A Political and Intellectual Proxy War over Greece
The escalation of the conflict over Greece is more than a dispute between the government of Prime Minister Alexis Tsipras and Greece's international creditors. The conflict is a proxy for two wars—one intellectual and one political—in which the Greek people, especially the poor, have been taken hostage. The intellectual war is over the sustainability of the euro project and the economic effects of austerity policies. The political war is over populist and nationalistic policies aimed at addressing the economic cost of the long and severe recession. As with all wars, propaganda has taken over, and facts are being used selectively. For all the talk of Greece's failed policies, it is often forgotten that the Greek economy last year was growing and Greek bonds had recovered some market access. Last summer Greek GDP growth was approaching 2 percent. The consensus forecast was for an acceleration toward 3 percent this year. Interest rates on 10-year government bonds had declined to 5.5 percent. The debate last summer was whether Greece would be able to achieve a "clean" (i.e. without financing) exit of the financial lifeline that had been extended in return for tough budget, tax, and structural measures imposed on it by the Troika (consisting of the European Commission, the European Central Bank [ECB] and the International Monetary Fund) and continue with just a precautionary credit line.
That positive growth trend was interrupted last winter. This interruption was not a result of new austerity or of the policies adopted by the new government. In fact, Tsipras' populist government has adopted no new policies. It was caused by the tremendous increase in uncertainty generated by Tsipras' confrontational strategy. Uncertainty kills growth. As a result, GDP in 2015 is likely to contract again. Compared to the growth expectations prior to the elections, every Greek could lose as much as €1,000 in income as a result, the equivalent of almost two months of pension payments for the poorest Greeks.
The Greek government has taken the country to the brink by calling a referendum on the program at a time when it knew such a step would lead to capital controls and bank closures. Neither the form nor the content of Tsipras' request was conducive to an extension of the program. The rules were clear to everybody, including the Greek government. Capital controls and bank closures hurt growth. When Cyprus implemented capital controls, GDP growth declined more than 5 percent in that quarter. Something similar will now happen to Greece. History shows that it is relatively easy to shut down banks but always difficult to reopen them and normalize financial conditions. The upshot is that the Greek economy will be much weaker on July 6, the day after the referendum, than it was June 26, when the referendum was announced. Tsipras says his tactics were an attempt to get a better deal. Was the gamble really worth it?
Common sense would say no. But many pundits and economists on the left in the United States and Europe are not only celebrating the referendum but also advising the Greek people to vote "no." In their minds, Greece is the poster child of the failure of the euro project and of the policies aimed at restoring fiscal discipline, and thus opposition to austerity is a cause worth fighting. In their view, the uncertain outlook and the suffering of the Greek people are less important than their ideological agenda. Populist parties across the world are supporting the referendum and a "no" vote, hoping that it will be seen as a celebration of democracy and a restoration of national sovereignty. It doesn't matter to these factions that the question of the referendum is too complex for the layman to understand and lacks legal meaning. Nor does it matter that the Council of Europe has said that the referendum will take place under conditions far short of international standards. In a proxy war, the cause is all that matters.
Let's discuss the economic issues in turn. First, advocates of a "no" vote argue that the euro is a failure because it prevents Greece from devaluing its way out of the crisis. An exit from the euro would allow it to devalue its currency, solving all problems, this argument goes. In fact, a Greek exit and devaluation would produce a near term depression, bankrupting the financial and corporate sector. Given the track record in Athens, the new Greek currency would have little credibility. Greece would likely become euroized. And no one can be sure the government would adopt the right policies in an unprecedented environment. In addition, having your own currency has not been a panacea for countries in crisis. For example, the large depreciation in the sterling has not boosted UK exports. All it did was to reduce real incomes via higher inflation. Inside the euro, Spanish exports boomed and the current account imbalance was reduced with no devaluation.
There have certainly been mistakes made in the operation of the euro institutions. For example, the ECB should have implemented quantitative easing (QE) when the Fed and Bank of England did in 2009, instead of tolerating the drastic spike in interest rates that sank the euro area into a serious recession. But mistakes have been corrected and the euro area is now more robust. The European Stability Mechanism (ESM) and the banking union are in place. The ECB is now doing QE and has explicitly said that Greece would benefit from QE if it concluded the negotiations of its budget, tax, and structural reforms. The monetary policy stance is now right.
Another argument for voting "no" holds that Greece's austerity policies have failed and that an exit will enable Athens to adopt a more stimulative fiscal policy and achieve better growth. This argument is equally misleading. A country that defaults and loses market access always finds it must run a primary surplus to pay the bills and to eventually be able to market its debt. How big the surplus needs to be is unclear, but there are a few examples of countries that have defaulted or had to regain credibility after a sharp crisis that can serve as a guide. After its default, Argentina sustained a primary surplus in the range of 4 to 5 percent of GDP. After hyperinflation, Brazil sustained a persistent 3 percent primary surplus. Greece had been asked to reach a 1 percent primary surplus this year, to gradually reach about 3.5 percent by 2018. That goal was very ambitious and possibly unrealistic, but essentially similar to what Greece would have to run in the event of a default. True, Greece has sharply reduced its fiscal deficit—in fact, probably too much. But this has been partly the choice of Greek governments, who have preferred fiscal adjustment over structural reforms to boost potential growth. Even Tsipras' government, which campaigned on an anti-austerity platform, sent a proposal that the IMF rejected for being too austere. Something in the Greek polity seems to be getting in the way of reforming the economy.
This proxy war supporting Grexit is being fought to support the cause of Keynesian fiscal policies in the United States and the United Kingdom, of economists and others who want to say "I told you so" about the unfeasibility of the euro, and of activists who want to promote populist policies elsewhere. It is interesting that many Anglo-Saxon economists are supporting a "no" vote, while Greek economists (and those in Latin American, who have experience with these issues) are mostly supporting a "yes" vote. American pundits won't have to live with the consequences of their advice. This proxy war must end. What Greece needs is a government that can provide lasting and credible political stability, liberalize the economy, break down oligopolies, reduce clientelism, and unlock growth.
All parties involved have made mistakes, and Greece has suffered enormously. Regardless of the referendum outcome, the Greek economy is going to need massive external assistance. Europe, and especially Germany, cannot fight against moral hazard and demand respect for the rules and then avoid dealing with the consequences of fighting against moral hazard and demanding respect for the rules. After the referendum, Europe must re-engage with Greece, devote all the resources needed—including conditional debt relief—and, paraphrasing Mario Draghi, do whatever it takes to help the Greek people recover from this tragedy.