Why Should EU Bail Out Greece?

Bailout Or No Bailout – That’s The Question

By Econotwist

There are several strong arguments within the European Union for NOT bailing out Greece,
as well as to do so.

One alternative is probably just as likely as the other.

But the case for letting Greece default on their debt is gaining traction among European
politicians.

There’s mainly three strong arguments against a bailout.

But first some history:

The fact that Greece has a large debt burden is old news.

Only in one of the last 20 years the country’s budget deficit has been below 3%, and Greece
have had a national debt of more than 100% of GDP since the 90’s.

In 2009 it looked like the debt situation in Greece would be better than in most Mediterranean
countries with a deficit of 6,7% of GDP, but in December the Greece authorities said it would
be 12,7% instead.

Suddenly the problems became acute.

Based on the fiscal policy estimated by the European Commission for the years ahead, the
Greek government’s gross debt will rise to 135 percent in 2011. If fiscal policy is not
changed, and at the same time the costs associated with maturity is rising, the debt level in
2030 will be about 200 percent.

Sharpen Up Or Default
When a country finds themselves in a situation like Greece, there are essentially three
options: The authorities can inflate off the debt (print money), devalue its currency (reduce
the burden of debt in domestic currency), or choose not to repay (default).

But for a country in the euro zone neither inflating or devaluation possible, because it
is the European Central Bank (ECB) that is governing the amount of euros in
circulation.

Greece has therefore only two options: Sharpen up or defaulting.

The obvious solution for Greece is a combination of raising taxes, cutting spending and
introducing structural reforms.

(This makes the relation to the U.S. problems invalid.)

A New Monetary Fund?

Because of the pressures from both the financial markets and the rest of Europe, it is
expected that Greek authorities will cut budget deficits.
Spending cuts, increased tax collection and pension reform will reduce the deficit to 8.7
percent this year and then to 2.8 percent in 2012.

The European Commission approved last week the Greek plan, with substantial reservations
(including demands for details on implementation).
The next step is that the finance ministers of the EU (ECOFIN) formally approves the plan.
That is, if another option does not present itself in the coming weeks:

1. A Proposal For A New European Monetary Fund

2. EU Have “Instruments” To Save Greece, Commissioner Says

But the responses so far indicate that financial markets do not trust the Greek authorities’
ability and willingness to correct its course. Even though there are now plans in the EU for
how Greece may be supported to get through the potential liquidity squeeze in the coming
months.

Why Save Greece At All?

Bailout or no bailout – that’s the real question.

There are at least three good arguments as to why such an action should NOT happen.
The first argument is that a rescue mission will be seen as a default, and a subsequent
restructuring of the national debt will get the economy out of the crisis in better condition than
it went into it.

History suggests that such a process is painful, and as the country will be banned from the
capital markets, the budgetary readjustments will be enormous.

A second argument are in place in form of potential moral hazard. If one country is salvaged,
the other countries in the euro zone could expect the same. It can then be detrimental to
budgetary discipline in Europe - and even to the European cooperation.

The third, and perhaps equally weighty argument, is that it is bloody unfair for taxpayers in
the countries that has kept their budgetary obligations to pay for those who have not done it.

The European Union is characterized by solidarity, but more and more people think there has
to be a limit to rewarding irresponsibility and stupidity.

But Something Must Be Done

Because the problems just won’t go away with a Greek bailout.

The long-term solvency problems in Europe will not disappear. The problems are huge also
for countries such as Ireland, Portugal, Spain, Italy, Belgium and maybe even France. They
can not be solved by other countries' assistance, the sums are too large and most developed
countries have their own long-term debt challenges to deal with.”

Even if we believe the short-term problems will be fixed in a way that avoids a major financial
shock in the near term, the focus will continue to be on budget policy tightening in the euro
zone in the coming years.

The pressure upon government rates will be substantial and economic growth is likely to vary
widely from country to country.

Divergence is likely to be an important feature in the euro zone’s cyclical upswing, which
makes the job even harder for the ECB.