There is both good news and bad news coming out of Brussels for Greece. The good news is that Greece seems to be well on its way to securing an agreement with its official creditors that will allow it to avoid defaulting on the IMF at the end of this month. The bad news is that the agreement is seriously flawed and has little chance of flying either economically or politically over the longer haul.
At one minute to midnight, and after five months of fruitless posturing, Greek Prime Minister Alexis Tsipras has made meaningful concessions in his negotiations with the IMF and his European partners that have crossed some of his former red lines. These concessions have been favorably received by his creditors as a good basis for negotiation and should pave the way for a final agreement over the next few days. That agreement in turn will allow the Europeans to provide Greece with the US$2 billion it needs to stave off an IMF default that would otherwise have occurred on June 30.
Before we get carried away by this agreement, we might want to ponder the thought that this agreement has little chance of working economically. For the arrangement prescribes the same sort of policies that have failed Greece so miserably in the past and that have driven the country into the deepest of economic depressions. Specifically, the agreement requires that, in the midst of an economic depression and within a Euro straitjacket that precludes devaluation as an offset to budget belt-tightening, Greece must effect as much as two percentage points of GDP in fiscal adjustment over the next twelve months and as much as four percentage points of GDP in such adjustment over the medium term. This has to beg the question as to why we would think that these policies will work this time around when they have failed so badly over the past five years.
To compound matters, Mr. Tsipras is proposing that over 90% of the fiscal adjustment be done through tax hikes. At the same time, he is eschewing any notion of structural economic reform that might modernize the sclerotic Greek economy and that might incentivize investors. Despite this, he is cheerfully hoping that somehow the Greek economy will recover.
At a political level, Mr. Tsipras is soon to find out that it is one thing to agree on an economic program with Greece’s official creditors in Brussels and it quite another thing to get the Greek parliament to implement that agreement at home. For not only are many members of his own Syriza party seething that he has gone back on all of his electoral promises, the opposition too is up in arms that he is proposing to asphyxiate the Greek economy with tax hikes. And all of this political dissatisfaction is occurring before the Greek economy takes another turn down under the weight of excessive fiscal adjustment in a Euro straitjacket.
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