Home > Greece > An ordered Grexit is economically desirable for everyone willing to lose political face

An ordered Grexit is economically desirable for everyone willing to lose political face

from David Hollanders

Many ponder the desirability of a Grexit. There is a heterogeneous group, including the right-wing German party Alternative for Deutschland and the left-wing of Syriza, who agree that a Grexit is optimal. On the other hand, Greek finance minister Varoufakis and the European Commission – for all their other differences – agree that a Grexit is to be avoided. The optimality-question of a Grexit can be broken down into three questions. Should Greece have entered the EMU? Now that it has, is an ordered exit optimal? If so, can the same be said of an unordered exit? Even if one disagrees about the answer to the third question, the first two questions should be answered affirmative. All parties involved – Greece, banks, the EC, ECB and the E(M)U – should thus agree on it. That is, if they are willing to lose face, for they have always pleaded against what is now optimal.

With respect to the first question, virtually everybody agrees that the euro has wrought havoc on Greece. GDP contracted -25.9% in 2008-2013, see the figure. While Greece suffered the worst, this contraction cannot be attributed to Greek particularities. The other two OECD-countries with the largest contraction (Italy and Portugal) are in the EMU. Iceland – without the euro and arguably hit harder in economic terms by the collapse, but with more political manoeuvre-space – contracted hardly (-0.5%). Also, overall the euro-block had negative economic growth, contrasting with positive growth in the US, UK, Japan, the EU, the OECD-block and the European part of the OECD.

Hollander1

Though the size of the catastrophe in Greece surprised many, it was not news that the euro-zone is not what Mundell in 1961 called an Optimal Currency Area (OCA).  The necessary conditions for an OCA include (i) fiscal transfers -to dampen asymmetric shocks (ii) a single labour market. Condition (i) is not in the political cards. Condition (ii) is far from satisfied, if for no other reasons, due to the tens of different languages in the EMU. Stretching the OCA-concept to its fullest, one could defend France, Germany, Benelux and Austria to be a three-lingual semi-OCA, where Germany and France can accommodate economic differences, with Belgium woven in the French economy and the Netherlands and Austria in the German economy. But this is already stretching the concept to its fullest, as there are substantial economic, lingual and culture differences even between for example the Netherlands and Germany. In any case, Spain, Portugal, Italy, let alone Greece do not come close to being part of such an OCA.

But then, even if one agrees that Greece should not have entered the EMU, one could argue that that is all water under the bridge. And that an exit would lead to extreme costs. This argument actually comes in two forms. First, it is argued that from the perspective of the EMU a Grexit shows that the euro – counter to earlier statements – is not irreversible, which will lead to speculative attacks on other countries, first and foremost Portugal, Spain and Italy. Second, it would lead to political and legal chaos in Greece.

Well, it may be true that bond yields of Spain shoot up, once for example Podemos wins the elections. But this is a symptom, not the problem itself. It shows the deadlock in the EMU where monetary sovereignty has been handed over to the ECB, which will only support bond-markets of countries that hand over fiscal sovereignty to the trojka, leading to a showdown between a Germany-backed monetary institution and national government backed by a democratic mandate. In other words, it is not the exit-option (which has and will always exist anyway) per se leading to speculative attacks but this political-monetary deadlock. A Grexit could even have a silver lining to it, if it forces countries to finally choose between national sovereignty or monetary union, incompatible as these are.

But, coming to the second argument, would a Grexit not ruin Greece (what there is left to ruin)? Would it not witness bank runs and/or a legal chaos, when euro-denominated contracts are transformed in drachme-denominated contracts? While bank jogs are already rampant in Greece, any Grexit should indeed be followed by immediate capital controls, like in Cyprus and like in the US in the 1930s (bank holidays). While this is a delicate task, it is not so difficult that it can’t be pulled off. The legal imbroglio can be exaggerated (any contract under Greek law can be changed relatively easily), but it is important indeed. Any contract between Greece and Greek companies and foreigners (including bond-holders) will be challenged – both legally and politically – when Greece acts unilaterally. This is why it is important to negotiate an ordered exit. This will lead to a paper loss on the side of creditors – as not everything will be repaid, not in euro’s anyway – but it will be the best route to economic growth for Greece. And Greece can only (partly) repay in the end – instead of refinancing loans as it does now to enable the Troika to pretend-and-extend – if it grows. It will furthermore make the EMU a more optimal (or less suboptimal) currency area, benefitting all parties.

This does not mean that there are no costs. Varoufakis should acknowledge that a debt-write off is institutionally impossible within the Eurozone, whereas Merkel would have to back-peddle on her statement ‘scheitert der Euro, dann scheitert Europa’. Indeed many people – including bankers, supervisors, academics and journalists – who prophesized a Grexit to be the end of the world, would lose face; and the more so, if Greece prospers afterwards, and can repay a substantial part of its debt, as Syriza has time and again pledged to do – to the extend compatible with Greek economic growth and stopping the humanitarian crisis. The paradox is that the more desirable a Grexit is from an economic perspective, the less desirable it is politically, for some at least.

  1. blocke
    March 18, 2015 at 5:18 pm

    The crisis is political not economic. The European union is in crisis because it s unable to bond together in a common defense of the civilization it represents and the economic community it half-way brought into existence. Unlike the US, which has a federal system, Europe has none; it relies and has always relied on the United States to save it from itself. Militarily, without the US Russia’s take over of the disunited Europe is a piece of cake. And economically, the inability of the larger economic national units in Europe (forget the Brits, they never believed in European union and have tried to torpedo it throughout its feeble existence); and the German government acts with an arrogance that makes its assumption of leadership within the union impossible. The European catastrophe of 1945 was so shocking that it was hoped Europe would embark on union, but opportunity usually comes once, and after it passes, it does not return. Cannot see anybody within the European union capable of rising to the historical challenge in our time.

