Director of Global Business and Economics Alexei Monsarrat recently interviewed Professor Leszek Balcerowicz on how Greece and Europe will resolve the debt crisis. As Polish Finance Minister in 1989, Balcerowicz instituted a wide-ranging series of economic reforms to transition that country to a market economy. His “shock therapy” is widely cited as the textbook example of how to quickly modernize an economy. 

Key points from the discussion were:  

  • Greece’s leaders should stop blaming Europe and the IMF for its problems. They need to clearly and honestly explain to the Greek people the reality of the country’s challenges, and assume ownership over its reform.
  • Greece has a lot of room to reform and, therefore, to unleash the productive capacity of the economy. The question is whether current reforms are creating the right political incentives for this to happen.
  • Private sector participation in reworking the country’s debt will need to be higher, and the interest rates lower, in order for relief to be effective.
  • There are no hopeless economic cases. Europe and the United States can solve their debt problems, but they need to act now. 

1.       You guided Poland into the market economy after decades of Communist rule. There was sometimes tremendous popular and political resistance to your efforts. How would you advise the Greek government to navigate their own popular and political firestorm right now as they try to move ahead? 

Balcerowicz: I think the Polish economic situation in the second half of 1989 was much more difficult than that of Greece during the last year and the present, but Poland’s political situation was much better than the present political situation in Greece. Why? Because the ruling Greek politicians–the leaders of PASOK (Greek Socialist Party)–contributed to the present crisis. The same goes to some extent for the opposition party (New Democracy).  

As the first non-Communist government in Poland, we were the newcomers. So, it was much easier for the policymakers in Poland to present and conduct the necessary radical reforms than it is for the present governing politicians in Greece, because as I said, they have through the previous policies, contributed to the present mess. And also, one should remember that PASOK in 2009, before the elections, campaigned by promising even more of debt-financed social spending. So, that is the difference.  

Now, what should they do from the political point of view? Of course, I am not an expert on Greece’s politics, but I would say they should honestly explain the economic situation in Greece, including why they have had to make such a reversal. 

Secondly, they should not blame external institutions, like the IMF or the European Commission, for reforms required in Greece.  In other words, they should assume ownership of the program. This was the case in Poland. We never blamed external forces for reforms. We said, “This is Poland’s strategy,” which was true, “and the IMF and foreign banks are our partners, in transition.”  

I can’t and don’t know whether this political strategy could work in Greece, but if it fails, then what would be the alternatives? First, elections, like in Portugal. They had elections, and there’s a new government, which promises more reforms. Or there could be a technical government or caretaker government as was  the case some years ago in Turkey, when Karamanlis was a very important reformer.  

2.       There is a fierce debate over whether Greece needs to set itself straight immediately, or if time, matched with some credible action, might prove to be a better healer. As the architect of “shock therapy,” would you recommend swift action for Greece, or can they muddle through? 

Balcerowicz: I think the most important problem is how to release and strengthen the growth forces in Greece. Paradoxically, they have ample opportunities for strengthening their economic growth because they have a very distorted economic system. So there’s ample room for reforms which would improve the fiscal situation. They should focus on reducing spending on those parts of the budget that are harmful to economic growth. This includes pensions; and they have increased the retirement age, which is a very important fiscal reform that is at the same time a supply side reform because it tends to increase official employment. They also have a lot of room for reforms which would remove the distortions from the supply side and increase competition. So, from purely the economic point of view, Greece is not a hopeless case.  

The question is not so much economics, but political economy. One should look at the various proposals and ask “to what extent do they shape the incentives for the politicians in Greece to reform?” That’s a very important consideration.  

Having said that, I would also like to add that it’s very difficult to find examples of countries with 160 percent public debt to GDP ratio that  grow in the long run without some debt reduction. And from this point of view, there’s a sea of difference between Greece, on the one hand, and Portugal, Ireland, even Spain, and Italy. Greece is the worst case from the point of view of the present ratio of public debt to GDP.  

Now, in Greece’s case, it seems so far that this strategy of delaying has been necessary and inevitable because we have been providing official credits through the IMF and European Union institutions. So official lending to Greece is expanding while private credit is decreasing, and  most of Greece’s debt is now due to the official lenders, like the IMF and European Union countries. And then the question is: if this continues, would debt reduction be ultimately required and obviously, what about the taxpayers in  countries like Germany, Finland, Netherlands, and other countries who would have to pay this bill?  

So, by postponing what appears to be necessary for the restructuring of the present debt, European Union institutions are only adding to their political problems, since they are increasing the probability that tax payers will have to bear the debt burden.

I would say there are a growing number of people who acknowledge an inevitability of some debt reduction with respect to the present debt burden. And if this is the case, the issue is how to do it while minimizing the repercussions for the banking sector in Greece, and for the banking sector in other countries. 

3.       What is your assessment of where they are with that right now in terms of the deal that’s on the table that the French government has put together and that the private sector banks are working on? Is it your sense that the way the deal is currently structured will need to involve an element of private sector participation? And do you think that right now the proportion of private sector involvement is about the right size, or is it too small? 

