Why Greece could be better off outside the EZ

Last week I wrote about the difficulty of doing business in Greece, and the role that the government plays in perpetuating the bureaucracy. Does all of this mean that Greece is doomed? Not necessarily. Returning to the drachma would be ignominious for Greece, but it need not decimate the country and may be the only realistic way of spurring the kinds of structural reforms that are essential if Greece is to make a sustainable recovery.

Greece faces a stark choice about how to return to growth. It can continue along its current path of endless austerity aimed at engineering an internal devaluation. This option would probably involve a decade of depression and is therefore likely to be politically untenable.

The alternative to internal devaluation is for Greece to default and abandon the common currency. A new drachma would depreciate massively, boosting Greece’s competitiveness almost overnight.

Greece has a vibrant tourism industry contributing around 18% of GDP that has suffered from cheaper holiday options in Turkey and northern Africa. Agriculture, manufacturing and pharmaceuticals are also sizeable Greek export industries. All of these sectors—and therefore GDP growth generally—would benefit significantly if Greece’s products and services saw their relative prices plummet.

In addition, there’s no reason to believe Greece would be left without a financial lifeline if it exited the euro area. Its departure would be handled like a divorce, in which Greece and the troika acknowledge that their relationship no longer works. The troika would provide some bridge financing to ease the turmoil that an exit would inevitably entail for Greece.

This financing would continue to be conditional on the same structural reforms that the troika is currently demanding. After a default and euro area exit, however, the Greek government would have much greater incentives to deliver.

Currently, the cost of failure to reform is not particularly high: criticism from the troika and demands for more austerity. After a default and euro exit, failure to reform would probably mean a loss of bridge financing with dire consequences. Greece could succumb to profound civil unrest of the kind seen during the military dictatorship. The country is not self-sufficient in food—if hyperinflation were allowed to set in, food shortages and malnutrition could ensue.

The threat of such a prospect may finally provide the impetus for a Greek government to get down to doing the hard work of structural reform. But there are no guarantees. Greece’s entire political class has always been obstructive and there is no obvious sign of new blood coming through the established political ranks.

And yet on my recent visit to Athens, bright, young Greeks spoke to me about their hopes of forming new political movements, untainted by the parties that have gone before. When I asked why this has yet to happen, they responded that Greece must sink further before it will be ready to revive itself.

“We are all on the sidelines,” one young man said to me, “waiting for Greece to hit bottom. We do not want to mobilise and get involved now, because the house of cards could come crashing down on top of us. We will wait until the collapse has happened and then we can finally start rebuilding anew.”

A Greek default and exit could signal the turning point that a desperately needed new political class is waiting for.


For RGE’s views on EZ endgame scenarios, see EZ Endgames: Timing is Everything

(As always, I greatly appreciate your comments. I’m on holiday this week and it will take me a few days to approve and post your comments, so please be patient!)

14 Responses to Why Greece could be better off outside the EZ

  1. Fani Angelou says:

    If Greece exits the EZ, Greeks will not be willing to accept any kind of structural reforms. The public sector will not change, the tax evasion will continue as usually, nothing will change because no one in Greece wants these changes. Returning to drachma would be the excuse to leave things as they are.
    If I could see a chance for the hypothesis used above to be materialized, I might agree with an EZ exit.
    This scenario might work in another country, not Greece. The past 2 year in the proof of what I say.

  2. Fontas says:

    I do not buy the point that the Greek government does not have sufficient incentives for reforms. Clearly, they had to and have made some progress with reforms. The problem in my view is primarily the social unrest these reforms cause. Government officials change every few months as they are deemed responsible for the situation and people just hate them and put them under pressure. Lack of incentives is not the source of the problem. Social unrest is the main reason reforms are slower.

  3. Alan says:

    A return to the drachma too might act as a form of self-policing in terms of Greece’s debt levels. The unsustainable levels of debt that have exacerbated this crisis have been bought about by the excess, and indeed access of historical, indigenously-cheap euro funding; which is perhaps another example of the impracticability of a single monetary policy across the cultural divide of Europe’s sovereign economies. In terms of pricing and debt levels, a return to the good old-fashioned dynamic of supply and demand in the sovereign Eurobond market might be the constraint a new drachma-based fiscal agenda in Greece needs.

