What Greece Has to Do Now: Fix Its Economy

Michael G. Jacobides

FEBRUARY 27, 2015

After weeks of media frenzy around the Greek election and the new government’s once-ambitious plans to renegotiate with the Eurozone over its debt crisis, the searchlights of publicity are shifting. For all of its bravado, Greece was pushed into a corner in an eleventh-hour deal that will extend a bailout agreement for four more months. And although it has been given a temporary lifeline, little has been resolved.

Greece’s creditors have by and large insisted that prior agreements be honored, and told the government that its radical plans for state largesse (let alone debt forgiveness) are off the table. A few verbal tweaks (such as renaming the “Troika” — which consists of the EU, the IMF, and the ECB — the “Institutions”) were given as a political concession to the newly elected government, which had created high expectations with its electorate.

The tentative agreement with creditors reached this week is much less favorable to Greece than what was on the table last fall. To be sure, the proposal set forth by the Greek finance minister is less detailed than that of his predecessor, and leaves some room for maneuvering, but this is a mixed blessing, as the EU, the IMF, and the ECB will need to sign off on specifics. Greece appears also to lose control of the €11 billion reserves of the Greek banking stability fund.

Worse still, the real issue, which is the possibility of lightening the real debt load by rescheduling payments and extending maturities (but without affecting the nominal value due to Greece’s official creditors), has been pushed away, and some in Germany would want to renege on a 2012 deal which reduced interest rates and extended payments.

This unfortunate state of affairs is partly the result of the difficult negotiating hand Greece dealt itself. Greece did have some good arguments going for it: It had achieved the biggest fiscal adjustment any developed country had mustered so far, stabilized its economy, and restructured its private debt. As for its official debt to the EU, the ECB, and the IMF, it consisted largely of payments that were made to pass through to EU financial institutions, between 2010 and 2012, so that the Eurozone banks and insurance companies would not be imperiled. So, clemency on loan terms might make procedural sense. It also made economic sense, allowing Greece’s GDP to grow, and thus ultimately pay the creditors, as Paul Krugman has repeatedly argued.

The initial reactions, in particular in the press, were positive. Greeks would be able to plead their case; to ask for support; to explain why they deserved it. But the new Greek team consisted of an inexperienced and ambitious set of politicians and academics with little, if any, policy experience. And as days unfolded, perceptions about them changed. Insistence was taken to mean intransigence and entitlement; gusto was seen as lack of respect; and the unusual negotiating style (which included leaking document drafts) infuriated the negotiators in the EU. The Greek team found out that in a restructuring, the debtor isn’t in the driving seat; and that Mediterranean posturing can win you more enemies than friends in Brussels and Berlin.

At the end of a difficult process, the Greek government has ended up deciding that a collapse of its banking system and a forced introduction of a parallel currency to pay state obligations is not a price worth paying in order to keep its promises to the electorate.

The EU is notorious for putting off its hard decisions. This is precisely what it did with Greece in the first place, by not allowing it to restructure in 2010, and thus building this mountain of debt. But this time around, kicking the can down the road has a silver lining in that it gives time to Greek society and polity to adjust. For ordinary Greeks, who were told by their politicians that there was an alternative way out, and that the EU would fold, it is certainly a rude awakening.

But it also means that public debate may shift from how best to renegotiate to how best to fix the Greek economy. For all the talk of reform, little has happened on the ground: this is partly a legacy of poor leadership from the previous government as well as of the Troika’s priorities. With financial negotiations now stalled, it’s time to focus on the “hard yard” — the issues in the public sector holding Greece back, such as red tape, barriers to competition, a clientelist, incumbent-friendly state, inefficient public services, and a challenging environment for new businesses. These were things that the previous government, especially from the summer of 2014 onwards, also failed to achieve, and that the Troika was unable to push for.

Will there be progress in this regard? Many a government has started with bold declarations, and the proposed agreement contains strong pledges. Yet when it was in the opposition Syriza, the new party of government, blocked any effort to reform the public sector, open up the economy, or infuse competition. It is now being asked to act against its ideology: its new commitments to stick with the agreed upon privatizations, to “fix” the pensions deficit, and to reform the inflexible labor market contradict its pre-election pledges.

Worse, Syriza started its tenure by appointing failed MP candidates to the position of Secretary Generals of key Greek ministries. The lack of experience, coupled with an inefficient public sector, does not bode well. Will an advertised collaboration with the OECD bear any fruits? It might, but so far there’s little evidence on the ground. It looks like “politics as usual,” and what will make or break this (or the next) government is moving beyond that.

One ray of hope is that some changes in the justice system may take place, and tax and duty evasion might be contained. Despite its travails, Syriza retains significant support from a large part of the electorate, which voted it in not because of its policies, but because of its quest for a fairer social system, with fewer people evading taxes or the law. But to do so will require determination, and a shift in government and governance.

This looks unlikely. The problem is that Greece needs operational, transformative changes in the short term, and a revamping of its productive base, starved of investment as it is, in the medium term. The Greek problem isn’t, as Krugman insists, a classic problem of macroeconomic policy. It’s primarily a problem of an economy rendered uncompetitive from state inefficiency and political turmoil.

So, what can we expect moving forward? Most probably another crisis, small or large. Organizations (and countries) in crisis really wake up only on the edge of the precipice. The tragedy is that sometimes this happens too late. The Greek crisis may have abated for a while, but if its root causes are not fixed, expect it to return, soon, to rock the Eurozone. And next time around, “the Institutions” may be less accommodating.

Michael G. Jacobides holds the Sir Donald Gordon Chair for Entrepreneurship and Innovation at the London Business School.