Balcerowicz:That’s a crucial question. For the extent of the debt restructuring, it seems to be rather small. Second, what would be the interest rates required of Greece? I would like to say that in the Polish case, we launched a comprehensive program, which on the one hand included the radical reforms, which released economic growth in Poland, but on the other hand, included substantial debt reduction, which we obtained after intensive talks with our creditors. So, there are two parts, two pillars of Poland’s growth, which worked. 

I think the private sector involvement is rather small, and again, if the interest rates are high, this would contribute to the further accumulation of debt without solving the issue of debt burden. In the Polish case, one form of the debt reduction was through very low interest rates.        

4.       Making long-needed policy changes in a crisis is challenging, but often seems the only way to force action.  How do you evaluate the way that Europe’s national governments and its institutions have handled the crisis so far? Will Europe come out of this having solved some of the underlying issues of the Euro i.e., with more integrated fiscal policy coordination? 

Balcerowicz:   Well, I should distinguish between crisis management and measures which aim at preventing a future serious crisis.  

On crisis management, it’s very difficult not to be critical, even considering the political complexity in the European Union. It’s worth remembering that the magnitudes of fiscal problems in Greece were revealed in 2009, and it took a couple of months to recognize this at the European level and the first reactions were sort of forced by the circumstances. These were decisions taken to the European Union level in May 2010. As you might remember, there was a creation of a provisional sort of a bail-out fund, which offered credits to Greece plus the European Central Bank started to buy Greek bonds and the bonds of other distressed countries. And then there was a discussion going on about the participation of the private sector, which I think is right in principal, but relatively little was done on how to reduce and minimize the spillovers. Instead, I think, they were discussing the pros and cons of private sector involvement. And then we enter the present situation, when we’ve got attempts to involve the private sector, but I think to the extent which is not sufficient to reduce the excessive debt burden in Greece, without, it appears, a program which would sufficiently reduce the spillovers from a larger involvement of private creditors in the solution of Greece’s debt burden. So, even recognizing the political complexity of the European Union, I don’t think one can be very positive about its crisis management so far. 

And that was a fundamental problem, for example, if the European Union creates a sort of European monetary fund, because in principle the envisaged European stabilization mechanism would resemble the International Monetary Fund. What would be the competitive advantage of these institutions? How would they cooperate? What would be the cooperation between the IMF and the European Stabilization Mechanism? So, it’s that sort of questions regarding the benefits of this Mechanism, which is meant to be a permanent one. 

With respect to measures proposed to reduce the risk of future crises, I think it’s largely a work in progress there’s some questions. For example, almost everybody agrees that the Stability and Growth Pact was a paper tiger. It was hugely violated. Nobody cared about it, including Germany and France, and everybody agrees that it’s necessary to sanction violations of it. This would involve automatic sanctions, but these automatic sanctions have not been enacted and that’s politically difficult.  

So, there’s doubt and there’s some other proposals, for example, that some Eurozone countries plus some other countries, including Poland, have entered a sort of “Euro Plus.” They take obligations with respect to each other basically to conduct better economic policies, meaning policies which would reduce the risk of the crisis. But the question is: “What are the incentives?” In what respect does this differ from the Lisbon agenda, which was basically based on peer pressure.  

So, it remains to be seen whether these new initiatives aiming at reducing the risk of future crisis will be effective. I don’t want to sound unrealistic, and there’s no good substitute for good policies at the national level. For that, you need a lot more pressures for reforms in the respective [troubled peripheral] countries, including Greece and others. So, in other words, one has to mobilize much more effective force for reforms in these countries–which should operate permanently–not just after the crisis. So, we need a lot more pro-market think tanks, I think, and pro-market media, or pro-reform media, pressing the government and trying to neutralize the impact of populist forces, which are present in every country, including the U.S. So, I think this is the ultimate solution, which is not a magic bullet, because it requires a lot of systematic work in every country. 

5.       Do you think that Europe, and for that matter, the United States, given where they are right now, have the time on their hands to create some of those systematic reforms. 

Balcerowicz: Of course. From an economic point of view, there are no hopeless cases. I remember Poland’s economic situation in 1989. It seemed hopeless to most people, but it turned out to be possible to first to propose a program, and then to implement this program. And there are some other examples of countries which are in deeper trouble, but work.  

And let me say at the end that from the point of view of the present public debt burden, there’s a special case of Greece, which should not be compared with those of other countries, like Ireland and Portugal, Spain, or Italy. These countries have much more room for and time for reform but, they should not delay the necessary reforms, because they need to strengthen the confidence in the financial markets. 

Interview Audio (.mp3)

Alexei Monsarratis director of the Atlantic Council’s  Global Business and Economics Program. He previously spent six years with the U.S. State Department in the Bureau of Economics, Energy, and Business Affairs (EEB), where he worked on a range of issues with transatlantic partners, including economic development and poverty reduction, post-conflict reconstruction, strategic economic policy relations, and energy issues.