Greece: Last Exit To Nowhere?

“Some economists, myself included, look at Europe’s woes and have the feeling that we’ve seen this movie before, a decade ago on another continent — specifically, in Argentina” – Paul Krugman: Can Europe Be Saved

“Think of it this way: the Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling.”
Paul Krugman – How Reversible Is The Euro?

Krugman is certainly right. Looking over towards Athens right now, you can’t help having that horrible feeling of deja vu. Adding to the uncomfortable feeling of travelling backwards rather than forwards in time (oh, I know, I know, when history repeats itself it only piles one tragedy onto another) is the uncomfortable presence of Charles Calomiris, a US economist of Greek origins. I can still remember reading, back then in the autumn of 2001, an article by the then Argentine Economy Minister Domingo Cavallo published in the Spanish newspaper El Pais which proudly proclaimed that everything was going well, and that the country’s reforms were being generally well received with the regretable exception of “a small number of neurotic US economists who continue to insist that we will default and break the peg”. He was, of course, referring to Calomiris, and at the time we were only a matter of weeks away from the dramatic moment when Adolfo Rodríguez Saá (the man who was President for a mere 8 days) would enter both history and the Argentine parliamentary chamber to utter the now immortal phrase “vamos a coger el torro por los cuernos” (we are going to take the bull by the horns). A phrase which was obviously belonged to the class of so called Austinian performatives, since at one and the same time as uttering it he effectively ended the peg. Well today Calomiris is again with us, and he is still hard at work going through the numbers, only this time round he is using his special insights to scrutinise his family homeland, for which he is prophesying not only eventual default, but also the generation of sufficient contagion to bring the whole Euro project itself to an untimely end. In an article in Foreign Affairs entitled “The End Of The Euro”, he tells us:

Europe is living in denial. Even after the economic crisis exposed the eurozone’s troubled future, its leaders are struggling to sustain the status quo. At this point, several European countries will likely be forced to abandon the euro within the next year or two….The only way out of this conundrum is for countries with insurmountable debt burdens to default on their euro-denominated debts and exit the eurozone so that they can finance their continuing fiscal deficits by printing their own currency. Here’s a hint for Europe’s politicians: If the math says one thing and the law says something different, it will be the law that ends up changing

Really, I don’t think of Calomiris as a prophet (or even as a Cassandra), I don’t even think of him as an especially insightful economist when it comes to the macro problems of the real economy, but I do think he has one exceptionally strong merit: he can do the math, and as he says, if it gets down to a battle between legal details and arithmetic, arithmetic will always win.

Easy Said & Easy Done, Down the Argentina Path We Go!

As it happens, the issue of Argentina as a reference case for Greece has surfaced again this week, in the form of an Op-ed in the New York Times by the co-director of the Center for Economic and Policy Research Mark Weisbrot.

Weisbrots’s argument is not new, but it is different, not only because he thinks Greece would be better off leaving the euro (many economists share that opinion), but because of the apparent eulogy he makes of the Argentine case.

“For more than three and a half years Argentina had suffered through one of the deepest recessions of the 20th century……Then Argentina defaulted on its foreign debt and cut loose from the dollar. Most economists and the business press predicted that years of disaster would ensue. But the economy shrank for just one more quarter after the devaluation and default; it then grew 63 percent over the next six years. More than 11 million people, in a nation of 39 million, were pulled out of poverty”

.

Now these are strong claims. But let’s leave aside the issue of whether or 11 million people were pulled out of poverty or not, and dig a bit deeper into what actually happened in Argentina, and let’s do this by comparing it with another country, one which arguably has similar social and economic development characteristics, Chile (see chart above). At the turn of the century Chile had a population of more or less 15 million, as compared with the 39 million Argentinians mentioned by Weisbrot. Now in 1998, just before Argentina entered its depression, Chilean GDP was some 79 billion dollars, while Argentina’s was 299 billion dollars. Now let’s fast forward to 2010, Argentina’s GDP at the end of last year was 370 billion dollars, and Chile’s 203 billion. That is to say, between 1998 and 2010 Argentina’s GDP (as measured in dollars, we’ll come back to this) increased by 24%, while Chile’s increased by 156%. As they say in Spanish “no hay color” (there is simply no comparison). Especially when you take into account when that Chile has only 38% of Argentina’s population, while it has 55% of Argentina’s GDP. So over the 12 years between 1998 and 2010 Chile (which maintained a floating currency throughout) evidently did a lot better than Argentina (despite Argentina’s abandonment of the float). And here’s another relevant piece of information: between 1998 and 2010 the Argentinian price level rose by 143%, while in Chile the price level rose over the same period by 48%.

