptable to the future anti-austerity Greek government.

Immediately after his election, Alexis Tsipras firmly restated the key promise of his campaign as the priority of the new government: the end of austerity in Greece. This implicitly meant banishing the Troika (the group of international lenders comprising theInternational Monetary Fund, the European Commission and the European Central Bank) from Athens and opening negotiations over the sovereign debt that was considered unsustainable. Interestingly, such promises did not seem to conflict with the idea that Greece should remain in the euro area; indeed Greece’s continued membership was never called into question.

Dismantling austerity was presented to the European debate as a necessary step to stop the so-called ‘humanitarian crisis’ driven by five years of belt-tightening measures, and to bring to an end the policies that had led to one of the largest recessions in history and materialised in a loss of 25 percentage points of GDP.

Defining the Mandate

Besides the insistence on the need to reinstate the minimum wage at the higher level of 2010 and to stop privatisation, in order to strongly affirm his commitment to anti-austerity policies, Tsipras surprised many observers by defining his mandate with provocative statements and choices during the very first days of the new government.

The first decision after his victory was to form an alliance between his Left-wing Syriza party and the far-Right and anti-European Independent Greeks. This somewhat ‘unnatural’ coalition unambiguously signalled the message that the new government would assign clear priority to domestic economic matters of common interest for the two parties: meeting the anti-austerity pledges and re-opening debt renegotiation discussions with the EU. Such an uncooperative stance vis-à-vis the EU had two main consequences. Firstly, it brought delay and suspicion in the initial phase of negotiations with the EU, and secondly, it fuelled significant capital outflows in Greece. The latter clearly did not help the economy and in particular, the banking sector, which was already under strain.

A second development that set off alarm bells in EU corridors was the suggestion that Tsipras may be prepared to use the sensitive matter of economic sanctions imposed by the EU on Russia to obtain leverage in the negotiations with the Troika. The prospect of easy money to finance Greek expansionary policies probably appeared appealing to Tsipras as well as to Putin, who could have seen it as a good investment to challenge the unity of the EU from inside. It is likely that such an option rapidly disappeared from the table. Any deal with Russia would have led to an immediate Greek exit. But it also appeared that even if such an extreme deal was never close to being struck, playing the security card would have backfired on Greece. Hostility vis-à-vis Europe is not appreciated by Europeans. Such hostility has an altogether different quality than the hostility shown towards Germany, which incarnates the austerity paradigm for many southern EU countries. The result would have been a loss of empathy and even political support from other peripheral euro-area countries.

Sovereign Debt Restructuring

Greece was clearly not alone in calling for a change in the policy approach away from austerity and more oriented towards growth and social issues. Countries such as Italy, Spain and Portugal had similar aspirations and saw in Greece and its new government the turning point in the EU policy direction towards a softer stance and more attentive to the requests of crisis-hit countries. However, the honeymoon was never idyllic. Some of Tsipras’ demands were perceived as dangerousby peripheral euro-area countries, which subsequently distanced themselves from the new Greek government. This was the case on the occasion of the talks about Russia as well as in reference to debt restructuring. The latter was perceived as especially risky in Portugal, Ireland and Spain. These governments quickly reaffirmed their commitment to fulfil their debt obligations, unlike Greece.

This may be one of the reasons why discussions about sovereign debt restructuring did not advance and the issue was not considered during formal EU negotiations. A debt-swap plan (to replace ECB holdings and EU rescue loans) presented by Greek Finance Minister Yanis Varoufakis in London in early February, did not even reach Brussels. Besides political considerations, there are economic reasons for this. The cost soon appeared too high. By declaring its willingness to be insolvent (even if only partially on official loans), the government was making it very difficult for Greek banks to access international financial markets. The securities of an insolvent country can hardly be used as collateral in refinancing operations, and liquidity is badly needed in this scenario. The Greek government would have lost its ability to regain access to financial markets at a time when capital would have started to flow out of the country.

Moreover, the success of Brady-style bonds proposed by Varoufakis relies crucially on the credibility of the commitment taken by the government towards future repayments. Data suggests that the burden for Greece of servicing debt is relatively manageable from an economic point of view, and even lower than in other euro-area countries. In other words, the request to renegotiate the debt actually signalled that the position of the newly elected Greek government was hardly compatible with a primary surplus in the next few years. Indeed, the current data shows that the government budget is heading towards a deficit. This means that the precondition for the plan to work was not there, thus making it harder for official lenders to accept a compromise.

These considerations suggest that the proposal of debt restructuring was of a political nature, pointing to a sensible choice and not an unavoidable outcome. For this reason, its implications would have gone well beyond economic consequences and financial market reaction.

