Greece and the Euro-Becker

 

I will discuss the following two crucial questions about Greece and the euro:

Should Greece have become part of the euro? No.

Should Greece leave the euro? Not now, but probably in the future.

Greece initially gained many apparent advantages from becoming part of the euro zone. The Greek government could borrow on the international capital market at interest rates that were only a little above the rates paid by Germany, the strongest EU economy. These low rates probably reflected a belief among investors that the strong members of the EU would support investors in the weaker economies if these economies ran into financial difficulties. Being part of the euro zone also led to easier access of Greek goods and services to the markets of other euro members, especially France and Germany. As a result, Greek GDP grew at good rates until the financial crisis hit.

However, being part of the euro zone created many problems for the Greek economy that only surfaced after the financial crisis began to take its toll. Since the cost of borrowing was low, Greece borrowed a lot from banks in France and Germany, and also from domestic banks, to finance a bloated government sector that had too many employees who retired early and did not have to work hard. It also had an inefficient and ineffective tax system that did not raise enough revenue to finance its ambitious spending programs. The government continued to operate inefficiently railways, mining and vehicle companies, and enterprises in many other sectors. Moreover, little effort went into reforming labor and product markets to make them more competitive and flexible.

These fundamental weaknesses of Greece were hidden during the good times after the creation of the euro. When the financial crisis and the Great Recession hit in 2008, investors began to require much higher risk premiums for government bonds and other assets issued by Greece and other weak members of the euro zone. Tax receipts of the Greek government fell significantly, which made it still more difficult to meet interest payments on Greece’s large external debt.

If Greece had continued with the drachma instead of replacing it by the euro, Greece would not have been able to borrow so much on generous terms because support from the EU would not have backstopped Greek government bonds. After getting into economic trouble, Greece would have had to devalue its currency to increase exports, reduce imports, and cut its borrowings. Since Greek wage rates and prices are not flexible, devaluation would have substituted for direct reductions in the real wages of Greek workers through labor market adjustments. In addition, the Greek government would have defaulted on much of its debt, as Argentina did at the beginning of the 21^st century. Greece would still have had to go through painful adjustments that would have significantly reduced the standard of living of the typical Greek family, but these adjustments would have been smaller and of shorter duration than what Greek is going through now with no end in sight.

I opposed the euro when it was created in 1999 because I believed it would prevent member countries from devaluing their currencies if they experienced negative shocks from the international economy. I expected the main shocks to originate in balance of payments problems instead of in capital accounts. After a while I began to believe that I had been wrong since the euro did very well during the early years of this century.

The past few years of major difficulties by the weaker members of the euro zone convinced me that the skeptics regarding the workings of a common European currency were right after all. Members of the euro zone with inflexible labor and product markets, the majority of members, have to endure painful and prolonged economic adjustments to negative shocks to their economies, such as Greece is experiencing, in part because countries in the euro zone are unable to devalue the international value of their currency. If it were not the financial crisis, other major shocks would have hit Greece and the other weak euro zone economies that would have badly stymied their economies.

To come more briefly to my second question, should Greece vote yes on a potential referendum to withdraw from the euro? The advantages of leaving are that Greece could greatly devalue its own currency, and default on much of its debt. The main disadvantage is that it would lose the substantial bailout assistance from the other EU members, especially France and Germany. Since Greek banks are also major creditors of the Greek government and Greek companies, default on the Greek debt would place these banks in unsustainable positions unless they received aid from the IMF or elsewhere. In addition, depositors would try to pull funds out of Greek banks to protect against losses from a depreciated drachma, and companies with euro-denominated debt would face financial ruin.

In light of this, the best solution for Greece would be to stay with the euro for the present while it receives additional aid from the EU and the IMF. But Greece should seriously contemplate pulling out of the euro zone later on, especially if by staying in Greece is forced to continue to undergo a painful and prolonged depression of its economy.

Comments

[Mitchell K.]

The EU has a unified currency but lacks unifying leadership. Internationalists in Europe probably hoped that a unified Europe would follow the Euro. They may have put the cart (the Euro) before the horse (political unity).

[an observer]

A much better analysis appears at the link, below

http://www.newyorker.com/online/blogs/johncassidy/2011/11/wynne-godley-eurosceptics.html

The Euro's problem was a failure to form a true Federal Government, in connection with the adoption of the currency. Hayek once again stood in the doorway of progress.

What should Greece do now.

Get out, while Obama is still President and the Fed can help. We have an entire world at stake here, all of southeastern Europe.

