It’s the Politics, Stupid!

Update: 6/30:  A very interesting piece by BrankoMilanovic, made the same point before me

I have been silent on Greece, because scores of excellent economists from all sides commented at length and in real time on the developments of negotiation, and most has been said.

But last week has transformed in certainty what had been a fear since the beginning. The troika, backed by the quasi totality of EU governments, were not interested in finding a solution that would allow Greece to recover while embarking in a fiscally sustainable path. No, they were interested in a complete and public defeat of the “radical” Greek government.

The negotiation has not been one. The two sides were very far in January, as it is and it should be, if two radically different views about the engines of growth confront each other. Syriza wanted the end of austerity, that was much harsher on the country than expected, while failing to bring the promised benefits, even in terms of public finances’ sustainability. And it wanted the burden of debt to be lifted The troika wanted get its money back (well, not all of it; the IMF has always been open to debt restructuring), and more of the policies imposed to Greece since 2010, because, well, “eventually they will work”. (no need for me to remind with whom I have been siding).

But there was a common ground that, had the negotiation been real, could have allowed to reach an agreement, in just a few weeks of discussion. Both sides agreed that the Greek economy is broken, and that it needs radical reform. While Syriza focused on reorganisation of the State, on putting together a functioning tax collection system, at closing inefficiency loopholes, the troika demands were more “classic” and somewhat ideological: pension cuts, labour market reform, and the like. A continuation of the memorandum, in fact.

If we look at the economics of it, Sequencing is crucial: implementing structural reforms in bad times, when the economy is not able to absorb the short run costs of such reforms, imposes excessive disruption and risks hampering the potential long run benefits. This is why the joint implementation of austerity and structural reforms is particularly pernicious. Their short run contractionary effects reinforce each other and may be self-defeating, leading to no improvement in productivity or in public finances’ health. The dire state of Greece’s economy stands as a reminder that such an outcome is all but impossible. Troika reforms and cuts to public spending were doomed to fail since the beginning.

What happened since then? Well, contrary to what is heard in European circles, most of the concessions came from the Greek government. On retirement age, on the size of budget surplus (yes, the Greek government gave up its intention to stop austerity, and just obtained to soften it), on VAT, on privatizations, we are today much closer to the Troika initial positions than to the initial Greek position. Much closer.

The point that the Greek government made repeatedly is that some reforms, like improving the tax collection capacity, actually demanded an increase of resources, and hence of public spending. Reforms need to be disconnected from austerity, to maximize their chance to work.  Syriza, precisely like the Papandreou government in 2010 asked for time and possibly money. It got neither.

Tsipras had only two red lines it would and it could not cross: Trying to increase taxes on the rich (most notably large corporations), and not agreeing to further cuts to low pensions. if he crossed those lines, he would become virtually indistinguishable from Samaras and from the policies that led Greece to be a broken State.

What the past week made clear is that this, and only this was the objective of the creditors. This has been since the beginning about politics. Creditors cannot afford that an alternative to policies followed since 2010 in Greece and in the rest of the Eurozone materializes.

Austerity and structural reforms need to be the only way to go. Otherwise people could start asking questions; a risk you don’t want to run a few months before Spanish elections. Syriza needed to be made an example. You cannot  survive in Europe, if you don’t embrace the Brussels-Berlin Consensus. Tsipras, like Papandreou, was left with the only option too ask for the Greek people’s opinion, because there has been no negotiation, just a huge smoke screen. Those of us who were discussing pros and cons of the different options on the table, well, we were wasting our time.

And if Greece needs to go down to prove it, so be it. If we transform the euro in a club in which countries come and go, so be it.

The darkest moment for the EU.

@fsaraceno