Don't believe the scaremongering: Greece leaving the euro would be no disaster
Greece can survive a default and a eurozone exit. The true madness would be continuing down its current path
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6:00PM GMT 11 Jan 2015
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Who would have thought that Greece would be on the verge of another crisis? Actually, lots of economists forecast that this would happen. But what next?
The Greek public finances have been mismanaged for many years. Much of Greek government spending has been wasted, including on ludicrously early retirement in the public sector. Meanwhile, in large parts of the private sector, tax payment has been lax. You can readily understand, therefore, how incensed German tax-payers get at the thought of their hard-earned money going to “help the Greeks”.
There is doubtless still a good way to go to get the management of both Greek government spending and taxation up to scratch, but on the macro numbers, the progress so far is extraordinary. From 15pc in 2009, the Greek budget deficit looks likely to fall to approximately 1pc this year. Next year the budget should be in surplus.
The trouble is that this has not brought any discernible benefit to the ordinary Greek. Average real incomes have fallen and unemployment, although down slightly from the peak, is still about 25pc. What’s more, as some economists, including yours truly, warned, since GDP has been falling, all this fiscal austerity has not stopped the debt ratio from rising.
What’s more, deflation is now well established. Over the last year, prices have fallen by 1.2pc, and they should go on falling. This means that even if real GDP increases a bit, money GDP may still fall, causing the debt to GDP ratio to rise. And yet still Greece has to tighten its belt.
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In these circumstances it is hardly surprising that the main opposition party, Syriza, has called for an end to austerity and for a good part of Greece’s debt to be written off. And, running up to the general election on January 25th, it is ahead in the opinion polls.
To some European commentators, what Syriza wants seems mad. Yet if anything is mad, it is surely continuing on the current course. Since 2008, Greece has suffered a fall in GDP of about 25pc, roughly equivalent to the drop that occurred in the US and Germany during the 1930s.
But I do not see how Mrs Merkel can concede what Syriza is demanding. A further debt write-off may just about be possible but an end to austerity surely cannot be conceded. If it were, then how would the governments in Spain, Italy, Portugal and, increasingly, France, be kept to the sticking place? So if it comes to a showdown and Syriza does not back down, I reckon that Mrs Merkel would force Greece out of the euro.
In some ways this sounds like a re-run of the crisis in 2012. But two things have changed since then – and they make a departure from the euro more likely, not less. First, excluding interest payments on debt the Greek government is now running a surplus. So if it defaulted and suspended or delayed interest payments it would actually have money to spare.
Even so, critics say that default would be disastrous as no one would lend to the Greek government ever again. Nonsense. History suggests that it would be a matter of months before the investment bankers came knocking on the door.
Nor is this simply the result of a powerful mixture of greed and short memories. What lenders fear is not the history of recent default but the prospect of future default. Once a country has defaulted, the prospect of another default in the next year or two is actually lower.
The second factor that has changed is that the German government now believes that the eurozone is able to withstand a Greek departure from the euro without much ill-effect. What they feared in 2012 was contagion from Greece to Spain, Italy and Portugal. They reckon that with the various support mechanisms in place that is now less likely.
If default and euro departure produced chaos and disaster for Greece then the continued membership of these other vulnerable countries would indeed be safe – at least for now. Their governments would be able to warn their people that if they didn’t take their nasty medicine they would end up like Greece.
The real risk for the eurozone, though, is that Greek default and euro departure go relatively well, and after a year or so Greece is beginning a vigorous recovery on the back of a weak drachma. In that case, the people of Italy, Spain and Portugal would ask: “if Greece can do it that way then why can’t we?” And there wouldn’t be a good answer. The euro-zone would do the splits as soon as you could say Jean-Claude Juncker.
Of course, virtually no one in the Greek establishment wants Greece to leave the euro. Yet the country desperately needs decent economic growth. An end to austerity and a debt write-off would only do half the job. The other half is improved competitiveness. Achieving that through sustained deflation would be slow and painful, and would intensify the debt problem all over again.
It is not unusual for governments to cling on to what is the source and origin of a painful economic predicament. This is a version of what is known in the psychological world as Stockholm Syndrome, when prisoners become emotionally dependent upon their captors and do not want to escape.
For example, in 1931, the UK’s National Government fought hard to keep us on the Gold Standard, which was breaking the UK economy. It was only when we were forced off it that the economy grew strongly. Similarly, in 1992, the Major government did not decide that it wanted to leave the ERM. On the contrary it bent every effort, and spent almost every dollar, to keep us in! Once again, being forced out was the source of our salvation.
If Greece defaults, departs the euro and devalues, I am sure that this would be portrayed by the European establishment and by the media, including in this country, as an unmitigated disaster for Greece. Yet in economics, things often turn out differently from how they initially seem.
Currency crises are dramatic and accordingly make good news stories. By contrast, a country being slowly roasted on the spit year after agonising year soon loses its prime slot on the News at Ten.
Of course, Greece could blow it. But default and euro exit would give her the possibility of escape from this awful situation. Just ploughing the same old furrow will bring misery and disaster.
Roger Bootle is executive chairman of Capital Economics roger.bootle@capitaleconomics.com
