The consequences of Greece’s impending breakdown

By Lawrence Summers June 20 at 12:45 PM

The Washington Post

Lawrence Summers is a professor at and past president of Harvard University. He was treasury secretary from 1999 to 2001 and an economic adviser to President Obama from 2009 through 2010.

When, as now appears likely, Greece financially separates from Europe, it will at one level be no one’s fault. The Greek leaders will rightly explain that having imposed more austerity on themselves than any industrial country has suffered since the Depression, they could not do more without light at the end of tunnel in the form of a clear commitment to debt relief. European leaders will rightly explain that they adjusted their positions repeatedly to accommodate the Greeks. They will stress that their publics would not permit Greece to play by different rules than the rest of Europe. And the International Monetary Fund will rightly explain that it would have blessed any plan agreed to by Greece and Europe that added up.

The trouble is that all the parties will get much more of what they fear from a breakdown than they would from something they regard as an unacceptable compromise. Historians understand how World War I was allowed to start but still, a century later, are incredulous that it happened. So, too, financial historians may look back at the next week and wonder how Europe’s financial unraveling was permitted.

Make no mistake about the consequences of a breakdown. With an end to European support and consequent bank closures and credit problems, austerity will get far worse in Greece than it is today, and Greece will likely become a failed state, to the great detriment of all its people and their leadership. Once Greece fails as a state, Europe will collect far less debt repayment than it would with an orderly restructuring. And a massive northern out-migration of Greeks will strain national budgets throughout Europe, not to mention the challenges that will come as Russia achieves a presence in Greece. The IMF is looking at by far the largest nonpayment by a borrower in its history. True, there are good reasons to think enough foam has been placed on the runway to prevent financial contagion. Yet, this was asserted with respect to Long-Term Capital Management, subprime mortgages and the fall of Lehman Brothers.

Diplomacy fails and catastrophes happen when nations are preoccupied with their own concerns and do not consider the political needs of their counterparts, becoming convinced that their counterparts won’t take yes for an answer. Here is an informed outsider’s judgment as to what needs to happen if disaster is to be averted.

Greek Prime Minister Alexis Tsipras needs to do what is necessary to make reaching an agreement politically feasible for his fellow Europeans. That means dropping ideological rhetoric about a new European approach and recognizing that Greece’s problems are significantly of its own making of its own making and make clear that he is absolutely committed to doing what is necessary to stay in the euro area. He needs to be clear that he will accept further value-added tax and pension reforms to achieve primary surplus targets this year and next, but that he expects a clear recognition that if Greece does its part, debt will be written off on a large scale.

German Chancellor Angela Merkel and European authorities must do what is necessary to make policy adjustments politically tenable in Greece. That means acknowledging that the vast majority of the financial support given to Greece has gone to pay back banks rather than to support the Greek budget. They must agree on debt relief and recognize the degree of adjustment in Greek spending that has taken place: with nearly 30 percent of government workers laid off. It also means announcing their intention to accelerate economic growth throughout Europe.

The IMF needs to recognize that this is now not about the numbers. It is about the high politics of Europe. Its job is to stand behind any deal that avoids breakdown.

The hour is late. But it’s often darkest before the dawn. Let us all hope that Greece and Germany use this weekend to work back from the brink before Monday’s summit.