The Strategist

The Debt Write-Off Will Not Save Greece from Problems

08/17/2015 - 14:45

Greek economic crisis continues to rage, and many famous people - from the Nobel Prize in economics (such as Paul Krugman) to senior officials (eg, US Treasury Secretary Jack Lew) - call for easing of financial aid to the country and alleviate its debt burden.

Domenico Salvagnin via flickr
Domenico Salvagnin via flickr
Even the International Monetary Fund, which, along with other European creditors, gave emergency funding to Greece, recently joined this call. However, as the chairman of the German Council of Economic Experts Christoph Schmidt put it, the measure would not be "a magic silver bullet to the Greek crisis".

"The public debt of Greece, of course, is high, and there is plenty of evidence that high levels of debt can hinder the economic growth. Yet, the country has more serious obstacles to growth, such as structural weaknesses and political games on the brink of a foul. It was necessary to pay attention for it first.

Moreover, it appears that Greece will depend on concessional financing from non-market sources for many years. This funding is provided under the condition of not change the debt ratios, but reform. The nominal amounts of Greek debt will have a value only when the country will come back to the debt markets and will begin to match the market, not preferential borrowing terms. During that time, Greece must carry out structural reforms needed to restore long-term growth prospects, and thus improve its ability to pay debts to creditors without significantly reducing its nominal value.

Also, there is another important reason why debt forgiveness is not the right answer. It is connected with the political architecture of the European Monetary Union. In the euro area, there is no strong central government authority, so anti-crisis policy is formed in the course of the political process, in which the heads of the 19 countries, participating in the union, have a right of veto. For normal operation of such a complex system, the policies of the eurozone countries are obliged to trust each other, they have to behave in a certain way, and for that we need the general legal framework and standards.

The restructuring of Greece's official debt, though it may bring short-term benefits, will weaken these rules in the long term, creating a precedent for exceptions to the rules. Other eurozone countries will sooner or later require the same concessions. In 2013, after the extension of the maturity of the debt of Greece, Portugal and Ireland have demanded - and got - a similar extension, even though their need for it was less obvious.

Rather than to make concessions that could lead to long-term instability in the euro zone, European leaders should advocate for measures to actively stimulate member countries to conduct a prudent fiscal policy. It will reduce the debt ratios and restore fiscal cushions, mitigating asymmetric shocks in the monetary union. Only then will the euro zone have a chance to implement the provisions of the Lisbon treaty on the ban on the financial rescue program.

The share of Greece accounted for less than 2% of the GDP of all the countries in the euro zone, however, the pursuit of short-sighted, short-term solution to its problems may lead to precedents that can destroy the entire monetary union. To prevent such a development, it is important that every solution for the Greek crisis should intensify, not undermine the cohesion of the euro zone. It is true that Greece had to go through the painful adaptation when taking the issue of deep structural weaknesses of public finance instability, as well as lack of price competitiveness. This adaptation has led to a reduction in Greek production. However, the prescription cannot be blamed for high unemployment and a lack of investment. These are symptoms of the country’s inability to reform the public administration and improve the flexibility of its economy.

The international debates on how we must cut spending to balance the interests of Greece and its creditors have been distracting distracting the attention of politicians too long. It's time to focus on the present imperative - the development and implementation of vital structural reforms at national and European levels.

The German Council of Economic Experts, which I chair, have developed a series of reforms called "Maastricht 2.0" for the direction of this process. These are designed to strengthen the regulatory framework, which is essential for long-term success of the euro zone. In particular, the banking union should be strengthened by extending the regime of financial rehabilitation and integrated financial supervisory authority. In addition, a mechanism of state insolvency must be created.

At the heart of the proposed reform lies the so-called principle of unity of responsibility and control, which suggests that the decision-making and responsibility for their effects are on the same political level - national or supranational. In other words, if some countries want to make their budget decisions, regardless of the partners in the euro area, they should not expect these partners to later join and save them.

Without a doubt, the European institutional regulation has undergone major reforms in recent years, reflecting the principles of the "Maastricht 2.0", in particular the principle of national ownership of the public finances and international competitiveness. However, the reform process is far from complete.
It is impossible to deny that short-term solutions of acute problems, such as easing the debt burden of Greece, threaten the long-term stability of the euro area. In order to survive (and ultimately to prosperity) of the European Monetary Union, its leaders must resist the temptation of easy solutions. "