Why was Angela Merkel in Athens last week?

The EU has received the Nobel Peace Prize and could take a break from the current Eurozone crisis. But this week the hype is over and Europe will be back to normal: struggling to define its own future at the forthcoming European Council on October 18th.

On the agenda is an ambitious draft for a ‘genuine economic and monetary union’ prepared by the four presidents of the EU, Herman van Rompuy, José Manuel Barroso, Jean-Claude Juncker and Mario Draghi who, beyond fighting over who goes to Oslo, also need to find a way to create a European version of de facto fiscal federalism. This will not be easy to achieve and more money will need to be spend.

Angela Merkel’s surprising visit to Athens can be seen as a first step to convince the German public of the necessity to radically change the Eurozone. The visit was purely symbolic. Nothing was decided on the current Greek rescue program – no talk about an extension for the debt service schedule or a change of fiscal deadlines. The Greeks only got a couple of warm words: “Much has been achieved; and much remains to be done”. This is a kind gesture but the visit came way too late if this was the intention. One would have appreciated to see Angela Merkel in Athens, when BILD was in the midst of running its dreadful campaign against Greece. Merkel’s trip had just one symbolic goal: It was a signal to the world that Europe and the Eurozone are now beyond “Grexit” debates. With her visit to Athens, Merkel definitely buried this option.

This does not mean that the Greek future is easy or rosy. It is important to stop questioning whether Greece will remain in the Euro especially considering the problematic situation in Spain and Cyprus.

At some point, Angela Merkel will need the support of the German Bundestag for another aid package, and in the past months it seemed suicidal to ask the Bundestag another time for more money. Probably, now there is a new strategy: to combine the needs for all three countries in one vote: Greece, Spain, and Cyprus. Probably Angela Merkel will not ask the Bundestag to change the nitty-gritty of the next programme for Greece, but she may pose the ultimate Rubicon-question: either we really embrace Europe (even at another price increase); or the risk of Euro break-up does become real. Framing it in this way could help Merkel to pass delicate hurdles and negotiations about the banking union in the German discourse. No doubt that the current Nobel Prize emotions may help to make Germany and the Bundestag opt for the former, although it won’t be easy.

In the meantime, the figures show the extent of the trauma that Greece is undergoing. Its GDP shrunk by around 7% in 2011 with a similar decline expected in 2012; in this fifth year of recession it has lost cumulatively over 20% of its 2008 GDP; unemployment sits at 24% (55% for young people) with 630,000 long-term unemployed; vital social services have been caught up in the massive spending cuts; poverty, homelessness, crime, and suicide rates are galloping. Had Germany undergone a similar adjustment programme, stones would have probably been thrown in Berlin like in 1968. The German lack of understanding of the Greek pain is part of the problem. Merkel’s visit was just a first gesture to show more understanding and put some balm on the Greek wounds.

Unsurprisingly, public sentiment in Greece has been badly affected. Public trust in government, the parties and institutions has sharply declined. The two parties (New Democracy and PASOK) that dominated Greek political life alternating in power since 1974, fell from a total vote of 77% in 2009, to just 32% and 42% in the twin elections of 2012 (May and June). Both parties are heavily blamed for the crisis. But the finger of blame is also pointed towards Europe.

By spring 2012 the Eurobarometer survey suggested that 14% more Greeks consider the EU a ‘bad' thing than a ‘good’ thing. This is a reversal of the situation over the previous two decades, when the gap between those with a positive view of the EU compared to a negative view reached highs of over 60%. Still, astonishingly, the broad pro-European anchor in Greek society is echoed in wide support for the euro – around 70% say they want to remain in the single currency. Not only is there little nostalgia for the drachma (memories of high inflation and low growth) but the catastrophic implications of an exit from the euro are broadly understood by a majority of Greeks: It would mean the loss of decades of development along with socioeconomic and political chaos.

However, while the Greek reform programme has not produced the expected results largely due to a faltering economy, the perception in Germany is that Greece had hardly made any reform progress and that basically the situation is helpless. This is clearly misguided although the results are mixed.

On the one hand, it is true that there is a disappointing lack of structural reforms. The Greek parliament has passed many important laws to liberalise the economy, but many of these steps appear not to have been thoroughly implemented on the ground due to a lack of capacity (or will) of the administration. Moreover, the conditionality of the second support package in March 2012 has been followed only to a limited extent. While this is mostly due to the excusable political vacuum between the elections in spring, the impression has gained ground that there is a lack of reform ownership in the Greek administrative system.

On the other hand, the lack of progress in reducing fiscal deficits in Greece conveys the false perception that consolidation efforts are far too limited. Quite on the contrary, the cuts to regular government spending have been very deep. Between 2009 and 2011 the Greek government has slashed primary expenditure (excluding interest) by nearly 18%, by far the most ambitious effort across the Eurozone apart from Ireland. However, interest expenditure has risen considerably. Thus, the additional austerity package of more than € 11 bn. currently under discussion is needed to bring down the large fiscal deficit, but carries the risk of further postponing a recovery. However, once the Greek economy rebounds, tax revenues will also increase. In this case the fiscal deficit is likely to narrow much faster than currently expected due to the considerable spending cuts already made.

Also in view of Greece’s second severe problem – the huge current account deficit and the economy’s loss of competitiveness – some promising developments have occurred recently. In the second quarter of 2012, Greek unit labour costs were nearly 16% lower than in the second quarter of 2009 when it had reached a maximum. And the current account deficit has been reduced by nearly two thirds when the first semesters of 2012 and 2008 are compared.

Nevertheless, a longer term approach is needed for Greece, as probably a decade will be necessary to put the economy on a sound and sustainable footing. Access to financial markets is currently not in sight. A combination of a long term financial aid programme with mandatory EU support for capacity building will be key to reform the Greek administration and ensure that growth enhancing structural reforms will also be felt on the ground. While this approach would leave the Greek parliamentary sovereignty untouched, the authorities would have to agree to a broad capacity building effort.

In short: after the Nobel Prize is before the next Greek bailout. But chances are increasing, that the euro zone survives as a whole and …ultimately sound.

Ulrike Guérot is Senior Policy Fellow at ECFR & Jürgen Matthes is a Senior Economist at the Cologne Institute for Econonomic Research.

Zum Beitrag im Blog European Council on Foreign Relations