Euro zone – Greek exit less likely?

For the European Union, the Greek economic crisis is a major issue that needs a solution. Should the crisis lead to Greece exiting from the euro zone, a wider financial turmoil could bring about more risk and economic uncertainty in the international economy.

Consequences beyond the euro zone area would be felt. Countries that are remotely related to the Greek problem would get entwined.

The Greek problem. As the impact of the world recession of 2008 hit the Greek economy, the country was awash with social welfare programs that were inadequately financed from taxation. The economy lived beyond its means, and it was highly indebted externally, and came dangerously close to collapse.

To help restore her fiscal position in the midst of its huge debts, Greece sought emergency financing and the European Union, the International Monetary Fund (IMF) and the European Central Bank (ECB) came to the rescue as a “troika” representing the creditors and providing loan support to prop up the country in crisis. The troika demanded painful economic reforms and monitored them.

Two major financial bail-out programs in 2010 and 2012 helped Greece with financing that amounted to 240 billion euros (around $270 billion) to help the economy through. As the support program is about to expire by Feb. 28, 2015, a newly elected left wing government under Prime Minister Alexis Tsipris in Greece wants a drastic reduction of the terms of the support for further financing to allow the economy more room for growth.

The newly-formed Greek government has threatened to abandon the program. Such a threat, if exercised, would signal Greek abandonment of the euro. Yet, the Greeks say they want to remain within the zone. What they seek is an improvement of the terms of the bailout to secure more space for growth and less pain.

Though it would seem that the borrower has as much power to inflict some pain on its creditors at this point, the creditors have as much ascendancy to make the borrower keep faith with its debt obligations. Abandonment of the bailout does not free the borrower from other risks, such as further economic instability, capital flight, and more bankruptcies of domestic enterprises.

Thus, room for compromise exists. Both borrower and the creditors would need to negotiate and assess the economic costs that each would be willing to bear to attain a workable future solution. Negotiations would be testy and could lead to brinksmanship, but in the end their joint interest would help them open a vent for a compromise bargain.

Why Greece wants to remain within the euro zone. The new government of Greece comes from the extreme left of the political parties. It is armed with strong and threatening rhetoric on the debt problem, yet its leaders express a desire for the country to remain in the euro zone. This is an expression of popular sentiment in the country.

Membership in the zone has enormous advantages for a small nation in a large economic grouping. Its labor force is free to move across this large economic boundary, offering it more choices of opportunities. The large common market provides access to a wide range of goods, technology, and other benefits of exchange within the region.

Under normal times, access to finance, to capital, to union-wide institutional services far exceed what one small country can provide for itself. Membership in the EU is itself not only a political statement. Under normal times that most countries aspire to, belonging to a large economic grouping assures a small country like Greece of unrestricted access to the advantages of a wide economic market.

An indication of the Greek position under its new government is that despite the political rhetoric in Athens, the new Prime Minister Alexis Tsipris agreed to talk with creditors on ways to find a future financing program. There appears to be a willingness to try out the possibilities.

It would appear from all this posturing that Greece wants improved terms for the credit bailout as a price for remaining within the euro. By leaving open the possibility that it could still be forced to exit from the euro, the Greeks want to use that threat as a bargaining chip to remain within the zone.

Why the European Union wants Greece within euro zone. The European Union does not want any of its members to exit from the euro. Such a move could foment a serious setback to the currency union experiment, aside from inducing a likely turmoil in the currency and capital markets. Addition of members is more reassuring than a reduction of members.

Fiscal discipline among members is a hard problem to impose on governments because of unique social and economic policies. Countries are subject to their own internal politics on these issues. European Union negotiated guidelines designed to limit fiscal spending have been missed by many member-governments.

Greece represents an extreme example for the moment. A resolution of its present problem would yield guidelines on how similar cases would be treated in the future. The institutions of the European Union would have to define the limits of economic accommodation in situations similar to and exemplified by Greece.

In other words, the terms of the bailout for Greece will define how the other countries in similar circumstances within the zone will be treated.

What form the compromise could take. The room for compromise involves both creditors and borrower digging in to find a common position that both sides could live with.

It could take the form of reducing the demands on excessive pain on the Greek citizenry through erasure of the budget deficit over a longer span of time. This could take the form of reducing the required budget expenses to settle the debt service over a longer time period.

This means a lengthening of the period of payments through a lightening of the yearly debt burden. Greece’s official debts comprise two-thirds of the total. There is room for future easing of that burden through negotiations.

The euro zone itself is likely to improve its overall position over time. Some easing of the Greek pain could be helped by an improvement of growth prospects within the euro zone. Recent efforts to go full blast with a monetary stimulus similar to that applied in the US that served to restore growth could happen as well within the euro zone.

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