What does the second Greece bailout mean?

“Greece is about to default and the Euro Zone has just come up with a comprehensive plan to bail it out. "

Does that sound familiar? It should. For just last May, international authorities agreed to a €110bn bailout, and now it’s time for a second round of bailout, this one as hefty as €120bn.

The way the bailout plan is structured, however, suggests that second round may not be the last. The Greek debt is about to touch 160% of its GDP, and the debt by all measures seems unsustainable. The government has been running deficits and needs external funding to cover the deficits and meet payments on debt. The only sustainable solution out of this mess for the Greek economy is getting back to growth.

However, the bailout plans all stress on austerity through reduction in spending and raising money through taxes- the plan is in fact to raise over €14bn over the next 5 years. Keynesian economics stresses on the importance of demand and consumption in order to promote growth, and such stress on austerity and low spending in the Greece economy is only likely to weaken the economy further.

Moreover, the plan fails to tackle some core political issues vital to restore growth. For instance, while the Hellenic Railways, which loses about €3mn a day, is due to be privatized, there is no clarity on how the staff strength would be reduced or costs cut. It is to be recalled that in 2009, Goldman Sachs and Morgan Stanley had pitched the Greek government on a plan to overhaul the system, by laying off half of it’s 7000 workers and taking on about €8bn but that did not go through in the election year. There also seem to be no strong measures against political lobbyists who often benefit most from the government’s excessive spending.

With weaknesses in the bailout plan, what thus appears immediately is a viscous cycle of bailout-austerity-low consumption-staggered growth-bailout.

While the markets at large may be responding positively to the measure, such a bailout brings us to a more fundamental economic question. Is Greece actually free-riding on the economic strength of other countries in the Euro Zone? Do the second Greece bailout send a poor message to other countries in the Euro Zone than they too may thus free ride? If so should actually be allowed to default or asked to leave the Euro Zone, as a punishment for it lax economic policies?

We shall look at some of these issues in our upcoming posts..do keep a look out!