Tuesday, 20 September 2011

Would Greek default bring Greek prosperity?

There have been few things that arouse people's feelings like the impending Greek default. The airwaves and the print media are full of informed and some less informed opinions and debates. Essentially there are two camps at the moment: those who feel that the austerity imposed on Greece is unjustified and creates unacceptable hardship for the Greek population and those who think that Greece has to pay for its sins.

I have advocated the latter but, I have to admit, there is little comfort in such a view. The Guardian comments pages carried an articulation of the first view, you can read it here http://www.guardian.co.uk/commentisfree/2011/sep/19/greece-must-default-and-quit-euro

The author essentially advocates a default of Greece and the re-introduction of the drachma in quick succession. He believes this will allow the government to de-value the currency and postpone the austerity programme, hence producing less pain for the Greek population.

The fascinating aspect of this view is that it operates with some of the conventional market-supply side frameworks it attacks. De-valuation is believed to bring about a quick recovery of the Greek economy, an increase in Greek exports and hence a significant rise in tax revenue.

This view is, strangely enough, as short sighted as all the IMF programmes of the 1990s were supposed to be. Yet, default is a favourite view of the opponents of reforms and austerity. Why?

There are several simplistic assumptions that would work against a successful recovery if Greece defaults and leaves the Euro.

First, a default will not only be bad for Greek credit in the future, but also for the rest of the European banking system, which, whether they like it or not, is the one that will have to lend the money to Greece once it leaves the Euro. A banking crisis will make quick lending on favourable terms and interests rates to the Greek economy or her government unlikely.

Second, a recovery of the Greek economy will depend on competitive industries and having goods to export. Greece has neither. It is essentially, as many observers commented, still a closed economy, importing goods from the Eurozone (on account of demand through high salaries in the bloated public sector) but able to export little since it has only a slender industrial basis. Being competitive in the world markets, in turn, would depend on attracting investment which, again, cannot come from Government since it is flat out broke, so requires the banks in the Eurozone to chip in. This is highly unlikely given the prior default.

Third, the default will remove any incentive to reform the tax system and to shrink the bloated public sector with massive pension liabilities. So, even after a default, the government will still face an enormous annual expenditure which will drive up inflation.

Last but not least, Greeks are saying they are hurting now since they cannot buy goods anymore as their wages are decreasing. However, things would be even worse after a default and the re-introduction of the Drachma. Since most goods are IMPORTED from the Eurozone, leaving the Euro will make these goods prohibitively expensive. The Drachma will not buy much in the way of IKEA furniture or French perfume. What will be left to buy are goods manufactured in Greece, of which there aren't many. Hence the Greek population will experience a far more serious decline of their quality of life after leaving the Euro than now.

The simplistic equation: leaving the Euro + devaluation = less austerity fails to recognise that Greece in future still needs an enormous amount of steady investment to improve its industries. Any short term relief from the postponement of the austerity and reform programmes are likely to backfire.

To have any chance of overcoming its problems, Greece needs to stay in the Euro and swallow the bitter pill of giving up its fiscal independence. This is a small price to pay for the chronic mismanagement, budget falsification and billions of Euros they received.

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