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Europe’s Greek Failure

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BRUSSELS – Narratives matter, especially when they are intertwined with hard interests. As Greece and its creditors court catastrophe, we are getting a clear picture of how conflicting narratives can lead to a lose-lose result.

The facts are indisputable. In early 2010, when the Greek government could no longer finance itself, it turned to its European partners and the International Monetary Fund for financial support. And they delivered: not only did other eurozone countries issue loans to Greece, but the IMF provided its largest-ever loan to the country. Later, Greece received even more support through the eurozone’s bailout funds. The result was hundreds of billions of euros worth of assistance.

But, as time progressed, Greece and its creditors came to view these facts very differently. As Greece’s economic situation deteriorated, its citizens got the sense that the loans were not really intended to help them, but rather to bail out German and French banks. With this narrative, Greeks could avoid admitting the role of their own government’s policy mistakes in thrusting them into recession.

Greece’s creditors, by contrast, felt that they had generously saved a profligate country from bankruptcy. This narrative allowed policymakers in Germany to disregard the fact that their country’s banks had financed Greek borrowing for too long.

Both narratives contain a large amount of truth, but conveniently overlook some important facts. For instance, a substantial share of the loans given to Greece until early 2012 was indeed used to pay off maturing debt. But it is likely that the holders of the debt were no longer French or German banks – who for the most part would have been unable to bear the uncertainty that preceded the 2012 bailout and haircut on Greek debt.

By the time the eurozone governments intervened decisively, most French and German banks had largely unloaded their holdings at a loss to hedge funds and other investors with a greater appetite for risk. Whatever debt they had held onto lost more than half its value in the haircut. Given this, it cannot be said that French and German banks did not suffer losses.

Similarly, the creditor countries were right that they had helped Greece, a country that had undeniably overspent for years. Their financial assistance allowed Greece to reduce its fiscal deficits more slowly than if it had simply gone bankrupt in 2010, as it enabled the country to remain connected to financial markets. In the first quarter of last year, Greece actually experienced a slight uptick in growth and a small decline in unemployment.

What the creditors overlooked was that, over time, the pain of austerity began – in the minds of many Greeks – to outweigh the benefits of their assistance.

Until a few months ago, it still looked as if Greece could achieve a primary surplus, albeit a small one, this year. When the country turned to its creditors for help, it was only because it could not cover some large payments on maturing loans. Greece had ceased to be a “bottomless pit.” With a bit of financial engineering, Greece’s creditors could have postponed some of the payments the country owed this year – payments that, it should be noted, everyone knew it would not be able to repay at this stage – and enabled it to continue its gradual recovery.

Instead, these clashing narratives created a deleterious spiral, fanning the flames of animosity and leading to the election of a left-wing government in Greece with a mandate to oppose austerity – with disastrous results for both sides. Rather than help Greece make its payments, the creditors reacted by imposing tough conditions for a new loan that would be used only to repay debts that they themselves held – a point that Greek Prime Minister Alexis Tsipras emphasized in his last proposal.

And yet, blaming the creditors for their “punitive” conditions, as Greek negotiators have done, would also be a mistake, for this simplistic narrative too obscures a complicated truth. Right before the talks were abruptly cut off for Greece to hold its referendum, the two sides had agreed on fiscal targets for Greece; all that was left was to determine how the targets should be reached. The Greek government wanted to raise some taxes. Its creditors believed that this approach would stifle growth even more, so they advocated increasing the tax base, such as by eliminating the lower value-added tax rates enjoyed by Greek islands, instead.

Though the creditors’ logic was sound and their intentions laudable, the Greek side believed that such a condition would amount to an affront to their country’s sovereignty. With that, their narrative morphed into one of national pride.

It was a classic “prisoner’s dilemma.” Both sides have known throughout the tortuous negotiations of recent months that failure to reach an agreement would benefit no one. Greece’s economy would contract even further, and its creditors would have to accept even larger write-offs.

But the two sides have remained locked in their respective narratives – narratives that the recent cutoff of negotiations and hastily arranged referendum have reinforced. Now, the Greek electorate is rejecting the creditors’ demands in the name of national pride, democracy, and sovereignty; the creditors are angry not only at their attitude, but also at their government’s unreliability.

Saving Greece was always going to be difficult, given its previous fiscal excesses and weak economy. But last year, it seemed that success was within reach – until the clash of narratives derailed the progress the two sides had made. This highlights a larger problem: the European Union lacks a unifying narrative strong enough to prevent the emergence of conflicting – and highly destructive – narratives within its borders. In this sense, the failure to save Greece amounts to a failure of Europe.

Daniel Gros is Director of the Center for European Policy Studies.

Copyright: Project Syndicate, 2015.
www.project-syndicate.org

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