Saving Greece from becoming a failed state

The last thing that Europe needs is a failed Greek state on its southern flank. Yet the International Monetary Fund (IMF) and Greece’s official creditors persist in prescribing for Greece the same failed policies that have brought the country to its present dreadful pass. If Greece is not to become a failed state, one must hope that the IMF and EU soon change tack and help Greece to successfully exit the euro, which has visited so much misery on that country.

One does not need to be a political scientist to appreciate that Greece’s politics have become upended by the depth and length of its great economic depression, which by now is on a scale similar to that experienced in the United States in the 1930s. Whereas in 2009, before the start of Greece’s economic crisis, the country’s two main establishment political parties (New Democracy and PASOK) captured 70 percent of the vote, today those two parties command barely 25 percent. This has facilitated the rise of the internally divided and far-left Syriza Party, which now in government has the greatest of difficulties articulating a coherent economic policy. It has also made room for the rise of the neo-Nazi Golden Dawn Party on the far-right of the political spectrum, which gives vent to a toxic brand of nationalism.

{mosads}With Greek youth unemployment currently at over 50 percent, there is the clear and real danger that Greece could become a failed state if its economy does not turn around soon and if its politics take a further turn for the worse. There is also the real danger that such a failed state could turn for succor to Russia in the event that the West is seen to have failed the country. In recent months, Greek Prime Minister Alexis Tsipras has already provocatively been cozying up to Russian President Vladimir Putin; despite U.S. objections, Greece has begun serious talks with Russia on the construction of a Russian gas pipeline through the country.

A first step toward preventing Greece from becoming a failed sate is to recognize the underlying causes of the country’s economic failure. While there have certainly been many contributors to the staggering 25 percent contraction in the country’s economy, the main culprit has been the practice of excessive budget austerity in a euro straitjacket. That straitjacket has denied Greece the use of an independent monetary and exchange rate policy that might have been used to boost its external sector as an offset to budget belt-tightening. In a rare moment of candor, even the IMF has admitted that in designing Greece’s adjustment program, it grossly underestimated the size of the fiscal multipliers.

Sadly, the IMF and EU are showing little sign of recognizing how pernicious budget austerity has been for Greece in a euro straitjacket. Indeed, despite the fact that the Greek economy has once again relapsed into recession, the IMF and EU are insisting that Greece engage in budget tightening of around 2 percentage points of gross domestic product in both 2015 and 2016. To compound matters, the IMF and EU are insisting that Greece does so at the same time that it cuts pensions and that it engages in labor market reform that must be expected to further reduce aggregate demand.

If the IMF and EU really want to save Greece from becoming a failed state, they need to change course and do so soon. Instead of again insisting that Greece engage in budget tightening within a euro straitjacket, the IMF and EU should seek ways to financially and technically support a successful Greek exit from the euro. They should also seek ways to support the modernization of the Greek economy that is so desperately needed. For only then will the Greek economy have a real chance of escaping from the downward economic and political spiral in which it has found itself these past six years.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.