The threat of Greek debt relief

Christoph M. Schmidt With Greece’s economic crisis still raging, prominent voices, ranging from Nobel laureate economists like Paul Krugman to officials like US Secretary of the Treasury Jack Lew, are calling for more lenient bailout terms and debt relief. Even the International Monetary Fund – which, along with other European lenders, has provided Greece with emergency financing – recently joined that call. But could such an approach really be the proverbial silver bullet for Greece’s crisis? The short answer is no. While Greece’s public debt is undeniably high, and evidence abounds that high debt can hold back economic growth, the country faces even stronger drags on growth, including structural weaknesses and political brinkmanship, that must be addressed first. In fact, Greece will likely depend on concessional funding from official sources in the years ahead – funding that is conditional on reforms, not debt ratios. Greece’s nominal debt stock will matter only once the country re-enters the debt markets and becomes subject to market, not concessional, borrowing terms. In the meantime, Greece must implement the structural reforms needed to restore the country’s long-term growth prospects and thus to strengthen its capacity to repay its creditors without a large nominal debt reduction. But there is another critical reason why debt relief is not the answer, and it lies in the political architecture of the European Monetary Union. Because the eurozone lacks a strong central governing body, crisis policies emerge from a political process in which each of the 19 member states has veto power. For such a complex system to work, eurozone policymakers must be able to trust one another to behave in a particular way – and that requires a common framework of rules and standards. A restructuring of Greece’s official debt, despite offering short-term benefits, would weaken that framework in the long run by setting a precedent for exceptions, with other eurozone countries, sooner or later, requesting the same concession. In 2013, the extension of Greece’s loan maturities prompted Ireland and Portugal to demand – and receive – comparable extensions, despite their less obvious need. Instead of offering concessions, which could create long-term instability in the eurozone, Europe’s leaders must remain committed to creating strong incentives for all member states to maintain prudent fiscal policies capable of reducing public-debt ratios and restoring fiscal buffers against asymmetric shocks to the currency union. Only then will the eurozone have a chance of upholding the Lisbon Treaty’s “no bailout” clause. Greece may account for less than 2% of eurozone GDP, but the pursuit of shortsighted ad hoc solutions to its problems may set precedents that could bring down the entire monetary union. To prevent such an outcome, it is critical that any solution to the Greek crisis reinforces, rather than undermines, the eurozone’s cohesion. It is true that Greece has had to undergo painful adjustments to address its deep structural weaknesses, unsustainable public finances, and lack of price competitiveness – adjustments that led to a drop in Greek output. But high unemployment and a lack of investment cannot be blamed on the medicine prescribed; they are symptoms of the country’s failure to reform its public administration and to enhance the flexibility of its economy. The international debate about how much austerity is appropriate to balance the interests of Greece and its creditors has distracted policymakers for too long. It is time to focus on the real imperative: designing and implementing vital structural reforms, at the national and European levels. To guide this process, the German Council of Economic Experts, which I chair, has developed a set of reforms – called “Maastricht 2.0” – that would reinforce the rules-based framework that is so essential to the eurozone’s long-term success. For example, the banking union needs to be strengthened through an enhanced resolution regime and an integrated financial supervisor, and a sovereign insolvency mechanism should be introduced. Underpinning the proposed reforms is the so-called “principle of unity of liability and control,” which demands that both the power to make decisions and liability for their consequences are kept at the same political level, be it national or supranational. In other words, if countries want to make their own fiscal decisions independent of their eurozone partners, they cannot expect those partners to step in and save them later. To be sure, in recent years, the European institutional framework has undergone major reforms that reflect the principles of “Maastricht 2.0,” such as the need to emphasize national responsibility for public finances and international competitiveness. But the reform process remains far from complete. There is no denying that short-term measures to address acute problems – such as debt relief for Greece – threaten the eurozone’s long-term stability. If the European Monetary Union is to survive and ultimately thrive, its leaders must not be tempted by facile solutions. Christoph M. Schmidt is Chairman of the German Council of Economic Experts. Copyright: Project syndicate

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The threat of Greek debt relief