Greece is finally growing again. But it has been arguably the eurozone’s greatest failure. Catapulted into a debt crisis with a 15 per cent government spending deficit in 2009, the country suffered eight years of economic contraction. Unemployment is still 23 per cent, youth unemployment 45 per cent. Greece’s “Great Depression” has been as deep as that of the US in the early 1930s, but twice as long.
Can Europe learn from the country’s painful experience? A first lesson is to reform at the top of the cycle. Greece had to adjust in recession because it failed to do so in its pre-crisis boom. Reforms should always be adopted in times of growth, when people are confident and losers can be compensated. An upswing can buy time to implement reforms, but should not be invoked as evidence that reforms are unnecessary. The eurozone is now in its strongest period of post-crisis recovery. But it should avoid complacency. Reforms are necessary for the long-term viability of the monetary union. We need a stabilisation budget and joint-borrowing capacity; greater risk sharing; and financial union to break the doom loop between banks and government.
After September’s election in Germany, and assuming Emmanuel Macron delivers domestic reforms in France, Europe will be at the top of its political cycle. This is the time to push ahead with eurozone reforms. They will require painful concessions: the Germans refuse joint deposit insurance or a fiscal backstop, the French are not keen to surrender control over the national budget and the Italians reject ceilings on bank exposure to sovereign debt. But something must give.
The second lesson is to use a balanced economic policy mix. There must be breathing space from restrictive policies. Since 2010, fiscal and incomes policies in Greece were heavily contractionary. Monetary expansion by the European Central Bank did not reach the periphery. Greece pursued a near mission impossible, relying on recessionary internal devaluation to regain competitiveness while having to grow to reduce debt relative to gross domestic product. The country needed support from a eurozone demand stimulus, eurozone inflation close to 2 per cent or proper risk sharing in the bloc. None of this was available.
A third lesson is to address financial fragmentation. The banks were brought down by an illiquid or insolvent government — a situation aggravated by capital flight. Companies tried to offset the prohibitive cost of capital by suppressing wages, while productivity was shrinking through disinvestment. This is no way to run a monetary union. A true banking union would limit banks-to-sovereign contagion. A joint deposit insurance scheme would assure depositors that Europe was behind them.
Fourth, expand non-bank financing. Fifth, deal with non-performing loans. Action to tackle Greek NPLs was too little, too late.
Sixth, focus on real not just nominal convergence. Greece eradicated its fiscal and current account deficits. Yet the crisis leaves a debilitating legacy. Between 2009 and 2016, real potential output declined by 13.7 percentage points. Investment has shrunk from 22 to 12 per cent of GDP. Instead of replicating this disaster, investment spending in the eurozone should be protected from recession and fiscal consolidation cuts. Raising productivity and potential growth should be the emphasis.
Finally, keep sight of the big picture. Greece’s greatest challenge is to shift to export-oriented growth, raise productivity, increase labour participation and improve its dismal, ageing demographic trend. The ageing eurozone must also address its slowing productivity growth. It must focus on real convergence, devising adjustment strategies that do not deprive the eurozone periphery of their best and brightest.