Investment-led Growth, Not More Cuts, Is The Only Way For Greece

The agreement reached in Brussels yesterday between EU governments and Greece came only with a huge loss of mutual trust. It remains to be seen whether the deal in these circumstances will win majority political support. Economically, it would at least offer a small opportunity for a recovery in the Greek economy. But this would only be the case if the investment elements of the deal can be implemented swiftly and comprehensively. If the rescue strategy, on the contrary, remains limited to an even sharper continuation of government budget cuts this programme will collapse just like the previous ones.

The dramatic negotiations between EU heads of government and the Greek government have changed Europe politically. The mutual harshness of the political arguments, the tougher and tougher conditions and the huge encroachments on Greece’s national sovereignty have evaporated mutual trust. We’ll have to wait and see if Europe can recover from this. We’ll also have to see whether, given these circumstances, national parliaments can even agree to this Brussels deal.

From an economic point of view the agreement is basically welcome even if it’s far from certain that it will work. It might, at least initially, remove the scenario of Grexit from the agenda. But this will only stick for the long term if the agreed measures breathe sustainable new life into the Greek economy. Given the tough saving conditions imposed this can in no way be guaranteed. The decisive aspect regarding the effectiveness of the deal is whether the accumulated burdens via these tough savings conditions and spending cuts dominate or the investment spurs agreed at the same time. Only if the latter is the case can Greece retain the prospect of staying in the Eurozone. For only then can Greece generate the economic growth that can actually bring about a swift reduction in the size of its debt mountain.

The fact that the Greek state faced immediate insolvency and, in the eyes of several actors, this was acceptable shows how thoughtlessly, nay irresponsibly, this crisis in the Eurozone has been dealt with in the last few months. And that’s not just true of Athens.

Monday morning’s deal has, besides many debilitating aspects, a few positive ones too. The most important is: It’s finally been acknowledged that Greece can only escape the crisis if the public purse is allowed to invest again. On the other hand, what we know of the deal’s details so far is couched in pretty vague terms in key areas. One example: Greece was entitled in the past few years to EU investment funding. But it couldn’t call upon the money because this was tied to co-financing. And the Greek state simply didn’t have that money.

Set Aside The Obligation For Co-financing Investments

The decisive factor now is whether such barriers can be lifted in future and Greece can swiftly make real use of the €35bn investment funding that, willy nilly, is due to it from the EU Structural Fund. Should that not happen then the nice-sounding investment pledges will swiftly dissolve in the air and it would be back to yet more saving that would weaken the Greek economy ever more. My proposal: For one year only one could give Greece access – without co-financing – so that the government could kick-start an immediate investment programme as indeed it must because time presses. The pre-financing of €1bn through EU funds set out in the deal documents is a step in the right direction. The fact that Greece can use part of the – albeit uncertain – proceeds from privatisations for investments can thus be seen in an equally positive light.

Delays In Emergency Lending Incomprehensible

With the deal, the planned conclusion of far-reaching pieces of legislation and the handing over of its request for a new aid programme the Greek government has furthermore let it be known that it not only intends staying in the Eurozone but sticking to its rules and regulations. That gives the green light for the ECB to make an immediate and urgently required rescue measure: Raising emergency lending to the Greek banking system. Without this step it would be only a matter of days for the payments system in Greece to collapse and all further measures other than humanitarian aid would in the end be in vain. The hesitant attitude of the ECB in this affair is incomprehensible.

Debt relief is no longer urgent if spurs to growth prompted by swift investments are in place. Even so, there would need to be a debt regulation sketching out a credible path to debt repayment. This is still possible with the agreement as it only rules out a nominal haircut but not longer maturities for repayment. The Greek government has committed to a budgetary stance aimed at producing surpluses excluding interest payments; in other words, the budget would display a primary surplus. This way the government is preventing future budgets from being over-loaded with more and more new financial burdens. But this is insufficient. Secondly, a way must be found to reduce – in a consequential and haircut-free manner – the debt legacy issues threatening to strangle Greece to death. Under realistic conditions that could have been achieved if Greece had been given a year’s grace but then committed itself to delivering a primary surplus of 2% of GDP for the next four years. But the current deal obliges the Greek government to stick to a harsher savings course that is bound to impose further tough burdens on the Greek economy.

Growth As A Pre-condition For Debt Repayment

Even so, such a binding commitment is subject to economic risks as the economic situation may turn out worse than forecast. The agreed debt regulation does not take this into account. So there is a grave danger that the Greek government may be forced to make ever more cuts in this serious crisis and the crisis then gets deeper and deeper. So, the risk of an economic downturn should be transferred to the schedule of debt repayment. The best way to handle this would be a prolonged repayment schedule linked to growth. This would amount to a credible strategy since it assumes dividends through growth and might even bring about swifter repayment if things work out particularly well. Such an agreement would put Greece on a credible path of debt reduction that, in turn, would reduce the risk premia for private lending to the Greek economy and thus encourage private investment.

The opportunity for easing future negotiations would be wasted if Greek debt were parked in its entirety at the ESM. That would relieve the IMF of its obligations towards Greece which it already wants shot of because of its own ground-rules. At the same time, the ECB would also be relieved and could take Greece back under the protective umbrella of potential sovereign bond purchases should turbulence return to financial markets. This would have increased the security of financial investors in buying Greek shares, enabling Greece very swiftly to return to private capital markets.

Tax Rises And Pension Cuts Are A Drag On The Economy

The agreement includes the rapid conclusion of long-term, fundamental institutional changes in taxation law and on the labour market as key elements. It would be sensible to rebuild the tax authority from the ground up and equip it with reliable staff. But that wasn’t quite agreed. Instead, tax laws will be altered in such a manner that the delays associated with making counter-claims will be significantly hindered and, with VAT, on average higher rates will be concluded. This would act as a drag on the economy, above all on consumption. The same holds true for the proposed real-terms cuts in pensions. Their effect would be socially devastating if not combined with the simultaneous introduction of basic social security and reliable health insurance.

The proposed reforms of the labour market remain vague and should focus on current best practice in the Eurozone.

All things taken together, the deal can offer the prospect of a return to health in the Greek economy only if its investment elements are taken up swiftly and comprehensively. Only then, too, will the recapitalisation of the Greek banking system come into play – and this is where the bulk of the funding on the EU side will go. Finally, only a dynamic economy can enable banks to undertake profitable loans. The institutional changes, either way, can only take effect over the longer term. A continuation of spending cuts alone would keep Greece trapped in its crisis. If the new agreements are rejected then an immediate return to chaos is pre-programmed – with an uncertain outcome.