Hugo Dixon

Greece needs to go to the brink. Only then will the people back a government that can pursue the tough programme needed to turn the country around. To get to that point, bailout cash for both the government and the banks probably has to be turned off.

It might be thought that the country is already on the edge of the abyss. This month’s election savaged the two traditional ruling parties which were backing the bailout plan that is keeping the country afloat. Extremists of both right and left gained strength – voters liked their opposition to the plan. But nobody could form a government. Hence, there will be a second election on June 17.

Will this second election express the Greeks’ desire clearly: stick with the programme and stay in the euro; or tear up the plan and bring back the drachma? That is how Greece’s financial backers in the rest of the euro zone, such as Germany, are trying to frame the debate. But the electorate doesn’t yet see the choice as that stark. Roughly three quarters want to stay with the euro but two thirds don’t want the reform-plus-austerity programme.

The next election is unlikely to resolve this inconsistency – or at least that is the conclusion I came to from a trip to Athens last week. The battle for first place is between Alexis Tsipras, the young leader of the radical left SYRIZA party, and the centre-right New Democracy party led by Antonis Samaras.

A victory for Samaras might seem to offer the hope that Greece will stick with the programme and the euro. He has, after all, campaigned for both. However, even if he comes first – which he did in this month’s election – he will not have a parliamentary majority. He will either have to stitch together a majority coalition or govern a minority government. Neither is the recipe for a strong government.

What should be the long-term vision for the euro zone? The standard answer is fully-fledged fiscal, banking and political union. Many euro zone politicians advocate it. So do those on the outside such as David Cameron, Britain’s prime minister, who last week called on the zone to “make up or break up”.

The crisis has demonstrated that the current system doesn’t work. But a headlong dive into a United States of Europe would be bad politics and bad economics. An alternative, more attractive vision is to maintain the maximum degree of national sovereignty consistent with a single currency. This is possible provided there are liquidity backstops for solvent governments and banks; debt restructuring for insolvent ones; and flexibility for all.

Enthusiasts say greater union won’t just prevent future crises – it will help solve the current one. The key proposals are for governments to guarantee each other’s bonds through so-called euro zone bonds and to be prepared to bail out each other’s banks. In return for the mutual support, each government and all the banks would submit to strong centralised discipline.

When euro zone policymakers are asked if there is a Plan B to cope with a Greek exit from the single currency, their typical answer goes something like this: “There’s no such plan. If there were, it would leak, investors would panic and the exit scenario would gather unstoppable momentum.”

Maybe there really is no plan. Or maybe policymakers are just doing a good job of keeping their mouths shut. Hopefully, it is the latter because, since Greece’s election, the chances of Athens quitting the euro have shot up. And unless the rest of the euro zone is well prepared, the knock-on effect will be devastating.

The Greeks have lost their stomach for austerity and the rest of the euro zone has lost its patience with Athens’ broken promises. But unless one side blinks, Greece will be out of the single currency and any deposits left in Greek banks will be converted from euros into cut-price drachmas.

It has become fashionable to talk about the need for a euro zone “growth compact” as weariness mounts over a diet of nothing but austerity. France’s new president Francois Hollande has popularised the idea. Even Mario Draghi has backed it. That gives the concept credibility as the European Central Bank president was one of the main supporters of the austerity-heavy “fiscal compact”, which requires governments to balance their budgets rapidly. Olli Rehn, the European Commission’s top economic official, has joined the bandwagon too: at the weekend, he advocated a pact to boost investment, while hinting that there may be scope to ease up a bit on the austerity.

But all this chit-chat won’t lead to much unless politicians are prepared take unpleasant decisions on reforming labour, welfare and banking – measures which would boost growth in the long run. That has to be the quid pro quo for loosening the current fiscal squeeze or further easing monetary policy – measures that would help in the shorter term. 

Without such a grand bargain, any growth compact is likely to amount to little more than extra funds for investment. Rehn mentioned the main ideas at the weekend: using EU budget funds to guarantee lending to smaller firms; encouraging countries with fiscal surpluses to increase public investment; and boosting the capital of the European Investment Bank. While these measures are worthy, they are not of the scale needed to change the course of one of the biggest economic crises in recent history.