Greek debt referendum: Bad for economy, but good for democracy

The shocking news of a Greek debt referendum this week has prompted European leaders to hold an emergency meeting today ahead of the G20 summit in Cannes, France.

European Union leaders are reportedly “irritated” and “annoyed" with Greek Prime Minister George Papandreou, who shocked his European colleagues and global markets by announcing a referendum on the latest EU bailout plan for his country.

But those not directly involved in bailout negotiations seem to agree on two things: The Greek call for a referendum is good for democracy although it is, at least in the short term, potentially bad for the economy.

“I welcome the referendum,” says Hans-Peter Burghof, chair of the banking and finance department at the University of Hohenheim. “It’s a reminder of the democratic basics that organize European societies. But since we have no date for the referendum and no clear idea what exactly it will ask, it throws overboard the whole schedule for the Greek bailout. We simply have no idea what’s going to happen next.”

Indeed, politicians, economists, and citizens in the eurozone are still trying to figure out what the implications of this decision will be.

Mr. Papandreou’s plan prematurely ended the short period of calm in the eurozone. The more relaxed atmosphere was brought about by last week’s emergency summit in Brussels, where EU leaders agreed a new bailout package for Greece, including a 50 percent debt write-off, a recapitalization program for European banks, and a massive increase in the capacity of the euro rescue fund.

It was widely welcomed as the moment when Europe’s political class finally wrenched the tiller from the grip of financial markets and regained control over the fate of the eurozone. Tonight, less than a week after the Brussels summit, EU leaders will gather for another meeting in Cannes, France, ahead of the G20 summit there tomorrow, trying to get back on top of the situation.

“In Cannes, the EU and the IMF have to decide now if they are willing to keep giving financial aid to Greece under these new circumstances,” says Professor Burghof. “If they don’t, Greece defaults and the money paid so far is gone.”

But the consequences would reach far beyond that, according to Michael Hüthner of the Cologne Institute for Economic Research, who points out that a negative referendum vote would also force a default. “If Greece defaults ... credit default swaps would have to be paid, causing a ripple effect throughout the whole financial world. The eurozone would see a dramatic drop in its economic performance.”

In order to regain the trust of investors and citizens, the EU treaties would have to be rewritten and Europe would have to start over, says Mr. Hüthner. “Basically, the economic risks of the referendum outweigh the possible gains in political legitimization.”

But the renewed anxiety of the financial markets could also have a positive effect, says Burghof. “Increased pressure by the markets is good. Countries like Italy can still help themselves, but clearly they need external pressure, otherwise government and society at large won’t accept that they have to act.”

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