22 September, 2011 - 10:29

Default and ye shall grow: Latin American lessons for Greece

With Greece’s debt spiralling out of control and pressure from the European Union mounting, the country is increasingly finding itself between a rock and a hard place. Even the Dutch Central Bank (DNB) is beginning entertain the idea that Greece could go bankrupt. But Greece is not the first country to face possible bankruptcy. Could it learn from the lessons of the past?
By Hans de Vreij and Klaas den Tek

As Greece teeters on the brink of bankruptcy, more and more people are recalling what has been happening in Latin America over the past decade or so. One country after another defaulted on its debt, devalued its currency, tightened its belt – and seemed only to benefit from it. Is a national bankruptcy by definition profitable? The available evidence certainly suggests so. Argentina, Paraguay, Uruguay, Venezuela – all experienced healthy growth rates right after they went bust. The same goes for Indonesia, which defaulted in 2002.

Mexico
The situation in Greece, Dutch economist Sweder van Wijnbergen argues, strongly resembles that of Mexico in the 1980s. As chief economist at the World Bank, he was closely involved in negotiations with Mexico when it defaulted in the early 1980s. Tough reforms and debt relief eventually put the country on the road to recovery, the economist says:
“Greece also needs a massive reform package to turn things around. But where do you start exactly? That’s tricky—everything in Greece is wrong now. The only option is to overhaul everything, as happened in Mexico. That, in the end, restored confidence so that it was able to tap the capital markets again.”
Impact
Greece could go bankrupt any day now. But the likely consequences cannot be compared to what happened in Latin America. Greece is one of the 17 countries of the eurozone and its debt crisis, as stock markets around the world have shown, is having an adverse impact well beyond Europe’s borders.

So should Greece be kicked out of the eurozone? That doesn’t work, says Professor René Tissen of Nijenrode Business University. “Europe is highly exposed in Greece – French, Italian and German banks in particular. First we have to restructure the banks’ debts – I’ve already called for debt cancellation – before we can arrive at a healthy situation.”
Van Wijnbergen agrees it makes little sense to let Greece go its own way:
“If Greece returns to the drachma, its debt, which is payable in euros, will simply sky-rocket even more. Greece then will pay back even less and we will receive even less. In addition, there is no mechanism to expel a country from the eurozone. They would need to take that step themselves.”

Domino effect
A Greek default could have a domino effect, causing other weak economies (Portugal, Ireland and bigger ones like Italy and Spain) to collapse too. In Latin America by contrast, Mr Tissen stresses, there was hardly a risk of any contagion - of undesired bankruptcies, that is. There, other countries only followed Argentina’s lead by declaring bankruptcy deliberately. “Faced with a weak economy, Argentina found a way out by starting with a clean slate and rebuilding its economy from there. The trouble is we don’t have that option now.”

Parting of the ways
Like Germany, the Dutch government is convinced that the richer euro countries should come to the rescue of the weaker countries of southern Europe. Not doing so could trigger a host of negative consequences, in the banking sector for example. Tissen is not optimistic, however. “My view is that Europe is on the verge of splitting up – one way or another.”

(cl/imm)