20 April 2010

Germany should share the blame for the Greek crisis

Jean Pisani-Ferry and André Sapir

After two months of acrimonious discussion, it is now likely that an EU-IMF package of
conditional assistance to Greece is going to be activated in the coming weeks. Markets
however did not react well to the agreement last week on the size of the EU package and the
terms of lending: spreads on ten-years government bonds have risen to new heights.
Bondholders visibly anticipate that some sort of eventual debt restructuring and perhaps also
that government involvement will likely make their own claims less senior than official
lending. So the default that assistance was meant to avoid is still threatening and nobody can
say whether there will in the end be a cost to be borne by the European taxpayer.

This possibility is a cause for worry for citizens throughout Europe but it is visibly German
citizens who are the angriest. As everyone else they do not rejoice at the prospect of paying
for another country’s mistakes, but they are also angry for two other reasons. First, they feel
that they have been cheated by their politicians who had promised that such a situation would
never happen thanks to the strict rules of the Maastricht Treaty and the Stability and Growth
Pact. Second, they feel that they had to tighten their belts after the adoption of the euro to
regain competitiveness and they do not see why the Greeks can't do the same.

It is true that the developments of the Greek affair look like the chronicle of a nightmare
foretold. It is true also that even after the principle of assistance had been agreed by the EU
leaders (in spite of German reluctance) they were told that it was only meant to impress
markets, not actually to be used. But Germany itself must share some of the blame for the
situation.

First, legitimate insistence on crisis prevention through European fiscal rules and EU
surveillance served as an excuse not to think about crisis management. But fires occur even
with the best sprinkler systems, and you need a fire brigade to put them out. The very notion
that preparing for crisis management would amount to recognising that crisis prevention rules
exist to be circumvented was mistaken. In the end, a fire brigade had to be assembled in a
hurry.

Second, Germany itself contributed to weakening the crisis-prevention system. It contributed

to the assault on the Stability and Growth Pact in 2003 and, perhaps more importantly, it
liaised with others to weaken its implementation. The Greek problem could have been
uncovered much earlier, had the EU ministers agreed on a thorough audit of the country’s
public accounts. So it is not for lack of tough sanctions that the mess was created, rather
because down-to-earth, mundane policing was not exercised. Third, Germany was happy to
improve its competitiveness vis-a-vis other countries in the euro area and failed to see that the
corresponding loss of competitiveness of Greece and others was in fact undermining the very
sustainability of these countries’ participation in the euro area.

In the end however interdependence cannot be eschewed. Had Germany refused to take part
in the assistance lending to Greece, Greece would have gone to the IMF without Germany
(and other EU countries) having a direct say on the conditions for assistance. And it might
have decided for a default, at a high cost for the creditor banks of Northern Europe. It is
natural therefore that despite all its reluctance Germany is participating in an EU/IMF lending
programme – it is in fact in its best national interest.

The harsh lesson from the crisis is in the end that the ‘never, ever any assistance’ philosophy
was an illusion. Does it mean that more disciplined countries, especially Germany, must
accept that others can draw on their resources at will? No. First of all, the very expectation of
possible assistance strengthens the hands of the potential lenders considerably. Before the
Greek crisis the notion that a euro area member could default was an abstract one: ‘we are no
Argentina’ was an easy reply to those expressing concerns. We have learned there are
potential Argentina’s in the euro area and this justifies even more exercising control over the
partners’ public finances. So the possibility of a bail-out may paradoxically strengthen, rather
than weaken, fiscal discipline rules and their enforcement. It is high time to use this
opportunity to reinforce crisis prevention.

Second, as it is now conceivable that a euro-area country will end up negotiating with its
creditors in the Paris Club as Mexico and Pakistan did in the past, the EU would be well
advised to think ahead and agree on principles for such renegotiation. This requires setting
rules for seniority and also determining who is entitled to set the terms of a standstill, of a
rescheduling, or of the reduction of an ailing country’s debt obligations. At the beginning of
the 2000s, an IMF proposal for a ‘Sovereign Debt Restructuring Mechanism’ whereby a
public, quasi-judicial authority would have fulfilled that role was widely discussed. Intense
Wall Street lobbying led to its burial. As the public debt of several countries, including
Greece, is overwhelmingly held by residents of other euro-area countries, there is now a
strong case for devising a similar European mechanism. This would counterbalance the
debtor’s temptation to expropriate the foreigners, and the creditors’ temptation to postpone the
day of reckoning.

The authors are respectively director and senior fellow with Bruegel, the Brussels-based
European think tank.