The benefits for Greece from being part of EU and Eurozone have been discussed by several commentators and analysts, and recognised by most voters and Greek parties, and so I take them as given and well-understood. For an brief discussion of these see here. The benefits for European partners from EU and the Eurozone staying intact have also being extensively discussed in media, and academic and policy circles. I revisit briefly the main ones below as they will serve as the framework for the proposal I will be putting forward shortly. This proposal, in my view, can tackle the several complex socio-politico-economic problems Eurozone partners are currently facing in a way that long-run stability and prosperity is safeguarded.
I review first some critical aspects of the drive for European economic and monetary integration.
Background
Price stability and the elimination of exchange rate uncertainty, and the associated low interest rates, within EU is viewed by all EU members as highly desirable and the engine for further economic development and expansion of intra-European trade.
Attempts to fix the exchange rates between national currencies in the pre-EMU era to facilitate indirectly price and exchange rate stability ultimately failed under asphyxiating pressure from the markets (e.g. “Black Wednesday” in 1992), making it clear to most of the EU members that the creation of a “permanent” monetary union was a foregone conclusion if the aforementioned goals where to be achieved.
Indeed, two of the main stated reasons for the creation of Eurozone had been price stability and the elimination of exchange rate uncertainty, and to ensure the permanent nature of Eurozone as much as possible, there are no explicit plans for managing a member’s exit. Reneging on either of these objectives would be seen as going against the founding principles of Eurozone, and would open “Pandora’s box” in terms of how markets would view its long-run prospects.
Germany has a startling commitment to price stability (and hence prudent fiscal policies that do not lead to high public debt and/or inflation) due to historical reasons. This commitment is shared by all major political parties, and had not been compromised even during the German reunification when a big part of the German population was under severe economic hardship. Forming a monetary union with the less fiscally-disciplined countries of EU was agreed with the understanding that once in union all countries will have to aim at low deficits and national debts, so that Germany would not have to “share” much of the “fiscal risks” of its partners. For the same reason, ECB was “built” by using Bundesbank as the prototype. Germany accepted to share some of these risks (and hence the loose terms and enforcement of the “European Stability Pact”) in anticipation of higher exports to its partners. The other countries accepted, in effect, the need for fiscal prudence in exchange of “borrowing” the credibility of Germany and thereby of access to low interest rates and large investments. These were also expected to assist national government to launch a series of reforms that would increase productivity and facilitate long run growth.
Greek governments failed to take advantage of this opportunity leading the country to the current crisis. As a result, and for various reasons that are beyond the scope of the current article, a significant proportion of the Greek population live below or just above poverty standards.
Aiming at finding a solution with a fair share of costs between partners whose goal is (taken for granted to be) long run cooperation and prosperity, I therefore propose the following - european in spirit - compromise, with the rational behind it following immediately after:
Proposal
Greece meets all its current commitments that arise from existing bailout packages.
An agreed relaxation of austerity takes place aimed specifically at alleviating the hardship of those in need and badly hit by the previous and current “Memoranda”. This would require, in particular, a reduction in the Greek primary surplus targets.
A timetable of gradual (explicit or implicit) haircuts of the Greek public debt owned by Eurozone governments is agreed in return of specific much needed structural reforms of the Greek economy. To ensure the agreement of voters in the fiscally-disciplined countries, and the long-run viability of the Greek debt, the targeted haircut should be between 50% and 60% of the debt owned by Eurozone governments. The agreed reforms in exchange of the haircut should make use of the expertise in other Eurozone countries. They should address the chronic problems of tax evasion and corruption, reduce the inefficiencies in the judicial system that make reaching and implementing decisions a very lengthy process, modernise the education system to ensure the creation and retention of multi-talented “human capital” as an engine of future growth, elimination of bureaucratic and production-sector distortions in order to attract much needed investment, and to foster entrepreneurship and innovation.
Every time a haircut takes place, pre-specified structural funds are given to Ireland, Portugal and Spain as a “reward” for having successfully implemented their own austerity programmes and an engine for economic development.
Further fiscal integration is agreed to ensure future fiscal discipline by all members.
This programme is agreed between all Eurozone members within the appropriate Eurozone’s institutions.
The Rationale
The rationale behind the proposal relies on a number of considerations, which are outlined below.
