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On the Greek Crisis and German Imbalances

Posted by (Author) on July 24th, 2015 - 3 Comments

Policies undertaken from a narrow national perspective that encourage systematic fiscal surpluses coupled with a national consensus on wage suppression between unions and industry facilitated by the state, impact negatively upon domestic spending while increasing national saving and may lead to mercantilist outcomes of systematic policy-induced positive trade balances with large financial flows going the other way. This mechanism in relation to export-dependent countries like Germany has been recognized for a while by leading American economists like Obstfeld (the IMF’s new chief economist succeeding Blanchard) or Bernanke, while many have also pointed out low domestic investment, consumption taxes, and rigidities in the service sector as additional policy-related reasons for this German systematic phenomenon.

It is therefore no wonder, given also the American similar experience with China, that American mainstream economists and in effect the leading economists in the world have been taking a strong stance towards Germany as of late, amplified by the understanding that German economic moralism is more akin to Kantian absolute ethics than to the outcome-based pragmatic Utilitarianism which forms the basis of mainstream economics. Having witnessed German rigidity and attitudes of the last few weeks, this last point is not as much of a perceived threat to mainstream economic philosophy but a threat to the stability of the monetary union and the global interconnected economy whose stability depends on sustainable bilateral trade and financial flows.

It is imperative that the above economic understanding filters down towards European decision-making bodies as nations with positive imbalances, unlike economies with negative imbalances, will not be disciplined by markets that have the general tendency to ignore long-run consequences. This then calls for coordinated policy and regulatory action at the level of the Monetary Union to discipline systematic offenders like Germany as it does with offenders of the opposite sort. This economic understanding is also crucial in order for German-led EZ to come to a mutually beneficial consensus regarding the now generally accepted non-sustainable Greek debt burden accumulated over the past decades via the above described mechanism, one side of which in this case were populist clientelistic Greek governments and a big-state socialistic attitude by Greek governments and society at large alike, which had led to a Greek appetite for policy-induced spending, systematic negative fiscal and trade balances and borrowing.

In addition to the above understanding of international trade and financial flows and of German economic moralism demonizing one side of the trade flows equation, it is generally accepted by the economics profession that Greek fiscal adjustment has been extreme and has not been combined with sufficient product and other market oriented reforms over the past half decade. The latter would have made the Greek economy more flexible in terms of price and wage adjustment and would have thus brought about much smaller declines in real output in response to the initial crisis and in response to the subsequent fiscal adjustment shocks that hit the Greek economy. In fact, such flexibility characterizing the Cypriot economy (with a main exception being the Banking sector) can largely explain the much smaller drop in real output facilitated by speedy internal devaluation at much faster rates than was the case in a Greek economy captured by Oligopolies in e.g. Food and Petrol, and a myriad of Professional groups including Pharmacists, Lawyers and others. The lack of necessary reforms is again mostly due to successive clientelistic Greek governments but also due to inadequate supervision and misplaced emphasis on mere fiscal targets by the Troika, which is currently repeating the same mistake in Cyprus in relation to much needed reforms in Justice and other institutional reform that would effectively break the link between politicians, lawyers and bankers that had led to the Cypriot Banking Crisis.

The remaining rigidities in the Greek economy, in the absence of speedy reforms to be undertaken in this front, make another often suggested piece of economic advice by American economists, the adoption and subsequent depreciation of a national currency, more relevant in the case of Greece than was the case for Cyprus. This author had taken a strong stance against this advice for the case of Cyrpus e.g. here and in a co-authored confidential report of the Cypriot National Economy Council to the Cypriot president two years ago. I believe that the main arguments against a new currency outlined in the above article and report largely hold for Greece. For example, Greece like Cyprus is an economy that imports a lot of what it needs in order to produce its exports or even services such as its tourist product, so that a depreciation would actually initially increase costs of production in Greece due to imports such us oil and raw materials, before wages had to adjust downwards even more to attain competitiveness. One can safely assume that Paul Krugman has never taken a look at the Greek input-output tables (or the Cypriot ones two years ago for that matter) before theorizing on the matter. Any gains in competitiveness and reductions in unemployment would then come about via devastating reductions from current real wage levels. Coupled with the fact that higher income individuals have transferred fortunes in euro abroad, we would likely observe the single biggest redistribution from poor and middle income to the highest of income classes in modern Greek history. Moreover, unlike Cyprus, Greece does not have a history of responsibility when it comes to money creation and it would be unlikely that a new Greek currency would do better than the Drachma’s abysmally bad record in terms of inflation and instability. Given also the poor Greek reform record, it is unlikely that much needed reforms would ever by implemented by a Greek government outside the EZ and without supervision. For a number of other economic reasons listed in the above article for the case of Cyprus, but also for political reasons Greece would be better off to try to reform within the Eurozone than outside it.

One failure of the current Greek government is that via a series of miscalculations and delays and also due to lack of capacity plus a touch of rigid ideology and unprofessionalism, it failed to take advantage of the consensus that existed on the Greek problem in mainstream economic thought but also among a number of governments including those of the US, France and Italy as of early 2015. A related failure of the Greek government is that it was unable to foresee that 1) delays would have severely and adversely impacted the Greek economy, and 2) that this deterioration would have weakened its negotiating power as its Prime Minister came to appreciate on July 12th.

