A Successful Restructuring in Greece May Leave a Weaker Europe Economy

Wall Street Journal | Monday, April 26, 2010 As of 10:17 AM (GMT +8 hours)

  

It matters little in the long run whether Greece's euroland colleagues and the International Monetary Fund agree to the requested €45 billion bailout— €30 billion from the euro-zone countries, €15 billion from the IMF. Even if the deal gets done, the bailers will have only applied a Band-Aid to a hemorrhage.

IMF Managing Director Dominique Strauss-Kahn (right) with Nicolas Sarkozy.

The loans would do little more than buy some time before Greece is forced to restructure—the polite word for a partial default— on its massive and rising debt

The country, now thought to have a deficit of close to 14% of GDP, has spilled and continues to spill too much red ink to be able to meet its obligations, on the best assumptions about budget cutting, growth, tax collections, the generosity of its fellow euro-zone members, and the ability of the IMF to impose draconian cost cuts on the Greek polity.

But even a successful restructuring would leave in its wake a seriously weakened European economy. The gaggle of agencies that will now involve itself in the making not only of Greece's but also other nation's economic policies is likely to be so unwieldy as to produce something between sluggish responses to economic developments and paralysis. IMF Managing Director Dominique Strauss-Kahn will want to demonstrate the sort of financial skill that will increase his chances of unseating Nicolas Sarkozy when the French presidential elections roll around in 2012. Jean-Claude Juncker, president of the eurogroup finance ministers, now has an excuse to dabble in national budget-making. Olli Rehn, the EU's economic and monetary-affairs commissioner, is demanding an "audit like" right to review national budgets before they are submitted to national legislators. There are others, but you get the idea: Rapid decision making is not in the euro zone's future, just when the pace at which markets react to news is accelerating.

More important, it is not clear that the social fabrics of Greece and several other countries can survive the deflation that will come on the heels of the IMF clampdown on spending. Restructuring means Greece's creditors, most notably the European banks that hold billions of dicey Greek government paper, will take big write-downs. That will force them to cut back on their lending, stifling growth in all of euroland, even in countries that haven't let their budgets get out of control.

Besides, nothing now in sight addresses the fundamental problem: The Greek economy, burdened by high labor costs, low productivity, and burdensome regulation simply can't compete in a globalized world. This wouldn't matter much were it not true of other euro-zone economies. It is now fashionable to say that the southern euro zone consists of profligate, laggard economies such as Greece, Spain and Italy, while the northern euro zone is home to sound, efficient economies.

There is some truth to that, but only some. The northern tier is indeed efficient by comparison with the southern tier. But, the current recovery in France and Germany notwithstanding, no one expects euroland as a whole to grow at a long-term annual rate close to that of the U.S. and China. Europe's failure to reform its labor markets and welfare states will inevitably become an irresistible drag on growth.

Doubt that and consider a new study by James Heckman and Bas Jacobs, professor of economics at the University of Chicago and professor at the Erasmus School of Economics in the Netherlands, respectively. In their careful and equation-laden study ("Policies To Create And Destroy Human Capital In Europe"), prepared for the nonpartisan National Bureau of Economic Research, they find, "High marginal tax rates and generous benefit systems reduce labor force participation rates and hours worked and thereby lower the utilization rate of human capital."

A better description of conditions in most European countries would be difficult to find. So it seems likely Europe will be an economic laggard long after the Greek problem is solved, if the injection of new layers of bureaucracy and the imposition of deflationary policies can be classified as a solution.

The political dissatisfaction produced by these circumstances will be exacerbated by the superior performance of other sectors of the global economy. The Chinese, ever eager to point out that their state-managed economy is turning in a performance that tops that of the West, are already letting it be known that they are writing Europe off and have no intention of making major investments there. Their cash is flowing to Brazil, Africa, the Middle East and, if truth be told, the U.S.

Meanwhile, the American economy is picking up steam. The consumer has come out of hiding, sales of tax-advantaged existing and new homes are up, corporate profits are exceeding expectations, and even the auto industry is seeing better days. Inevitably, Europeans will wonder whether the euro, a currency concocted by politicians more intent on European integration than on creating a sustainable currency, and the growth-stifling eurocracy, might just be the reasons for their inability to keep pace with faster-growing countries.

—Irwin Stelzer is a business adviser and director of economic-policy studies at the Hudson Institute.

Write to Irwin Stelzer at irwin.stelzer@wsj.com