A showdown appears inevitable between Greece and the EU now that an explicitly anti-EU left-wing party, Syriza, won the recent Greek elections. The new Greek Prime Minister, Alex Tsipras, has promised to end austerity, even if it means pulling Greece out of the Eurozone and reinstating the Drachma. Could this work out for Greece?
If I were a betting man I would say no. The chips are stacked against Greece, but there is a way it can be done, and with Greece coming out ahead.
The current problem with Greece is that the Euro is too powerful a currency for Greece’s weak and unproductive economy. The strength of the Euro is set by Germany’s dynamic, productive, export-oriented economy. Because Greece isn’t as dynamic or productive as Germany, its goods can’t compete on the international market so long as they are priced in Euros. The Euro also provides an artificial boost to the spending power of Greeks, enabling them to purchase foreign goods that would be priced out of reach (like German cars) if they had a normal currency. The result is an atrophying, import-oriented economy.
There is a way out – but just barely. If Greece abandons the Euro for the Drachma, the Greek export sector will instantly get a boost. Unfortunately, this also means that the rest of the Greek economy will get hit in the face by a gale force wind because the price of every import good will skyrocket. The government budget will also come under immediate strain. Budget deficits will be forced to end overnight as the government is cut off from foreign capital.
The key to overcoming these difficulties is to power through them as quickly as possible. This means enabling the export sector in every way possible. This includes massive deregulation as well as aggressive tax cuts on producers. (I know, I know, a lot of Greece’s red tape emanates from Brussels. But with all eyes on the currently battle, nobody will care if EU decrees on toilet seats and light bulbs go ignored.)
As well, because the government has an apparent operating surplus today (i.e. not counting the interest payments), balancing the budget quickly isn’t as far-fetched as it seems - as long as you are willing to forgo paying interest on your debt. These can be renegotiated, as all the leverage will then lie with the Greek government. You want your money back Mr. German banker, then let’s talk.
Unfortunately, to pull this off, austerity will have to be maintained – and for the short-term, even tightened. Once the export sector kicks in, tax revenues will surge and the immediate crisis will have passed. But until then, the people will be hit hard, and for this program to succeed, they must grin and bear it. On the positive side, once the crisis ends, Greece’s economy will have been completely transformed from the sick man of Europe into a Mediterranean tiger.
Can Greece do this? Well, my homeland of Estonia did just that in 1991 when it separated itself from the Soviet Union. Radical free-market reforms were instituted and all subsidies to unproductive Soviet-era industries were dropped - instantly. As a result, by 1994 its GDP had collapsed by 45%. 45%! But by 1999, the GDP had recovered and was growing fast. The upside was that the economy of 1999 was completely different from the economy of 1991. Estonia had become the most dynamic economy of Europe.
One thing that enabled it to happen was national willpower. Everybody was willing to take the pain, because the alternative was unthinkable – national failure and shame. Pensioners, who had their savings wiped out when rubles became worthless, and who could barely make ends meet (especially if they didn’t have kids), had the memories of the Republic they grew up under in the 1930’s to see them through. We had to prove we were better than our hated Soviet overlords, but a lot of those old people had lived through Stalin’s reign so they were tough. Also, thanks to the Soviet Union, socialism was thoroughly discredited. Any Estonian who advocated for socialism was considered a traitor.
Does Greece have this willpower? I doubt it. In today’s Greece, socialism has not been discredited by history. In fact, socialism is looked to for salvation, as an antidote to the hated German-imposed austerity. And Alex Tsipras is not Mart Laar, Estonia’s most important Prime Minister of the 90’s, who won the Milton Freidman Prize in 2006, and who instituted the world’s first flat tax.
Here’s an anecdote of how radically free-market Estonia was before it joined the EU: when Estonia was invited to join the World Trade Organization, the government was told that it had to reduce tariffs and duties as a condition of acceptance. The Estonian delegation looked puzzled. But we don’t have any tariffs or duties on anything, so how can we cut them? In contrast, Tsipras wants to rehire civil servants and bring prosperity back by raising public pensions! Well, he can certainly try that if he wants to, but he had better have high-speed printing presses on hand to keep up with the resulting inflation.
Like in a lot of financial crises, a solution is at hand and it is possible, but only for those willing to take the bitter medicine that it requires.