Message to Merkel: Think Outside the Box

The Greek debt crisis is a collision of two seemingly incompatible necessities. One is to put the Greek economy into a position for long term health; the other is to keep it from expiring in the short term. If these are to be reconciled, the players in Europe need to think outside the box, rather than retreat into bluster, blame, and the repetition of old positions.

The first necessity is a reform of the Greek economic structure. Some of these reforms are aimed at creating a more competitive private sector. While governments like Germany and France that are busy prohibiting Uber in order to protect the established taxi industry should be a little embarrassed about pressing this point, a freer private sector has a good track record as a driver of growth. Greece is likely to benefit from such moves in the long run, and in the short run they don't actively stifle recovery. Politically such reforms are hard, but they are not in themselves counterproductive for a return to prosperity.

The real challenge for reform is the public sector. If debt is not simply to compound into more debt, Greece has to find a better balance of public sector expenditures and revenues, a process that includes both annoying improvements in tax collection and desperately hard reductions in pensions and other aspects of the social safety net. In short, the dreaded austerity.

Germany's Chancellor Merkel, is holding a hard line on this, and with some justification. If the existing imbalance continues, and the Eurozone partners provide open ended finance, then membership in the Eurozone becomes a kind of blank check for its members to have a fiscally unsustainable level of public services and government employment with other countries footing the excess costs. This sets up a "moral hazard," where bailing someone out just provides an incentive for them (and others) to run up the bills again. There is no reason why Germany and its Eurozone colleagues should let Athens continue programs that must be paid for by the rest of Europe.

The big problem with this austerity budgeting is that it has the predictable consequence of shrinking a damaged economy even more. While Krugman and Keynes are controversial to some, the data is hard to argue with: contracting the government sector into a recession is a proven recipe for making the recession worse. And this is just what has happened in Greece, with prior austerity measures clearly helping its economy go from bad to disastrous. Whatever its "just deserts," no nation can take this kind of economic challenge over the long term and emerge unscathed.

Germans in particular should be sensitive to this. The burden of reparations that followed World War I may have had different origins than the debt burden of the Greeks, but both proved unpayable. As Bill Clinton reminds us, it's hard to fight arithmetic. A punitive insistence on squeezing Greece as a kind of morality play for domestic political consumption in northern Europe is its own kind of moral hazard. Europe as a whole has a large stake in helping Greece to avoid the Weimar Republic experience of economic catastrophe leading to terrible political outcomes. Europe needs to step up to that challenge, never mind how it got there.

So what to do? Get outside the box, Mrs. Merkel, and get creative. One possibility would be to uncouple the short and the long term problems and treat their solutions separately. Keep insisting on some version of the reforms, but pair that with establishing a one-off, expansionary economic rescue package outside of the normal budgeting. After World War II, having learned the lessons of letting Germany suffer into economic chaos, the victors implemented the Marshall Plan as a means for pumping necessary liquidity into damaged, shrinking economies. Greece needs just such a jump-start to break the spiral of austerity and decline. With a recovering economy, the bite of austerity gets less severe; in a deteriorating economy, austerity simply becomes the guarantor of continuing decline. Europe should not underwrite Greek pensions for decades; Europe should underwrite the return to economic growth that will let Greece pay those pensions from an expanding economy.

Faced with two irreconcilable problems, Europe needs two solutions: long term reform paired with a short term stimulus. Having voted "No", the Greeks need a yesable proposition from their European partners. That proposition cannot simply be years of un-buffered hardship. Mrs. Merkel & Co., roll up your sleeves and figure out something that Greece can agree to that isn't either a sentence to poverty or a blank check. History might even call it the "Merkel Plan."