If restructuring of the Greek public debt was agreed upon with European lenders, it would have benefitted Greece, but with very large political implications for EMU. It would have had financial implications, as the restructuring would have resulted in monetary losses for EU countries lending money to Greece – and not only for the ECB. It would have also implied that some euro-area countries, for instance those under a programme (Cyprus), or previously under a programme (Portugal and Ireland) or currently adjusting their public finances (Italy, Spain and France) would most likely ask either for similar treatment or a significant relaxation of all constraints on budgetary policy and debt-reduction rules. Such requests would be politically difficult to refuse and the consequences potentially dramatic. EMU is not a federal system; it lacks political power at the central level and its current governance structure is based on rules. Calling basic rules into question at such a broad level would represent a real threat to the European construction.

Addressing Structural and Institutional Problems

It is difficult to say in these early days whether these discussions brought about by the Greek government were simply a reflection of inexperience on the part of the new government or a serious intention to play hardball. What is certain is that if Tsipras wants to offer a fresh opportunity to Greece, he needs to resist the temptation to take dangerous shortcuts and commit his government to tackle deep-seated economic and institutional problems that necessitated the intervention of the Troika in the first place. Simply banishing the Troika will not be enough. He must indeed exploit the potential of Syriza, a completely new force on the Greek political scene, to remove the countless barriers that have prevented Greece from developing along the path of solid economic growth. After joining the monetary union, the country experienced fast growth mostly based on excessive consumption spending that was funded through cheap credit coming from other euro-area countries. This led to excessive accumulation of debt without, at the same time, reinforcing the economic fundamentals of the country. Put simply: following unsustainable growth, the subsequent reversal was inevitable. The adjustment has been extremely painful, but it has happened now and the time to build a sounder economy has come. The Greek government faces its biggest challenge and its biggest opportunity.

It is a challenge because most of Greece’s problems are fundamentally structural, and not just related to the economic cycle. A key problem is the low quality of its institutions. Greece ranks low in each of the worldwide governance indicators produced by the World Bank. Political corruption and nepotism are widespread and significantly affect the functioning of the entire country. In this area, the new government could do much, given its wide internal consensus and the lack of strong legacies with past decisions and the previous balance of power. Another problem facing Greece is its citizens’ detachment from and disaffection for institutions and the government. The most evident expression of these sentiments is the high level of tax evasion and more generally the difficulties encountered in collection of tax revenues. Here, the new government must introduce a more efficient tax system, which should not be designed to favour specific power groups (as currently occurs, for example, in the taxation of naval shipping activity), but to restore greater equality. Last, but not least, productivity is very low, relative to other European countries, in most economic sectors. Here the challenge is great as there is no easy solution to this problem; but there is no doubt (as confirmed by numerous studies on Greece) that any progress in building better institutions will also be beneficial for productivity.

Most of these problems cannot be solved by passing individual measures in parliament. They require a change in the mindset and in practices at all levels. But economic policies and reforms are the necessary starting points. The economy has collapsed and there is an urgent need to generate growth, even if it is only of a short-term nature. Citizens will support the government’s efforts to pursue deeper changes only if there are signs that the economy is improving.

Given the current conditions and the size of the economy, growth can only come in the short term from external demand. Greece desperately needs to boost its exports. The dramatic adjustment in wages and in prices should have created the right conditions for this to happen, but so far it has not worked. At least not as much as in other countries like Portugal, where increase in exports provided a good buffer against the fall in internal demand and offset the GDP contraction driven by fiscal consolidation. By contrast, Greece has been unable to increase exports. One possible explanation relates to the fact that the export sector is very small and dominated by services (naval shipping), which bring little domestic value.

Reallocating resources towards the tradable sector in order to increase the share of exportable goods will be a tough task. In the context of difficult access to credit and low productivity, the decision for firms, which are usually very small, to go international is more difficult than ever. But a shift in this sense is necessary.

It can be argued that demand could be boosted through other channels. One is certainly investment. However, the room for public intervention is very limited, and from the point of view of the private sector, uncertainty, both of a political and economic nature, is still too high. Moreover, foreign investment in Greece has always been very low relative to other small economies and it is quite unlikely that this trend will change – unless Greece manages to present itself as a new country.

In this respect, the opportunity for Greece today lies in the fact that Tsipras is new in the business of politics and could represent a rupture with the past ways of doing politics. In this sense, he could act as a real game changer. For him to succeed, it will be necessary for the Greek public to follow his lead and give him their support. If signals emerge suggesting that this is occurring, Tsipras might also succeed in gaining support from the EU.

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Dr. Cinzia Alcidi & Alessandro Giovannini

Dr. Cinzia Alcidi is Head of the Economic Policy Unit at the Centre for European Policy Studies (CEPS) in Brussels and Research Fellow, LUISS – School of European Political Economy.

Alessandro Giovannini has been a member of Economic Policy Unit since April 2011.

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