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  • Mathieu Provencher

Greece, the spoiled child of Europe

Here we go again… Greece asked for debt relief, hoping for debt forgiveness, and got away with it a few days ago (the relief for now, forgiveness perhaps in the near future). Let’s see the difference between “relief” and “forgiveness” and let’s try to understand why Greece is in such a position. After all, other European countries have indeed gone through very tough “structural reforms” (take a look at Ireland for example) without much more than a little wining, nothing like the political machine of despair put forth by the Greeks.

Just to put things in perspective, take a look at the following graph:

(compilation: Mathieu Provencher, data: IMF)

As you can see on the graph, Greece’s debt has been growing every year for more than 35 years in a row (deficits represent an increase on existing debt). Their debt is now most probably unpayable… even if Greece dedicated more money to paying it back, they would likely not even cover the interests on it.

“Debt relief” is generally understood as an easing of debt conditions. It can come as an extension on deadlines for debt repayments, a decrease in the interest rates to be paid, or perhaps as a reduction in the overall debt owed, also called debt forgiveness. “Debt forgiveness” is when creditors erase debt, simply accepting that they have lost the money they lent. Debt forgiveness is also known as a “haircut” in financial markets (which Greece received in 2012, cancelling around 50% of their private debts).

The latest deal between Greece and its European creditors mostly aims at lending money to Greece so it can pay back some other loans (that need to be paid soon). We call this debt-for-debt concept “rolling-over” or refinancing your debt… which, as you can imagine, is not very constructive in itself.

The idea is to make it more likely for Greece to pay back its debts later. If, for a reason or another, Greece’s economy grows substantially in the near future, the Greek government will have more money in their coffers. They can then use that extra money to pay back the new loans and everyone will be happy.

However, history clearly suggests (remember the graph) that even in periods of high economic growth, Greece just keeps pilling up debt. The Greek culture and political scene tend to generate high government spending and relatively low tax revenues. Unfortunately for Greeks and their creditors, a substantial amount of spending seem to have been unproductive, which means less money in the future (or now because of bad choices in the past).

SO, what should the government of Greece do? There are two sides to this question:

(1) The German-type argument claims that Greeks should pay their debt by implementing tough structural reforms that will make Greece more competitive and thus more successful. Reducing unproductive government spending and collecting more taxes from higher economic activity will allow Greece to repay their loans. This argument is often supported by the example of Germany that reformed not too long ago and is now the strongest economy of the European Union. Ireland, Spain, and Portugal all accepted the reforms and are now doing better than Greece.

(2) The French-type argument claims that reforms lead to lower economic output, which makes debt worst and creates social frictions. These social problems lower the chance of reforms to stay because new governments will be elected with the promise to stop the reforms. Very high unemployment can lead to hysteresis while social tensions lead to lower tourism, which is a fairly important industry in Greece. It is argued that reforms can always be imposed after the economy recovers.

I hope you guys understand a bit better the current debate over Greece and their creditors.

Thanks for reading and don’t forget to have fun!!!!!

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