Sigrún Davíðsdóttir's Icelog

– Forget economics, politics is key to understanding the Eurozone

The cries of the Grexit criers lately have mostly been a repetition of an earlier discourse: in February 2012 Citi’s economists Willem Buiters and Ebrahim Rahbari coined the term “Grexit,” by July 2012 estimating its likelihood to 90%. Cheered on by the media, economists have taken over the debate of the Eurozone which is why much of it has been such a futile exercise: it is not economics, which ties the Eurozone together but the political determination of its leaders to make the euro work. With political will likelihood of any exit is 0. Ergo, Grexit is as unlikely now as it has always been in spite of the EU brinkmanship. One route Greece seems to be exploring is a tried and tested one: the “bisque clause” from 1946.

In December 2009 the European Central Bank, ECB, published a working paper, Withdrawal and expulsion from the EU and EMU; some reflections (recommended read, clear and intelligent), by Phoebus Athanassiou. As Athanassiou pointed out, talk of ‘secession’ from the European Union, EU and European Monetary Union, EMU would earlier “have been next to absurd, considering the EU’s contribution to lasting peace and stability in Europe,” not forgetting successful enlargement. Athanassiou concluded that “negotiated withdrawal from the EU would not be legally impossible… a Member State’s exit from EMU, without a parallel withdrawal from the EU, would be legally inconceivable; and that … a Member State’s expulsion from the EU or EMU, would be legally next to impossible.” – But legal aspects are one thing, economics another and politics yet a separate aspect.

The eurocrisis has hit EU’s economy; economists and the financial media have led the crisis discourse. But the euro is a political construction, built on political will and at the root of the crisis there are politics: there has been a political unwillingness in the EU to be more than fair-weather friends. Fearing loss of sovereignty ministers have been unwilling to yield power to the various EU institutions (Athanassiou has some intriguing observations on sovereignty). – This is in essence what Mario Monti wrote in the summer of 2011 in a timely Financial Times article where he partly blamed the eurocrisis on the EU being too deferential and too polite to its member states.

With the crisis and hesitant action it has been ever more difficult to portray the EU as a success in spite of earlier glory. Much of the political demagogy on the left and right ends of the political spectrum in Europe is nourished by politicians from the established parties who have been far too willing to blame the EU for their own failures.*

Now Greece has voted in a new government who though critical of how the Troika, i.e. EU Commission, European Central Bank, ECB and the International Monetary Fund, IMF, has dealt with Greece makes no mention of Grexit and claims it wants to repay its debt. In a BBC interview minister of finance Yanis Varoufakis stressed that Greece was not going to toy with “loose or fast talk of Grexit” and fragmentation, which would only unleash destructive forces.

“Grexit is not on the cards,” Varoufakis said. At the same time, the government is hell-bent on finding a way to tackle what Varoufakis has called a “humanitarian crisis” in Greece, in addition to scutinising earlier privatisation and renegotiating, perhaps with an eye on the so-called “bisque-clause” from 1946.

Renegotiating, or whatever term will be found, is no mean feat also because all solutions are bound to be relevant for other problem countries. The Irish found a clever way though with their Promissory Notes, did it unilaterally with the ECB governor Mario Draghi commenting dryly that the ECB “took note” of it. – EU has always been brilliant at finding compromises though arguably its comprises have not always been brilliant.

The changing euro sentiment

On August 14 2007 ECB governor Jean-Claude Trichet stated that the bank was paying great attention to developments in the market, i.e. nervousness, increased volatility and ‘significant re-appreciation of risks’ which could be ‘interpreted as a normalisation of the pricing of risk.’ The bank had provided liquidity ‘needed to permit an orderly functioning of the money market… We are now seeing money market conditions that have gone progressively back to normal,” was Trichet’s reassuring conclusion.

Two years and some months later, in December 2009, it was clear that Trichet’s hopeful words were just that: hopeful. Ireland was under crisis clouds after the Irish government had been forced to fulfil its blanket guarantee of the banking sector. The situation in Portugal and Spain looked ominous not to mention Greece. All of this made Athanassiou’s paper a timely one.

Fast forward from Trichet’s 2007 statement to the ECB’s recent statement of a monthly asset purchase amounting to €60bn, at least until September 2016. ECB governor Mario Draghi has repeatedly stressed that the bank alone will not pull the EZ out of stagnation and slow growth. The political appetite for growth stimulus and the structural reforms needed has been negligible and attempts to challenge growth-quenching corruption, where needed, even less. It might even be argued that with the asset purchase, aka “quantitative easing,” into austerity-ruled EU the Union is like a boat rowing in opposite directions.