So why use USD as the measure of comparison? I do this since it gives the most convenient yardstick evaluation (euros would do equally well) of the relative external values of the two economies. This is important, since Argentina apparently high growth levels have been also associated with high inflation levels, which have been constantly compensated for by devaluing the peso. In fact Bank of America Merrill Lynch currency strategist – and former IMF economist – Thanos Vamvakidis makes an essentially similar point (although with different conclusions) in a research note covered recently by FT Alphaville’s Tracy Alloway:

“In our view, …(the results of our study)…. point to the conclusion that exchange rate devaluations do not lead to permanent competitiveness improvements in rigid economies, such as in the Eurozone periphery. In this context, tail risk scenarios about EUR exit are misplaced. Structural reforms are the best bet to improve the periphery’s growth prospects, within or outside monetary union”.

Does this whole debate sound familiar to anyone? Anyone remember when Italians were paying themselves in million lira notes? In fact, it was precisely to break the Southern European countries from the high inflation, high interest rates, periodic devaluation dynamic that the Euro was thought to be such a good idea in the first place. It hasn’t worked as planned, but that doesn’t mean that the most traditional and the most simplistic solutions are necessarily going to be the best ones.

On the other hand, does this mean we should then go on to dismiss the coming out of the euro option out of hand for Greece? Evidently not. Let’s look at another comparison, this time Argentina and Turkey.

Now in 1998 Turkey had a dollar GDP of $269 billion, and by 2010 this had become $742 billion. That is it had nearly tripled. Yet Turkey’s dollar GDP dropped sharply in 2001 following a substantial devaluation of the Lira. Conclusion, competitive devaluations are sometimes useful, so what makes the difference?

Well Paul Krugman got near to it, when he said in his article on Weisenbrot’s proposal:

“Greece, as a relatively poor country with a history of shaky governance, has a lot to gain from being a citizen in good standing of the European project — concrete things like aid from cohesion funds, hard-to-quantity but probably important things like the stabilizing effect, economically and politically, of being part of a grand democratic alliance”.

We can sum the essence of all this up in a couple of phrases “institutional quality” and “structural reforms”. Or put another way, Turkey devalued as part of an IMF programme (it was actually recommended, in the days before the heavy hand of the EU took management control at the IMF), while Argentina broke the peg and devalued in order to get out of one. Turkey was not only able to benefit from the reform pressure instigated by the IMF (the stick), but also by the promise of EU membership under certain conditions (the carrot). Indeed, curiously, EU cultural reservations about Turkish membership have probably lead to far stricter reform hurdles than were either applied to the current members in the South or the East, and Turkey is undoubtedly the great beneficiary of this strictness.

Which brings us to the main point: should Greece leave or not leave the Euro? Well, let’s go back to something Krugman said in another blog post (How Reversible Is The Euro):

“Think of it this way: the Greek government cannot announce a policy of leaving the euro — and I’m sure it has no intention of doing that. But at this point it’s all too easy to imagine a default on debt, triggering a crisis of confidence, which forces the government to impose a banking holiday — and at that point the logic of hanging on to the common currency come hell or high water becomes a lot less compelling.”

or as he argues in his latest post:

“That said, Weisbrot is right in saying that the program for Greece is not working; it’s not even close to working. At the very least there must be a debt restructuring that actually reduces the debt burden rather than simply stretching it out. And the longer this situation remains unresolved, the less hope I have that Greece will be able to stay in the euro, even if it wants to”.

The present situation is unworkable, and unsustainable, not only because the accumulated debts are unpayable by Greece alone, but also because the tiny size of the manufacturing industry Greece has ended up with and the general lack of international competitiveness of the Greek economy make an export-lead growth process with the present state of relative prices virtually impossible. There are solutions to both these problems consistent with remaining within the Eurone and without default – issuing Eurobonds to accept part of the Greek debt and enforcing a substantial internal devaluation to restore external competitiveness, for example – but since the adoption of these two strategies is virtually unthinkable given the current mindsets in Brussels, Frankfurt, Berlin and Madrid then we are more or less guaranteed to find ourselves facing some kind of Greek default, and given that the programme as it stands isn’t working (this is where the situation so resembles pre-default Argentina as the extent of the fiscal correction means the economic contraction feeds on itself given that exports cannot expand fast enough to counteract the decline in government spending and domestic consumption), it would be strongly advisable to accompany this default with some sort of devaluation.

