Plan B for the Eurozone

26 January 2011

Plan B for the Eurozone

Ewout Irrgang

The neoliberal weekly The Economist has argued in favour of a ‘Plan B’ to solve the crisis of European debt. According to the magazine, a plan must be developed as quickly as possible for Greece, and possibly also for Ireland and Portugal, for an orderly form of debt restructuring in order to return these countries to solvency. This is a polite way of saying that Greece and possibly also Ireland and Portugal are bankrupt and that their debts must be rescheduled. But why should Greece in fact be declared bankrupt?

Ewout Irrgang According to the IMF the deficit in 2009 was higher by 15.4% of GDP than the Greek government’s already upwardly adjusted figure, while the national debt was in 2009 higher than had been thought, by 127% of GDP. But this need not mean bankruptcy. This lies in a combination of a number of other factors. Because of an unfavourable development of wages and productivity, Greece has become les competitive in relation to the rest of the Eurozone. If it still had its own currency, the drachma, the country could devalue, bringing about a more rapid rise in exports and thus more rapid growth in the Greek economy as a whole. A bigger economy and a smaller budgetary deficit would reduce the debt as a percentage of GDP. Because of the euro, however, this is no longer possible. Nor can the Greeks do as the US has done and increase the quantity of money in circulation and thus increase inflation, partially eroding the heavy debt. Instead, Greece is attempting to use draconian austerity policies to reduce the deficit and stabilise the debt as a percentage of GDP.

Spending cuts are, however, so extensive that the Greek economy is set to shrink enormously. In 2010 and 2011 it is expected to contract by around 7% of GDP. Greece is therefore caught on the horns of a dilemma. Cuts are needed in order to limit the deficit, which is causing a rapid increase in debt, but the effect of this is to bring about a contraction of the economy and thus a continued increase in the national debt as a percentage of GDP.

As a consequence of this the IMF now expects the debt to reach a peak of almost 160% of GDP. Is it then foolish of the financial markets to continue to demand an interest rate of around 12%, indicating that they believe that Greece will restructure its debt? No, and relevant here is another argument from political economy. The IMF estimates that the primary deficit in 2010 fell by at least 3%, a figure which does not include interest payments. If interest payments are included, the Greek deficit remains at 10%.

If Greece itself comes to the conclusion that it will never be able to repay everything, then it will have a problem. How will it then finance its remaining deficit? Should it decide to put a stop to all interest payments in anticipation of a debt restructuring, it will nevertheless still be faced with a primary deficit of more than 3%. Factoring in the planned new cuts, the country will, however, achieve a primary balance of its budget by the beginning of 2012.

The Greek government would then be able, without foreign financing, to negotiate a debt restructuring which could amount to between around 30% and 50%. Would that be both possible and justified? Yes, because an excessive granting of credit is the fault of the credit provider – the financial markets – as much as it is the fault of the one – Greece – to whom the credit is being extended. Incredible sacrifices are now expected of the Greeks. But why should this not also go for the holders of Greek bonds? Certainly if it seems inevitable, the EU would be better able to opt for a Plan B. Before they do so themselves.

Ewout Irrgang is a Member of Parliament for the SP. This article first appeared, in Dutch, on 20th January on the website usmarkets.nl

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