Greece: an entirely political crisis

A commentary in the VoxEU Debate Development and the crisis, Has austerity gone too far?

Posted By Sergio Capaldi, Intesa Sanpaolo - Research Department on 18 May 2012

Now that the latest attempt at forming a national government has failed, the Greeks will be voting again on 17 June. If surveys of voting intentions are anything to go by, the crisis is only just beginning to get really nasty. 

The example of Greece is evidence of the need for reforms to be consolidated and socially fair, since – not least in order to secure greater popular support – it would have been better had the rigour been coupled with a more substantial helping of social justice. The discontent generated by the adoption of measures that have hit many of the people hard has fuelled the rise of opposition parties that are more critical of what the government is doing or are manifestly populist in nature. In seeking to get the public finances back on track (failing which, it needs to be said, the country as a whole will be plunged into the abyss) Europe has not given sufficient attention to the issue of social cohesion in a country that has been swindled by a corrupt and incompetent ruling class. As the squeeze takes hold, Greece is already playing a very dangerous game of blackmail and more or less credible threats. Greece's destiny is largely in the hands of its people. If the anti-bailout front win the day, the country's exit from the Euro will happen in a matter of weeks. The parties of the radical left overestimate the scope for renegotiation and have been pushing for an unacceptable modus operandi that has forced the rest of Europe into a more rigid stance.

If Alexis Tsipras' radically left-wing Syriza party does as the results of some polls suggest, it could be the biggest party, and, given the majority premium (50 seats), a government without its support will be unsustainable. Even in that case Syriza might not, however, be able to form a parliamentary majority opposed to the bailout. The latest surveys show a marked downturn in the performance of the Communist Party (KKE), whose seats could be vital in surpassing the 151-seat threshold. The next election, then, could bring in a highly fragmented parliament that would find it difficult to govern the country, and could exacerbate the crisis by potentially setting the status quo in stone and not offering Europe a partner with whom to engage in dialogue on reforms.

Whatever the new government turns out to be like, it will seek to renegotiate the terms of access to financial aid, but will find it impossible to change the direction of fiscal policy or reverse the progress made on many fronts as part of the country's reform process. Europe may well be able to give more attention to the structural imbalances by acknowledging the progress made over the cyclically adjusted targets, but will not accept outright abandonment of the policies adopted. The election of France's President Hollande and Italy's support for measures to sustain growth will not be sufficient to change the direction or nature of the financial constraints within which Europe has to manoeuvre. If Syriza becomes the glue in a majority coalition made up of Dimar and the KKE, then, given the radicalism of the approaches adopted by both these parties, it may well be that the future government will become even more confrontational and ignore the requirements of Europe and the IMF.

If that happens, then events in Greece are likely to take more or less the following course: 1) it is likely that the external financial support would be suspended, so the country would again default in the course of only a few weeks; 2) a long time before that happens, the prospect of the country leaving the Euro would prompt households and businesses to withdraw their deposits in massive amounts, and, without support from the ECB, the runs on banks would cause many of them to fail one after another;  3) the government, faced with this state of affairs, would be obliged to close off access to the credit system;  4) the economic recession would become even more severe and would eventually make the original situation even worse, with the state, in a matter of weeks, being unable to pay either salaries or pensions, and the crisis taking on the characteristics of a profound depression before the Greek central bank, having reassumed the power to print and mint the drachma, would flood the economy with liquidity; and 5) the drachma would immediately lose value, while inflation would simultaneously rise and adversely impact the purchasing power of salaries and pensions.

In the best-case scenario, the process of regaining equilibrium will take years and the social and economic costs be well in excess of what Europe and the IMF are asking to bear. Access to foreign financial markets will be made more difficult by reputational and legal issues, and the country will be obliged to finance much of its own deficit by monetisation, thus