THE EURO, THE DRACHMA AND GREECE: limited options in an impossible situation
Associate Professor of Economics, UniversitÃ© de Grenoble (France)
Associate Professor of Economics, Laurentian University (Canada)
Co-Editor, Review of Keynesian Economics
The final agreement between Greece and the Eurogroup is a disappointment for anyone who held high hopes that Greece would have taken away more than a mere extension to the existing deal.
In the end, Greece gained very little and the continued austerity will do very little to close the growth gap. It is difficult to see anything short of a total capitulation. Perhaps the view Greece could walk out with a victory was naÃ¯ve in light of the formidable power of the Eurogroup and its financial allies.
How could this have happened?
Greeceâ€™s biggest mistake in entering these negotiations was to state at the very beginning of the negotiations that under no circumstances was it prepared to leave the Euro. Indeed, Syriza campaigned on putting an end to austerity without abandoning the European currency. This was a mistake. With so much at stake, you cannot enter such high-level negotiations with your opponents already knowing the outcome of the negotiations. This is simply a fundamental fact of politics 101. And with time running out for Greece, the Eurogroup only had to wait it out. With the financial siege firmly established, Greece had no chance.
Yet, refusal to consider leaving the Euro is at best a second-best solution, at worst an agreement to continue deflationary policies. Indeed, critical economists have been arguing even before the creation of the Euro in 1999 that it was an illegitimate currency and was doomed to failure.
The origins of the Euro can be found in the Optimum Currency Area literature, defended by many economists and pioneered notably by Canadian economist and Nobel Laureate, Robert Mundell. Yet, this view is now being vigorously contested today as it is betrayed by the facts of experience, as the on-going crisis has pointedly shown. According to the endogenous OCA, the creation of a unique currency should have resulted in a reduction of economic disparities between member countries.
Yet, this never materialized. In fact, we were told that a common currency would lead to an increase in intrazone trade by as much as 50%, when in reality they rose by a mere 4%.
The immediate issue at hand, however, is not whether the Euro zone constitutes an OCA, but rather to evaluate objectively the original conditions surrounding the creation of the Euro. We can identify two important ones. First, there is the thorny issue of fiscal transfers between member countries in order to deal with shocks and intrazone imbalances, and second, there is the issue of having a common monetary policy alongside a range of fiscal policies, particular to the each member countries.
It is in this sense that the Euro remains an incomplete currency lacking the necessary institutions to support its creation. A monetary union cannot operate without a political union, by which we mean a minimum degree of fiscal federalism.
In light of this lack of completeness, the Euro has exacerbated existing macroeconomic disparities between member countries, who have lost their ability to adequately deal with economic downturns. Indeed they have no exchange rate, no monetary policy, and especially no fiscal policy: since the adoption of the Fiscal Pact, member countriesâ€™ fiscal budgets are now under the strict supervision of Brussels.
But the heart of the problem is not only to solve the immediate problems of Greeceâ€™s debt and the consequences of austerity, but also to address and hopefully solve the Euro architecture.
At this stage, we believe there are only two possibilities, each fraught with obstacles and consequences that cannot be taken lightly: either complete the Euro project or leave the Euro. Anything short of either solution, like maintaining the status quo, will simply perpetuate the existing deflationary problems.
The first option of completing Euroâ€™s architecture would entail 2 important changes: i) enter into a full union by adopting a common fiscal policy and a common, synchronized tax system; ii) adopt a Canadian-style transfer payment system that redistributes fiscal revenues from â€˜richâ€™ to â€˜poorâ€™ countries.
This option, however, remains at best illusive. From a political perspective, it is virtually impossible. Fiscal federalism implies paying European taxes (as opposed to national taxes) â€“ something Europeans do not want, and then redistributing them, which implies financial solidarity, which Europeans want even less. Yet, the obvious problem is that Germans do not want to see their tax money going to the Greeks or to the Portuguese, who they see as the authors of their own misfortunes.
The second option favours a negotiated exit from the Euro for Greece and other countries facing insurmountable adjustments imposed by austerity, although no less fraught with its own problems and uncertainties.
Unfortunately, this topic has become taboo, especially in Europe, even among critical thinkers. Yet, it strikes us as odd that a great many critical economists and intellectuals, who once railed against common currencies, are now shunning discussion over a Euro exit. Now, they argue that abandoning the Euro would be too painful for any country, let alone Greece, and that it would be best to continue using the Euro, even if this means an important loss of fiscal and monetary sovereignty.
If there is a silver lining here, it is that this recent deal is only in effect for 4 months, during which time Greece will have the opportunity to recover and regroup. But in order to win the next round of negotiations, Greece must either push for political union and the creation of the appropriate institutions (which we believe is a lost cause), or put a grexit on the table. That will be the only way Greece will gain leverage entering these intense negotiations. In doing so, however, Greece must be prepared to leave the Euro.
Of course, it will not. And now the rest of Europe knows this, and any demands by Greece will be seen by the rest of Europe as a bluff.Â For instance, Finance Minister Varoufakis now says that if Europe is not prepared to accept it s reforms, it will have no choice but to call fresh elections or propose a referendum (it is not clear what the referendum would be on). Unfortunately, it is difficult to take these as serious given Syriza’s tendency to bluff and capitulate.
Undoubtedly, there are many challenges and uncertainties in pursuing this strategy, many which go beyond economics. Among the economic challenges, Greece does not have a well-developed export sector (except for tourism), which means any devaluation, voluntary or imposed by outside speculators, would have a very limited impact on growth. There would also be the challenges associated with Greek banks, with the technicalities of introducing a new currency, the cost of issuing new bonds, the needed fiscal and taxation reforms, and many more. Undoubtedly, this scenario may prove too overwhelming to consider, and may justify in large part the desire to stay within a flawed system.
There are also geo-political issues to consider to take into consideration: if Greece left the Euro it would have to leave the EU and would lost considerable benefits from belonging to it. With its proximity to the Middle East, its continued tension with Turkey, there is certainly much to consider.
Despite these challenges and the intimidating political situation, a grexit must be on the table in 4 months. In a recent blog, former Finance Minister, Philippos Sachinidis, recently stated: â€œRecession in Europe needs to be fought with a federal Keynesian policy, involving a new system of fiscal transfers followed by a consumption increase in the Northern countries along with Europe-wide projects together.â€ He is correct. The problem, however, is that a Keynesian policy cannot be followed under the Euroâ€™s current architecture, which was precisely the objective of the Euroâ€™s creators, and why Germany and other countries resist any changes. It is in the sense that the Euro is an ideological currency. It must be abandoned for the sake of Europeâ€™s future.
But there are a number of sensible proposals floating around that can make for a smoother transition to sovereignty. One solution is the simultaneous issue of an electronic currency, as was recently done in Ecuador. The central bank introduced a virtual currency tied with the use of smartphones that replaces paper money. Ecuador is a fully dollarized economy that cannot print its own US dollars, has no exchange rate, no independent monetary policy and only a limited use of fiscal policy, not unlike Greece.
Associate Professor of Economics, Laurentian University
Founding Co-Editor, Review of Keynesian Economics