|The fortunes of Greece and the EU are intertwined. Image credit: AP|
Those who support an exit from the euro and the reconstitution of the drachma, argue that Greece is trapped in a “downward spiral” whereby costs remain fixed and cuts only push the economy deeper in the abyss. As such, they advocate that the only way to break this vicious cycle is to repatriate monetary policy powers, depreciate the currency to reduce costs, regain competitiveness and inflate your way out of the crisis. In an abstract world, in laboratory conditions so to speak, this view could have been correct, yet in the real world, under the given conditions in which Greece finds itself, such a theory is pure fallacy from beginning to end, since it asserts that the main problem is in relative prices, not in absolute productive capacity, implying that no real reforms are needed once the depreciation occurs – something that is dangerously misleading as it gives the impression that nearly painless solutions exist, but for some “inexplicable” reason they are not taken into serious consideration (for more also see “On the fundamental fallacies of Euro-exit advocates”).
Let me be precise: A currency depreciation would only prove beneficial if the country had much idle capital that could not operate under the high costs, but would be prepared at any given moment in time to restart operations, once relative prices had fallen thanks to the depreciation. However this does not hold true in Greece, since the country does not have any industrial capacities who have been under-performing due to the recession, nor does its commercial navy reside within its numerous ports, nor do hotels have many empty rooms during the summer season. In short the impact of reducing relative prices would be relatively small, since the productive capacity of the economy will not expand as much as necessary, while any marginal benefits will be annulled by the increased costs in the import side – and there we have much to worry about since Greece imports even basic goods. As such even with massive depreciation Greece will still require deep structural reforms, to broaden its productive capacities by attracting new investments and reallocating resources from non-tradable to tradable areas (from consumption-oriented, to export-oriented areas).
About the issue in question: Greece has a very narrow productive base, upon which a very broad consumption culture was established, something that is reflected in the chronic current account deficit of the country. This is clearly unsustainable, since it requires constant foreign funding that increases the stock of national debt. For Greece the only path back to recovery, under the given conditions of the debt crisis that deprive the government from implementing expansionary fiscal policy, is deep structural reforms that will aim at reversing the current account deficit, by means of increasing the productive base.
For that to be achieved four conditions need to be met:
- Abolition of all bureaucratic obstacles and other protectionist policies
- Dismantling of the rigidities in the labor market
- Confidence and liquidity in the banking sector
- Institutional stability and confidence in the political system
Firstly, by abolishing bureaucracy and by eradicating all barriers to trade and obstacles to economic activity, the government will have established a policy framework that will favor the reallocation of capital from non-tradable to tradable areas, since it will become much simpler, faster and less expensive to put together whatever available resources to set up an extroversive enterprise.
Secondly, by dismantling the rigidities in the labor market, structural unemployment will be addressed in its source, while the reposition of workers to the export sector will be facilitated. Here of course it needs to be said that horizontal wage cuts are detrimental to the economy as is the support to the privileges of special interest groups.
Thirdly, by ensuring stability and liquidity in the banking system, capital flight will be reduced, the silent bank runs will be minimized, while the looming financial panic will disappear, allowing for renewed economic activity.
Fourthly and perhaps most importantly, the policy-makers need to make sure that institutional stability is preserved. This means two things: (1) the political order will not change every few months, (2) the policies affecting the economy will have a long-term horizon, instead of being altered every few weeks the troika thinks that more austerity is needed.
By meeting these four conditions the country will have established the necessary framework, within which the productive capacities can be expanded, ultimately reversing the current account deficit, bringing about recovery over the longer run.
With respect to the above four conditions, a currency depreciation would:
- have failed to eliminate bureaucracy, but would instead require more state mechanisms in place to control prices, capital movement, exchange rates, fight the parallel economy, combat increased tax evasion etc.,
- conceal the need for real reforms in the labor market (and beyond), since politicians will have the incentive to postpone “unpopular” measures, by means of printing money,
- exacerbate the stress in the banking sector, by increasing uncertainty, encouraging withdrawal of deposits, producing financial panic, lead to large scale bank failures because of euro-denominated debts becoming much higher in relative prices and so on,
- increase political and institutional instability since the ramifications of the exit from the euro both in terms of politics and economics would be far-reaching, thus increasing uncertainty about the future – and without confidence in the future prospects of a country there simply is no investment.
Greece requires structural reforms as far as its interior is concerned. The key is to increase the productive base of the country which at the moment is very narrow. As such all efforts need to focus on the reallocation of resources from non-tradable into tradable areas, since the option of expansionary fiscal policy is not available, due to the sovereign debt crisis. Towards that end it is clear that an exit from the euro would do much more harm than good, by producing perverse incentives, exacerbating uncertainty in the economy, the banks and the political system and by failing to deliver the much-vaunted “competitiveness” the Greek businesses need to regain.
The future of Greece is within the Euro and the EU, so if we want to speak along realistic lines we need to see how to make this work. If it can be done by Greece alone it’s good. If it can be accomplished within the context of a coherent, reformist European strategy that will systematically address all the asymmetries of the Eurozone and the EU, then it will be even better.