Today we are fortunate to have a guest contribution written by Jeffrey Frankel, Harpel Professor of Capital Formation and Growth at Harvard University, and former Member of the Council of Economic Advisers, 1997-99. An earlier version was published in Project Syndicate.
Alexis Tsipras, the Greek prime minister, has the chance to play a role for his country analogous to the roles played by Korean President Kim Dae Jung in 1997 and Brazilian President Luiz Inácio Lula da Silva in 2002. Both of those presidential candidates had been long-time men of the left, with strong ties to labor, and were believed to place little priority on fiscal responsibility or free markets. Both were elected at a time of economic crisis in their respective countries. Both confronted financial and international constraints in office that had not been especially salient in their minds when they were opposition politicians. Both were able soon to make the mental and political adjustment to the realities faced by debtor economies. This flexibility helped both to lead their countries more effectively.
The two new presidents launched needed reforms. Some of these were “conservative” reforms (or “neo-liberal”) that might not have been possible under more mainstream or conservative politicians.
But Kim and Lula were also able to implement other reforms consistent with their lifetime commitment to reducing income inequality. South Korea under Kim began to rein in the chaebols, the country’s huge family-owned conglomerates. Brazil under Lula expanded Bolsa Familia, a system of direct cash payments to households that is credited with lifting millions out of poverty.
Mr. Tsipras and his Syriza party, by contrast, spent their first six months in office still mentally blinkered against financial and international realities. A career as a political party apparatchik is probably not the best training for being able to see things from the perspective of other points on the political spectrum, other segments of the economy, or other countries. This is true of a career in any political party in any country but especially one on the far left or far right.
The Greek Prime Minister seemed to think that calling the July 5 referendum on whether to accept terms that had been demanded previously by Germany and the other creditor countries would strengthen his bargaining position. If he were reading from a normal script, he would logically have been asking the Greek people to vote “yes” on the referendum. But he was asking them to vote “no”, of course, which they did in surprisingly large numbers. As a result – and contrary to his apparent expectations — the only people’s whose bargaining position was strengthened by this referendum were those Germans who felt the time had come to let Greece drop out of the euro.
The Greek leadership discovered that its euro partners, predictably, are not prepared to offer easier terms than they had been in June, and in fact are asking for more extensive concessions as the price of a third bailout. Only then, a week after the referendum, did Mr. Tsipras finally begin to face up to reality.
The only possible silver lining to this sorry history is that some of his supporters at home may – paradoxically – now be willing to swallow the bitter medicine that they had opposed in the referendum. One should not underestimate the opposition that reforms will continue to face among Greeks, in light of the economic hardship already suffered. But like Kim dae Jung and Lula, he may be able to bring political support of some on the left who figure, “If my leader now says these unpalatable measures are necessary, then it must be true”. As they say, Only Nixon can go to China.
None of this is to say that the financial and international realities are necessarily always reasonable. Sometimes global financial markets indulge in unreasonable booms in their eagerness to lend, followed by abrupt reversals. That describes the large capital inflows into Greece and other European periphery countries in the first ten years after the euro’s 1999 birth. It also describes the sudden stop in lending to Korea and other emerging market countries in the late 1990s.
Foreign creditor governments can be unreasonable as well. The misperceptions and errors on the part of leaders in Germany and other creditor countries have been as bad as the misperceptions and errors on the part of the less-experienced Greek leaders. For example the belief that fiscal austerity raises income rather than lowering it, even in the short run, was a mistaken perception. The refusal to write down the debt especially in 2010, when most of it was still in the hands of private creditors, was a mistaken policy. These mistakes explain why the Greek debt/GDP ratio is so much higher today than in 2010 — much higher than was forecast.
A stubborn clinging to wrong propositions on each side has reinforced the stubbornness on the other side. The Germans would have done better to understand and admit explicitly that fiscal austerity is contractionary in the short run. The Greeks would have done better to understand and admit explicitly that the preeminence of democracy does not mean that one country’s people can democratically vote for other countries to give them money.
In terms of game theory, the fact that the Greeks and Germans have different economic interests is not enough to explain the very poor outcome of negotiations to date. The difference in perceptions has been central. “Getting to yes” in a bargaining situation requires not just that the negotiators have a clear idea of their own top priorities, but also a good idea of what is the top priority of the other side. We may now be facing a “bad bargain” in which each side is called upon to give up its top priorities. On one side, Greece shouldn’t expect the ECB and the IMF to be willing explicitly to write down the debt they hold. On the other side, the creditors shouldn’t expect Greece to run a substantial primary budget surplus. A “good bargain” would have the creditors stretch out lending terms even further so that Greece doesn’t have to pay over the next few years and would have the Greeks committing to structural reforms that would raise growth.
One hopes that the awful experience of the recent past has led both sides to clearer perceptions of economic realities and of top priorities. Such evolution is necessary if the two sides are to arrive at a good bargain rather than either a bad bargain or a failure of cooperation altogether. The non-cooperative equilibrium is that Greek banks fail and Greece effectively drops out of the euro. This may be even worse than a bad bargain, although I am not sure.
Admittedly, both Kim and Lula had their flaws. Moreover, Korea and Brazil had some advantages that Greece lacks, beyond Syriza’s delay in adapting to realities. They had their own currencies. They were able to boost exports in the years following their currency crises.
But a recurrent theme of the Greek crisis ever since it erupted in late 2009 is that both the Greeks and the Euro creditor countries have been reluctant to realize that lessons from previous emerging market crises might apply to their situation. After all, they said, Greece was not a developing country but rather a member of the euro. (This is the reason, for example, why Frankfurt and Brussels at first did not want Greece to go to the IMF and did not want to write down the Greek debt.) But the emerging market crises do have useful lessons for Europe. If Tsipras were able to shift gears in the way that Kim dae Jung did in Korea and Lula did in Brazil, he would better serve his country.
This post written by Jeffrey Frankel.