“The boom, not the slump, is the right time for austerity at the Treasury”

Jean-Claude Juncker’s €315bn fund is too little too late; a nod in the stimulus-direction rather than a real u-turn. After over six years of austerity the EU seems slow in revising on the 1930s lesson that the state has to step in when the private sector is sluggish. Greece now seems to want a realistic solution. Although only 2% of the EZ GDP it might inject new ideas into the Troika solutions, i.e. forcing reality instead of unsustainable solutions – effectively, earlier measures for Greece did not solve the problem and everyone involved knew it.

Simon Wren-Lewis’ summary of the obvious lessons from the Great Recession is: “Give any student who has just done a year of economics some national accounts data for the US, UK and Eurozone, and ask them why the recovery from the Great Recession has been so slow, and they will almost certainly tell you it is because of fiscal austerity.” Further, Wren-Lewis has recently summed up the necessary lessons from earlier attempts to debt restructuring, with a timely focus on Greece, saying the “Troika should welcome the opportunity to put right earlier mistakes.”

Yet and yet, austerity was the first and still is the strongest reaction to the eurocrisis. The IMF, for its part, has to a certain degree acknowledged its part in the mistaken routes chosen. For Greece there was a certain woeful blindness as to what the measures in 2012 would achieve in terms of growth, inflation, fiscal effort and social cohesion; this should not happen again as Reza Moghadam former head of the IMF European department wrote recently in the Financial Times, admitting to his share of the responsibility since he was part of Troika discussions 2010 to 2014 and pleading for halving Greek debt.

The new Greek government has plenty of research to bolster its case. In a 2013 paper, Òscar Jordà and Alan M. Taylor have shown “that austerity is always a drag on growth, and especially so in depressed economies: a one percent of GDP fiscal consolidation translates into 4 percent lower real GDP after five years when implemented in the slump rather than the boom.” And as John Maynard Keynes wrote in 1937, quoted by Jordà and Taylor: “The boom, not the slump, is the right time for austerity at the Treasury.”

To a certain degree the faith in austerity has been steered by predictable party politics as Simon Wren-Lewis covers here. Not surprisingly Wolfgang Schäuble claims that “austerity is the only cure for the eurozone.” With policies earlier belonging to the political right having to a great degree permeated the left, New Labour being the arch-example, there has been remarkably little left opposition to austerity. The political antagonism within the crisis countries has tended to be between parties in power, enforcing austerity and the opposition, opposing austerity so as to gain from the unpopular austerity measures.

Austerity is the easy route – structural reforms the really difficult one

But the last few years of austerity in Europe have also shown that although austerity is a tough path to follow, structural reforms are even harder. The Troika prescriptions for program-countries have all come with a list of structural reforms, which have been far tougher to fulfill. Though the structural reforms advised have often been sensible domestic politics and interest groups block them. The latest IMF review on Greece, from June 2014, lists the tough reforms still lacking, i.a. tax administration and public sector reforms.

The fact that there has often been little ownership of measures in the program countries has been part of the problem. One reason why Iceland sailed relatively smoothly through its IMF program was Iceland’s strong ownership of the program. Execution will be easier if the Greek government can renegotiate a sustainable plan it believes in contrary to earlier measures, which all involved knew was to a certain extent little but wishful thinking.

Consequently, scrutinising Troika programs it seems that although a tough path to follow austerity has been the easy route compared to structural changes where strong interest groups and politics clash.

Corruption – the dirty porn of EU politics

It is intriguing to note that the worst hit EZ countries are also countries where sentiment of corruption is high, as can be seen in the Eurobarometer. Yet, corruption has not been high on EU political agenda.

Only in 2011 did the EU Commission establish an Anti-Corruption report to monitor and assess efforts of individual EU countries to address corruption. The first report was published in 2014; reports will now be published every two years.

Given the fact that the cost of corruption is assumed to be 5% of GDP on a world scale, and clearly higher in corrupt countries, it has taken the EU scarily long to turn its attention to this problem. Again, that is no doubt partly due to the politeness Mario Monti had in mind – corruption is an embarrassing and dirty word in the EU, truly the dirty porn of EU politics.

Foreign media mostly focused on Syriza’s presumed anti-EU sentiments even though majority of Greeks want to stay in the EU and the euro. But Greeks noticed that Syriza broke with the norm of silence on corruption and campaigned on fighting it. Any step in that direction will be a great political achievement – and an example to follow for other countries. The fact that Syriza campaigned on the issue of corruption is already inspiring other countries, most notably the Spanish Podemos party.

