The EU’s Greek Bailout Mistake
By Randall Holcombe • Monday May 10, 2010 2:01 PM PST •
Without the EU’s $1 trillion bailout, Greece would surely find its economy in really big trouble, as opposed to the merely big trouble it’s now facing. The negative economic impact would ripple throughout Europe, and the world. Stock markets rallied on news of the bailout, showing that the financial community approves of this move to avoid a catastrophe.
At one time, Europeans didn’t think a move like this would be a good idea. Article 104b(1) of the Treaty Establishing the European Community, ratified in 1992, says, “The Community shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State...” Yet that is what Europeans are doing (with help from the International Monetary Fund, and therefore also the US).
Members of the EU agreed to limit their deficits and public debt as a condition of membership, and Greece violated the agreement, which landed them in financial trouble. One way to look at this bailout is to ask whether, when the rules are violated, the violators should suffer the consequences, or be helped by those who didn’t violate the rules (or didn’t violate them as much). On that ground, the answer is clear: Greece violated the rules and should not be bailed out. Furthermore, as cited above, the bailout violates the EU’s own rules saying the Community shall not assume the commitments of central governments.
Another argument is that the euro zone countries are bailing out Greece to protect themselves from the fallout, not just to help the wayward Greeks. But this argument seems weak on several grounds. The argument is vague enough that before addressing it one would need to figure out how, exactly, a Greek default would harm the other euro zone countries.
One thing that should be clear is that a Greek default would not weaken the euro. The euro, as a monetary unit, would be unaffected. In fact, the bailout is more likely to weaken the euro, because it makes it more likely that the other euro zone countries will tolerate inflation to lessen the real value of the Greek debt they are taking on. Looking just at the strength of the currency would argue against a bailout, not for it.
A default would hurt European banks that hold Greek debt, so a bailout indirectly supports those banks. But if that’s the concern, a better policy is for each individual nation to support its own banks. The easy and direct way would be for the national governments to buy the Greek securities held by their banks.
Everybody knows that Portugal and Spain are teetering on the edge, and could follow Greece into default. The Greek bailout can help reassure investors to keep interest rates in those countries down, lessening the likelihood that they, too, will require assistance. But when they do require assistance, the EU may not be willing or able to act. Would they devote another huge sum of money to Portugal? And the speculation is that Spain is too big for the EU to offer a bailout similar to the one Greece got. So, temporarily, Greece has been propped up, but when Spain and Portugal end up in the same position, the bailout mechanism will collapse.
Without a bailout the message would have been sent to Portugal, Spain, and the rest of the EU to shape up fiscally, or they could find themselves in the same trouble as Greece. With the bailout, the message seems to be that fiscal problems aren’t that urgent, because the more responsible EU countries will step up to rescue the irresponsible.
If Greece hadn’t been bailed out, the effects would have been felt largely by the Greeks, whose irresponsible government put them in this position. (But, we must also fault the Greek unions and public sector workers who insisted on unsustainable public sector spending.) The bailout means that the effects will be spread more generally throughout Europe.
Meanwhile, a poor precedent has been established. Despite the EU’s agreement that some countries would not bail out others, the EU has demonstrated that their agreements have no teeth.
Were the Europeans correct when, in 1992, they agreed they would not bail out members, or are they pursuing the correct policy now, with the bailout? I think it’s the former. They knew what the right policy was to begin with, but didn’t have the courage to carry it out.