15th June 2012
Griffith University lecturer Fabrizio Carmignani gives a in-depth explanation on the background, the parties, and what it means for Europe and the economic fortunes of the Eurozone and more broadly.
The background: bailing out a country in deep recession
The previous election held on 6 May resulted in a highly fragmented parliament and all attempts at forming a viable coalition to support the government have failed.
Facing the risk that the political stalemate would further aggravate the economic crisis the country is going through, the Head of State dissolved the new elected parliament and called for new elections to be held.
Data from the World Economic Outlook of the International Monetary Fund (IMF) showed the growth rate of Greece was -6.8% in 2011 and it is expected to be close to -5% in 2012. Unemployment has more than doubled since 2008 and it is now around 20% of the total labour force. Government debt as a percentage of GDP is around 150%, lower than in 2011, but still some 40 percentage points higher than in 2008.
In 2009, growing government expenditure and external shocks led to a sharp increase in government deficit and debt. Initially, the government was able to mask the figures, but revised estimates released in early 2010 revealed that the deficit to GDP ratio was -13.6% and that the debt to GDP ratio was already above 120%. Investors and markets lost confidence in the government’s ability to repay its debt. It then became very difficult for Greece to mobilise affordable finance.
The first bailout agreement with the European Union (EU), European Central Bank (ECB), and IMF was achieved in May 2010. The agreement established that the EU countries and the IMF would provide Greece with a 45 billion euros in bail-out loans, with more funds to follow, totalling 110 billion euros. In return, Greece was required to adopt harsh fiscal austerity measures.
The deficit started to decline, but the recession deepened. In November 2011 the coalition government of Lucas Papademos negotiated a significant debt write-down with the EU-ECB-IMF. Again, the rescue package was conditional on the implementation of a tight programme of fiscal stabilisation.
The combination of recession and fiscal austerity led to demonstrations and significant social unrest. Nevertheless, some positive results were achieved, primarily a decline in the government structural deficit and in the current account deficit.
Papademos' government was supposed to last until February 2012. Instead, it carried on until April 2012, when finally the parliament was dissolved and new elections were called. Since then, the political stalemate has halted any further economic progress.
Lining up to give Greece a new bright future
A total of 22 parties are competing in Sunday’s election. However, at this stage, attention can be restricted to a few key players.
The New Democracy party of Antonio Samaras received the relative majority of votes (18.85%) in the May elections. This is a centre-right (conservative) party that historically has alternated in power with the Socialist Party. New Democracy and Socialist broadly share the same stance with respect to bailouts. While they would renegotiate some of the terms – especially the timeline for the adoption of more fiscal stabilisation measures – they are also committed to keeping Greece in the currency area.
The big surprise of the May election was the success of the Coalition of the Radical Left – Unitary Social Movement (Syriza), led by Alexis Tsipras, which came second in the May election with 16.8% of votes. This is a hard-line left wing party that proposes a unilateral cancellation of the agreements with the EU and the IMF, without guarantee of permanence in the monetary union, and the implementation of a radical programme of expenditure to sustain the economy.
In particular, according to Tsipras’ statements in the campaign, Syriza would revoke the 22% reduction to the minimum monthly wage and the abolition of collective labour contracts that were part of the measures imposed by EU-ECB-IMF. Syriza would also increase public expenditure to 43% of GDP in order to strengthen social welfare. This proposed level of expenditure is significantly larger than what requested by EU-ECB-IMF.
New Democracy and Syriza are running head-to-head in the polls, with the Socialist Party in third place and well behind the other two. The other main competitors include the centre-right Independent Greeks, the Communist Party, the Democratic Left, and the extreme-right New Down. They are generally in favour of a unilateral cancellation of the agreements, with the exception of the Democratic Left that follows the line of the renegotiation.
Recent polls show that the majority of Greeks have oriented to vote according to their position on the euro. The same polls suggest that most Greeks are indeed willing to remain in the currency union and fear a return to the national drachma. Yet, there is a generalised sense of aversion against the conditions imposed by the European Union.
