Benjamin Studebaker

With the recent election of Syriza (Coalition of the Radical Left) in Greece, it’s time to revisit the Eurocrisis. I’ll be trying to answer several questions:

1. What’s going on in Greece right now?
2. What does Syriza want to do?
3. What does the troika want Syriza to do?
4. What happens if Syriza and the troika can’t agree?

What’s Going on in Greece?

In 1999, the euro was introduced, a single currency replacing the francs, drachmas, lira, marks, and other old European currencies. Each European country gave up independent control of its monetary policy (its interest rate and money supply) to the European Central Bank (ECB), which was intended to be roughly analogous to the US Federal Reserve. In the United States, the individual states (California, Alabama, etc.) are financially protected by the federal government. Foreign investors don’t have to worry about say, an Alabama default, because Alabama’s finances are guaranteed by the the federal government. When an economic crisis hits the US, the federal government takes action to rescue the states that are most adversely affected, even though this often means transferring large amounts of money from healthier states to sicker ones. Investors assumed that the Eurozone worked in this same sort of way, that it was just as safe to invest in Greece or Spain as it was to invest in Germany or the Netherlands. As a result, governments in the European periphery (countries like Ireland, Spain, Portugal, Italy, and Greece) were suddenly offered extremely attractive low interest rates by bankers living in the European core (countries like Germany). They succumbed to the allure of this cheap money, borrowing excessively.

When the economic crisis hit, countries bailed out their financial institutions, acquiring a heavy debt burden. At the same time, the recession sharply reduced government revenues, creating large deficits. Additionally, over the course of the 2000’s, the influx of cheap money into the periphery led to inflation. This pushed up wages in the periphery, making it difficult for goods and services produced in the periphery to compete with those produced in Germany:

This made it difficult for the periphery economies to recover. So naturally, the periphery wanted the European Union to act like the US federal government and use the resources of the core to help the periphery recover. This could have involved a number of different strategies:

1. Push up inflation in the core–by raising inflation in countries like Germany, the EU could help the periphery regain competitiveness without having to undergo extensive deflation (which involves high unemployment and shrinking wages, both very painful for everyday workers).
2. Debt forgiveness, bailouts, and refinancing–by relieving the periphery of its debt burdens to bankers living in core countries, the EU could reduce the costs for periphery countries, allowing them to inject more stimulus into their economies and speed up their recoveries.

The trouble is that the EU doesn’t have a strong independent federal government like the United States. Instead, its operation requires the consent of the individual member states. It’s one thing to convince the federal government that Nevada needs some of New York’s money–it’s quite another thing to convince New York that this is the case. The periphery found itself having to ask Germany to consent to these policies, and Germany saw no reason to do so. The German economy had benefited immensely from its competitiveness advantage over the previous decade, and the German government had no interest in relinquishing this advantage to help the periphery. And really, who could blame them–the German government exists to serve the interests of the German people, not the Greeks or the Spaniards. Fundamentally, the EU is structurally flawed. To support the single currency, it needs a single federal government with independent coercive power over the European states, and because European voters are loathe to relinquish their sovereignty, that federal government doesn’t exist. Without that government, the single currency is intrinsically unstable and can easily be made to serve the interests of the most powerful European states (at this point in time, Germany) at the expense of the rest.

So instead, what happened is that the periphery countries had to negotiate settlements with the troika (European Commission, European Central Bank, and the International Monetary Fund). In practice, this meant negotiating with Germany, the strongest European country and the one most capable of relieving the debt burden. Germany refused to meet most of the periphery’s demands, forcing the periphery to undergo years of austerity, deflation, and unemployment. This protected the German economy and the core bankers, but it visited immense suffering upon the people of the periphery, especially Greece. Per capita GDP collapsed:

Unemployment soared:

And the government sharply reduced spending on public services:

As you can see, Greece still hasn’t really recovered. Unemployment is still over 25% today, and per capita GDP has not come anywhere close to returning to pre-crisis levels. The Greek people continue to suffer with no end in sight. So, naturally, they’re exhausted and fed up and want hope–that’s where Syriza comes in.

What Does Syriza Want?

The extant agreement between Greece and the troika calls for Greece to run a surplus of 4.5% of GDP every year and pay that sum to the troika. From the point of view of the troika, this is a trivial amount of money that does not make a substantive dent in Greece’s total obligations (realistically, Greece will never repay its obligations in full). However, from the Greek point of view, this is a very large amount of money. If you’re an American, think of it this way–4.5% of US GDP is about $790 billion. That’s more than the US federal government spends on defense. Even this underestimates the true impact of that money, however. According to the IMF’s research, if Greece had that money available to spend on public services, it would have a multiplier effect. This means that if, say, Greece were able to spend an extra $1 billion, it would get some of that money back in additional revenues, perhaps as much as half of it, depending on the tax rate. So it’s clearly in Syriza’s interest to get the troika to reduce the amount of surplus Greece needs to run. In theory, if Greece were able to reduce it from 4.5% to 0%, it could raise government spending by 9% of GDP and potentially reduce unemployment by 10%. In practice, it’s very unlikely that Greece would be able to get the troika to agree to 0%, but if Syriza could get the figure down to something like 1% or 2%, that would give Greece more than half of those benefits without making a huge difference to the solvency of the core banks.

What Does the Troika Want?

The troika doesn’t want to negotiate a new arrangement with Syriza. It’s very popular in Germany for politicians to resist calls on Germany to offer further relief to peripheral countries, and so German Chancellor Angela Merkel is at present refusing to consider any reduction to Greece’s burden, claiming that Greece has already received more than enough help.

What Happens if There’s No Agreement?

Greece remains a sovereign state–if the troika continues to refuse to renegotiate, it can unilaterally stop paying the 4.5%. If Greece does this, the troika can deny loans to Greek financial institutions, destroying market confidence in them and sinking Greece’s financial system. However, if the troika were to take that step, Greece would no longer have any reason to agree to resume making payments. Indeed, Greece would no longer have any reason to stay in the Eurozone, as its financial system would already be in tatters anyway. It could decide to resurrect a heavily devalued drachma, and that could be the beginning of the end for the euro in the periphery. Germany’s economic power in the European Union depends in large part upon its control of the euro. If countries withdraw from the euro, Germany’s economic power is reduced, making it more difficult for the German government to use European monetary policy to secure advantages for Germany. So Germany has strong incentives to prevent countries from abandoning the euro. What we have here is a game of chicken–Germany hopes Greece will back down rather than risk burning its financial system to the ground, while Greece hopes Germany will back down rather than risk Greece undermining the euro and European economic stability more broadly. It’s important to remember that Syriza stands for Coalition of the Radical Left. These people were not elected to protect bankers, be they German or Greek. If Syriza backs down, it could fatally compromise the Greek people’s confidence in the democratic political system. Greece is experiencing suffering on par with what was experienced across the western world during the depression of the 1930’s. If the suffering is not addressed, Greeks may be willing to change the political system until they find someone who will do something about the problem, and that someone could be a very scary person. If the troika is wise, it will offer Syriza a compromise and reduce the rate. It’s a small amount of money to the troika, but it would make an immense difference to quality of life in Greece and will stabilize the economic and political systems that support the troika’s long-term success.