    • Nietil
      March 18, 2015 at 10:13 pm

      ” The European catastrophe of 1945 was so shocking that it was hoped Europe would embark on union, but opportunity usually comes once, and after it passes, it does not return. Cannot see anybody within the European union capable of rising to the historical challenge in our time.”

      I suppose no one in Europe is sufficiently stupid to start a continental civil war that could morph into nuclear WWIII, yes. For that is what you are asking for. The US didn’t just happen to ‘have a federal system’, six hundred thousand of their citizens murdered each other to establish one. Somehow I don’t see why any intelligent European would find Yugoslavia to the power ten to be a desirable outcome.

      What is shoking is that any sane person could think that European integration is something to hope for when the only feasible way to achieve it is, and always has been, killing tens of millions of Europeans and potentially even more people globally. The whole project is moronic from the begining.

  2. March 18, 2015 at 9:25 pm

    Reblogged this on iGlinavos and commented:
    Making the case for Grexit… perhaps

  3. blocke
    March 19, 2015 at 5:33 am

    ” The US didn’t just happen to ‘have a federal system’, six hundred thousand of their citizens murdered each other to establish one.”

    What an interpretation of American history? Forget the federalist of the 18th century, Don’t have civil war and let a house divided continue; forget about the Civilization of Europe and let it crumble in another orgy of fascist nationalism. I don’t see anything about this generation of politicos worth saving, People in Europe aren’t sufficiently stupid to start continental civil war, are you kidding.

    The stupidest leadership generation in European history started WWI and when it ended couldn’t remember what it was about. And Hitler when the Brits finally called his bluff in 1939, remarked: “nun was?” That kind of European cleverness brought about the death of 60 million people. How you going to stop that by reverting to a Europe of great power politics and oligarch exploitation. If you were a civilized person, you would understand that Europe was in the first fifty years of the 20th century the “Dark Contintent,” And you want to return to this state of intercourse. Don’t count on the Americans saving you again. Thoughout most of American history they did not want to have anything to do with Europe. Its tempting to let the place go. And then it can descend into a civil war, a Syria or is a Ukraine writ large.

    That is what you’ll get, not a continent of disunited peoples, filled with hatred of each other, living in harmony with each other. When before 1945 did you have that? Learn some history. The attempt to have a democratic free Europe is the ONLY hope for Europe, as a civilization.

  4. Ton Notermans
    March 19, 2015 at 8:22 am

    A orderly Grexit would economically be the best thing for Greece indeed, but an “unorderly„ one would not be that much worse either. I am not sure why a default would be institutionally impossible. A partial default on Greek debt has already be engineered. At the moment the problem is political in the sense that Greece would not get the approval from its creditors, but there may be little the creditors can do if Greece defaults anyway. The vast majority of Greek state debt is issued under Greek law, so the post-Grexit litigation would probably be limited. (Jonathan Tepper’s „Depart, Default, Devalue“, remains one of the best pieces on this)
    The interesting question rather is why Tsipras and Varoufakis don’t opt for a Grexit. While starting off with a lot of noise, Tsipras has had to gradually backtrack on all his election promises. He did not wish to talk to the Troika any more. Well, we do not use the name Troika any more, but that is how far the change went. He wanted an end to austerity, but he has had to submit a list of reforms to his creditors which will make that impossible. He wanted to mitigate the acute social crisis in his country by channelling support to the poorest families and by rehiring some of the fired public sector employees, but it looks like the EU will torpedo this plan soon. Now he is resorting to some desperate measures to service the debt by attempting to plunder pension funds. With an, orderly or unorderly, Grexit, he would have stood a better chance of keeping at least some of his election promises.
    My interpretation of why even Syriza clings so desperately to this 21st century version of the Gold Standard is that he is afraid he cannot keep the country together without the external constraint of the Euro. First, devaluation means a cut in real wages and a boost to the export sector. If syriza’s friends in the trade unions do not accept this, not much is gained .Secondly, with a Grexit Greece will be temporarily shut out of financial markets so a big spending spree to undo the damage of austerity is out of the question, but the political pressure for a spending spree might be irresistible outside of the Euro. Third, one must admit that Greece has been living beyond its means for many years. The public sector was corrupt, inefficient and overblown and tax collection was a mess. There is no way of going back to this system, but I am afraid that is what many in Greece would expect once the Euro fetters are severed. In short, in a country with a very fragmented political system, the chaos after leaving the Euro might come from the political and not the economic side. I see a possibility that Greece would turn into a failed state.
    What might be the solution? Here Varoufakis is quite right, iI find to draw a comparison with how the Western Allies, the USA in particular, treated Germany after 1945. West Germany was not burdened with a mountain of debt, as happened in 1919 in Versailles. It received financial and technical assistance, and the allies helped to restructure the German state so as to turn it into a functioning and fairly well governed economy. This would probably be the best solution for Greece. The EU should promote a recovery of the Greek economy instead of trying to destroy it and that would mean allowing Greece to devalue, default and use exchange controls and temporary tariffs and other trade controls if necessary. Simultaneously the EU should give Greece all the assistance necessary to create a functioning state apparatus. I am quite aware that such a solution is politically impossible. The creditor state governments have decided to socialise the risk of all of their citizens and financial institutions who -unwisely perhaps – decided to invest large amounts in Greek sovereign debt and now are only interested in having Greece repay every penny no matter what the political and economic consequences; not only fro Greece but for the entire EU. Really amazing how short-sighted creditors can be.

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