Does anything think Romney will honor the commitments we have to Greece,

[PADRAEG]

It is disappointing to read that Mr Becker hesitated in his skepticism. Euro can't survive across so diverse economies. Greece should leave now, or be pushed out, along with all the PIIGs, including Ireland ;((( It is up to those nations to correct for the problems noted. Else they all fall, and then China! India could be a winner, USA if Obama is booted in favor of someone who wants to create real jobs!

[Jack]

I though both wrote very good essays this week.

But...... I wonder:

"But Greece should seriously contemplate pulling out of the euro zone later on, especially if by staying in Greece is forced to continue to undergo a painful and prolonged depression of its economy."

By staying they likely face the bitter meds of living up to lending requirements and as Becker points out suffering a bit because of it. But they'd have the, perhaps unwelcome, advantage of having their feet held to the fire with little choice but to fight corruption and institute a far more efficient tax collection system. And the EU tends to hang together.

On the other hand they could bail, default, devalue and still suffer by getting little for their exports, paying dear for their imports and having the "freedom" to continue with irrational policies that would make it unlikely for them ever to rejoin the EU or be a first rate nation.

With the export advantage of cheap currency, would Greece begin the "beggar thy nation" trend of the late 20's of nation after nation attempting to export their unemployment and other problems via devalued currencies?

Tough call, and one I suppose they'll have to make. But left to the voters should we bet on a policy of pain now winning over pain later?

Mitchell: Yeah, that has seemed the problem from the beginning -- "sovereign nations" of a single currency, but perhaps enough benefits to justify hewing to agreed upon standards? Maybe?

Padre: I'm curious. Do you see anyone on the candidate's bench who appears to have a better (or any) jobs policy than that proposed by the current admin? Also....... it strikes me that Europe's ONLY hope is that of integrating and drawing advantage from diverse economies. One of the major problems of the USSR was the failure of "Russiafication" of the unwilling satellite nations, but the EU has the tailwind at its back of the nations having agreed to join and make it work. Let's hope they can as the alternative doesn't sound good at all.

[NEH]

Greece is always portrayed as the poor and sick man of Europe. But is this really true? Let's put up some numbers and see. According to the World Bank, it has the 37th largest purchasing power in the World, the 31st Purchasing Power Parity, the 33rd largest gross GDP. Not shabby by any means. It's main industries are, Tourism, Shipping, Industrial Production, Food, Textiles, Chemicals, Metal Products, Mining and Petroleum. A fairly diversified economy. As for the breakout of the percentage of the economy these industries represent, Service Industries (tourism and the like) is 78.8%, Public Service sector 40%, Industry 17.9%, Agriculture 3.3%.

So why is Greece having problems with it's Loan repayment schedule? It's called "Trade Balance". Between January of 2009 and September of 2011 it's trade balance has been in negative territory month on month. From an approximate low of -3,250 mil. euros to a high of -1,580 mil. euros. One can't make loan payments when the cash flow is negative. What Greece needs is not more loans, but to increase its export rates and bring in more tourists dollars. All badly hit by the world wide economic down turn. Business, Industry and the Consumer are all going to have to open their pocket books again and begin to spend. Otherwise, the downward spiral is going to continue.

On the Socio-political front, Greece does have some systemic problems that need too be addressed. Such as, its bureauocracy, the rampant and flagrant tax evasion, general corruption and low international competiveness. Given some changes here, it would help the overall general problem.

[Emilywismer]

What impact would Greece's leaving the Euro Zone have on France and Germany?

[NEH]

Emily, If you're Greek, France and Germany can go and take a leap. They're part of the problem by being major exporters to Greece. The Eurozone as a fair trade paradise with Economic Parity? Think again. ;)

[NEH]

Whoops! Stats correction. The sector percentages are correct. That Public Sector percentage ought to be dropped and restated as the Public Sector represents 40% of Total Economic Output.

I apologize for that... Now everything adds up correctly. ;)

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[Shaf]

This article is very interesting! I do wonder what the correct answer is. Here's an article that you might find interesting that asks the very same question. Except it's from the perspective of some Greek business students

http://www.businessbecause.com/making-the-headlines/mba-students-should-greece-exit-the-euro-article81156.htm

[Jack]

Shaf: It's good to consider that in the US some states run net deficits to the Federal purse for years while others return more money to the Feds than they receive. Ha! I'm not suggesting we toss Texas, my own wealthy state of Alaska or any of the other, mostly "red" states typically running deficits to our Treasury.

http://taxprof.typepad.com/taxprof_blog/2004/09/red_states_feed.html

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