Greece’s economic programs have all failed because they have been based on unrealistic views of how financial markets actually work. The four fundamental flaws of the Greek economic strategy pursued until now are as follows:
First, E.U. governments, the European Central Bank and the International Monetary Fund have assumed that the present European financial crisis is simply a liquidity crisis and not a solvency crisis. The countries in crisis are not only missing the liquidity to make their debt payments due today, but lack the growth to generate enough income to consistently pay for their obligations in the future. This turns the temporary financing into something permanent, as Greece’s unresolved crisis has shown.
Second, the Greek economic and financial programs have failed repeatedly because they have assumed that Greece’s debt would be sustainable in a distant future year. The crucial mistake is assuming that Greece’s debt would be fully supported by the economy’s growth after many years instead of immediately, which is precisely what financial markets need to see to be confident that the crisis is finally being firmly resolved.
Third, the financial support needed to resolve the Greek crisis was granted before and not after the debt restructuring losses were properly assigned. As a result, the officially-held debt became part of Greece’s solvency problem.
Fourth, without adequate front-loaded financing but rather drop-by-drop multilateral financing, Greece has not had a fair chance of pursuing a successful crisis-resolution strategy. Specifically, all of the agreed official financing for Greece should be immediately provided, not just the next tranche of the €31.5 billion loan.
The solution to address these critical issues is based on the simple idea that Greece’s sovereign debt needs to be made sustainable now—not in 2020, as the IMF assumes, or any other future year.
What is needed, first, is a reduction or a write-off on the sovereign, officially-held Greek debt that is sufficient to ensure that Greece’s entire sovereign debt becomes a constant or declining fraction of GDP. Sizable, front-loaded, official financing would ensure that Greece can credibly signal its debt repayment capacity over the medium term. GDP-linked warrants ought to be issued that will allow creditors and investors to recover as much of the losses on the old debt as possible as the Greek economy finally grows again. More importantly, Greece will signal its willingness to share with creditors and new investors alike its improved economic performance over the years but in a way that protects its debt service.
Greece made its choice to stay in the Eurozone. Now the rest of Europe, notably, Germany needs to make a choice to help Greece regain strong, sustainable growth by permanently addressing its financing needs.
Editor’s note: A longer version of this essay, co-authored by José M. Barrionuevo, Nikolaos Georgikopoulos and Guillermo Nielsen, appeared as an op-ed in the New York Times on Nov. 6.