When the options are costly, leaders avoid reforms.
The Greek crisis was caused by huge deficits in the budget and the current account, which means that the country had been spending and consuming much more than it had been producing for a long time. When the 2008-2009 global financial crunch hit, Greece revealed the depth of its economic problems. Global lenders no longer considered Greece a good credit risk, and the country could not make its loan payments.
Greece had three options: default on its debt, exit the euro zone (the “Grexit”) or implement tough austerity measures and reforms in return for financial support from abroad.
Greece chose to tighten its belt in 2010 and ask for more money. But policymakers did not implement the structural reforms needed to reboot economic competitiveness — and they did not end privileges for politically well-connected groups. Instead, politically less influential groups, such as the young and the unemployed, were hit hardest by the austerity measures, which included harsh budget cuts and a jump in taxes. Moreover, the Greek government implemented only the minimum changes required to receive continued financial support from abroad.
There’s a pattern here. When the options are costly, leaders dig in and avoid reforms. My research, published as part of a special issue of Comparative Political Studies on the “Political Economy of the Euro Crisis” and in my book, shows this reaction is typical for countries where the dominant crisis resolution strategies are economically and politically costly. So in Greece, leaders were unwilling to make internal adjustments, such as widespread austerity measures, and especially significant structural reforms. But Grexit, which would entail a strongly devalued new Greek currency (“external adjustment”) was even more unpopular.
Policymakers with this type of “vulnerability profile” fight to avoid any serious reforms as long as possible. Crisis management in these countries is difficult: political turmoil and public protests abound. Reforms are delayed. The lack of firm crisis management means that outside support, typically from the IMF, usually is called in to avoid financial meltdown. And when policymakers cannot avoid implementing reforms in return for this outside support, they usually design these reforms in a way that shields their own voters and targets those that are politically least influential.
Other countries handled similar crises at a much lower cost.
In the Baltic states in 2008-2009, governments slashed public spending and fired thousands of public employees. They experienced sharp recessions and high unemployment, but the crisis was resolved rather quickly. Because these countries had relatively sound finances and flexible labor markets, the internal adjustment strategy was much less costly than the alternative, giving up their pegged exchange rate to the euro.
A currency devaluation would have been highly costly. It would have scuttled their plans to join the euro zone. It would also have significantly increased the debt burden of individuals and firms who had borrowed in euros rather than the national currencies. Given this vulnerability, Baltic policymakers were able to implement these drastic measures quickly and without major public protests.
Crisis resolution was also easier in Poland, where the zloty was never pegged to the euro. So lowering the exchange rate was much less costly than austerity and internal structural reforms. Poland, therefore, immediately allowed its currency to depreciate, and rode out the 2008-2009 crisis without having to implement deep austerity measures.
It’s harder to reform Greece’s economy.
But in Greece, both external and internal adjustment strategies carry very high costs. The budget and the current account deficits are huge. The cutbacks needed to rebalance the Greek economy are therefore also huge. But Greece also has an entrenched political system, where corruption, favoritism and lax rules mean people who benefit from this system are reluctant to allow for change. Internal adjustment has been challenging. The alternative, Grexit, is also a risky and costly strategy, and one that has been deeply unpopular among Greeks.
Greek voters’ perceptions about the consequences of different crisis resolution strategies illustrate this difficult vulnerability profile. In a recent survey that I conducted jointly with Elias Dinas, Ignacio Jurado, and Nikitas Konstantinidis, 59.7 percent of respondents stated that they expected significant income losses if the government implemented the austerity measures it promised its creditors — or if Greece were to leave the euro zone, as you can see in the figure below.
So Greeks are between a rock and a hard place: No matter how the government tries to resolve the crisis, people know that their incomes will take a hit.
This vulnerability profile explains why the Greek government is trying to implement only the bare minimum required to get continued financial support from outside and, it hopes, some debt relief.
Why do creditors continue to support Greece?
European policymakers struggle to achieve two main goals: safeguarding the idea that the euro is irreversible and stable; and protecting their own banks and taxpayer money. To achieve these goals, the IMF, European Commission and European Central Bank have lent Greece huge sums to keep it financially afloat and in the euro zone, while demanding austerity and deep reforms in return. But they have been unwilling to either let Greece default or to grant substantial debt relief.
This approach to manage the Greek crisis has drawn a lot of criticism and debate from all sides. At the same time, Greece’s lack of decisive action and willingness to push painful decisions down the road leave its economy still in disarray and its debt problems mostly unresolved.
Will Greece remain in the euro zone?
Despite numerous protests and riots, the repeated election of a populist left government and a referendum against the conditions associated with a bailout package, the euro is still popular in Greece.
But support for the euro is declining. The figure below shows more survey evidence we collected in Greece over the past year. As the crisis drags on, voters seem to realize that Greece will not be able to remain in the euro zone without some big changes — and continued austerity. Support for the euro has dropped by more then 10 percentage points over the course of only a few months.
As long as creditors are willing to finance Greece’s financial needs at the bare minimum it needs to survive, and as long as a majority of Greeks want to stay in the euro zone, the crisis is unlikely to be resolved quickly. If a majority of Greeks starts to prefer a return to a drachma, however, the crisis could quickly escalate one last time. So Grexit, Greece’s exit from the euro zone, might eventually mark the terrible end of a terrible crisis.
Stefanie Walter is full professor for international relations and political economy in the department of political science at the University of Zurich, and author of “Financial Crises and the Politics of Macroeconomic Adjustments” (Cambridge).