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Europe's best-laid plans crumble

A vote in Greece, a referendum on austerity / How Sunday's critical election will determine far more than one country's EU membership

00:00 EDT Saturday, June 16, 2012

ROME -- ereguly@globeandmail.com

When Greeks think of austerity, they think of the pain they have to endure to make sovereign bond investors happy.

Their pensions and wages are getting crunched, their taxes are going up and 150,000 civil servants are axed. A new property tax is built into electricity bills. Don't pay it and your lights go off. The result is soaring unemployment, a dying economy and sullen or desperate citizens.

On Sunday, Greece will get a chance to retaliate against the austerity measures in the second general election since the inconclusive vote on May 7. It is being billed as a referendum on Greece's membership in the euro zone. If the anti-bailout parties win, Greece's exodus from the common currency region would go from possible to probable.

But the election is much more even than a vote on euro zone membership that stands to reshape the future of Europe and ripple or tear through global financial markets. The result will also help to define the era of austerity ushered in by the financial crisis, and marks a new phase in the European debt crisis that has been galloping forward, relentlessly, since the 2008 subprime disaster almost torpedoed the global economy.

In Greece, France and other countries, voters are pushing for a re-examination of the policies that have failed to improve economies or livelihoods.

The Greek vote is the most significant referendum to date on the economic concept called austerity, which came into vogue after the crisis-induced spending sprees of 2008-09.

Sunday's results will shake not only Greece, but the entire European Union. The Greek election, much like last month's French one, will also serve as a reminder to global leaders of the power of voters who are backed into economic corners, with no ready way out.

The Greek vote, and the pressure it is putting on the other 27 austerity drives across Europe, is the strongest sign yet that a new way of thinking about the euro is rapidly emerging as harsh austerity faces a backlash. The new way would replace austerity with austerity-lite. It would try to balance austerity with growth policies. It would not demand quick results.

Above all, this new way of thinking would recognize what voters are saying: That the tools used so far to try to end the three-year debt crisis, now morphing into a banking crisis, are failing. The measures may have stalled the deterioration for a while, but they will not work.

The Greek electorate is far from alone in delivering this message. In France, François Hollande was able to send Nicolas Sarkozy, whom he painted as Angela Merkel's fawning austerity lap dog, packing in the May presidential election.

The austerity-lite approach may yet break the Franco-German alliance. Indeed, Ms. Merkel is sticking to her austerity-for-all message as the prime crisis-fighting tool, in spite of evidence in country after country that saving Europe will require a more subtle and tailored strategy than cut, cut, cut.

On Friday, she dismissed "quick fixes" for the euro zone, lashed out at Mr. Hollande for blocking EU supervision of national spending, and attacked France's shabby economic performance. "If you look at the development of unit labour costs between Germany and France, differences have now been growing a lot more strongly, a topic that must be discussed," the Chancellor said.

In retrospect, letting Greece crash the euro zone party was a grave mistake, a milestone in the annals of geo-economic stupidity. Eleven years ago, when it adopted the euro, the country was uncompetitive, had turned tax evasion into a national sport and had recruited Goldman Sachs's currency-swap buccaneers to disguise the true extent of its debt.

Greece has been bailed out twice since 2009, at a cost of close to €300-billion ($387-billion). In spite of the bailouts and significantly lower debt, the Greek economy remains in freefall, "reminiscent of war damage," Greek economist Costas Lapavitsas wrote in the Guardian earlier this week.

Greece's hemorrhaging hasn't stopped at its borders. Since 2009, Greece, representing a mere 3 per cent of the EU's economic output, has inflicted enormous financial, economic and psychological damage to both the EU and the euro zone as well. The contagion effect helped to send bond yields soaring in Italy, Portugal and Spain, whose debt, after Thursday's double downgrade, traded at 7 per cent yields. That level is considered fatal. Greece, Ireland and Portugal all sued for EU and International Monetary Fund bailouts not long after their bond yields crashed through 7 per cent.

Popular discontent in Greece with government policy and economic rot has found an outlet in Frau Merkel, who had become the pan-European poster child for austerity gone wrong. During the frequent Greek protests and riots, she was depicted in posters as a modern-day Nazi. German flags were burned. At a rally in Athens on Thursday night, Alexis Tsipras, the Syriza leader and possible next prime minister, criticized his New Democracy opponents, saying: "You pulled down the Greek flag and handed it to Angela Merkel as a trophy."

New Democracy, the main centre-right party, endorsed the Greek bailout programs, which were offered by the EU and the International Monetary Fund in exchange for (German-inspired) austerity - spending cuts and tax increases.

