What’s Next for Greece?

Greece just dodged another bullet — one from its own gun, no less. But with the political meltdown of last week and the naming of a new prime minister, it is on the way to approving the Troika bailout package and financially staying afloat for another few months.

Few could understand what former Prime Minister Papandreou was thinking when he called for a referendum — a move that led to the collapse of his government and cost Greece dearly in what was left of the trust and sympathy it had from other EU leaders who had put themselves on the line politically for this struggling country.

Within hours of Papandreou’s call for referendum, many of my perplexed Greek friends were hypothesizing that this was Papandreou’s exit strategy – a way out of having to play the sadist in turning the screws ever tighter at the direction of their new EU and German masters, with no real end in sight to the economic recession. More generous Greek observers suggested that it was a clever ploy to force the opposition into supporting the package. However, the vast majority of Greeks believe it was a just a colossal misread of the Greek people and the EU.

Regardless of the former prime minister’s motivations, there is no doubt it has had a powerful effect in Greece. They have a new “coalition government” with a distinguished technocrat at its helm — something that the EU had been pushing for for nearly six months. Second, they have had a de facto referendum on the bailout package. And third, and most importantly, the Greeks made it abundantly clear that, at least for now, they feel strongly about staying in the Euro.

However, in spite of the strong Greek remonstrations in support of the euro, significant political work lies ahead in keeping their place in this family. For starters, Greece has to pass a budget before the end of the year that makes further dramatic cuts and implements the deeper austerity measures and structural reforms demanded by the Troika.

While this would be a Herculean task for any government, doing so with political parties gearing up for new elections will make the task of the new prime minister ever more difficult. A technocratic cabinet does not mean a technocratic parliament or a technocratic government bureaucracy. The former will be posturing for the elections and the latter will be worrying more about protecting their jobs than improving the work of the government.

It is also telling that only six of the more than forty ministerial positions in the new government are slated for the main opposition party, New Democracy, and the two main posts they have taken are Foreign Affairs and Defense, the least likely to pull them into responsibility for the misery being imposed in domestic affairs. The anemic representation was no doubt a matter of choice, as the leadership of the opposition wants as little responsibility as possible for the austerity program in front of the elections.

While the new prime minister is likely to be able to push through support for the bailout package and a new round of measures, he will still face significant problems in implementation. It will prove difficult for the prime minister to forcefully direct a cabinet chosen primarily by the parties in the coalition, and the Office of the Prime Minister in Greece lacks any significant staff support to help him oversee the work of the ministries and provide significant independent policy support and analysis.

Meanwhile, the Europeans were fortunate that the Greek drama of the last week distracted attention from their unfinished and somewhat anemic bailout package agreed to at the Summit. While a fifty percent voluntary haircut on the 206 billion euros held by private bondholders is significant, to Greece it provides only roughly a twenty eight percent reduction in the 367 billion euros of total official debt, assuming that all the private bondholders accept the deal.

And in the next four to six months, the country is going to need to borrow an additional estimated 30 billion euros to recapitalize its banks. So the net effect is that Greece will likely be able to only reduce its debt burden by roughly 70 billion euros, or nineteen percent. Even the EU estimates put the benefits of their package to lowering the debt burden to at best 120 percent of GDP by 2020, which is near the limit of what most economists think is sustainable to still have any growth.

Greece’s efforts to get its economic house in order suffers as well from the deteriorating situation in Europe. The European Commission recently slashed its growth forecast for the eurozone to half a percent for 2012, and Italy has been tested in a way that raises new challenges for the continent. With Greece’s GDP depending heavily on tourism from the rest of Europe and its shipping sector sensitive to changes in global growth, the worsening external environment is likely to cause Greece’s economic contraction to be worse than already predicted and financing needs to be even greater.

All this suggests that the drama is not over in Greece. Expect many more twists and turns in the months to come, to be overshadowed only by the larger drama of Italy and stress in European banks.

The best we can hope for in the interim is the quick approval of a bailout package and a messy but successful process to pass a new budget and implement the cost-cutting measures required under the EU. This is a tall order for a caretaker government amidst the political posturing of the pre-election season. But with the constant pressure of the EU and Troika to withhold funding and a threat of expulsion from the eurozone, this is achievable in the short run.

In the medium term, these efforts will fail unless the political leadership in Greece can articulate and effectively communicate a more positive vision for the future. Unless they can convince the population that the austerity program is leading to something significantly better for Greece’s current and future generations, the citizens will eventually reject the path that they are on. Greeks need to be convinced that that program they are being asked to implement will bring real benefits and not just a never-ending race to the economic bottom to balance the budget and pay back their debt. They need to believe that jobs in the private sector will replace the ones being cut in the public sector and that economic growth will be as important as austerity in charting their future.

A lot is at stake, not just for Greece and the eurozone, but for all of us if this fails. Greeks made it clear last week that it was ready to take another dose of horrible-tasting medicine to stay in the Euro. They will need to move swiftly in the coming days to convince European leaders that they meant it. At the same time, European leaders are going to have to be prepared to do more in the coming months to support Greece on a reasonable path back to growth if they truly want to keep the current eurozone intact. Absent more from both sides, the current effort has little chance of succeeding.