  4. phil tormey says:

    Always enjoy your writing. Analysis always very informative. Thanks Phil

  5. Pingback: Debt crisis: as it happened – March 6, 2012

  6. First of all, no Greeks are expecting Greece to hit bottom, because they feel it already did.
    Secondly, you can’t compare the tourism industry of Greece with Turkey and Africa. It is not only the quality that differs, but also the legal framework of each country. Greece will still not be able to compete them, even with “new drachma”.
    Finally, the financial sustainability problem in Greece could be solved if they wanted this to happpen. But there are lots of traders that have waited long for theese ups and downs of Euro. And what I can still not understand, is how can France and Germany insist that Greek government should save money, and in the same time they sell to Greece military submarines and aircrafts.
    Everyone has to understand that there is a big part of the system that sustains the problem.
    Instead of getting rid of Greece, maybe EU should think of controling the influence of financial trading and assessment organisation. Otherwise the problem will remain, there are other weak economies too. Except if EU also gets Italy, Spain, Portugal out of euro…
    Anyway, your article is great and offers a “financial” solution, but I don’t think that the problem is still financial.

  7. derekinfrance says:

    Enjoy your holiday!

    I found your argument, that Greece would be better off outside the EZ unconvincing. First, after the problems of printing and issuing of new Drachma and what their exchange rate may be against all other currencies, all accountancy systems in banks, companies, government, etc will have to be changed into the new currency. These organisations will then have to provide up-to-date exchange rates to EU customers (ie the bulk of their tourist industry). The government ministers and central bank will have to withdraw from the EZ and ECB: thus losing any input (which is valuable to Greece). I could go on.

    Even beyond these financial problems, you already point out other potential threats. I’m sure young Greeks feel excluded, yet have hopes. Those hopes could be burned up in the ashes of civil strife and economic collapse.

    The current Greek government has considerable work to do. Plenty of financiers are betting on failure. Let’s live with hope – within the EZ!

  8. I (still) do not understand why a Greek default would automatically result in Greece leaving the Euro. As far as I know, there are no procedures for a member country to leave (or be kicked out of) the Euro.

    Greece imports everything and exports very little besides vacations. Even if it defaults, Greece may be better of inside the Euro, and no one can force it to leave…

    • Quick follow up.

      You say “if hyperinflation were allowed to set in, food shortages and malnutrition could ensue”. That makes complete sense to me, but isn’t that exactly what would happen if Greece left the Euro and had to buy its food (and everything else) with Drachmas?

  9. mutteringsofafool says:

    Agree with your sentiment, the PSI efforts buys some more time, but it’s not solving the fundamental issues. Drip feeding bailouts to Greece doesn’t address the structural problems in a country that today isn’t financially viable.
    Leaving the Euro is going to create a whole lot of pain, but I would be very surprised if someone isn’t working on a plan to do it with the minimum amount of pain possible.

  10. CKE says:

    “”Greece faces a stark choice about how to return to growth. It can continue along its current path of endless austerity aimed at engineering an internal devaluation. This option would probably involve a decade of depression and is therefore likely to be politically untenable.”

    You may be right, probably are about a decade of depression. But, in the U.S. prior to the great depression, wages tended to adjust to deflation in a year or two and growth tended to return relatively quickly (the depression of 1921 is a good example). Wages may be sticky, but in an unregulated market that’s all: they are not frozen.

    One problem with a top down devaluation is that it forceable devalues all wages (and internal prices), but it may be that not “all” wages (or prices) need to adjust. It may be that the relative value of wages are more important. That some jobs need lower wages while others do not. A devaluation clouds this.

    On growth, the question for Greece is the same as for all nations: how do you shift real resources away from unproductive endeavors and into productive ones? A personal opinion is that top down approaches don’t work very well.

