04 Jul 2015 originally published at http://www.greekdefaultwatch.com/
This is the narrative: Greece found itself with an unsustainable debt in 2010, and the troika, in order to avoid the repercussions of a Greek default, demanded that Greece take up new loans and implement a very strict diet (austerity). The result was an economic catastrophe, and for years, Greeks have suffered to service a debt that will never be repaid. Greece, the syllogism continues, needs a haircut to breathe and kick-start economic growth.
The problem is that this narrative is not true. After five years of austerity, five years of confiscatory tax increases, five years of spending cuts, the state in 2014 barely broke even. Very little of the austerity has gone to pay back debt. Instead, this effort has been about bringing spending in line with revenues.
Yes, Greece has gotten new loans to pay back old loans; yes, the Europeans lent money to Greece in order to bail out their own banks; yes, only a small share of those loans went to support state spending; and yes, Greece’s debt burden has risen in relative terms due to a shrinking economy.
But none of this has anything to do with austerity.
To understand why, recall that in 2009, Greece had a primary budget deficit of €24.4 billion. Primary means without interest payments on debt—which means that even if in early 2010, there was a deal to eliminate all of Greece’s public debt, the Greek government would still be €24.4 billion short (10.3% of GDP) relative to the 2009 numbers.
The austerity of the past five years has been about closing this hole and reducing spending to the amount of money that the Greek state can collect. The state finally managed to do this and it ran a primary surplus of €630 million, which is a mere 0.4% of GDP, in 2014 (it also ran a surplus in 2013 if one excludes government support for financial institutions; the IMF excludes it but Eurostat includes it).
Greece went from minus €24.4 billion to plus €630 million by cutting €34 billion in spending—but its revenues declined by €10 billion because the economy contracted (even though revenues as a share of GDP were at all-time highs in 2012, 2013 and 2014).
In other words, this entire effort has been about no longer gaining weight—Greece has not even gone on a real diet yet to pay back the debt. This means that even if one were to assume a debt haircut in 2010, Greece would have had to implement a similar austerity package.
There are only two scenarios under which a haircut would have made Greece’s austerity path less severe. First, if one assumes that immediately after defaulting on €301 billion of debt in 2010, Greece would have been able to borrow again in order to finance its deficits (which is impossible; in a 2010 paper, IMF staff estimated that countries regain partial market access after about 5 years).
Alternatively, one could say that Greece would have recovered faster because no one wanted to invest in a country with such high debt. That’s a counter-factual that is impossible to prove. I find it implausible given that Greece has never managed to attract serious levels of foreign investment, which would be susceptible to such calculations, and because the major driver of the recession has been a decline in consumption which is linked to austerity.
The only legitimate counter-factual is to say that austerity should have been implemented sooner rather than drag on for five years. In that case, the secondary effects on the economy could have, likely, been milder. But as the IMF acknowledged, in its ‘mea culpa’, a sharp adjustment was inevitable:
In any event, a deep recession was unavoidable. Greece lost market access in the first half of 2010 with a fiscal deficit so large and amortization obligations so onerous that it is difficult to see how a severe economic contraction could have been avoided. Indeed, if Greece had defaulted, the absence of deficit financing would have required primary fiscal balance from the second half of 2010. This would have required an abrupt fiscal consolidation, and led to an evaporation of confidence and huge deposit outflow that would have most likely made the contraction in output even larger. (p. 22)
Now, the story going forward is different. The more debt Greece has, the more of a primary surplus it needs to maintain in order to repay it. The IMF, for instance, said that a primary surplus of 2.5% of GDP is not enough to render the debt sustainable. Many argue that a primary surplus of this scale will impede growth, which is not what the evidence shows, and especially not in a country like Greece were deficits are usually associated with transfers (pensions, wages) rather than investment.
But that’s another debate for another day: the important point is that one should not confuse debt and austerity, and one should not think that Greece has had austerity because there was no debt restructuring. Austerity was almost exclusively about the deficit so far.