Greece’s recovery plan an economic death spiral

The International Monetary Fund has a clear idea about what is wrong with Greece. The eurozone’s weakest link has a serious fiscal problem, with excessive budget deficits leading to ballooning national debt.

It also has a competitiveness problem caused by its costs being higher than those of fellow members of monetary union.

It is also clear that the bailout orchestrated by the IMF, the European Commission and the European Central Bank will merely be a short-term fix unless it can help get Greece moving again. If it can’t, it will be worse than useless.

Normally, an IMF package works as follows: a team of experts flies in from Washington and offers immediate financial help to save a country from bankruptcy and to keep the speculators at bay.

In Greece’s case the €110-billion (R1-trillion) it has been promised provides two or three years of grace from the demands of its creditors.

In return the IMF demands both macroeconomic and microeconomic reforms to generate export-led growth.

Countries are expected to sort out their public finances through a mixture of spending cuts and tax increases. Often the fund will call for privatisation, labour market reform and changes to make the environment more business-friendly.

Export-led growth is possible only because recipients of IMF help are told to devalue their currencies and — if circumstances allow — cut interest rates. This easing of monetary policy offsets the fiscal tightening and allows the country to grow.

But Greece is a member of the eurozone, so it can neither devalue nor cut interest rates (which are, in any case, at rock-bottom levels). Even worse, its main export market is the rest of Europe, the slowest-growing region of the global economy.

What does that mean? It means that while demand is going to be sucked out of the Greek economy through a three-year pay and pension freeze, with a big jump in VAT, there is unlikely to be a pick-up in exports to compensate.

Instead, the slump will deepen. Greece, without the benefit of stronger growth, will be unable to meet its ambitious targets for reducing the deficit, which in turn will lead to demands for even deeper budgetary cuts, which will weaken demand still further.

That is not a recovery plan. It is an economic death spiral. —

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Larry Elliott
Guest Author

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