Greece: The Primacy of Politics to Provide a Solution

Greece: Athens

Just a few years ago, Forbes Magazine – that self-proclaimed “Capitalist Tool” – identified the primacy of politics as the greatest danger facing Europe and the European Union (EU).

The publication merrily took a swipe at Mario Draghi, president of the European Central Bank (ECB). Mr Draghi was described as overly eager to embrace the misguided discourse of his political masters – a man living in a virtual reality shaped by wishful thinking.

Notwithstanding Forbes’ damning verdict, Super Mario went on to secure the euro’s survival, backing-up his “whatever it takes” bravado with a cool €1.2 trillion in QE funds.

Two years on, the primacy of politics – a concept that seriously spooks investors and the markets they operate in – is again brought to the fore with Greek voters electing into power a government decidedly reluctant to dance to the prescribed tune. Even before that government was properly seated, investors and creditors the world over embarked on a concerted campaign to remind the Greek that they cannot ignore the markets’ iron-clad dictates.

Not one to be intimidated that easily, Greek Prime-Minister Alexis Tsipras will shortly dispatch his finance minister to Brussels to lay the groundwork for a renegotiation of the 2010 bailout package that subjected his country to an extremely severe austerity programme. The Eurozone’s finance ministers seem willing – if not really anxious – to open negotiations but have ruled out any and all forms of debt relief.

“Though Prime-Minister Tsipras said yesterday that the country’s creditors cannot really expect Greece to ever fully repay its national debt, an impasse is not in the making”

Though Prime-Minister Tsipras said yesterday that the country’s creditors cannot really expect Greece to ever fully repay its national debt, an impasse is not in the making. In fact, there is plenty room for negotiation. As US economist Paul Krugman pointed out in an article for the New York Times, Greece has been running a primary surplus since 2013.

Under the deal it struck with the troika – comprised of the European Central Bank, the European Commission, and the International Monetary Fund (IMF) – the country agreed to work towards running a primary surplus equivalent to 4.5% of its GDP. This surplus represents the sum of what Greece takes in via taxes receipts and what it spends, excepting interest payments. As such, it represents the net transfer of resources to creditors.

Wiggle Room

Since Greece complies with the surplus requirements the troika imposed, there is some wiggle room here. Mr Krugman suggests the troika considers relaxing its demands on this point. Allowing Greece to reduce the primary surplus to, say, 1% of GDP would free up significant sums for spending.

This would make plenty of sense. Rigid austerity policies, such as those forced on Greece, tend to become downward cycles: as less money is spent, the economy contracts, and tax receipts dwindle necessitating yet more austerity. This is the way Greece saw about 25% of its GDP evaporate over the past six years.

However, the reversal of this trend is within realm of the possible. Mr Krugman shows that freeing up money for Greece by reducing the primary surplus requirement will see the multiplier effect kick in. The IMF estimates this multiplier to be about 1.3. Thus, each additional billion euros in government spending is likely to result in €1.3bn being added to the GDP. About forty percent of this amount will be recaptured in taxes. So, in the end, each additional billion euros spent, will reduce the primary surplus by only €500m.

Eliminating the primary surplus altogether means adding 9% to Greece’s GDP, fully 12% up from what it would have been with austerity policies left unchanged. Mr Krugman predicts that under such a scenario, unemployment would drop by approximately ten percentage points.

All Happy

While it is unlikely that the new government in Athens will be entirely excused from running a primary surplus, it seems equally unlikely that the troika will flatly refuse to consider some relaxation of its demands. Moreover, a smaller primary surplus in no way implies that Greece reneges on its debt obligations – keeping everybody, including the Germans, happy.

Dutch Finance Minister Jeroen Dijsselbloem – president of the Eurogroup and representing the Eurozone’s nineteen finance ministers – said on Tuesday that there is “very little support” for a debt write-off amongst his peers. That said, Mr Dijsselbloem continued to affirm that the Eurogroup could possibly have a second look at the “sustainability” of Greece’s debt.

Meanwhile, German Finance Minister Wolfgang Schäuble called on the Greek government to put measures into place that “ensure the economic recovery continues.” Perhaps unwittingly, Mr Schäuble offered Prime-Minister Tsipras a way forward that avoids a head-on confrontation between Greece and its creditors.

It is precisely at this point that the primacy of politics pays off. Greek voters have awarded Prime-Minister Tsipras a solid mandate to seek a new deal. Earlier, these same voters had signalled a clear willingness to accept far-reaching reforms, and the resulting austerity, in order for their country to stay in the Eurozone.

In fact, Greek voters have consistently rejected politicians proposing radical and irreversible change. Even Prime-Minister Tsipras, leader of the Coalition of the Radical Left, had to tone down his rhetoric and solemnly promise the electorate not to take Greece out of the Eurozone. The coalition’s lead economist Yanis Varoufakis – tipped to become the country’s new finance minister – assured markets that a “Grexit” is not on the cards: “We are not going to Brussels and to Frankfurt and to Berlin in confrontational style. There is plenty of room for mutual gains and benefits.”

Going Long on Greece

Thanks to politics, Greece may yet have a chance to rise from the ashes. With a weakened euro, a renegotiated bailout deal, and possibly some direct or indirect help from the ECB’s quantitative easing programme, going long on the country would seem a fairly safe bet.

Developments are sure to be watched closely in Spain where the left-wing and Eurosceptic Podemos (We Can) Party has now taken a commanding lead in the opinion polls. Fully 28% of Spanish voters wish to elevate the party to power – and that percentage is rising fast. The ruling centre-right Partido Popular (PP) saw its following slashed in half (from almost 45% of the electorate in 2011 to barely 19% now), while the Workers’ Party (PSOE) is also sliding down at an accelerated clip.

Spain is heading to the polls on December 20 for a general election and though much can still change, voters are likely to unambiguously signal their discontent with continued austerity.

This produces an interesting quandary for both Mr Dijsselbloem’s Eurogroup and the European Commission: give the Greek too much in the upcoming renegotiation and Spain will be next-up demanding a new deal, with Portugal following not far behind. However, refusing to relax the conditions to which Greece has been subjected will inevitably lead to a polarisation that serves nobody – least of all the creditors. Politics – and the pragmatism of its practitioners – will undoubtedly carry the day.