By Max Hänska
After a spectacular swing to the left, away from a political establishment that ruled the country uninterrupted for decades, Greece’s election signals the changed mood that is taking hold of Europe. Austerity has failed. What economists have been saying all along, has now been loudly affirmed by the electorate.
I take it as a given that Greek debt is unsustainable in the long run, and that austerity measures have precipitated a spiral of economic contractions that have aggravated economic woes—this much, at least, should be uncontroversial. But identifying the problem is the easy part. Finding a workable solution is the hard problem. In finding a solution Europe faces an economic and a political challenge.
The economic arithmetic
Greece rightly wants to get a reprieve from cuts that have battered the country for close to half a decade. The question is how to fund additional spending?
Greece is running a small primary surplus (before servicing debt), so in theory it could decide to default on its loans (though the government has declared it will not default), strengthen its tax base by fighting tax evasion and direct additional revenue towards spending, instead of servicing debt.
However, reneging on its obligations would probably also force the ECB to retract its liquidity line to Greek banks—which have been drawing heavily on the ECB to remain liquid as capital flight has remained high. Disrupt this liquidity line, and Greece will have a banking crisis on its hand. To raise the money to shore up its banks without external funds (it is not clear that this would even be possible), it would have to cut public spending even further than it has already done, in turn suffocating the economy and reducing its tax base. A banking crisis would probably precipitate more cash-in-hand transactions further decreasing declared income, and thus tax revenue.