2 thoughts on “Greece – the conundrum of currency and institutions (Part 3)”

  1. Posted 30/01/2017 at 10:33 | Permalink

    You view the question of Greece’s membership of the euro largely in terms of the country’s need for institutional and moral reform: “Greece will need to put its house in order and create a modern state and solid institutions in order for the country to get back to a prosperous trajectory and the currency is not the single biggest dependency for it.”

    In my opinion, you are mistaken to do so.

    The question of Greece’s euro membership needs to be considered in its own terms. So too does the question of institutional reform in Greece. To conflate the two issues makes little sense. Indeed it begs the question why did Greece’s institutional shortcomings – obvious for decades – only become so pressing after it joined the euro? Answer: because it should never have joined the euro. Euro membership for Greece was wrong on its own, economic, terms and gravely aggravated the country’s institutional shortcomings.

    As far back as 1972, British Treasury official Derek Mitchell wrote a private note for his political masters on the implications of monetary union. Mitchell warned that “Full EMU would deprive member countries of many of the policy instruments needed to influence their economic performances and (particularly in the case of the exchange rate) to rectify imbalances between them. . . . In an EMU, equilibrium could only then be restored by inflation in the ‘high performance’ countries and stagnation in the ‘low performance’ countries, unless central provision is made for the imbalances to be offset by massive and speedy resource transfers.”

    The scenario that Mitchell depicted – of inflation in high performance countries and stagnation in low performance countries – is exactly what we face today. German residential property prices are soaring and unemployment there is at a 20-year low but Greece must endure economic depression.

    Greece needs to reform its institutions whether it remains in the euro or not. But it also needs to leave the euro, whether it reforms its institutions or not. The two questions are substantially separate and distinct.

  2. Posted 06/02/2017 at 17:02 | Permalink

    Thanks for your comprehensive reply – I appreciate your feedback and views.
    Indeed there is an argument for Greece to go out of the Euro and try to restore competitiveness through currency devaluation. A few arguments to consider based on latest experience would be:
    • Globalization has scattered supply chains all over the world much more than in the past. Therefore, in many cases to build different products producers need to import a number of materials/components from abroad. Currency devaluation makes those imports more expensive thus reducing the potential net positive impact of currency fall on margins and prices. Case in point, this morning (06/02) the British Chamber of Commerce published a survey which shows that the fall of the pound led to profitability margin compression for nearly as many businesses as those that experienced margin expansion. You could argue that if you devalue the local currency as much as e.g. 2/3s, margins and prices would have room for a healthy competitive adjustment, however the dynamics that would kick-in in that case, eg inflation, foreign debt servicing etc can be much more destructive in the mid-term than the competitiveness benefit (especially in countries with problematic institutions like Greece).
    • The point that Greece should have not joined the Euro in the first place is indeed a hard one to argue against. Bloomberg just a few days ago compiled an analysis with data from the European Union statistics office for the past 18 years (1998-2016). One of the key findings was that Italy’s GDP per capita over that period has shrank 0.4% in real terms. So Italy’s economy during the life of the Euro has broadly shrank – even Greece did better than that. Is it that Italy should not have joined the Euro in the first place too or maybe consider going out now? Similar arguments can be made for example on Spain’s structural unemployment, France’s GDP growth stagnation and so on. On the other hand, European countries have been growing and benefiting consistently from the single market up until the Euro area crisis.

    I am not familiar with Derek Mitchell’s perspective on the quote you mentioned. If he meant to predict that the current monetary union will eventually end up with “inflation in the ‘high performance’ countries and stagnation in the ‘low performance’ countries” by and large he got it right (although just Germany has shown signs of inflation trending towards the 2% ECB target only lately). But could you reach an equilibrium through this in practice? I think recent experience has shown that weaker debtor countries have plummeted in deep recessions instead of remaining stagnant which has led many people to question the European project overall.

    A monetary union without a fiscal and banking union has many flaws by construct. So, if the European model needs to be tweaked to work by definition, the question becomes not which of the countries should have not entered or which should consider to leave, but rather how we can create the conditions for the current Union to work for all countries and its people.

    Considering the above, I focused on the pre-requisites for Greece to get back to sustainable growth while remaining within the European Union. If you have in mind a comprehensive blueprint of the steps a European country can follow to successfully issue its own currency and at the same time dis-integrate from Europe and its institutions, I would be very interesting to explore it.

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