The Sleepwalkers: Germans and Greeks must avoid a Grexit

Karl-Heinz Paqué and Aristos Doxiadis

The German version of this article was published in Wirtschaftswoche on 13th April 2015.

It is an eerie picture. In a few days or weeks, the Greek government runs out of money to pay its internal bills and external debt service. The threat of default looms larger than ever, but both the Greeks and the Germans remain remarkably calm, though for completely different reasons. The Greeks somehow assume that, eventually, Europe will support them whatever they do. In turn, the Germans somehow assume that a Grexit will not really be such a bad thing.

Alas, both Greeks and Germans are wrong. The Greek error is most obvious. By now, 18 of 19 Eurozone governments are quite convinced that a Grexit would not anymore lead to a massive contagion of other crisis countries. They are right as these countries are dealing with their imbalances, and that is clearly recognized by financial markets. An invisible firewall has emerged around the western Mediterranean plus Ireland, with vast political consequences: the Spanish, the Portuguese and the Irish governments are by now among the loudest voices against special favors to Greece – in view of the hardships that their own populations had to suffer to regain credibility. In short: Greece stands alone. The consequences of this isolation are dire. If the Greek government really ignores the need for Eurozone-conditionality on financial aid, there will simply be a default. This will probably lead to Grexit and to a new currency that very few in Greece want to have. Wages will be massively lowered and paid in (soft) new Drachmas; and savings will be drastically devalued, thus leading to an expropriation through the backdoor. Eventually, ordinary Greek people will come out dramatically impoverished.

The German error is less obvious than the Greek one, but hardly less serious. A substantial part of the German economics profession and the political establishment holds that a Grexit will free the Greek economy to become competitive by a hefty once-for-all devaluation of the new currency, which massively reduces unit labor costs. This is an illusion. After all, unit labor costs have already been cut down in the course of five-year-austerity by almost 30 percent, which is roughly the magnitude that was rightly diagnosed beforehand as the country’s “cost bubble” vis-à-vis the rest of the world. The hard work on costs and incomes has already been done. Now it is mostly institutional changes and political stability that are required to unchain economic forces of growth. A new (and soft) currency would endanger what has been achieved as it would give way to unsustainable inflationary forces. For years or decades, Greece would become a sort of Argentina in Europe; with an additional disastrous brain drain to the economic centers of northwestern Europe.

Reason enough to stop sleepwalking and to prepare a final and decisive reform program to make Greece fit to stay in the Eurozone. The core economics of such a program is not really difficult to envisage. After all, the Greek economy largely consists of small and at most medium-sized firms, with no lack of entrepreneurial talents. Family investment in education is high, especially in prestige professions. Land and geography are underutilized. Most experts agree that the growth and employment potential of all these could be tapped by removing bureaucratic barriers, which are massive by any international standards. Changes in the judiciary process and in tax collection practices can also help substantially. European institutions such as the European Investment Bank could provide targeted finance for innovative ventures and export oriented small and medium enterprises, to bypass the lack of domestic credit.

It is clear that the Greek government cannot keep spending on early pensions or wasting money on unnecessary hirings. And it should tone down the unrealistic expectations of collecting huge amounts by combatting tax evasion; only growth will bring in more revenue. However, provided that the Greek state meets the target of a moderate primary budget surplus, it is not necessary at this time to agree on all aspects of spending or of tax policy.

A program like this could well be made acceptable to many voters that brought the Syriza-led-government into power. Their vote was mostly anti-austerity and not anti-growth or even anti-employment in small and medium-sized firms. Many also realize the benefits of foreign direct investment in infrastructure, so privatization linked to new investment can be widely accepted. However, the Syriza-government would have to say good-bye to any plans of massive debt relief and of returning to a largely state-controlled economy, which is out of the question for any nation in a modern Europe. All this requires courageous political leadership on the Greek side. And it requires a strong dose of pragmatism in Berlin and Brussels. It is worth the effort.

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