The article below, written by Yannis Ioannides and Chris Pissarides, is part of the ongoing discussion on this blog about the costs and benefits for Greece to continue being part of the Eurozone. The authors argue that Greece has a strong interest to stay in the Euro.
A shorter version of this article in Greek was published by Kathimerini, November 27, 2011.
The full article of Yannis Ioannides and Chris Pissarides
There have been calls recently for Greece’s (and probably some other countries’) exit from the euro. High profile among these is one by Nouriel Rοubini, and one from our friend Costas Azariadis. If Greece were outside the euro, the argument goes, it would have a powerful tool in its ineffective arsenal, the exchange rate. A massive devaluation of its currency would quickly restore competitiveness without having to go through painful wage cuts and the many other sacrifices that are required. We beg to disagree.
Our main disagreement is with the vision that such writings have of Europe’s single currency. The Eurozone is not a club that countries may enter or leave according to the economic parameters of the day. If that were the intention of the founding fathers, there would be no euro but a European Bretton-Woods type system of fixed exchange rates, with the old Deutschmark as its anchor. European governments went into the trouble of creating a single currency with a new central bank, and not a system of fixed exchange rates, because they wanted to remove speculation about exchange rate adjustments once and for all. The Eurozone is part and parcel of the process of European integration. Although the extent of fiscal coordination necessary to make the common currency function properly was underestimated, it remains a critical part of the movement for closer European integration.
Britain remained outside the euro and it is likely to continue outside, but its prime minister understands well this role of the Eurozone. That is why he attached so much importance to the recent Brussels summit on the debt crisis and emphasized so strongly that it is necessary for the Eurozone to find a quick and lasting solution to its debt problems. He never suggested that perhaps countries would consider leaving it. It is also why, when agreement was reached with Sarkozy and Merkel as protagonists, the British Tory press was so concerned about Britain being “left behind” in a united Europe led by the core of the Eurozone. And it is not only the government that thinks so. Tony Blair, in an interview on the BBC on November 13, emphasized that it would be disastrous for Europe if any country left the euro.
Critics of the euro seem to forget that the euro was originally conceived as a pillar of closer economic union, and it is even more so today, more than ten years after its birth. If Greece were to exit the Eurozone the big question is not whether the new drachma will depreciate by 50 or 70 per cent, but whether Greece will ever succeed in becoming a modern European country with fully paid-up membership rights in a united Europe. We fear that a runaway Greece will command little respect by its European partners, will be cited as an example of a massive failure in Europe by Europe’s enemies, and will not be regarded as a port of entry into core Europe by prospective international investors, in the way that countries like Ireland and Cyprus are today. Is that what we want for Greece, for the benefit of some temporary relief from austerity measures that are painful but long overdue?
We believe that even if the narrow economic argument for leaving the Eurozone were watertight, there would still be strong reasons not to leave the Eurozone. The long-term prosperity of the Greek economy depends on it. But the narrow economic argument is not watertight.
To be sure, Costas Azariadis has considered the costs of some of the drawbacks of not remaining in the euro. But he seems to be unduly confident that suspension of interest payments would confer net benefits on Greece. We think that such a policy move would be disastrous, both for Greece and for the world economy.
To start with, this would amount to default, with capital “D.” It will then become necessary to recapitalize European and other banks much more than now. How do we know that this will be cheaper than bailing out Greece? The exit option might even become more expensive than a current bailing out strategy. The shocks from default to the European, and indeed the world, economies are hard to assess at the present juncture, but they could be enormous. It is not at all clear that the Eurozone can withstand the shock, considering the rapidity with which capital markets and speculators can attack other vulnerable economies. In a nutshell, it could well be the end of the Eurozone, arguably for the wrong reasons.
Costas Azariadis claims that “Argentina has recovered from its default of 10 years ago, and prospered.” We think that this is an exaggeration but more importantly, conditions in Argentina were very different from the conditions faced by Greece today. First, Argentina went through turmoil for several years after default. Is Greece prepared to do it, without European help? Second, Argentina distanced itself from the IMF and relations are still very cold. It still has a poor reputation in international capital markets and cannot borrow easily. Third, Argentina exited a currency board with the United States, a country that was a trading partner but not one that was part of an economic union. The United States did not care very much whether Argentina had or did not have a currency board with its dollar; Europe cares about Greece and the Eurozone. Fourth, a key to Argentina’s re-emergence was that Argentina is a producer and exporter of natural resources. She was very lucky in that the price of these resources went up a lot soon after it defaulted, giving it a welcome bonus for which it made no sacrifices. Greece’s only natural resource is its sunshine, and it is doubtful that the price of it will rise much.
A return by Greece to the drachma is not a panacea. Azariadis suggests the new drachma may be introduced at 600 to the euro. But it would surely float, and no one can guess where its value would be in one, two or three months from now, let alone in three years. Greece will not have the resources to defend it, and the drachma’s new value would be determined by the combined effect of its value as an asset and as the price of Greek exports, both of which are affected by expectations about the future. The pre-euro experience is not a guide of where the new drachma would settle, and how much it would fluctuate before it settles somewhere. Uncertainty would kill international transactions for some time. It is hard to believe that the euro will not stay as the store of value and the unit of account for a long time, exactly as the dollar, and the golden sovereign, were before that especially for large transactions.
Under a pessimistic scenario of a greatly depreciated drachma, an offer by Greece to its creditors of 35 cents to the dollar (as Argentina did), would still leave the debt at about where things are now (in real terms). None of these thoughts is a substitute for a quantitative analysis, but our assessments worry us.
If Greece were to leave the euro, any local pressure for reform would disappear at once. Moreover, subsequent labor and other unrest would intensify because people would feel poorer and this can create havoc in the tourism sector. Greece imports much of its food from the EU (but also lemons from Argentina and garlic from China), and all these would become more expensive. And even with a vastly favorable exchange rate, the fundamentals of why there is little productive investment in Greece would not change. Worse yet, there may be no incentive for them to change.
Given how unpredictable Greek politics are, we might not have the luxury of being able to study in depth the full impact of Greece’s abandoning the euro. Greece may be forced to, or even choose to, exit the common currency at some point down the line. But, to us “no to euro” looks like a very risky option at the moment. There is no doubt, the euro is an expensive currency for Greece, and indeed for the entire Eurozone. As a start, a looser policy by the European Central Bank that would cause some inflation in the Eurozone and some depreciation of the euro, would be a much better policy that would benefit all the beleaguered countries of the Union and not just Greece.