Southern European Bailouts Must Focus On Reform

As European leaders meet in Brussels this week for a summit on the future of European integration, bailouts for the south will be heavy on their minds. Rescue funding for Greece’s heavily indebted government and Spain’s bust banking sector are sore topics of debate by now, but debate will continue nevertheless.

Greece has missed, again, the preconditions for releasing its next tranche of bailout funds. I explain why in the City A.M.

Greece has become complacent about making necessary structural changes, having received two bailouts, interest rate support from the European Central Bank (ECB), and an internationally sanctioned private debt restructuring earlier this year. It has failed to reform its public sector, privatise state-owned companies, increase competitiveness — all conditions for receiving additional international support.

Read the full article for a detailed description of how far Greece has fallen behind the reform targets set out in its two bailouts and also behind the rest of Europe.

As leaders discuss next options for releasing Greece’s bailout funds, Greeks have taken to the streets in tens of thousands as part of a 24-hour general strike to protest further austerity measures. But Greek austerity has been relatively mild compared to that of its Baltic counterparts, which endured harsh cuts in wages and government spending as well as some tax increases. Those countries are now outperforming the rest of Europe. For example, Estonia cut government spending and public wages. A flexible labor market also allowed for businesses and workers to agree on wage cuts in order to improve competitiveness. GDP fell by 14 percent in 2009, but bounced back the very next year with 2 percent positive growth. Unemployment shot up to 17 percent, but quickly receded to 12 percent the next year and is still declining. Greece, on the other hand, has limped along the path to reform and has brought persistent negative growth and rising unemployment along for the ride.



Greek prosperity cannot begin until Greek reform begins. Despite making cuts since receiving its first bailout package in May 2010, Greece has a long way to go. As European leaders debate and anti-austerity—rather, anti-reform—protesters shout in Athens, both parties would do well to recognize this fact. Europe shouldn’t keep handing out euros to a complacent Greek government and everyday Greeks must realize that they will have to accept a temporary and steep decline in living standards for conditions to improve in the long run.

Meanwhile, Spain will probably make an official request for aid soon. After denying the need for rescue funding over the past month, Spanish officials indicated this week that Spain might request a “precautionary credit line” (i.e. approved bailout funding on which to be drawn at Spain’s discretion) as early as next month. Officials estimate that the first request will be for roughly €50 billion. But this is just the tip of the iceberg. Earlier this month, I estimated the total funding needed to bring Spain’s banking system up to capital adequacy standards by 2014 at €113 billion.

Like its Southern European neighbors, Spain must also make serious reforms. In The EU ObserverI explain why liberalization of the Spanish labor market is an important structural change that would go a long way towards addressing Spain’s long run economic woes.

The next several weeks are a pivotal time for Europe. Greece will most likely receive its next tranche of bailout funding in order to pay its November obligations, but with new conditions and less international tolerance for any more of Athens’ deviations away from those new targets. Spain is also likely to request rescue funding for its banking system, almost certainly entailing new reform targets for Madrid as well.

Let’s hope that Greek complacency does not continue and Spanish complacency does not begin.