Solutions to the Eurozone debt crisis must take into account both economic necessity and political acceptability. Unfortunately, there is often a gap between those two features, where economic necessity is politically unpopular and politically acceptable policies are unwise economically. This is certainly the case with the Eurozone crisis, in which it seems that the gap between economic realities and political acceptance is getting larger, not smaller.
That Greek failure to make progress toward achieving goals agreed as part of their last bailout should raise questions about whether still more, largely unpopular bailouts are the answer, is unsurprising. Following the most recent bailout package agreed in July, dreadful economic performance and the slow pace of reforms has led to ever bigger budget gaps and predictions that Greece could run out of money as early as October. The troika consisting of representatives from the European Central Bank (ECB), International Monetary Fund (IMF) and the European Commission reportedly left Athens in frustration at the lack of improvements made, following their most recent visit to observe the situation. To those in favour of bold steps to save the euro, this cycle of drama feels hopelessly repetitive, though that is to say nothing of how it must feel for Europe’s taxpayers, who have been told time and again that the next bailout will be the one that counts and that ultimately this strategy will work. While some taxpayers and their representatives in national government seem willing to continue down this road, others appear less so.
In the latter camp, I refer most notably to the Germans, who are by no means alone in their reticence, but who stand to contribute more than most to determining the outcome of this crisis. It is for this reason that the move made this week by the German finance ministry to draw up scenarios for Greek default and exit from the single currency has had such a profound impact on financial markets. Following media reports on Monday of the scenarios under discussion, the continent saw widespread declines in financial stocks, coupled with rumours of a downgrade in the credit rating of major French banks, due to doubts about whether those banks could withstand a major haircut on Greek debt holdings. This is precisely the reaction that EU figures had hoped to prevent in avoiding talk of a Greek default and the related issue of departure from the Eurozone.
In other words, it is not the case that most politicians at national or EU level believe in the strategy of throwing increasing sums of money at a Greek government that seems unable to put it to good use, but that the alternative is almost certainly worse. However, as argued in a Financial Times editorial last Sunday, there is the aforementioned gap between economically necessary and politically acceptable responses to this crisis, and that gap continues to complicate the search for viable solutions. To the extent that the strategy undertaken so far should become increasingly unacceptable politically, the fact that bailing out Greece is probably an economic necessity may come to be seen as irrelevant.
One event in particular that does not bode well for the political situation in Germany is the resignation of Juergen Stark, formerly of the Bundesbank, as the ECB’s chief economist. Officially, Stark is resigning for personal reasons, but his objection to the handling of the crisis, notably the purchasing of government debt by the ECB, which he twice voted against, is likely behind his decision. It was for similar reasons that Axel Weber, tipped to succeed Jean-Claude Trichet as ECB President, resigned as head of the Bundesbank last spring. Given the high regard in which the Bundesbank is held and the importance Germans assign to the ECB pursuing Bundesbank-style policy, Stark’s departure will serve to reinforce the opinion that the crisis is not being handled in a way compatible with German interests. Thus the divide widens between political acceptance and the necessity to protect against the economic consequences of, at the least a Greek default, and likely the accompanying spread of contagion to all or some of such indebted economies as Portugal, Spain and Italy.
The German finance ministry has sought to address the issue of contagion, noting that there are considerable differences between the situation in Greece and that in other troubled countries, insofar as the former is the only Eurozone member that has been unable to enact reforms that put their country’s finances on a sustainable path. It is debatable whether this is true, given the daunting situation facing Italy and the recent evisceration of the emergency budget intended to address the state of their public finances, to name one example. Further to that, regardless of evidence that can be pointed to in support of Greece being a special case, it is difficult to predict what would actually come to pass if Greece were to default hence why sovereign defaults tend to be unpleasant affairs.
It would appear that the German government is playing on this uncertainty and risk surrounding a Greek default in order to bolster support for the European Financial Stability Facility (EFSF) and its permanent replacement, the European Stability Mechanism (ESM), as a way to help Greece through the default and ensure against contagion to other states. If successful, this would surely benefit the government, whose junior coalition partners, the Free Democratic Party (FDP), may not vote in favor of the EFSF legislation on 29th September. However, assuming that those swayed by this tactic would then expect that Greece actually be allowed to default, there may be better ways for the government to secure a majority.
In short, there is no simple way to bridge the gap between political preferences and economic realities, with the inability of the Greek government to enact most of the reforms that are so clearly necessary to solve their sovereign debt crisis, yet so politically unpalatable to the Greek public, as a case in point. This is one of many reasons why elected leaders are expected to take a slightly more nuanced view than the publics they represent, and to resist political pressure when the economic consequences of failing to do so may be harder to appreciate, but potentially catastrophic.