Global markets plunged on Thursday as investors continued to react with nervousness to the prospects of Greek's debt crisis spreading to other countries on the European Union's periphery. This is primarily because Greece remains in a murky situation despite its parliament's approval of tough new austerity measures linked to its bailout.
The 110 billion euro refinancing package negotiated between the Greek government and the International Monetary Fund last weekend is all about muddling through. Greece has promised to reduce its budget deficit by an amount equal to 11 percent of GDP over the next four years. This is a huge shift in a brief period of time; if the United States made a shift of similar scale, it would imply budget cuts and tax increases equal to $1.5 trillion. The Greek government has committed itself to better tax collection, lower pensions, reduced military spending, and a host of other measures that are likely to lower the living standard of almost everyone in the country.
Greece's fiscal mismanagement has been so severe that even if it does everything the IMF has asked for, its budget will still be far in the red. Almost no one thinks the three-year IMF loan program will be the end of the story. Even if the rioters go back to work, the pensions are cut, and the taxes are collected, Greece is likely to be back at the table in 2013 to renegotiate its debts. With luck, the global economic environment will be more benign, and private financing will be more readily available.
Would another alternative--exiting the euro--be less painful, for Greece or anyone else? The answer is almost certainly no. Adopting its own currency in place of the euro would not spare Greeks the pain of adjustment; their pensions might not have to fall in terms of the new currency, but they would certainly be lower in terms of their ability to buy goods and services from the eurozone. Domestic interest rates would be sky-high; joining the euro brought Greeks huge benefit as interest rates on domestic mortgages and commercial loans moved closer to those in other European countries. A new Greek currency would bring a return to the bad old days.
Keeping Greece within the eurozone is in the interest of other European countries, too, for reasons of politics as much as economics. The aspiration to be part of the European Union and the eurozone has been an extraordinarily important force in southern and eastern Europe. Countries have transformed their economies, reformed their judicial systems, democratized their political systems, put once-powerful military establishments under civilian control, and embraced a vast number of social changes in hopes of joining the great European project. If Greece were to abandon the euro, many aspiring members would conclude they have no hope of joining--and would have far less incentive to persist with the sweeping changes the EU insists upon. Europe could become a less democratic and arguably less stable place.
The May 7 EU summit is likely to issue a ringing defense of the euro. This is all well and good. But at this stage, there is little the EU can do quickly enough to mitigate the financial-market pressure building on other heavily indebted EU member states, notably Portugal and Spain. Calming the markets is likely to require evidence that those countries are moving swiftly to bring their public finances into balance.