It has caused some concern abroad that Syriza is going to stop or review the on-going privatisation. There is however indication that assets have been sold not on best price but best connection; something the Troika should not be too politie about, not least in a country with the sorry reputation of corruption. Privatisation will not be popular in Greece if people see state assets sold in a corrupt way.

Demagogues and the German problem

In 2009 it was easy for Athanassiou to refer to the success of the EU and the euro. Now the story in many EU countries, even in stoic and earlier so staunchly pro-EU Finland, is the rise and rise of anti-EU demagogical parties. So far, these are fringe parties, very often indirectly nurtured by politicians blaming the EU of their own failings.

But it is equally worrying that German Chancellor Angela Merkel is increasingly irritating other EU leaders with her moralising on other countries. After almost a decade as the leader of EU’s most powerful country, Merkel seems to be falling pray to the inherent law of power: the longer time in power the more myopic a leader is, ever more occupied with his or her legacy. This has not proved positive for her European engagement.

Given her long time in power Merkel has followed the course of the crisis countries from well before the crisis. She has had ample opportunities to speak out or warn her colleagues. Greece had for example been running a budget deficit more or less uninterrupted since the early 1980s enabled by German banks financing much of this deficit.

German banks, though prudent at home (or rather, Germans are prudent borrowers) were large lenders not only in Greece but also in other crisis countries, also in Iceland. German banks have behaved like the kind of teenagers who are faultlessly polite at home but run wild when partying at friend’s place cutting up the furniture and peeing in the corners.

Merkel did not seem worried until the problems in Greece and elsewhere threatened German financial stability. With the Troika involvement the German risk migrated to public sector lenders and the German banks avoided facing their risky behaviour.

It’s not the economy stupid, it’s the politics

Merkel herself is aware of the political dimension of the euro, or rather the lack of its political anchor. Her predecessor Helmut Kohl and his contemporary European leaders constructed a monetary union without a proper political dimension. More could not be achieved at the time; the wishful thinking was that the missing political part would come later. According to a German official Merkel thinks the euro, with the political part missing, is “a machine from hell” that she is still trying to repair. – As things stand now the machine will hardly be repaired any time soon– the one legacy likely to elude Merkel.

All through the eurocrisis the politics have lagged behind. As shown convincingly by Philippe Martin and Thomas Philippon concerted action such as the Outright Monetary Transactions, OMT already in 2008 and not as late as 2012 would have made the world of difference, not least for Greece.

Those running the “machine from hell” were slow in figuring out how to deal with the crisis. Domestic politics in the EZ were pointing in all and sundry direction. Merkel’s way of tackling any problem is to move slowly, very slowly. Her sluggishness has cost the Greeks dearly. But since the destiny of Germany and Greece are tied together in the euro the German sluggishness certainly has come at a cost to the Germans themselves.

Apart from the lack of political union to back up the euro – or at least some mechanism to deal with crisis – the EU made bad uses of what little mechanisms in place. This is what Mario Monti, wiser after his time as a European commissioner, pointed out in 2011, i.a. regarding Greece: “As for politeness, would Greece have been able to run for years public deficits vastly above its officially published figures – until the excess became known in late 2009 – had Eurostat had the power to conduct serious investigations to check the adequacy of nationally produced statistics? Of course not.”

Had the ECB been allowed to react already in 2008 with some form of OMT (yes, wishful thinking but let us assume these measures were conceivable already then though clearly not politically palatable) it would have run into the problem of ELSTAT where gathering statistics has turned into a political thriller still running: as late as January this year an ELSTAT supervising commission, one of whose members is from Eurostat, expressed concern and disappointment that some officials tried to influence ELSTAT’s reassessment of debt and deficit figures Brussels had called for. – Tackling the problem of ELSTAT would strengthen the trustworthiness of the new government.

The price of politeness is also evident in EU’s unwillingness to acknowledge the problem and cost of corruption (as I have pointed out earlier); unwillingness, which in itself a political vice among the EU countries. The EU countries are in it together but shrink from sifting through their neighbours’ dustbins to come up with compromising material.

Greece – with appetite for “bisque”?

Yanis Varoufakis and his team have had ample time to study the best approach but time is limited. Deposits are flowing out of Greek banks and the present Troika program ends on February 28, which jeopardises i.a. the ECB’s Emergency Liquidity Assistance, ELA.