Syriza, the Coalition for the Radical Left, led by the charismatic young Mr. Tsipras, came out of nowhere in the May election to capture 17 per cent of the vote, putting it a close second behind New Democracy. Syriza wants to shred or greatly dilute the austerity programs, yet, incredibly, hopes to keep Greece in the euro. The EU and the IMF have already had something to say about that and it was pretty blunt: No austerity, no bailout loans, boil in the dark.

If there is one thing the two main parties, and the cacophony of smaller ones, ranging from the communists to the liberals, have in common, it is acknowledgment that deep, hard, long austerity is now a suicide pact. "All Greek parties will ask for similar things," predicts Greek communications strategist Stratos Safioleas. "They want some sort of renegotiation with the European Union. Even Syriza is starting to moderate its rhetoric. I think they won't do anything reckless."

The election remains too close to call. Greek electoral law prevents polls in an election's final two weeks, and in unofficial polls Friday, New Democracy and Syriza were running neck and neck.

From France's Hollande to Paul Krugman, the economist and New York Times columnist, austerity is earning a growing chorus of detractors.

Endless austerity, they believe, is the medicine that is killing the patient. As the dark effects of austerity eat away at Greece's economic soul, other European leaders have taken note. They fear that the same crisis-fighting treatment will have a similar effect in their own countries. The first to break ranks with the pro-austerity movement was France's Mr. Hollande, who wants an equal focus on growth and more time to balance France's budget deficit.

Italian Prime Minister Mario Monti, who replaced Silvio "What crisis?" Berlusconi last November, is in general agreement with his French counterpart. In Spain, Prime Minister Mariano Rajoy has also been begging for more lenient budget targets, for fear that the Spanish unemployment rate - 24 per cent - will keep rising and trigger nasty social unrest that could end his career. Notably, the €100-billion bank bailout deal he is negotiating with the EU will almost certainly come with no extra austerity demands.

The fresh thinking on austerity in France and Spain has inspired all the Greek parties. Their calls for a new deal on austerity have been given moral legitimacy, they claim, and they may be right. Even some EU officials seem in agreement.

According to various reports on Friday, quoting unnamed officials, the EU and the IMF, the sponsors of Greece's twin bailouts, are open to the idea of dulling the austerity pain by reducing interest rates on bailout loans and extending repayment periods, among other little goodies. And if Greece succeeds in negotiating a lighter austerity load, you can bet the other countries on life support - Portugal, Ireland and, now, Spain - will demand the same.

There was no sense, however, that they would allow Greece or any other crippled country to shred their austerity programs.

Austerity-lite, of course, could ultimately backfire. Any pullback on efforts to balance budgets would earn the ire of the bond markets if that easing does not translate into growth. Bond investors adore growth, but they also want tight fiscal discipline.

More worrying is the outcome of the Sunday election in Greece itself. If Syriza wins, the question of offering austerity-lite may be moot if the party vows to shred austerity. If New Democracy wins, austerity-lite may be offered, but it may not work, given the dire state of the Greek economy. Greece could still exit the euro zone, unleashing economic and financial fury throughout Europe.

But one thing is certain. No matter who wins on Sunday, the Greek election is the strongest backlash yet against an increasingly discredited economic policy. Will Ms. Merkel acknowledge that austerity isn't working? The great game of chicken is just beginning, it appears. As the Greek election is too early to call, so is the success of Europe's anti-austerity movement.

*****

GREECE VOTES

One election, four outcomes

The Greek election on May 7 was an inconclusive mish-mash - no party got more than 20 per cent of the vote and negotiations to form a coalition government broke down. That created a power vacuum that the Sunday election will try to fill. As of Friday, the two front-runner parties - the centre-right New Democracy and the radical left Syriza - were running neck and neck. It could go either way. Here are four possible election scenarios:

1.New Democracy takes the most votes of any party and nabs the 50-seat parliamentary bonus awarded to the front-runner in the 300-seat chamber. ND forms a coalition with the socialist Pasok party, which came third in the May election. The ND-Pasok majority coalition keeps the austerity programs largely intact, but with some significant tweaks to buy support from recession-weary voters.

2.Syriza wins, takes the 50-seat bonus and forms a coalition with like-minded smaller parties from the left, including the Democratic Left. This outcome triggers a confrontation with the EU and the IMF as Syriza tries to dilute significantly, but not scrap, the austerity programs, which the previous government promised in return for the second bailout. The coalition survives only because Syriza negotiates a compromise that could be called austerity-lite.

3.Syriza wins and vows to scrap the austerity programs no matter what. The EU and IMF withhold bailout loans and Greece, out of cash, defaults on its external debt. Chaos ensues as Greece has no choice but to leave the euro zone and reprint the drachma. This scenario appears increasingly unlikely as Syriza moderated its tone in the final days of the election.

4.The election is merely a repeat of the May election, that is, inconclusive. This would require a third election or rapid formation of a cross-party, unity government which could easily fall quickly.

Eric Reguly in Rome

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