The Greek rescue program is seriously derailed. By the end of this year, the economy will be one-fifth smaller than it was five years ago, and the government is forecasting another 4.5 percent decline in 2013.
The collapse helps to explain the high drama involved last week, as the Greek government tried to drive through parliament a double dose of austerity in the teeth of recession, and the country’s international creditors worry over whether to give the country its next 31 billion euros ($40 billion) of life support, rather than let it default on debt repayments later this month and crash out of the euro.
Given such a desperate situation, it’s all the more surprising that Greece continues to borrow abroad at a stunning rate. The current account deficit, a measure of external borrowing for the country as a whole, was 21 billion euros in 2011, or about 10 percent of gross domestic product. While it slowed somewhat in 2012, Greek borrowing still ran at an annualized rate of 14 billion euros in the first half of the year.
Heavy foreign borrowing is sensible when a country is faced with a temporary fall in growth. It can help to cushion the effects on domestic consumption. But Greece is not suffering from a temporary slowdown in the economic cycle. In a situation where the decline in activity is more permanent, large-scale borrowing to sustain consumption only increases the pain down the road.
The paradox of a simultaneous plunge in economic activity and increased external borrowing raises the question of why Greece is borrowing at the rate it is. The answer appears to be that the Greek political system is seriously dysfunctional. There simply is no credible plan for the long term and, certainly, none that would envisage repaying external debt.
The past weeks have shown that the ruling parties in Greece are more focused on fighting each other than on reforms that could support economic growth and real change in the country. The result is political deadlock and a rate of increase in debt levels that even the biggest rescue packages can’t keep up with.
Policymakers have begun slowly to recognize the unsustainability of these debt-and-borrowing dynamics. The International Monetary Fund has been pushing the euro area to find ways to reduce Greece’s debt, but governments and the European Central Bank, which holds about 45 billion euros of Greek bonds, have resisted any suggestion they should forgive the debt that’s owed to them.
Greece will only be truly “saved” once it manages to get along without additional borrowing. Achieving this requires that official creditors stop lending money to the current Greek elites, that official and private creditors write off the country’s debt, and that domestic economic competitiveness increases to a point where it gives a strong boost to exports.
A Greek debt default and a simultaneous euro-area exit would achieve all of these goals, virtually overnight. Obviously, the adjustment would be rough, and turmoil would probably prevail for a number of months, but the adjustment would take place.
The current soft approach, in which international money is channeled to the ruling elites with the aim of smoothing transition to a sustainable position within the euro area, has yielded close to nothing in terms of structural economic adjustments. Instead of a smooth transition, Greece is in the midst of a disastrous collapse in output.
This unfortunate outcome must be blamed on the inability of the Greek political elites to deliver the structural economic changes that are needed. Salary cuts and tax increases alone simply cannot re-establish the competitiveness of the economy. And if true economic reform cannot be delivered, then a euro-area exit remains the only other available option. This is a sad and unavoidable conclusion. •