1. Grexit would have severe consequences for all parties involved. If Greece exits EU in order to exit Eurozone (according to the provisions of the existing treaties), the most likely scenario is that Greece will also default in order to reduce the obligations of its State (to its creditors). The reason is that Greece has no access currently to markets anyway, and a Grexit will anyway mean the loss of reputation that is necessary to attract foreign funds in the short run. As a result the Greek government will have to rely on issuing New Drachmas to finance its budgetary needs. Greece falls in a period of unprecedented very high inflation and drachma depreciation. There is also a combination of a strict programme of structural reforms, extensive nationalisations and tax-financed fiscal expenditures. European tax payers will bear significant loses from the Greek default as European governments will have to increase taxes to cover the loses in their balance books (around 60% of the Greek debt, which is around 175% of its GDP). Finally, Eurozone loses its institutional characteristic of irreversibility with significant negative implications for long-run price stability and intra-European trade.
2. To appreciate the proposed compromise, one must also consider what would seem to be the best outcome each side could hope for, given the current status quo.
- EC/ECB/ECOFIN and Eurozone voters’ would prefer that the Greek government meets all its obligations according to the existing bailout packages.
In this case, the Greek public debt is repaid in the long run. The impact on Eurozone taxpayers is small (arising from the combination of low interest and long term repayment period attached with the Greek debt owned by their governments). On the other hand, extensive painful reforms take place in Greece, possibly with a small, “symbolic”, relaxation of austerity measures. Social unrest emerges because there is still a big part of the population in severe economic hardship. In the medium run, however, economic recovery takes place and the extend of inequality is reduced though at a very high short-run social cost.
- The Greek government and voters, on the other hand, would prefer that Greece withdraws from the existing bailout programme and strikes a deal with its creditors for the servicing of its debt with a combination of a very long repayment period, very low fixed interest rates, a swap with “permanent” bonds, and small primary surplus targets. This of course would amount to an indirect haircut (though both parties would refrain from using this term for the obvious reasons).
In this case, Greek public debt becomes viable in the long run. No further austerity measures are implemented, though some structural and other reforms that try to boost productivity while tackling current severe inequality are introduced. Eurozone taxpayers, no the other hand, have to bear a significant tax burden. Fears for similar “free-riding” behaviour on the part of other Eurozone countries in the future (bringing price instability and high Eurozone-wide interest rates from the back door) could lead to a higher degree of fiscal integration. This, possibly, might lead also to a “federal-type” system of intra-Eurozone “fiscal insurance” of the kind encountered in federal countries like Canada. It is also very likely that there is a “domino” effect and more countries in fiscal troubles attempt to strike similar deals. As a result, some political unrest may emerge across Eurozone countries. In the medium run, however, the current Eurozone crisis is tackled and the founding aims are attained.
Clearly, both the above outcomes are better, for all parties involved, than the worst-case scenario of Grexit discussed earlier. Therefore, either side would prefer to yield to the other, though each side would prefer not to be the one to yield. This creates a very dangerous environment for negotiations with Grexit being a probable event. For instance, to avoid the political cost of yielding to the other side, governments might decide to resort to referenda, where extreme views might be influential, especially given the level of economic hardship in some of the fiscally challenged Eurozone countries. Moreover, both the above outcomes entail the risk of creating irreparable long-run damages at the European project by facilitating a non-cooperative spirit between partners. As a result another major socio-politico-economic crisis in the future could be lurking around the corner. In other words, either of the above outcomes have the potential to be de-stabilising and detrimental themselves for the future of Eurozone. These make the need for compromise even more pressing.
3. Agreements between long-run partners must be met, and the State must have continuity, to ensure that long-run investments do take place and symbiosis is mutually beneficial overall.
4. Assistance during hardship between long-run partners is necessary. But, it must not be permanently unconditional, so that free-riding does not emerge and create a schism in the structure of the partnership.
5. Any “new deal/contract” between Eurozone partners must be final and not prone to a future renegotiation. Therefore, any form of relief must not be conditioned on performance measures that, in the future, could be open to different interpretations or could be influenced by external factors such as adverse world economic activity. I believe that conditioning any type of debt relief on nominal GDP would introduce such a problematic performance measure.
6. Democratic outcomes should be respected, but this should be true for all parties involved. Moreover, in an economic and monetary partnership without political integration, democratic outcomes in some countries might be imposing a high cost on other countries, whose voters, in turn, might express their own “voice” through their political system in order to avoid those costs. Furthermore, partners with similar characteristics should be treated similarly. Therefore, a compromise between Eurozone partners must take into account the existence of other fiscally challenged countries that have successfully implemented their austerity packages in the near past. In this way, an agreement between Eurozone members will be fair and stable in the long run, and hence supported by all parties involved.