Put another way, if the most valid argument against going back to the Drachma always was that this would imply default, now that default is coming, why not allow Greece to devalue? As Krugman says, the issue isn’t whether Greece would openly decide to exit the euro, the issue is what happens if the markets force this solution on Greek and European leaders against their will? Given the programme isn’t working, the likelihood of this kind of event occurring in the next 2 or 3 years is far from being negligible, so why not be proactive rather than always relegating ourselves to being reactive? What matters is whether Greece becomes Turkey (oh, what a historical irony) or Argentina. If the powers that be can agree on an ordered restructuring of Greek debt, and a controlled exit from the Eurozone, then Greece has some possibilities of turning the situation round. If exit is forced on Greece in order to escape the clutches of both the EU and the IMF then the move will be, as I suggest in my title, simply the last exit to nowhere. And especially in a historic context of ageing populations and rapidly rising elderly dependency ratios, ratios which will only rise further if thousands of young people exit Greece in the search for work elsewhere, as young Argentinians did in 2002/3. That’s another difference most people who make this comparison don’t mention: when Argentina devalued the country still had a fertility rate which was slightly above replacement level. Greece has just had more than 30 years with a total fertility rate in the region of 1.3. So while Argentina could look forward to years of demographic dividend and rapid “catch up” growth, if things go wrong Greece can only look forward to an ever older population and ongoing social and economic decline.

The tragi-comic events surrounding the fate of IMF Director General Dominique Strauss Kahn may well mean that we are about to see significant changes in that organisation. It is to be hoped that, if this is the case, such changes will also involve a rethink of the IMF’s role in Europe’s crisis, and in particular of the objectives and means of implementation of the Greek programme, with the Fund moving towards a less-eurocentric and more balanced position, one which would be in the collective interest of the community of citizens of the wide variety of countries the institution represents.

This entry was posted in A Fistful Of Euros, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

19 thoughts on “Greece: Last Exit To Nowhere?

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  2. I don’t understand your argument. Suppose Greece defaults. How would it then benefit from devaluation?

    “the tiny size of Greek manufacturing industry and the lack of international competitiveness of the Greek economy make an export lead growth process with the present state of relative prices virtually impossible”

    Is it written somewhere that countries can only export manufactured goods? Also, again given you are talking about a default, why does Greece need exports?

    Lastly, you do realize that “Greece becoming Turkey” is an absurd proposal. Greece’s GDP would have to go down by about 2/3 for this to happen.

  3. You make an argument but I really don’t understand how the mentioned Argentina comparisons are supposed to support it. There is a widespread notion that EU institutions act only out of stubbornness and just don’t want to admit defeat for their precious euro. This is a very simplistic approach. If Greece leaves the euro there will certainly be serious and quite unpredictable ramifications. There is actually a strong likelihood that Greece will be worse off and the historical paradigm of Argentina is neither completely applicable nor a guarantee for success. Care to discuss or even consider some of the things that could go wrong if you all got your wish?

  4. SG,

    “I don’t understand your argument. Suppose Greece defaults. How would it then benefit from devaluation?”

    If it only defaults, as envisaged (for example) as envisaged in the new bailout mechanism planned for 2013 and beyond, this won’t change the underlying economic reality of a totally distorted economy which finds it difficult to grow. Indeed the situation can become worse, as credit will be difficult to obtain, and interest rates high.

    Devaluation, Turkish, not Argentinian style can push start the economy, and help the manufacturing sector to grow. So my argument is either to do both things at once, or accept that the Euro experiment didn’t work between 2000 and 2008, and that all EU institutions (plus the ECB) have some part of the responsibility. Hence we share the lossses via the issuing of Euro Bonds, and in return Greece accepts the need for a difficult internal devaluation to get growth back. But since no one, apart from a few internationally renowned macro economists, is convinced of the desireabilty of the latter course, realism leads me to think we will be forced (possibly kicking an screaming) down the former one. In which case I am simply arguing, via the comparison between Argentina and Turkey that orderly default and devaluation are better than the disorderly version. I stress, I am not chosing this path, it is the majority consensus opinion that rules out Euro Bonds and internal devaluation that is (de facto) going for that solution, since that is where the continuing application of current policies will inevitably lead.

  5. SG,

    “Is it written somewhere that countries can only export manufactured goods? Also, again given you are talking about a default, why does Greece need exports?”

