With the Greek economy contracting by 7 per cent per year, there is every chance that any cuts in debt now will be more than matched by a fall in national income. As a consequence, debt as a proportion of national income could just keep growing. The markets may be welcoming the deal now. But the only real test of whether there is a sustainable solution to the crisis is if Greece can borrow on the open market – without support and guarantees, and at interest rates that do not cripple the economy. Clearly we are a long way from that point.
Indeed, on current trends, a solution will never be reached unless Greece leaves the euro. According to the Heritage Foundation/IEA’s index of economic freedom, Greece is the 119th most-free economy in the world. This is comfortably above North Korea but on a par with India. Greece scores particularly poorly on labour market freedoms.
The real problem is that Greece is an outlier even within the EU. For example, an average of 70 per cent of 60-64 year olds in the EU do not work. But the figure reaches 80 per cent for the most indebted countries in Europe (including Greece). Southern EU countries have also proven unwilling to deal with shadow economies that make up between 20 per cent and 25 per cent of their national income. These are structural issues and their causes can be traced back to dysfunctional labour markets, high government spending and regulation.
And this cuts to the heart of the issue. I am not a fan of Keynesian solutions to economic problems. But when you have a country with rigid labour and product markets, and a fixed exchange rate, austerity alone is not the solution.
Yes, more debt needs to be written off, but the programme of Eurozone support should be stopped within six months. We must also see radical domestic reforms – over a decade or more. At the same time, Greece must be allowed to issue its own currency. This could be done with a minor treaty change that allowed countries to issue currencies in parallel with the euro, as long as the country also withdrew from the Eurozone’s decision-making mechanisms.
If this had been done two years ago – when I first proposed the idea with Alberto Mingardi – Greece might be a very different place today. But it is never too late to rectify a mistake. Exchange rate flexibility ensures that austerity in government can be delivered while the private sector recovers. Lower government borrowing then leads to a lower exchange rate. But changes to currency arrangements and can never be a long-term solution. Sustained and radical economic reform is crucial for the Greek economy to be revived.
This article originally appeared in City AM.