There are not many policy issues on which I agree with my colleagues Paul Krugman and Joseph E. Stiglitz and the former Greek finance minister Yanis Varoufakis. But one of them is the view that an exit from the eurozone would be advisable for Greece.
Unfortunately for Greece and for Europe, we may now have to live with a third bailout program, in which Greece will receive a rescue package worth 86 billion euros in return for additional austerity measures. The new agreement would likely drag Greece through three more years of a long-lasting costly experiment that has so far failed miserably.
As of June, the eurozone countries, the European Central Bank and the International Monetary Fund had provided the Greek government and banking system with 344 billion euros ($375 billion) worth of public credit — nearly double Greece’s annual economic output), or about €31,000 ($33,000) for each Greek citizen.
One-third of the public credit that has flowed to Greece since 2008 has been used to bail out private creditors; one-third went to finance the Greek current account deficit (the excess of imports and net interest payments to foreigners over exports and transfer payments from abroad); and one-third vaporized by financing the capital flight by Greeks.
The public credit has delayed a Greek bankruptcy for some years until it was officially declared on 3 July by the European rescue fund. However, it has failed to revitalize the Greek economy, which had lost its competitiveness in the inflationary credit bubble the euro had induced. To compete, Greece needs a strong devaluation — a relative decline of its price level. Trying to lower prices and wages in absolute terms would be very difficult, as it would bankrupt many debtors and tenants.
It would arguably be better to inflate prices in the rest of the eurozone, as the European Central Bank is trying through quantitative easing: purchasing large quantities of bonds to drive down the value of the euro. If the rest of the eurozone posts inflation rates of slightly less than two percent, as the E.C.B. hopes, Greece would be competitive after a decade or so, provided that its price level stays put. However, even such a mild form of an “internal devaluation” would be very arduous, as it requires precisely the kind of fiscal restraint that the Greek population rejected by an overwhelming majority in the referendum.
What about the solution favored by leftists: more money for Greece? No doubt, massive government spending would bring about a Keynesian stimulus and generate some temporary internal growth. However, apart from the fact that this money would have to come from other countries’ taxpayers, this would be counter-productive, as it would prevent the necessary devaluation of an overpriced economy and keep wages and prices above the competitive level. Here, the case of Ireland is instructive.
Like Greece, Ireland became too expensive with the sharply falling interest rates that accompanied the introduction of the euro. When the bubble burst, in late 2006, no fiscal rescue was available.
The Irish tightened their belts and underwent a drastic internal devaluation by cutting wages, which in turn led to lower prices for Irish goods both in absolute and relative terms. This made the Irish economy competitive again.
Granted, Ireland also received fiscal aid. But that came much later, toward the end of 2010, and when it came, the internal devaluation stopped almost immediately. Twelve of the 13 percentage points of the Irish decline in relative product prices came before that date. Of the eurozone countries hardest hit by the financial crisis, Ireland will be the only one this year to see its G.D.P. surpass its pre-crisis level.
Greece’s devaluation started five years after Ireland’s, and by now has reached 9 percent. Analysis by Goldman Sachs researchers suggest that product prices would have to decline by another 13 to 22 percentage points for Greece to be competitive. (Wages in neighboring Turkey, Bulgaria and Romania, the latter two being European Union members, are only one-third to one-fifth the level of Greece’s.)
The better alternative is a Grexit accompanied by debt relief, humanitarian aid for the purchase of sensitive imports, and an option for eventual return to the euro.
Greece could reintroduce the drachma as the only legal tender. All existing prices, wages, contracts and balance sheets, including internal and external debt, could be converted one-to-one into drachma, which would devalue immediately.
The devaluation would induce Greek to buy domestic rather than imported products. Tourism would get a boost, and capital flight would be reversed. Rich Greeks would return with their money, buy real estate and renovate it, fuelling a construction boom. As the trade deficit gradually turned into a surplus, creditors would at least get some of their money back.
Greece would have the option to return to the eurozone, at a new exchange rate, after carrying out institutional reforms — such as public recording of land purchases, a functioning tax collection system, accurate statistical reporting — and meeting the normal conditions for eurozone membership. It could take five or ten years.
It is true that Grexit would make it clear that membership in the eurozone is not irrevocable and could expose member countries to speculative attacks. But this is not very likely, as the markets’ calm reaction to Greece’s recent capital controls and the “no” vote in the referendum showed. It also has advantages insofar as it would lead other countries to adopt more prudent financing and steer clear of the debt trap that caused the inflationary bubble in the first place.
Until Europe is turned into a federal state — as it should become, at some point — it will not have a currency like the dollar. Until that time, what is needed is a “breathing” currency union, with orderly entry and exit options, coupled with an insolvency rule for member states. This would be a better compromise between the conflicting goals of avoiding speculative attacks and excessive debt accumulation than the current promise of eternal membership.
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