What about Greek growth?

What about Greek growth?

Instead of spending energy on retribution for the Euro crisis, negotiations between Greece and the Eurogroup will be more fruitful if they focus less on debt and more on economic growth. But in a country with soaring unemployment and poor debt-to-GDP ratios, the way to fix the issue may require a new approach to an old problem.

It would not be a Eurogroup summit if it finished early, with an agreement in hand. Playing to that script, Greece and its EU partners agreed late last Friday to a four-month extension of the Greek bailout – subject to Greece outlining more structural reforms. Markets jumped higher on the news, which pushed any eventual Greek exit from the Euro at least four months back.

No one thought this would be the end of the negotiations, however. The substance of any long-term agreement is yet to be decided. From the perspective of Greece, and any other party interested in avoiding a departure from the Euro, the latest agreement removed an artificial deadline and will allow more thorough meetings to occur.

This in turn means Finance Minister Yanis Varoufakis has four more months to work out new bailout terms that will ease Greece’s debt and austerity burdens, while simultaneously satisfying German Finance Minister Wolfgang Schäuble and Dutch Finance Minister Jeroen Dijsselbloem that Greece is not getting off easy.

Such a feat will not be simple, especially as there is evidently no love lost between these three personalities.

This next round of negotiations will be much more amorphous than the last, purely because of the less-pressing deadline, but Greece appears to be more focused since Syriza was elected.

Debt relief has been the more prominent of the two demands (the other is austerity relief) since the very beginning (one of Prime Minister Alexis Tsipras’ main campaign promises was to negotiate a debt write-down). That focus is a dead end with Schäuble.

The more likely area for restructuring of the Greek bailout is over austerity, and the need for economic growth. If nothing else, it would steer the discussion away from the moralistic narrative from countries like Germany that Greece continues to be irresponsible and must pay for its actions.

Greek’s Vanishing Growth

Unfortunately, the cost for Greece to shoulder the burden of a 150+% debt-to-GDP ratio and an obligation to run a 4.5% primary surplus turned out to be economic growth. By focusing so intently on the debt angle of the Greek situation – which can so easily be cast into a morally righteous creditor versus debtor story – proposals to return Greece to growth have been almost missed completely.

Greek GDP growth

Source: Eurostat

Greece has been in a deep depression for the better part of a decade. Unemployment is 25%. For young people, the rate is double that. A major cause of the lasting effect is the source of the depression itself – a financial crisis, which tends to cause slower recoveries. But another cause is the fiscal drag imposed by the Troika’s primary surplus covenants on the bailout.

Falling Greek government spending during crisis

Source: OECD

In the long term, it was inevitable that Greece would have to reform its government expenditures, but the short-term consequences of the Troika’s austerity have provided an extra headwind for the Greek economy. Most macroeconomists agree that austerity during a recession is crippling for any recovery – a belief not shared by German or IMF policymakers.

The same austerity headwinds were felt in places like the US and UK, but were much more relaxed than the 4.5% primary surplus imposed on Greece – and still hurt their relatively stronger economies. Since government expenditure becomes personal income, which in turn becomes private consumption, cutting government spending so harshly during a recession in part makes it a depression.

Friday’s compromise with the Eurogroup on lowering of Greece’s required primary surplus to 1.5% is a tremendous win for the new Greek government, and ultimately for Europe as well. For all the conversation about debt restructuring, addressing GDP growth through primary surpluses would be a superior outcome.

Of course, 3% more government spending will not cure the ills of Greece’s economy. Greece’s GDP is still 25% lower than it was in 2008, but perhaps a compromise of this type would signal a shift in focus in Europe from debt to a more constructive conversation about growth. In tandem with the structural reforms that the Eurogroup is requesting (such as cutting down on tax evasion), a move like this could prove positive for the Greek economy. It would certainly end up increasing the likelihood that Greece can pay back its debt.

And that debt seems out of control. Even though Greece has already restructured its debt, which included lower interest rates and extending maturities, its debt-to-GDP ratio has gone up since Greece’s initial bailout. Higher debt-to-GDP ratios hurt Greece’s already poor standing with creditors.

There are two reasons this ratio keeps growing despite reforms and spending cuts. First, GDP has slumped as discussed above. Pumping more energy into promoting growth in Greece – and not with ineffective government spending cuts – would help in lowering debt-to-GDP.

The second is more nuanced. Eurozone debt-to-GDP ratios are the same regardless of the interest rate or maturity of the debt. All of the concessions that Greece has won since the initial bailout have not changed its headline debt under the Maastricht definition.

A group of private equity managers believe that Greece’s debt-to-GDP, under other accounting conventions, would only be 68% versus the official rate of 177%. All this means that focusing on GDP growth is the only realistic way for Greece to lower its debt-to-GDP in current negotiations.

The difficulties of navigating the highly politicized negotiations between Greece and the EU could make any compromise difficult, but if the news of the last week has indicated anything, it is that there is room for agreement and it may be relaxing austerity.

For Greek voters, this will be proof that Syriza could follow up on its promises. For the EU as a whole, Syriza’s aggressiveness could be a turning point for the stagnation that has plagued Europe since the financial crisis.

But more importantly, it would be an important victory for the Greek economy that could make paying off those debts easier over the next generation – after all, the best way to overcome burdensome debts is to be wealthier.

Categories: Economics, Europe

About Author

Alex Christensen

Alex is an Editor at Global Risk Insights, who also currently works in investment research. His work on political risk and economic policy has appeared in many forums, including Business Insider, Seeking Alpha, Oilprice.com & The Emerging Market Investors Association. He holds a Master’s in Economics from the London School of Economics and BA from Washington University in St. Louis.