Proselytising on Greek debt makes little sense – the debt is there not only because of Greek appetite for debt but for banks’ willingness to lend. The banks have sold off their Greek debt, IMF and ECB gobbled it up. It is too late to punish the original lenders, now it is only the Greek borrower left. There are many ideas floating around, here is Fistful of Euros’ Alex Harrowell summing up some of these ideas.

The problem with Greece is not just its debt, but the fact that the country is ever more crippled by earlier non-solutions as Syriza has stressed. Yet, the new Greek leaders have emphasised that they want to repay its debts to its lenders, ECB and the IMF as Alexis Tsipras said in a statement January 31. Greece is clearly trying to come up with a route that might suit everyone but is at the same time adamant that it must be allowed to run expansionary policies at home. Hiring Lazard as adviser shows the government pays attention to the markets as well as expecting tough talks.

The Troika loans amount to €226.7bn, ca. 125% of GDP, roughly two-thirds of total public debt of 175% of GDP. As Syriza has pointed out the unfortunate thing here is that the GDP has been shrinking making the debt ever less sustainable. This is i.a. part of the vicious circle that is dragging Greece down.

One way of going about the Greek problem might be to learn from history. The Stiglitz report, Report of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, from 2009 refers to the so-called “bisque-clause” from 1946:

There might also be alternative ways of ensuring flexible payment arrangements that would allow automatic adjustment for borrowers during bad times. For instance, one possibility is for coupon payments to remain fixed and for the amortization schedule to be adjusted instead. Countries would postpone part or all of their debt payments during economic downturns and would then make up by pre-paying during economic upswings. A historical precedent was set by the United Kingdom when it borrowed from the United States in the 1940s. The 1946 Anglo-American Financial Agreement included a “bisque clause” that provided a 2 percent interest payment waiver in any year in which the United Kingdom’s foreign exchange income was not sufficient to meet its pre-war level of imports, adjusted to current prices.

Sources have mentioned to me that the “bisque-clause” has inspired the approach being advocated by the new Greek government.

The “erroribus” of exit

“The world works thus that some help erroribus to circulate and others then try to erase it – and thus, both have something to do,” professor of antiquity at the University of Copenhagen Árni Magnússon (1663-1730) wrote.

Athanassiou’s conclusion was that “negotiated withdrawal from the EU would not be legally impossible even prior to the ratification of the Lisbon Treaty, and that unilateral withdrawal would undoubtedly be legally controversial; that, while permissible, a recently enacted exit clause is, prima facie, not in harmony with the rationale of the European unification project and is otherwise problematic, mainly from a legal perspective; that a Member State’s exit from EMU, without a parallel withdrawal from the EU, would be legally inconceivable; and that, while perhaps feasible through indirect means, a Member State’s expulsion from the EU or EMU, would be legally next to impossible. This paper concludes with a reminder that while, institutionally, a Member State’s membership of the euro area would not survive the discontinuation of its membership of the EU, the same need not be true of the former Member State’ s use of the euro.”

For those who have nailed their professional reputation to Grexit it might be hard to swallow that nope, Grexit is apparently not on the agenda – not for the new Greek government, not for the German government and, so far, no other EU government. German politicians may talk bravely about contained contagion from Grexit but dream on, who is willing to test the containment?

In order to understand the eurocrisis and find sustainable solutions forget the economics and focus instead on the politics. After all, the euro is a political construction, based on political will and as long as this will is there among Europe’s leaders there will be no Grexit or any other exit. Neither the ECB nor any EU institution will pull the rug from under Greece – this is not a question of some technical trick to force an end no government in Europe wishes for.

The euro is not just a currency, but the tangible sign of a union in which the earlier success of the internal market and enlargement was to be joined and entwined. For a few years it worked well, further cementing earlier progress. There are those who say it could never have worked and they are among the loudest in the Grexit choir as is, unsurprisingly, part of the UK media.

So far, the EZ countries have solved one problem after the other – yes, (too) often it has been too little too late, not always glorious. However, the political will to solve EZ troubles has been there and still is. Which is why it would be more fruitful to focus on the possible solutions – as the Greek government seems to be trying to do – rather than fable about Grexit.

* Earlier, Þórólfur Matthíasson professor at the University of Iceland and I have argued that the eurocrisis has to a large degree been symptom of underlying problems in the crisis-countries, ignored or not solved in time, to be solved at national level.

Cross-posted on Fistful of Euros

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