    No it isn’t, but show me a country that is paying its way only by exporting services? I think that model doesn’t work, and in any event, you have to look at the skill profile of Greece’s over 50 population. We are not talking about a group of people with the kind of skills to compete will India’s fast growing IT sector, for example, or with Brazilian initiatives in biotechnology. In volume terms these populous emerging market economies have large numbers of highly qualified young people. What countries on Europe’s periphery need is work, working for large numbers of relatively low skilled people in export oriented economies.

  6. SG

    “Also, again given you are talking about a default, why does Greece need exports?””

    Oh, that’s very easy, this is simply an accounting issue. After years of running a very large current account deficit (15%) much of Greek debt is external. Even defaulting you don’t reduce that to zero, you just give it a so called haircut. You need to default becuase given realistic growth expectations and the pending liabilities associated with a rapidly rising elderly dependent population you cannot realistically pay it down (you could of course simply default on your elders rather than on bondholders, but some would call that the end of the welfare state, and I am NOT advocating that).

    But if you get growth back you can pay some of it, and that is what the negotiations will be about. Where to draw the line. Paying it back involves exports becuase to have the outflow on the financial account you need a surplus on the current one (look for example at Germany).

    Of course, you can pay some of it back by getting a CA surplus by reducing and reducing imports (see my recent “Greek GDP mystery” post) but there are limits to this, and it is associated with a very severe compression of living standards, which most people consider to be rather undesireable.

  7. SG,

    “Lastly, you do realize that “Greece becoming Turkey” is an absurd proposal. Greece’s GDP would have to go down by about 2/3 for this to happen”.

    Look, I’m not sure you are saying this seriously. I am not suggesting Greece bring their per capita income to Turkish levels, what I am proposing is that Greece (after Euro exit) follow the Turkish model and not the Argentina one. That is to say that Greece really bite the bullet of making substantial reform in the same way Turkey has. Maybe one day they could then come back into the Euro (assuming it was still there). Otherwise they are doomed.

  8. Beta 42

    “You make an argument but I really don’t understand how the mentioned Argentina comparisons are supposed to support it.”

    If you don’t mind my saying so, I don’t think you have read the article carefully enough.

    “There is actually a strong likelihood that Greece will be worse off and the historical paradigm of Argentina is neither completely applicable nor a guarantee for success”.

    In fact this is exactly what I am saying, and why I disagree with Weisenbrot when he uses Argentina as a role model. I am arguing for the Turkish model.

    “If Greece leaves the euro there will certainly be serious and quite unpredictable ramifications”.

    Of course, and I don’t underestimate these at all. What I think Krugman and I are saying is that the current programmes are not working, and that the Euro is gradually entering a systemic crisis which could see Greece forced out by the markets in totally undesireable circumstances. All it takes is for capital flight to set in and the government be forced to call a banking holiday. This nearly happened in Ireland incidentally, which is why the ECB forced the central bank to accept the bailout and pressure the government to do likewise.

    So what I am arguing is to do something BEFORE this happens, to try to lessen the consequences.

  9. “I am not suggesting Greece bring their per capita income to Turkish levels, what I am proposing is that Greece (after Euro exit) follow the Turkish model and not the Argentina one.”

    And what I’m saying is that your analogy with any of the two is a failing one, just looking at GDP should suffice to know this, but you can look at a whole array of data if you prefer. And I think analysis derived from such a bad analogy permeates your entire argument.

    “If it only defaults, as envisaged (for example) as envisaged in the new bailout mechanism planned for 2013 and beyond, this won’t change the underlying economic reality of a totally distorted economy which finds it difficult to grow. Indeed the situation can become worse, as credit will be difficult to obtain, and interest rates high.
    Devaluation, Turkish, not Argentinian style can push start the economy, and help the manufacturing sector to grow.”

    So if default is so bad, why should Greece ever choose it? But let’s leave this aside for now, what facts lead you to believe that Greece has a totally distorted economy? Not only that, but an economy that needs more manufacturing?

    “I stress, I am not chosing this path, it is the majority consensus opinion that rules out Euro Bonds and internal devaluation that is (de facto) going for that solution, since that is where the continuing application of current policies will inevitably lead.”

    inevitably, unless we have Euro bonds and an internal devaluation. Agreed. So we should be pushing for the obvious solution then!

    “show me a country that is paying its way only by exporting services?”

    the UK? the US? Depends what you mean with “only by”. Actually I think it is flawed to think of Greece as a country, and not a US state for example. Florida is the perfect example of a services state and I can’t see why Greece should not be like Florida.