Moreover, the high-risk Varoufakis-Tsipras strategy followed during the first half of the current year was built on the premise of increasing the cost of non-agreement for Greece’s EZ partners/creditors by letting Grexit surface as a realistic scenario, without realizing that their actions were at the same time reducing the benefits of a co-operative solution for the others with Greece nor that an important core within the EZ was beginning to view Grexit as a preferred outcome. For example, Fabio Ghironi explains Schauble’s preference for variable geometry with a core that excludes Greece in a recent post.

As we now stand, Greece is faced with an impossible deal which is nevertheless the best deal it can currently have. Building its credibility by implementing reforms would put Greece in a better position to strike a sustainable deal as EZ partners came to trust the Greek state more. At that future point, it would be important for Germany to view improvements in the currently negotiated unsustainable deal (that includes unrealistic fiscal goals and automatic fiscal destabilizers) as a necessary fix and not as a broken contract Greece should be punished for not enforcing. It will again come to be a choice between economic moralism versus economic Utilitarianism, and Greece would in that case foreseeably  have all the support it could possibly hope for by mainstream economic thought and most level-headed governments around the world.

Categories → Οικονομία

  1. avatar
    Savvakis C Savvides on July 25, 2015 - (permalink)

    From your conclusion, and correct me if I am wrong, I read something like “Greece should go along and destroy its economy because then it would gain the sympathy of the economic thinkers in the world”?

    The choice facing Greece was always between permanent or temporary destruction. I am not for Grexit. But it’s effects are at worst temporary especially as it should knock off the impossible and never repayable debts.

    The path offered and accepted, is suicidal leading to the closer one can imagine of what constitutes permanent destruction. Businesses are already migrating away from Greece. Bulgaria already has 11,000 Greek companies registering there in search of reliable taxation, sound legislation and a stable business environment. This is already happening as we speak.

    By the time we reach as you imply the “future point” where Greece’s partners may decide that they “are in a better position to give Greece a sustainable deal” (big IF by the way) Greece would have gone down the abyss. So, although I have enjoyed reading your piece Marie, I am really at a loss to understand or draw any practical conclusions from it that can save the patient on the operating table.

  2. avatar
    Anonymous on July 29, 2015 - (permalink)

    Some random thoughts:

    Debt relief was never off the table. Greece’s sovereign debt has been restructured with haircuts on principal and at least via a partial re-profiling of the remaining debt, which made servicing costs manageable. Creditors now agree that more debt relief should be forthcoming, the only disagreement is on the mechanics of it. The fixation on a writedown of principal is not based on economics – except perhaps for an assumption that the debt-to-gdp ratio is the only factor that markets price in assessing a sovereign’s credit worthiness – and ignores the political economy generated by the fact that other countries have democracies (voters) too, to whom a “haircut” looks like an outright loss on tax money.

    A return to the drachma will be more suboptimal than the suboptimal course of action currently mandated by the institutions. The only time when Greece should have considered a Grexit was at the onset of the crisis, purely on legalistic grounds pertaining to the legal jurisdiction under which the debt contracts were issued. And even then it is not clear whether it would have worked out.

    There are reasons why a Grexit would probably not work. As Marios indicated, the numbers don’t add up, and historically money creation has not been the Greek sovereign’s forte. And keep in mind that the politicians that have failed over and over and over again to reform Greece – and, more recently, to handle negotiations at the international level – are hardly politicians one can trust to safely guide Greece into the drachma era. Greece will not become a success story by going back to the drachma, and I do not see how the detrimental effects of such a move will be at worst temporary.

    Not sure if Argentina is a good example of why Greece should go back to the drachma. Argentina did improve its numbers. It also did lie about those “improved” numbers. It also is still a mess by all accounts. It also does not look likely to come out of the mess anytime soon. And it also managed to achieve such subpar outcomes by relying on what was back then rising international prices for commodities, hardly a condition that’s now present in Greece.

    It is worth making the point, I think, that going back to what “it used to be like” amounts to going back to a state of the economy that Greeks have, for good reason, long forgotten and replaced with the more recent memories of economic development. Fond recent memories which, however, only existed because of the euro.

    More practically, there is nothing, not a single thing, that prevents the Greek government from pushing forth with long-needed structural reforms. Sure, the balance is too much on austerity, How is that an excuse for not cutting down on red tape, fighting corruption, and making the country more friendly to foreign investment? Not everything is about taxes.

  3. avatar
    Andreas N. on July 31, 2015 - (permalink)

    This is a really important note that should not be missed by the Cyprus troika:

    The lack of necessary reforms is again mostly due to successive clientelistic Greek governments but also due to inadequate supervision and misplaced emphasis on mere fiscal targets by the Troika, which is currently repeating the same mistake in Cyprus in relation to much needed reforms in Justice and other institutional reform that would effectively break the link between politicians, lawyers and bankers that had led to the Cypriot Banking Crisis.

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