What if Greece exits?

Alok Ray

The global economy needs rebalancing in several areas. But the biggest immediate concern is the crisis in the Euro Zone. The latest OECD report forecasts that the 17-member zone will shrink by 0.1 per cent in 2012. Even Germany is expected to grow by a meagre 1.2 per cent. India is already feeling the heat in terms of slowing export growth, drying of capital flows and funds from European banks, and lower economic growth.

The heavily indebted Greece — burdened with a general unemployment rate of 25 per cent (the same as in the US during the Great Depression of the 1930s) and 50 per cent for people below 25 years — may decide, in the forthcoming elections, to leave the Euro Zone, rather than agreeing to further doses of austerity imposed on it by the European Central Bank (ECB) and the International Monetary Fund as the price of a massive bailout package. If that happens and the Greeks (both the Government and the private sector) decide, or are forced to renege on their debt obligations, there would be a banking crisis in Europe whose effects would spread to all parts of the world (including India).

Solution elusive

What can be done? Some economists recommend infusing massive liquidity through the ECB and more government spending, leading to more debt in the short run, but hoping that the resulting growth would contribute to more tax revenue and higher level of GDP — both of which would help reduce the debt-GDP ratio in the medium term. These, along with substantial debt relief (‘haircut') on the part of the creditors, would make the debt level sustainable which would restore confidence of the market, lower the interest rate for new borrowing and bring back investment to the troubled economies. According to all schools of thought, reduction of debt to sustainable level is a must, but serious disagreement remains over the timing and the phasing of budgetary restraint.

Critics say that all these have already been tried. Greece and Spain have been running huge budget deficits for several years and the ECB, though grudgingly, has injected a lot of liquidity (around €1 trillion)in the banking system. But these have not doused the fire. So, they believe that if Greece has to stay in the Euro Zone, there is no alternative to austerity, which would bring down wages and restore competitiveness. According to this view, the hardship for the Greek workers would be more if they decide to go off the euro and devalue their currency.

Then, the international community would not give any financial help and the Greeks will have to fend for themselves. The rich Greeks are already withdrawing euros from banks, sending money abroad and will avoid much of the hardship. They would bring money back with big capital gains after the drachma settles at a much lower level relative to the euro.

The massive devaluation of the drachma needed to restore international competitiveness would mean a severe fall in real wages of workers through a big jump in the price level. Lowering the value of euro relative to the dollar or the yuan is not going to solve the problems of countries such as Greece or Spain. The benefits in the form of additional exports would accrue to Germany, not to Greece or Spain. In other words, unless the basic imbalance within the Euro Zone (lower competitiveness of Greece and Spain relative to Germany) is corrected either by lowering wages (internal devaluation) or exchange rate (external devaluation), the problem of the peripheral countries in Europe will continue.

Greater fiscal union

Another group is arguing for a move towards greater fiscal union (or fiscal transfers from the more prosperous countries such as like Germany or France towards the poorer members of the union), greater labour mobility (and acceptability) within Europe for Greeks and Spaniards to take advantage of jobs in Germany.

None of these suggestions is liked by the majority of German tax payers or workers.

(The author is a former professor of economics, IIM, Calcutta. )

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