A slightly edited version of this article was published in the New York Times, on 26th February 2015.
Everyone frames the depression in Greece as an issue of macroeconomics: fiscal policy was tightened too quickly; government debt is too high; the tools of currency devaluation and monetary expansion are not available inside the euro zone. No doubt these are important factors, but they tell less than half the story. Local politics and microeconomic factors are at least as important in explaining the depth of the crisis.
Greece has fared much worse than other euro zone countries, which also faced a ‘sudden stop’ of foreign financing, and then enacted similar austerity programs. It lost 26% of GDP from the pre-crisis peak, while Portugal, Ireland and Spain lost no more than 7% each. Much of this difference is due to foreign trade.
In all four countries, when capital from abroad stopped flowing in, increasing exports became a primary goal, to offset the drop in domestic demand. The other three achieved this quickly, as projected in their adjustment programs. Greece did not. If it had, its recession would have been much shallower; by one estimate, a 25% rise in exports could have limited the drop of GDP to just 3%. Fiscal contraction would have caused much less damage.
This failure of trade adjustment is a puzzle to those economists who tend to view competitiveness in terms of labor cost. Wages did in fact drop by much more in Greece since 2010 than in any other country, and labor cost is no longer a barrier to exports. Firms have not taken advantage of this for three reasons: regulations, fear, and size. Continue reading
This was posted in openDemocracy, as part of the debate on the future of the euro zone.
In his speech, which opens this debate, George Soros argued that misunderstandings and misconceptions are shaping history in important ways. This is true in general, of course, and it is true in specific ways within the eurozone.
Proponents of the euro expected that under a single monetary policy and in the absence of currency risk economies would converge, as capital, goods and people would move more freely. An implicit assumption, never properly examined, was that national economic institutions would also become more similar. As Jean Pisani-Ferry tells it, in the early 1990s, part of the European elite selected central banks as a good candidate for merging into one tightly knit system, since they were already operating more or less in the same way; whereas welfare systems or industry policy were markedly different. It was perhaps thought that these other institutions would follow suit, eventually.
What seems to have happened, however, is that the monetary union actually served to mask and therefore preserve institutional differences in most other levels of the economy – in business strategies, in wage setting, in fiscal planning. Under the illusion of harmony, imbalances were allowed to get out of control. Continue reading
Martin Wolf argues, in this blog post, that Spain could not have prevented the real estate bubble and the subsequent crisis of its banks. Spain was a well governed economy, fiscally prudent and with a conservative bank regulator. If he is correct, and I think he is, the fundamental problem is not the eruozone, but the free flow of capital. Continue reading
I am not going to add one more evaluation to the dozens that have been written about Thursday’s Eurozone summit. I think that Joe Stiglitz sums it up rather well. However, I am tempted to comment on the comments, not just of the past two days, but of the past several months.
Competent academic economists, and even outstanding ones, can be quite naïve about the political process. They seem to judge policy making by the benchmark of a rational, intelligent and benevolent dictator, who seeks to optimize social utility of whatever entity she is commanding. Much of the recent commentary on the Eurozone crisis is a clear example of this. Continue reading