Three options for Europe, three options for Greece

The countries in Europe have different productivity. Germany is large and near the top, Greece has a lot of debt and is near the bottom in productivity. With an open market and easy credit, the mismatch in productivity produces a trade imbalance within the EU, and that accumulates as debt. Poor Europe buys goods from rich Europe partly on credit.

Assuming things remain constant, this credit is nominal only – it’s to keep trade flowing and will never be repaid. This is usually OK. Sovereign debt is usually permanent, and it’s really a monetary instrument (bonds are a kind of slow money) rather than a cashflow debt that’s expected to be repaid. The market will sustain the debt if it matches the pace of growth, so that the debt to GDP ratio is roughly constant. If debt grows much faster than GDP the market gets jumpy and starts perceiving sovereign debt as ordinary cashflow debt, and we get the current mess.

What, then, is to be done? Europe as a whole has three options:

Fiscally responsible utopia: Europe can insist that every country be equally productive. They can legislate that it be so, and try to impose it by austerity. This is the policy that Merkel’s Germany stupidly pursues. It doesn’t work. Possibly, rich Europe could take more leisure and higher salaries as an easier way to even out productivity. In any case, assuming equal productivity and therefore a dynamically stable balance of payments is at odds with reality, and therefore not a viable basis for an economic union.

Transfer payments: The rich productive countries can transfer their surpluses to the poor countries, so that the economy runs at full speed, trade is at max, and the poor countries receive a net influx of real value (goods and services). In monetary terms this can be done by mutualizing the debt at the ECB and letting it grow, or by straight taxation and transfer payments. As for the transfer of value to poor economies, it can be consumption oriented (which is easy to sell but bad) or it can be oriented to real investments (hard to make happen, good). This is the obvious right way, and it’s the way the EU functioned, with great success, up to the 90s. Successful economic unions like the US are built with the assumption of unequal productivity, mutualized external debt, and internal transfer payments.

Monetary protectionism: Mismatches in productivity can be technically reconciled by any form of protectionism that restricts the flow of trade or credit enough to even out the balance of payments. Trade has to be less, if the poorer countries are to consume within their means. This can be done with tariffs, or more easily by getting out of the Euro and having once again separate currencies. Currencies can be devalued, making a poor country nominally equal in productivity with a rich country but only by making the poor country import less. This is more cohesive and gentle on societies, but doesn’t promote growth or productivity in the zone as a whole.

What about Greece then? Greece in the present context also has three options. For your reference, according to the 2011 budget, real revenues of the Greek state were €55bn, and real expenses were €63bn. That’s a primary deficit of €8bn, excluding any debt-related or charitable transfers. Primary revenues have since fallen, due to the damage done by austerity, but I don’t know what would be accurate figures today. I doubt accurate figures exist. And yet, what Greece should do is based on these numbers:

Promise to run a surplus to pay off debt: Greece can take the troika package which allows it to run a deficit for 2-3 years and impose a haircut on private bond-holders (including individuals and pension funds). However Greece is then supposed to run a primary surplus and start paying off debt. This is unlikely ever to work. Most likely Greece will end up with a shrunk, depressed economy and unable to run a surplus save by wholesale economic destruction. It will likely also be be bound, without transparency or mandate, into clauses that force it to surrender its assets.

Default within the Euro: Greece can at any time suspend bond payments and, since it won’t be able to borrow, cut spending abruptly and run a balanced budget. This is the “zero” option, and it’s the right option. The earlier Greece does this the better. If Papandreou had any integrity he should have taken this option three years ago. In any case, as soon as Greece cuts enough to balance its budget, this option becomes preferable. Greece can perfectly well stay in the Euro and in the EU, and negotiate with creditors after such a default. It’s like Chapter 11 bankruptcy, on Greece’s own terms.

Leave the Euro and devalue: Greece can shut its economy over a weekend and issue some new national currency. There will be economic chaos for a few weeks, and then Greece will devalue the new currency a lot, becoming once again a low-cost place to live or go on holiday. iPhones will be expensive and tomatoes will be cheap. The Greek state will be able to run a small deficit indefinitely, borrowing from the people. This is palatable, but doesn’t match peoples aspirations to be connected to the world and have iPhones.

So Europe has to wake up to the idea that it needs to set up a real economic union, like the US, with a real central bank handling sovereign debt, with transfer payments between states, and with bankruptcy protection mechanisms. Greece has to suspend bond payments and balance its budget sooner rather than later, and in doing so press the EU in the direction that it needs to go.

Germany’s economic architecture for Europe, and the troika plan for Greece, are ruinous respectively. These are insane options. The protectionist option of regressing to national currencies is comfortable but doesn’t improve matters in the long run. The Euro was created to let the Eurozone compete with the US and other large economic zones. This is good. It works. Abandoning the Euro serves interests such as the US or UK, but not Europe.

The political debate that should be happening all over Europe, but isn’t, is why should the whole zone pursue a monetary policy that only Germany likes – and only a narrow segment of German capital at that. Italy or Spain aren’t helped by the monetary policy that the ECB and the Euro currently pursues. You could say that therefore the Euro is bad, but that’s plainly disingenuous. It’s like criticising the car because the driver is heading to the wrong place.

The people of Europe need to make a union that serves everyone’s interests in balance, not declare that that such a thing is impossible and abandon the union that we have. With respect to the Euro, it does mean one monetary policy for everyone, just as in the United States. That monetary policy needs to be politically steered to meet the needs of all economies, and right now that would be a more growth-oriented, moderately inflationary policy.

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