Drawing on this stylised picture of the electorate’s preferences, one would be tempted to conclude that New Democracy (in coalition with the Socialist Party) might have the edge in this election. Its proposal to renegotiate the terms of the agreement, but still guaranteeing permanence in the Eurozone would appeal those who fear the drachma as well as dislike the tough conditionality.
Realising this, New Democracy has run a campaign stressing the risks associated with the unilateral cancellation approach proposed by Syriza.
Yet the electoral outcome remains very uncertain. For one thing, threatening voters with disastrous scenarios in case Syriza wins might not be a winning campaign theme for New Democracy.
In fact, since May 2010 bailout, Greeks have become accustomed to the threat of returning to the drachma. They might believe that no matter who wins, the EU is not going to throw them out of the currency area.
Moreover, New Democracy and Socialists (having run the country since 1974) bear most of the blame for the current state of affairs. They failed to reform the economy in the 1990s, they have been fearful of upsetting their supporting constituencies in the public and private sectors during the crisis, and they have missed the opportunity to reduce expenditure, but pushed for higher taxes.
Conversely, Syriza is “new”. Tsipras himself is only 37 years old, albeit he started his political career very early in the late 1980s as member of the Communist Youth. Its upbeat slogan – “We are opening the path of hope” – must sound very attractive to the ears of the median Greek voter, whose hopes have been compromised by the two main traditional parties.
But the fact of being new can also cause some concerns about Syriza’s ability to deliver and run the executive. Moreover, the platform of Syriza is not immune from contradictions as it does try to appeal to constituencies with radically different interests, such as civil servants (who benefited the most from the decades of fiscal profligacy) and unemployed and young people (who paid the highest cost for the inefficiency of the economic system).
Tsipras seems to be convinced that he can have both: the cancellation of the existing agreements with EU-ECB-IMF and the permanence in the euro-area. His argument is that EU cannot afford to have Greece dropping out of the currency as this would start a chain reaction of unpredictable consequences. Thus, even a unilateral cancellation would not in the end bring the drachma back.
Again, this must sound very comforting to the Greeks. But then one wonders how the other troubled countries of peripheral Europe would react to a cancellation – or even a renegotiation –
of the terms of the Greek bailouts? Why should not Portugal, Ireland, and Spain renegotiate? And what would Italian voters think now that the total bill they are paying for the EU bailouts has grown to €48 billion while the country is still in deep recession and undergoes a tough programme of fiscal austerity?
If Greece is the end
The destinies of the European Union are clearly linked to this Greek election. However, it seems that this link is quite asymmetric: Greek elections can make things a lot worse, without much chance that they can make things any better.
The best outcome that Europe can hope for from the Greek election is a government willing and able to keep the country in the currency area, prepared to undertake the fiscal measures and reforms needed to relaunch the economy, and conscious of the fact that rescue packages from other Member States cannot come as a free lunch.
This best outcome will not solve the European problems. The EU will still have to face the crisis in the other peripheral countries, the attack on the euro, and the weaknesses of the banking sectors. But at least it will not worsen the situation.
Any other outcome will likely trigger a sequence of traumatic events. Many observers have tried to anticipate these events and predictions range from the end of the world as we know it to a generalised banking crisis in Europe. In all these predictions, the breakdown of the currency union is a recurrent theme.
From a strictly economic perspective, Greece is small enough not to represent the ultimate threat to the survival of the euro. In fact, some would argue that an orderly exit of Greece from the union would benefit all.
However, the issue here is not just whether the euro area can economically resist the dropout of Greece. Instead, one should wonder how the dropout of Greece would be interpreted by markets, investors, and citizens. To some extent this might depend on how the dropout occurs; that is, if it is a unilateral decision of Greece rather than an imposition of the EU.
But in both cases it would send a very bad signal. It would put Spain under pressure. And after Spain (leaving aside Ireland, Portugal, Malta, and Cyprus) there is Italy, which is definitely too big to fall without making much noise.
By Fabrizio Carmignani, Griffith University
Fabrizio Carmignani receives funding from ARC for a project on the estimation of the continuous piecewise linear model and its macroeconomic applications.