In the months leading up to Greece’s election on January 25th much of the debate has centred around Greece’s elevated public debt levels. The argument revolves around whether Greece’s public debt, currently at 176% of GDP, is too high, thus hindering growth and crowding out investment. SYRIZA, the opposition party currently leading the polls, promises a sizeable haircut as part of its election rhetoric and a key pillar of its post-election plan. A haircut is also viewed by certain economists in both the United States and Europe as a key solution to the Greek “problem”.
But Greece’s problem is not one of high public debt.
The sustainability of public debt should be judged primarily by the cost to service the debt and not by its debt to GDP ratio. This cost has been reduced significantly through the reduction of interest rates on the “official sector” loans. Indicatively, for the €142bn loans from the EFSF, the country pays merely 0.5% above euro short-term market interest rates, which are now close to zero. In 2014, Greece made interest payments of €6bn, corresponding only to 1.9% of its public debt – a manageable level considering that Germany and Italy are paying 2.7% and 3.8% respectively. At the same time, refinancing risk has also been addressed through maturity extensions of these loans. While the level of debt held by the official sector has not been reduced in nominal terms through a haircut, it has been reduced in present value terms.
So it is not the high level of public debt that discourages investment – Greece’s problem is structural.
Its problems stem from the incessant bureaucracy, the sizeable and unproductive public sector; the complex and ever-changing tax system; the lack of flexibility in the labour market; the high level of political uncertainty; as well as the lack of free and competitive market functioning. The reforms needed to restore Greece’s competitiveness are not a secret recipe. They have been outlined by international organisations such as the OECD as well as bodies within the country such as the Hellenic Federation of Enterprises (SEV) and, of course, by the Troika itself. Unfortunately, despite a prolonged crisis most reforms have yet to be implemented while many reforms were passed only on paper without being executed. The outgoing government, as well as those that preceded it, were unwilling to bear the political cost of changing the status quo and dealing with vested interests, chosing instead the path of over-taxation and horizontal cuts.
The result? After six years of fiscal austerity the sacrifices of the Greek people are at risk of having been in vain.
Admittedly, a further haircut of public debt would not constitute a negative development for Greece, but it does not address the root of the problem. A haircut on its own can neither produce growth nor create the jobs needed to reduce Greece’s high unemployment. If not accompanied by the necessary reforms it will at best bring short-term benefits to the Greek economy- without a competitive production base Greece will sooner or later be trapped in an indefinite spiral of deficits and debts. The next government will have to implement substantial reform if it wishes to propel Greece onto a path of sustainable growth.