ATHENS – German Chancellor Angela Merkel¢s upcoming visit to Athens will be a far less tense affair than her earlier journeys here during Europe¢s long financial crisis. Of course, Greeks have little love for Merkel; but, thanks to Europe¢s modest economic recovery, some of the poison has been drawn from Germany¢s relations with Europe¢s most damaged and distressed economies.
Indeed, Europe is no longer considered a risk to global financial stability. The eurozone¢s core economies are showing signs of revival, and financial conditions in the over-indebted periphery are improving as well. But, given capital shortages, depressed demand, and the slow pace of reform in the eurozone periphery, continued progress is far from certain.
In the eurozone economies that were hit hardest by the global economic crisis, the output and employment losses have been huge and persistent. Real (inflation-adjusted) per capita income in the eurozone as a whole hovers around its 2007 level; in Greece and Italy, however, it has sunk to the levels recorded in 2000 and 1997, respectively.
Meanwhile, the eurozone¢s overall unemployment rate is 12%, and it is much higher in the periphery. In Spain, more than 25% of the labor force is jobless, while Italy¢s youth unemployment rate stands at 42%. In Greece, where the overall unemployment rate has climbed to 28%, some 60% of the country¢s young people are unemployed. Recovering from such crippling employment losses will not be easy, and will require a speedy return to high and sustainable growth rates.
Consider Greece, where the government is planning a return to the capital markets in the coming months to finance the country¢s long-term borrowing needs, even though securing such financing would require paying unsustainably high interest rates. The fact that the government seems willing to do so translates clearly its desire to move beyond the influence of the “troika” (the International Monetary Fund, the European Commission, and the European Central Bank).
Indeed, since 2008, Greece¢s GDP has shrunk by almost 25%. Recovering lost capacity will require large amounts of capital, but there are five reasons why such financing is unlikely, under present conditions, to be forthcoming:
• As a result of austerity, public investment as a share of GDP continues to fall and has now reached a record low. Having already committed substantial rescue funds, eurozone authorities do not seem inclined to inject fresh capital.
• Sources of domestic private capital are limited, because the recession and the related near-collapse of asset prices, along with a sharp increase in taxation – particularly on high incomes and on capital – significantly weakened balance sheets.
• Bank lending has slowed drastically, as a result of Greek banks effectively defaulting in the wake of the troika-imposed losses on sovereign creditors and the nationalization of the country¢s banks. A record-low level of deposits and the recession-related rise of non-performing loans have weakened Greek banks¢ capital position further. (Today, companies in the eurozone periphery borrow at substantially higher rates than their counterparts in the core. For bank loans, the ratio is almost two to one; for long-term financing, it may reach as high as ten to one.)
• Greece¢s unsustainable debt position is discouraging foreign private investment. The assumptions about primary surpluses, private-sector involvement, and GDP growth underlying the government¢s commitment to reduce its debt level, which currently exceeds 170% of GDP, to 124% of GDP by 2020 cannot be realized, given Germany¢s opposition to restructuring the official financing that replaced the defaulted private loans. Some easing of loan conditionality – via extended maturities and reduced interest rates ‒ will be agreed later this year, but it will not be enough to calm fears of a new default.
• Trust between foreign and Greek investors is lacking, and it will not be restored until debt sustainability is achieved. But Germany and the other core eurozone countries consistently block any proposal that contemplates debt mutualization or fiscal union. Ideas such as Eurobonds, a single European finance ministry, and increased capitalization of Europe¢s common rescue funds (the European Stability Mechanism and the Single Resolution Mechanism) are not even being contemplated.
Along with inadequate capital supply, Greece is suffering from a demand shortfall, as the troika continues to squeeze the country with harsh austerity. If these policies are not relaxed or offset by more expansionary policies in the eurozone core, demand will remain depressed, discouraging further investment.
Finally, on the reform front, time is running out. For the last few years, rather than confronting the special interests – state-protected businesses, public-sector trade unions, and lobbies – that inhibit reform, Greece has spread its economic misery horizontally through blanket spending cuts. Reforms such as privatizing state-owned enterprises, opening up closed professions, abolishing restrictive business practices, and reducing the size of the public sector have been undertaken very slowly and inefficiently, and they will not significantly alter growth prospects.
As it stands, Greece is unlikely to meet the recovery challenge – and other peripheral economies will probably falter, too. Sufficient reforms and capital are lacking, while the social rifts resulting from austerity increase the risk of potentially devastating political instability. With the European Parliament election approaching, the prospect of populist anti-austerity parties prevailing in the periphery – and of anti-euro, anti-bailout parties gaining power in the core – heightens the risk of instability even more.
Should financial turbulence return and herald a new eurozone crisis, the monetary union¢s sustainability will again be called into question. To prevent this outcome, Greece and the eurozone¢s other peripheral economies must limit austerity, buttress demand, undertake reform, increase investment support, and pursue fiscal union. Unfortunately, these keys to ensuring a cohesive and prosperous eurozone are likely to be left unturned – until, perhaps, the next crisis occurs.
