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Exiting the eurozone would only add to the debt burden without resolving Greece’s competitiveness problem, which stems primarily from regulatory barriers to competition, restrictive labour practices, and red tape that raise the cost of doing business. Staying in the eurozone, on the other hand, raises the question of whether Greece’s post-Soviet economy can deflate itself back to competitiveness. The answer is probably not, because real rigidities prevent the adjustment process from working. What Greece needs is what the IMF calls “growth-oriented structural reforms” – greater reliance on market forces and the rule of law.
Appropriately, the new IMF/EU-funded programme includes broad-based structural reforms intended to introduce flexibility in labour markets and intensify competition in goods and services markets. In fact, the new Greek programme reads like a blueprint for reforming a post–Soviet bloc country circa 1990. It includes privatisation, administrative reform, labour and product market reform, and it provides for bank recapitalisation to ensure that the debt restructuring will not destabilise the banking system. While all this is positive for medium-term competitiveness and growth, it also means that the reform process will be protracted and politically difficult.
The point is that Greece’s real income and wealth will fall sharply in any case, regardless of whether Greece exits the eurozone or not. The choice is between negative growth with inflation or negative growth without inflation. In my view, returning to a devalued drachma will not help Greece’s economy recover faster from the deep recession. Greece will still be the most heavily regulated country in the OECD, while its competitiveness ranking would probably slip further due to the inevitable restrictions on imports and bank deposits. Looking back to the drachma period before 2001, there was a recurrence of currency crises resolved through devaluations that did not improve competitiveness on a lasting basis.
If Greece drops out of the eurozone, the inevitable adjustment to a lower standard of living will be unfairly distributed because it will happen through inflation. Low-income people are the most exposed to inflation because they do not own foreign bank accounts or other inflation-protected assets. The redenomination of all contracts from euros to drachmas is tantamount to expropriation of savings, while large debtors will benefit –including Greece’s two main political parties, which have borrowed three times their annual budget subsidies from a state-controlled bank. It is also doubtful that Greece would attract much investment from abroad. Who would guarantee the stability of the drachma after its devaluation? Surely not the same political system that brought Greece to the brink of disaster. No Greek exporter, hotel or restaurant will convert euro income into drachmas, knowing that the drachma tomorrow will be worth less than today. The drachma would be the main currency for government employees and pensioners only. The result would be economic chaos and uncontrollable social explosion.
What led Greece into this mess is its ineffective, incompetent, and corrupt political establishment, which viewed politics as a means of providing favours to special interest groups in exchange for vote-buying. If you offer the printing press to this political system, it will just go back to business as usual. It is by cutting off their access to cash, by remaining in the euro, that you can force political change along with economic change.
[Article re-run on 8th June]