I'm back!! After 24 years at Cornell, I finally took a sabbatical and took the opportunity (among other things) to do a massive mental reset while engaging in a "politics fast." I recommend a major break to anyone who can do it and even better if you can do it somewhere far away. I found on my return that, unlike me, the world has continued both in politics and economics. Not only that, but John A. actually still thinks occasional thoughts on economics might be worth putting on AMERICAblog - So here goes.
The Greeks are my favorite topic of the moment, and not just because I have Greek ancestors on my mother's side (my father keeps telling me that "your people" are going to bring down the EU). The Greek mess is my favorite example of how politics and economics really are two sides of the same coin, and ignoring one side can get you into deep trouble with the other. This is true not just for the Greeks themselves but also for the powers that be in the EU who dream up and impose the "stabilization packages" that are supposed to lead to a happy life for Greece.
Let me be clear right up front. I believe it is only a matter of time before the Greeks leave the euro. They might do it sooner or they might do it in a couple of years but the reasons will be both economic and political, which is why I thought it was a fine idea for Papandreou to actually think of asking the people who will have to pay for it whether or not the proposed bailout was a good idea.
The EU promoted "bailout" wasn't all that generous. It merely recognized an obvious fact: the Greeks aren't going to pay all of that debt. But in return, the Greek people are supposed to endure at least 10 years of austerity and depression in order to get to a situation that is merely bad instead of awful. Why wouldn't the EU offer something better? Because it might set a bad precedent for the banks and the other members of the EU who are looking a bit shaky right now, such as Spain and Italy. In other words, the main reasons have nothing to do with the Greeks themselves and a lot more to do with the rest of the Euro zone and their banks. Apart from that there seems to be a sort of schoolmarmish desire to punish the misbehavior of the profligate Greek government.
There is no question that there was misbehavior on the part of the Greek government. But there is seemingly no recognition that the people who did well over the past 10 years are not at all the same people who are being asked to pay over the next 10. Even worse, there is little recognition that it takes two to tango, and the Greeks didn't contract all of that debt without a bit of help from outside. All of this makes for a very difficult political situation. You can't very well insist on an austerity program that can only be implemented at the point of a gun. And that is, in my opinion, exactly what they are in danger of trying to do right now.
There is a vast difference between embarking on a path like that because the Germans made you do it (and make no mistake, that is how many Greeks see it), and embarking on it because you chose it yourself as the least bad option in front of you. Even if the new national unity government can make the first bailout stick and force agreement to the current second bailout, there is no guarantee that the volatile Greek political system will take it lying down. Far more likely is what the newspapers politely call "civil unrest", a.k.a., fighting and rioting in the streets, either now or in a few years when the grinding down of Greek wages and prices enters its third or fourth year with no end in sight.
The alternative isn't too wonderful either (and is definitely worse for the rest of the EU). If the Greeks default on their debts, leave the Euro, go back to their own currency, and devalue drastically, they will suffer a major recession made even bigger by the suspension of EU aid payments. But they will have the chance to grow from that point rather than stagnating (at best) for a decade or more. And whether or not that is technically a deeper recession than what they are already going to get, the fact that they can hope to see a positive trend within a year or so makes it by far the more attractive course of action from a political point of view. Perhaps not for the current leadership or for their soon-to-be-formed unity government, but very likely it is better for whoever ends up in charge of Greece in a year or two.
Interestingly, there is a good example for Greece to follow if it decides to leave the euro. Argentina faced a similar problem a decade ago, and solved it by abandoning its formerly cast iron link to the US dollar and repudiating most of its debt. The horrified international banking community forecast disaster but in fact Argentina is far better off now than any of them imagined it could be. While Argentina exports beef and wheat, the Greeks certainly have their own potential foreign exchange earning industries and could promote them effectively if they devalued and in effect cut their prices in half. (Wouldn't YOU like a Greek vacation if I gave you a 50% discount? I know a lot of Germans would.)
So here is the question: Is it better to take the hit now and get it over with by leaving the euro and devaluing, or is it better to try to engineer an adjustment over the next decade, knowing that the Greeks are very unlikely to be able to stay the course? Economists will wrangle over this but politics is what will decide it in the end.
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