  11. theta says:

    Hello, very interesting points. I see two issues with your thesis:

    Firstly, if Greece were to exit the EZ, the pressure to reform will decrease, not increase. The consequences of the badly ran economy/state that now manifest in inability to keep up with the EZ core countries and cause painful depression would then appear in the form of currency devaluation and subsequent high inflation, which is much more palatable politically and socially. People protest firecely in a 10% wage reduction with price levels stable, but don’t complain that much when they get a 5% raise while inflation runs at 20%+ per annum, even though they are worse off in the latter case. In addition, runaway inflation erodes debt pretty quickly and allows for big nominal GDP growth, even though living standards do not necessarily increase. This was the economic environment in Greece in the 80’s. Such an environment was very fertile ground for politicians doing favours to their voters in exchange for votes, as there was no real fiscal policy contraint. It was very easy to print more money and let the currency devalue in the open market, if the bidget deficit grew too large. To a certain extent, if the society at large prefers the country ran that way, having your own inflationary currency is more natural than being confined in a hard currency straitjacket. This is after all what the US and the UK are doing at the moment. But don’t be fooled into thinking that the current political class, and the millions that support them will decide to change for the better once theyegain monetary independence. And yes, despite the angry voices and social unrest, there are millions that used to benefit and to a certain extent continue to benefit from this corrupt, inefficient and bankrupt system. And especially after having been hurt for the last couple of years, returning to the drachma will be the perfect excuse to re-live the good old days, and never go ahead with any reform.

    Secondly, the bridge financing that you mention will probably bring more problems than it will solve. The reason is it will have to be in Euros. The biggest benefit however of leaving the Euro is to rid yourself of the debts in hard currency and have the power to monetize your debt. This cannot happen when you have an additional loan in Euros (and probably with seniority status over the existing debt). The only way it can happen is with unilateral redenomination of all existing debt in new drachmas (although I hope they find a new name instead, I personally like Phoenix, as it’s symbolic too), and then let currency devaluation and inflation erode it. Greece is not very far off from regaining competitiveness. Despite all the negative publicity in the last couple of years, it’s still a country with tremendous natural beaty, a well educated work force, very hard working and innovative people (yes, despite the perception for the opposite). In case of introduction of a new curency and complete redenomination of all debt, the required currency devaluation so that the trade deficit disappears won’t be more than 50%. And then growth will resume sharply (in nominal terms anyway, but that’s enough to get the economy moving). In that case the new currency will be actually used and within a couple of years everything will have returned to normal. The alternative (continue to have euro-denominated debt) will result in much of the real output going to service the euro-debt (the drachma-debt won’t be an issue in any case), which will result in continued hyperinflation instead of just high inflation, and in the end a dual-currency system as most Greeks will continue to transact in Euros (especially those in the tourism industry that will continue to quote in Euros to all foreigners).

    At the end of the day, what currently is happening is a return to the living standards that the Greek economy deserved, which means a reduction of living standards for Greek people overall in the short and medium term. This can happen in a number of ways, either via a depression within the EZ, or via huge inflation outside the EZ. What matters in the long run is how to make the economy stronger so that it grows in real terms and increases living standards. This can only happen with structural reforms, and unfortunately the only was I see them occuring is if Greece stays in the EZ. I agree with the person you quote that it will need to hit bottom before a critical mass decides to rid itself of the old rotten system, but I just don’t see that happening outside the EZ. Outside the EZ, the living standards will continue to decrease but people psychologically won’t feel depressed (the money-illusion I explained above) and therefore will forgo reforms. To use an analogy, the EZ is a fitness club, a very demanding one. Greece at the moment can’t keep up as it’s not in shape and it falls behind in all the fitness metrics. If it were to exit the club, it would feel no pressure to keep exercising in order to keep up and it will keep further behind, but it won’t think that way, it will just take it easy and think that it didn’t belong to that club anyway.

  12. pavlo says:

    Greece needs a devaluation and a return to sensible price levels. As a businessman I find their export prices unrealistic and I can buy cheaper ( and just as good quality ) in Spain, Portugal or Italy. As I tourist I find hotel and restaurant prices way too high for what is offered. Again I find better quality at lower prices in other countries. For some reason Greek hotels and tavernas refuse to lower prices to reflect modern times. They will live with the consequences.

  13. Pingback: EZ break-up stands to benefit the core « Euro Area Debt Crisis by Megan Greene

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