Economic Concept: All actions reflect the \"institutional framework\" of society

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Economic Concept: All actions reflect the "institutional framework" of society:

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Debt Isn’t Killing Greece. Its Leaders Are

The country was poised for 3% growth before Syriza took power. More debt relief would reward loony policies.

By, Holger Schmieding
WSJ, Updated July 17, 2015 7:03 p.m. ET

Half the world seems to be obsessed with debt relief for Greece. The farther observers are from Brussels, Berlin or Frankfurt, the more they seem to believe that only a massive upfront write-off of public debt can save Athens. Some proponents of such a “haircut” have clear motives: Greece wants any relief it can get, and the International Monetary Fund wants to safeguard its own exposure by asking eurozone governments to take losses on their own debt holdings. But in many cases, the haircut enthusiasts simply do not understand the basics.
Debt relief is only a side issue. Getting economic policies right matters much more. A government that pursues radical left-wing policies will suffer the same fate as the populists’ paradise of Venezuela, whether it gets debt relief or not. A country that enacts serious supply-side reforms can enhance its capacity to sustain debt via economic growth and the fall in financing costs that comes with improving credibility.
Business World Columnist Holman Jenkins Jr. on Eurozone efforts to prop up Greece’s failing economy, and the crises to come. Photo: Getty Images
Greece is an example of all this. The government already has enjoyed substantial debt relief. With the “voluntary” haircut for privately held Greek bonds in February 2012 and adjustments to the maturities and interest rates on debt held by other governments in late 2012, Europe reduced the net present value of Greek public debt by 40%. The average maturity of that debt has been extended to 161/2 years, with an average interest rate of 1.5%. Many countries with a much smaller debt-to-GDP ratio have to bear a far heavier interest burden.
What’s crushing Greece today is not its level of debt. It’s the country’s policy mistakes of the past six months.
Late last year, Greece had a debt burden equal to 177% of its gross domestic product while running a fiscal deficit of 3.5% of GDP. After inflation-adjusted GDP growth of 2.3% on an annualized basis in the first three quarters of 2014, Greece was on track to grow 3% in 2015, in line with Spain. In late 2014, Greek employment was finally rebounding at an annual growth rate of 2.4%. Coming out of the very deep crisis of 2010-13, its banks were finally solvent, its exports were rising and the private sector started to ramp up investment again.
This growth was creating its own form of debt relief. With nominal GDP growth predicted at 3.9% in 2015 and 4.2% in 2016, and the fiscal deficit falling, the debt ratio would have dropped to 172% of GDP in 2015 and 167% of GDP in 2016. While still high, the trend was encouraging and annual debt-service costs were easily manageable.
Then came Prime Minister Alexis Tsipras and his far-left Syriza party. Their reform reversals in the public sector and distrust of the private sector, combined with six months of botched negotiations with creditors, have destroyed confidence both at home and abroad. Today, banks are closed and probably insolvent. And the country is back in recession.
Instead of rising, both real and nominal GDP may decline by 3% this year, followed by a 1.5% rebound in 2016 if Greece implements the deal Mr. Tsipras struck with creditors Monday morning. The fiscal deficit could easily be 5% of GDP this year and still 2.5% next year despite the corrective measures Greece has to take. As a result, Greece’s debt ratio will rise above 187% in 2015 and 2016.
Recapitalizing the banks could cost up to €25 billion ($27.48 billion), according to initial estimates by Greece’s international creditors, from whom Greece will have to borrow the money. Adding this to our estimate above raises the peak in Greece’s debt ratio to 202% for 2015 and 2016 before a meaningful decline can kick in.
Less than six months of radical-left rule have inflicted damage that will likely push up Greece’s debt-to-GDP ratio by 35 percentage points relative to the baseline. This drives home one point: It isn’t the debt that matters. Greece needs to get its policies right again. The question is whether an upfront haircut helps or hurts this effort.
If Mr. Tsipras now implements most of the reforms to Greece’s judicial system, its public sector, its product and labor markets—reforms that Mr. Tsipras agreed to Monday morning—investment could start flowing back and growth could return from 2016 onward. Once recapitalized, the banks could make a spectacular recovery. By privatizing the revitalized banks some four to five years from now, Greece could recoup the €25 billion capital injection and use that to reduce its debt accordingly.
But a large-scale upfront haircut sets the wrong incentives for this transformation. It would reward Syriza for its loony policies of the past six months. Easing the burden modestly later this year through longer grace periods—if Greece implements the demanded pro-growth structural reforms—and holding out the carrot of further incremental relief as a reward for staying on track would set the right incentives.
This is what Europe is offering, and it will have a far greater influence on Greece’s future than a debate about some arbitrary debt threshold.
Mr. Schmieding is chief economist at Berenberg Bank.

Explanation / Answer

In this article, the seeds of the ongoing economic crisis in Greece are attributed to the failure in political structure and policy framework rather than the economic deficiencies. It has been pointed out that many proponents of Greek’s Debt crisis strongly support the idea of writing-off debts for Greece. They believe that only a major debt relief overhaul can revive the Greece economy. However, they forget that Greece has already enjoyed substantial debt relief policies in the past without much success. Thus, the economic collapse of Greece is mainly due to its political structure wherein the PM and his Syriza party’s radical left wing policies have inflicted great damages to the economy. Instead of enacting supply side economic reforms which could have helped Greece’s capacity to sustain debt via economic growth and improved credibility, the new government destroyed confidence and credibility in both public sector as well as private sector. Before the implementation of these policies by the government, the Greece economy was in fact witnessing an increase in GDP, exports, employment and , investment. However, after these policies implementation, Greece was back in recession with poor economic growth. Thus, the need of the hour is for Greece to get its policies right again so that investment can increase and banks could be recapitalized thus leading to an increased economic growth of the nation.

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