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.
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.