Larry Summers has recently proposed in the Financial Times a plan that could form the basis of an agreement between the Greek government, the European authorities and the International Monetary Fund (IMF). This plan is articulated around three axes:
- Serious policy adjustment and structural reforms including a pension reforms, an increase in VAT and a primary surplus;
- Debt relief to reduce the size of Greece’s public debt ratio;
- New disbursements to Greece.
Larry Summers suggests that both Syriza and Greece’s creditors should accept this plan as a compromise because the consequence of a Grexit would be dramatic for the Greek population, the future of Europe and the financial system.
This plan offers indeed the basis of a compromise. A debt relief package would represent a major political victory for Syriza. In exchange for this concession, Greece’s creditors would obtain that the Greek government start implementing measures to address Greece’s budgetary and economic problems. And both parties would avoid the damage that a Grexit would do to the Greek economy.
The likelihood that this plan be accepted should not be overestimated. Its premise is that Syriza would accept to follow a traditional policy of fiscal and structural adjustment. Greece’s prime minister, Alexis Tsipras, will have difficulties convincing his hard-left, anti-market colleagues from Syrisa, who are dreaming from a radical departure from the traditional recipes recommended by mainstream economists. In these circumstances, Tsipras would have to shift the center of gravity of its majority towards the center left. This development may be possible if Tsipras consider that the costs of Grexit would outweigh the political costs of betraying many of his colleagues and friends. He would also need to agree that Greece would benefit from the proposed economic program in terms of economic growth and job creation.
To tip the balance in favor of an agreement, Greece’s creditors will therefore have to accept measured fiscal effort and reforms. And it is likely that Tsipras will negotiate strongly, notably by stressing without ambiguity that a default and a Grexit would have catastrophic consequences for the future of both the euro area and the European Union.
What if no agreement can be reached on this Plan A?
To avoid the turmoil that a Grexit would bring, the European authorities should consider a Plan B articulated around two axes: no further disbursement to Greece and no Grexit.
Following this approach, the negotiations on a new program would stop but Greece would be allowed to stay in the euro area. However, the European Central Bank (ECB) would not increase further its exposure to the Greek banking system. The implications would be that Greece could not longer afford a deficit on its primary fiscal account and on its current account (assuming that the Greek government would not receive external financing from third party like Russia). In other words, Greece would have to leave within its means and move to some form of economic autarky.
This outcome would lead to numerous benefits for Syriza. Greece would default on its debt; there would no new program with the Troika; the Greek government could therefore decide what is best for its country; the Greek banking system would not collapse; and Greece would be allowed to stay in the euro area and the European Union.
This solution would also present a number of advantages for the European authorities: they would not take the responsibility of forcing Greece to exit the euro area; the principle of irrevocability of the euro would be therefore preserved; no new loans and no debt relief would be granted to Greece. There would be of course a price attached to this Plan: Greece would default on its debt. This would not necessarily imply that the outstanding debt would never be reimbursed. It will always be possible that a new government in Greece will accept to return to the negotiating table in the future, possibly rapidly if the policies supported by Syriza would not bring benefits to the population and lead to general elections. For this plan to become possible, the ECB would need to keep supporting the Greek banks, with the current limit of exposure to Greece, despite the fact that Greece would default on its debt.
One drawback of this plan is that Greece would not gain competitiveness through an external devaluation since it would stay in the euro area. This problem should not be overestimated because it is widely recognized that the benefits of a devaluation would be limited because Greece’s exports represent a very small share of the economy. It would be for the Greek government to decide whether or not the benefits of Grexit would outweigh the benefits of keeping the euro. But it would have interest in taking a clear and credible decision quickly on this question to avoid that confidence in Greece’s participation in the euro would remain low, which would complicate further the task of the Government.
We have to hope that Syriza and its creditors negotiate a new program that would get Greece back on a trajectory of growth and sustainability within the euro area. If this is not possible, there is an alternative that should be offered by the European authorities to limit the damage that a Grexit would impose on Greece, the euro area and possibly the global economy.