Why would Greece accept more pain when unemployment is at 21 percent, the economy is enduring its 5th year of recession and rioters are hurling gasoline bombs in the streets of Athens? Because the alternative might be worse.
Greek leaders are gritting their teeth as they move forward with a plan to further slash spending in return for a bailout of about $172 billion from other countries in Europe and around the world. The Greek Parliament is scheduled to vote on the plan Sunday.
Greece is trapped in a lose-lose predicament: It must deepen an austerity plan begun in 2010 that will throw many more people out of work. Or it must default on its debts, abandon Europe’s single currency and see its banking system implode.
Here is a closer look at Greece’s two bleak options:
1) Impose deep spending cuts in exchange for the bailout.
Greece needs the bailout to make a $19 billion bond payment due March 20, and its failure may trigger a disorderly default pushing Greece into a catastrophic adventure.
In addition to the $172 billion bailout, Greece is negotiating a deal that would reduce the $270 billion in debt it owes private creditors. Under that arrangement, a combination of reduced principal and lower interest rates would save Greece about 70 percent on debt payments.
Selling government-owned companies, exposing professionals like architects and pharmacists to more competition and imposing other reforms is designed to make the economy more efficient in the long run.
Such austerity can be counter-productive because it can slowdown the economy and reduce tax revenue. So far, austerity has done nothing to reduce Greece’s debt burden. Government debt as a percentage of the economy actually grew after it began imposing austerity — to nearly 160 percent in the July-September quarter of 2011 from 139 percent a year earlier.
2) Default and drop the euro.
Defaulting on its debt would ease the immediate strain on Greece’s finances and probably cause it to abandon the euro, the currency used by 17 countries. Dropping the euro would leave Greece with a much cheaper currency, its own drachma. That would juice Greece’s economy by making Greek products less expensive around the world. This would give Greek exporters a competitive edge.
Exiting the euro would throw Greece’s banking system into chaos. Lenders would panic over the prospect of being repaid not in euros but in drachmas of dubious value. Adopting a suddenly much weaker currency could also ignite Greek inflation because prices of imported goods would soar.
International investors would be reluctant to lend to Greece’s government, its companies or its banks. The freeze-up in credit could cause a depression, worse than what Greece is suffering now. Economists at UBS estimate that Greece’s economy would shrink by up to 50 percent if it left the eurozone.