Don’t Blame Germany for Greece’s Profligacy

Greece would have faced far greater austerity had Germany and the rest of the EU not come to its rescue.

The Wall Street Journal

By JEREMY BULOW And  KENNETH ROGOFF

Updated April 16, 2015 7:19 p.m. ET

In the court of world opinion, a large majority seems to believe that even if the Greeks may have been a tad fiscally irresponsible, it is the Germans who have driven Greece into depression through cruel insistence on austerity and debt repayments.

This populist narrative misses the essence of the problem: The Greeks are experiencing an emerging-market debt crisis, albeit one on steroids. Those convening in Washington, D.C., this week for the spring meeting of the International Monetary Fund might want to keep in mind that Greece’s problem is not simply the straitjacket of the single currency. The euro has fallen by 13% over the past year against an effective index of eurozone trading partners, yet Greece is hardly booming.

The deeper issue is that European integration by design has reduced the independence of European Union member states legally, fiscally and politically. Interdependence helped Greece run up debts far in excess of a normal advanced emerging-market country, but it is now making these debts devilishly difficult to unwind.

Let’s first dispense with the “it’s all German-led austerity” nonsense. In 2009, fueled by a three-year jump in government spending to 54% of gross domestic product from 45%, the Greek government was running a primary deficit equal to 10% of its GDP, according to IMF estimates. In other words, new borrowing equaled all principal and interest due, plus an extra 10% of GDP. When major accounting fraud was reported, private lending to the Greek government stopped and bailouts from the “troika” of the European Central Bank, European Commission and the IMF—to the tune of €240 billion—were needed.

Yet the bailouts could not begin to substitute for both the lost lending and the collapse in tax revenues caused by a deep recession. By 2014, Greece supposedly ran a 0.3% surplus with government spending at 47% of GDP plus continuing “cohesion” transfers from the EU of about 3% of GDP and ECB support for the Greek central bank.

True enough, northern EU countries are saying they want to be repaid the debts Greece still owes even after the significant write-downs it has already received. Sober observers realize that further debt write-downs are both desirable and inevitable. But don’t blame today’s austerity on tough repayment terms that have never been, and probably never will be, implemented. Already the EU’s current bailout terms include no principal or net interest until 2020. Greece has enjoyed a much smoother cushion than say, the Asian financial crisis countries in the late 1990s.

Greece has experienced a fall in income comparable to the Great Depression of the 1930s. Its per capita income, which rose to 70% from 49% of German levels in the heavy borrowing period between 1999 and 2009, returned to 47% in 2013. And the so-called troika has exercised considerable leverage over how Greece’s fiscal consolidation has been engineered, including over tax hikes, spending cuts and labor-market reforms. But Greece would have experienced far greater austerity had it been forgiven all its external debts in 2009—with all foreign sources then refusing to lend the country more money.

Greece’s external creditors as a group have given Greece much more in new money than they have taken out in repayments since the start of the crisis. But capital flight (mostly by Greeks) has reduced bank deposits by more than €100 billion. Once again the ECB has stepped in to provide Greek banks with emergency loans to help prevent the fire sale of Greek business, consumer and government debt.

Greece’s integration into the EU does limit its options more than those of a standard emerging-market defaulter. For example, even if a Greek eurozone exit, or “Grexit,” were to occur (we consider mutual consent to a wall of capital controls far more likely), European courts could well insist that Greece honor the euro value of contracts. Normally, dunning creditors can threaten to hassle a country’s trade, and to seize future repayments to any new foreign creditors—witness Argentina. Greece, however, is far more exposed because of the huge trade, subsidy and commerce privileges it enjoys through EU membership. Whether such threats are credible or not remains to be seen, but Greece’s Prime Minister Alexis Tsipras’s recent trip to Moscow was clearly intended as a warning.

Eurozone leaders would like to portray the Greek crisis as unique, but in many respects it is merely extreme. The ECB has been able to contain the fallout to other eurozone-periphery countries by promising to buy their debts in mass quantities and support their banks. But the ECB guarantee is fragile and could be undermined by politics in northern EU countries, or a populist surge in suffering debtor countries.

Solutions to Greece’s woes ultimately require structural reforms at both the national and pan-European level. Its debts will eventually need to be further written down, and the country will need aid beyond that. Greece may yet someday suffer the yoke of heavy repayments; we hope not. But so far austerity in Greece is due to having maxed out its credit-card limits. Let’s not be confused by populist rhetoric.

Mr. Bulow is a professor of economics at Stanford University’s Graduate School of Business. Mr. Rogoff is a professor of economics at Harvard.