According to Greek mythology, the noble Iphigenia was sacrificed so that the warships could have a fair wind to Troy. According to eurozone mythology, Greece should become the Iphigenia for the euro to sail ahead. However, this sacrifice would fail to do the trick. Since Greece cannot access capital markets and Greeks have no appetite to leave the eurozone, a “Grexit” would have to be a decision made by Brussels and Berlin. Would the eurozone be justified in ejecting Greece? And would it be wise?
A familiar argument in favour of a forced exit is that Greece is not adjusting. True, the budget deficit remains high, public sector restructuring is slow, tax evasion persists. Yet, if one focuses on the adjustment so far, a different picture emerges. Greece achieved a total primary budget deficit reduction above 8 percentage points of GDP over two years (2010 and 2011); in cyclically adjusted terms the reduction was 11 percentage points. This is the OECD’s fastest fiscal consolidation for decades –amidst a steep recession to boot.
Has Greece fared so badly in reforms? The Lisbon Council, Euro-Plus Monitor of November 2011 listed Greece second in adjustment progress; the OECD Going for Growth report of 2012 lists Greece first in responsiveness to reform recommendations. They can’t be that wrong.
Doomsayers look at the current account deficit and predict Greece will never restore competitiveness. Yet, adjustment of unit labor costs was rapid, following bold labor market liberalization and steep wage cuts. Recent analysis by Eurobank Research [Greece Macro-Monitor, 19 July 2012] shows that internal devaluation is delivering. In terms of real effective exchange rate based on unit labor costs, Greece has recovered post-2001 losses, and will be reaching a sustainable current account by 2015.
Many point out the lack of political resolve. Yet the most painful adjustment program in recent history (including a 22 percent minimum wage cut -32 percent for new workers under 25) was passed by the Lucas Papademos government last February with a two thirds Parliament majority. The June elections produced a new three-party coalition government (conservatives, socialists and democratic left) determined to put the program on track. An additional €11.5 bn budget cuts are just being finalized.
So the adjustment so far does not quite justify such image of policy failure. The economy’s steep decline does. Recession was little below 7 percent in 2011, and will exceed 7 percent in 2012. It is already the fifth year of recession, unemployment at 22%. This is economic devastation. Yet, of all contributing factors (political wavering, structural impediments, austerity), the fear of Grexit itself stands out, paralyzing investment and economic activity. Even healthy, efficient Greek firms see suppliers requiring cash for imports, foreign clients turning their back because “we are happy with your business but don’t know whether you’ll be around for long”. Capital scarcity or exorbitant credit costs condemn them to slow death by asphyxiation.
Similar is the case for privatization. Yes, the programme has faced endless political and bureaucratic impediments. Yet investors keep away from a country in risk of currency redenomination, and their reluctance only serves to further accentuate the risk. Overcoming the Grexit catch-22 is Greece’s most formidable challenge. And beating the Grexit scenarios is one of the best things Euro-partners can do for Greece.
The Grexit camp has its favorite lines. Greece’s public debt is not sustainable, they say, it must exit. This is absurd. The large majority of Greece’s public debt is held by the non-private, official sector. A currency redenomination and devaluation would render Greece’s public debt unserviceable. Greece would be forced to default, generating real capital losses for Euro-partners and poisoning relations for years.
If the main factor undermining debt sustainability is the steep contraction of the economy, the solution is not Grexit but growth. The time extension of fiscal adjustment by two years would moderate the recessionary impact of austerity, allowing for a faster return to growth. And Greece can return to growth through a double boost of faster structural reforms (which work on the medium-term), and a direct stimulus of investment and liquidity. EU instruments such as structural funds and a greater engagement of the European Investment Bank and the European Investment Fund would be crucial.
Greece should leave because it is destabilizing, say others. Yet, a Grexit would be the mother of all destabilizations in the Eurozone. If Europe were to accept it, it would officially confirm the euro breakup risk as valid. The claim to an irreversible EMU would be shattered. The Eurozone would surrender to toxic speculation over which country would be next. Southern depositors would be running on the banks, and futile adjustment programmes would be swallowed up by a vortex of self-fulfilling panic.
The sacrifice of Iphigenia would soon turn out to be the ritual beginning of a collective suicide for the euro. As her sacrifice led to a decade-long Trojan war, a Grexit would bring years of horror to the Eurozone.
The writer is professor of European politics and economy, Athens University of Economics
Longer, unedited version of the op-ed published on the Financial Times, 16.8.2012