So Long, Austerity?

Two and half years after Greeks voted into power a coalition government led by Antonis Samaras, the head of the center-right New Democracy party, they returned to the polls this weekend.

The elections, which were forced because the Greek parliament was unable to select a new president, have propelled Greece back into the world’s headlines. The Coalition of Radical Left, known by its Greek acronym Syriza, won a decisive victory, polling at 36.3 percent of the vote compared to 27.8 percent for New Democracy, 6.3 percent for the neo-Nazi party Golden Dawn, and six percent for To Potami, a centrist party. Those results hand Syriza 149 seats out of 300, and it will form a coalition government with the far-right, anti-austerity party of Independent Greeks (which won 4.7 percent of the vote). Syriza’s 40-year old leader, Alexis Tsipras, who ran a successful anti-austerity campaign, will be the next prime minister of Greece.

Until 2010, Syriza was a small fringe party on the far left. Its transformation to electoral powerhouse is commonly explained as a reaction to the devastating effects of the economic depression that has racked Greece for about eight years now. Since 2007, Greece has lost one fourth of its GDP, and its unemployment rate has surpassed 25 percent. It is, in other words, natural for Greek voters to turn toward a party that is promising them a different economic recipe.

In particular, Syriza has promised to do away with austerity, which was imposed on Greece in 2010 by the European Union, the European Central Bank (ECB), and the IMF (collectively known as the Troika), after Greece’s reckless economic policies caused it to over-borrow and subsequently lose its ability to finance its huge debt. To eliminate its deficits, Greece had to cut spending and raise revenues, a combination that caused widespread economic pain. It certainly didn’t help Greece’s self-esteem that the bitter medicine was administered from abroad.

In addition to austerity, Greece was supposed to launch a full reform of its dysfunctional administrative machinery and economy so that it could begin to regain lost ground. But vigorous resistance by powerful interest groups undermined many of the structural reforms, while the slowing of the European economy and political uncertainty in Greece made a bad economic situation worse. Things began to look up in 2014, when the Greek economy grew for the first time since 2007. But this proved too little, too late to benefit the governing coalition, made up of New Democracy and PASOK, the socialist party that has towered over Greece since 1981.

Indeed, the biggest loser of the Greek crisis was PASOK, which initially emerged in the 1970s as a radical alternative to the political status quo. In its years in power, PASOK relied on a combination of fiscal expansion and low taxation, which translated into widespread prosperity for most Greeks. The party’s main rival, the right-of-center New Democracy, proved able to copy this winning recipe thanks to low-interest borrowing afforded by Greece’s euro membership. But it was PASOK that got most of the blame when Greece had to be bailed out in 2010; the economy had imploded under PASOK’s watch. The party’s leader, George Papandreou, thought he could manage the situation with economic stimulus, but his Keynesian experiment turned sour when financial markets turned their backs on the country, forcing it to seek a bailout. As a result, PASOK went from regularly polling over 40 percent to polling around five percent.

Among the many anti-austerity parties that sought to capitalize on the Greek voters’ disenchantment after 2010, Syriza was most successful because it was best able to imitate PASOK’s early radical style­­­—a mix of populist language and grand promises of change through the expansion of the public sector—which many voters had come to associate with the good times. But this parallel doesn’t mean that Syriza will be as successful as PASOK was back in the day. To do that, Syriza will need to generate positive economic results. It has full confidence that it can renegotiate Greece’s bailout deal to get rid of most fiscal conditions attached to it. But is that possible?

For many in Europe, especially in the debtor countries of the eurozone, a Syriza victory does offer a renewed opportunity to call for the relaxation of austerity measures, which Germany has supported. So far, however, the discussion has focused on the narrower issue of the renegotiation of Greece’s foreign debt. The debt is unusual in that it is primarily held by the member states of the eurozone (along with the IMF and ECB) rather than private investors. Despite a substantial haircut in 2011, Greece’s debt has exploded (since the country’s GDP has collapsed) reaching a nominal value of close to 170 percent of GDP.

In practice, however, servicing the debt is less onerous than its size would suggest because the debt’s real present value is much lower and it carries long maturities and low interest rates. The interest is likely to be further lowered—and the maturities extended—in the coming negotiations, although more extensive debt forgiveness appears premature. At most, Greece could perhaps expect an additional relaxation of some of its most stringent fiscal targets, including the requirement that it produce a large (4.5 percent of GDP) primary surplus.

Such measures, however, are unlikely to prove sufficient to finance Syriza’s economic program, particularly in light of a combined revenue shortfall and bank deposit outflow caused by creeping political uncertainty. Given that Syriza is also opposed to many of the structural reforms that are necessary to overhaul Greece’s economy and that Greece still lacks access to international financial markets, the implementation of its program requires nothing less than a commitment by the EU to permanently finance Greece’s growing deficits. That just isn’t realistic.

Tsipras thus faces the following choice: He could take whatever adjustments the Troika offers and execute a U-turn, betting that the Greek economy will benefit from the ensuing political stability, the fall of oil prices and the euro, and new quantitative easing policies that the ECB recently announced. If, on top of this, Tsipras proves able to reform Greece’s notoriously dysfunctional administration, fix the pension system, and cut down on corruption and tax evasion, he will be hailed as a great reformer and will dominate Greek politics for the next decade. Needless to say, such a strategy requires considerable vision, political skill, and expert maneuvering both in the European and Greek arenas. Tsipras and his team, however, are inexperienced when it comes to the former. Furthermore, if these adjustments fail to improve Greece’s economic outlook, Tsipras could face the same fate as Samaras, who, like him, began as a critic of austerity, or his predecessor, Papandreou, whose 2009 fiscal expansion program blew up in his face.

Alternatively, Tsipras could turn down the Troika’s offer. He may be unwilling to execute such a significant U-turn and renege on his promises because of his ideological opposition to market-oriented structural reforms. Or, he may be willing to do a U-turn but fail to convince the substantial chunk of his party that is made up of unreformed die-hard Marxists to follow him. Greece is still subject to the conditions of the bailout program and needs the last 7.2 billion euro installment to cover its financing gap. Hence, for the time being, the new government will need to abide by the program’s requirements—that is, the very combination of austerity and reforms that Syriza has pledged to overturn. This may be enough to break the party. Such a development would usher in a political crisis, possibly leading to another round of elections that would further undermine Greece’s fragile economic situation. At that point, Greece could see anything from a grand coalition between New Democracy and Syriza moderates to a full-fledged economic collapse and Greece’s exit from the euro.

There is no doubt that a Greek collapse and exit from the euro would be a negative development for the European Union and the eurozone alike. On the one hand, Germany prefers to avoid such an outcome, even if it is widely considered to be manageable and unlikely to cause a financial contagion. It must also deal with the widespread disenchantment with austerity and the rise of populist parties in many European countries. On the other hand, the Greek voters, despite their economic suffering, still support the country’s membership in the euro by a large margin and would steeply penalize any government that takes the country in that direction. Even if the worst can be avoided, however, the road ahead will be bumpy.