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Avoiding A Greek Tragedy
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Even as the European Union and the International Monetary Fund lay the groundwork for a giant first-round bailout, debate is on about whether Greece can avoid sovereign default. Some view Greece as Argentina revisited, noting the stunning parallels with the country that, in 2001, set the record for the world’s largest default (in dollar terms). Others, such as Greek Prime Minister George Papandreou, see the problems as difficult but manageable, and complain of interference from ill-intentioned foreign speculators.
Avoiding default may be possible, but it won’t be easy. One has only to look at official data, including Greece’s external debt, which is 170 per cent of national income, or its gaping government budget deficit (almost 13 per cent of GDP). The problem is also one of credibility. Thanks to decades of low investment in statistical capacity, no one trusts the Greek government’s figures. Nor does Greece’s default history inspire confidence.
Greece has been in default roughly one out of every two years since the 19th century. Loss of credibility can bite hard and fast. Historical evidence clearly shows that, whereas government debt can drift upward inexorably for years, the end is usually sudden.
And it can happen to any country, although advanced countries can usually tighten fiscal policy with sufficient speed and credibility. Unfortunately, for emerging markets, adjustment is often impossible without outside help. That is the precipice on which Greece stands today.
A debt crisis is not inevitable. But the government urgently needs to take credible fiscal steps, concentrating not only on higher taxation, but also on rolling back some of the government spending — from 45 per cent of GDP to 52 per cent of GDP — that occurred between 2007 and 2009. It must also avoid relying too much on proposals for tax increases, which ultimately affects growth and sustainability. It would be far preferable to balance tax increases with some reversal of runaway government spending.
I have Greek friends who say that Greece is not alone. And they are right. Some countries are almost inevitably going to experience bailouts and defaults. One of the more striking regularities that I found is that after a wave of international banking crises, a wave of sovereign defaults and restructurings often follows. This correlation is hardly surprising, given the massive build-up in public debts that countries typically experience after a banking crisis. This time too crisis countries’ debt has already risen by more than 75 per cent since 2007.
However, fiscal meltdown does not have to hit every highly indebted country. What a country like Greece should do is stay clear of the first and second waves of restructurings and IMF programmes. Perhaps watching other countries suffer will help convince its local political elite to adjust. If not, Greece will have less control over its adjustment and potentially experience far greater trauma, even an eventual outright default.
There is a joke about two men who are trapped by a lion in the jungle after a plane crash. When one of them starts putting on sneakers, the other asks why. The first says: “I am getting ready to make a run for it.” But you cannot outrun a lion, says the other man, to which the first replies: “I don’t have to outrun the lion. I just have to outrun you.”
Greece has yet to put on its sneakers, while other troubled countries, such as Ireland, race ahead with massive fiscal adjustments. Greece’s new socialist government is hampered by campaign promises that suggested there was money to solve the problems, when, in fact, things turned out to be far worse. Unions and agricultural groups hold up traffic with protests every other day.
Most Greeks are taking whatever action they can to avoid the government’s likely insatiable thirst for higher tax revenues — the wealthy are shifting money abroad while ordinary people are migrating to the underground economy, which is estimated to be as large as 30 per cent of the country’s GDP. It is already one of Europe’s biggest, and growing.
In the case of Argentina, a pair of massive IMF loans in 2000 and 2001 only delayed the inevitable harsh adjustment, and made the country’s ultimate default even more traumatic. Like Argentina, Greece has a fixed exchange rate, a long history of fiscal deficits, and an even longer history of sovereign defaults. Greece can avoid an Argentina-style meltdown, but it needs to engage in far more determined modifications. It is time to put on the running shoes.
The author is Professor of Economics and Public Policy at Harvard University, and was chief economist at the IMF.
Copyright: Project Syndicate, 2010.
(This story was published in Businessworld Issue Dated 22-02-2010)
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