    “you have to look at the skill profile of Greece’s over 50 population. We are not talking about a group of people with the kind of skills to compete will India’s fast growing IT sector, for example, or with Brazilian initiatives in biotechnology.”

    You know what is the unemployment rate for this age group in Greece? The idea that Greek 50 year olds need to work in manufacturing would strike most Greeks as very strange, including the 50 year olds themselves.

    “What countries on Europe’s periphery need is work, working for large numbers of relatively low skilled people in export oriented economies.”

    Or they could do what they usually do, working in the professions, managing small businesses in trade, tourism etc

    “Even defaulting you don’t reduce that to zero, you just give it a so called haircut.”

    I thought you actually meant a default, not restructuring etc

    “Paying it back involves exports becuase to have the outflow on the financial account you need a surplus on the current one (look for example at Germany).”

    I don’t get it. Who said you need to pay it back? Assume public debt is cut to 90% of GDP. That is a perfectly stable position if the deficit is equal to the growth in nominal GDP. With nominal GDP growing at something like 5% (which the Greek economy exceeded consistently virtually every year since 1996!) and an interest rate of about 5% you don’t even need a primary surplus!

    Also, you have to differentiate between public and private debt in Greece. The state is basically insolvent, Greek private citizens on the other hand are in principle among the most solvent in the West (unless the recession continues much longer). They could easily keep borrowing to fuel growth. But this can only happen if the fiscal situations stabilises and the banking sector is freed to resume operations.

  10. Devaluation solves nothing; it is just a recalibration of the underlying problem. The costs are still there. We have simply changed the scale. It is like replacing Fahrenheit with Celsius and hoping that would make the winter milder.

    Sweden tried to devalue its way out of trouble three times in the 1980s. That left the country with a property market and a banking system in ruins and three years of solid recession. After that Sweden changed stance and solved the fundamental costs crisis by making its labour market and goods and services fundamentally more competitive, rather than just relatively “cheaper” for a little while.

    Isn’t that the long term solution for Greece, rather than just papering over the real problem with devaluation and default?

    http://wp.me/pMCV1-16

  11. Donald, Sweden devalued in 1992, and it was that devaluation that laid the basis for Sweden’s subsequent renaissance. Wolfgang Munchau on the topic:

    “The reason for this tectonic structural shift lies almost entirely in the real devaluation of the krona, the Swedish currency. After Sweden abandoned the peg against the ecu, the former European basket currency, in 1992, the krona’s effective real exchange rate depreciated by 30.7 per cent compared with today. The real devaluation of the krona provided Swedish export industries – electronics, heavy engineering, cars and trucks, forestry products, among others – with an invaluable boost to their competitiveness. The renaissance of Swedish manufacturing industry is not a tribute to the quality of Swedish management, as it is sometimes claimed in Sweden. It is a real devaluation story first and foremost.”

    http://www.ft.com/intl/cms/s/1/042da2f2-40e9-11db-827f-0000779e2340.html#axzz1N5f1HEFI

  12. Why do you compare Chilean and Argentinian growth since 1998, when the default and ending of the peg occured in 2001?

    As your graph indicates, Argentian growth has outpaced Chilean growth since the end of the “peg-recession”.

    Shouldn’t this be a data point in favour of Greece reintroducing the drachma and defaulting at the same time?

  13. Sir,

    I remember the devaluation 1992 very clearly. I also remember that fellow Swedes were still paying the bill 15 years later. Mr Münchau’s FT column is an opinion piece and causality is almost impossible to determine as we don’t know what would have happened without structural reforms and/or devaluation. I’m of the opinion that it is better to deal with the cause of the problem rather than the symptoms.

    After a devaluation the Greek retirement system still needs to be fixed, the Greek tax system still needs to be fixed. The Greeks have lived beyond their means (just like us Swedes had for decades) and have become accustomed to a standard of living they cannot afford. These are the issues that have made Greece uncompetitive. And that is the real issue, not the FX-rate. It is just the thermometer.

    Without a structural solution Greece will be in the same situation again and needs to devalue again, just as Sweden had to do three times during the 1980s. After a few of those the price to pay for Greece will be far higher than it would be today. That’s why many Swedes were still paying the bill 15 years later. Do we want that for the Greeks, or the German banking system for that matter?

    Isn’t it better to address the structural problems rather than just trying to lessen the symptoms through a devaluation and default? Or we run the risk of running out of plaster.

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