Greece is approaching the climax of its crisis, and its choices will influence the course of Europe for years. Although Greece represents only 2% of the European Union’s GDP, the impact of those choices will be wide.
The Greek crisis is fundamentally the result of its membership of the eurozone. Greece is paying the price for a belief in the ancient fallacy that possessing “hard” money puts a weak economy on a par with the strong. In reality, “hard” money is more likely to destroy a weak economy, a lesson about to be re-learned in Portugal, Ireland and Spain. Greece is heading for an exit from the euro and the rest of the eurozone periphery is likely to follow, with severe implications for the monetary union. Coping with an exit will require the reintroduction of economic controls, a major retreat from the neoliberal, pro-market approach to economic policy.
The Economic and Monetary Union (EMU) is often presented as a political step in the integration of Europe, a demonstration of solidarity among Europeans. The reality is quite different. The euro is an international reserve currency that can compete against the dollar and serve, first and foremost, the interests of big banks and enterprises in Europe. It is a peculiar form of money, created from nothing by a hierarchical alliance of independent states.
There are two fundamental problems with the construction of the euro, reflecting its peculiar make-up and leading to its failure. The first is the contradiction between monetary and fiscal policy. The monetary space of the EMU is homogeneous, and the European Central Bank (ECB) allows banks to borrow against the same interest rate benchmarks. But the fiscal space of the EMU is heterogeneous, and each state ultimately exercises sovereignty in collecting taxes and spending. The union has attempted to deal with the problem by imposing fiscal discipline via the Stability and Growth Pact, or the much harsher Fiscal Compact. But national sovereignty over fiscal matters has not been abolished.
The second problem is a much less noticed but equally severe contradiction: the monetary space of the EMU is homogeneous but its banking space is heterogeneous. There is no such thing as a “European” bank, only French, German, Spanish and other banks. Even though banks can obtain liquidity from the ECB in the “European” space, they are obliged to turn to their own state when their solvency is in doubt. Banks operate with transnational money, but they are ultimately national.
At the root of both problems lies the absence of a unitary or federal European state. Europe remains a continent of nations overlaid with an economic structure that pretends nations do not matter. Yet nation states have remained integral to the EMU. This reality is fundamental to the eurozone crisis and makes its resolution very hard.
Loss of competitiveness
The true cause of the eurozone crisis is cumulative loss of competitiveness by peripheral countries, not fiscal indiscipline. Germany has won the competitive race within the EMU by keeping its unit labour costs almost flat for nearly two decades. This has led to large current account deficits for the periphery, mirrored by large German surpluses. The deficits were financed for many years by cheap credit because of lax ECB monetary policy, causing the vast indebtedness of the periphery. The peripheral states are to all intents and purposes insolvent.
The EU has attempted to fix this with bailout loans. It has also imposed austerity and structural adjustment leading to wage reductions and the crushing of unit labour costs in the periphery. The shift has been violent, particularly in Greece, and the attendant social costs have been enormous. But the policy is hopeless since German costs have remained flat: peripheral countries would have to decrease wages without limit to claw back competitiveness and begin to catch up with Germany. The most likely outcome would be social explosion and the collapse of the eurozone.
The policy failure means that peripheral countries are now even less capable of servicing their debts, and the longer the crisis has persisted, the closer banks have been drawn to their nation states to obtain capital, to secure emergency liquidity assistance and make loans. The banking space of the EMU has become more strongly national as banks have more closely embraced their nation states. The monetary union is disintegrating from within.
Disaster could be forestalled only by major reforms. They would have to include, at the very least, the equivalent of a Marshall Plan to raise productivity and competitiveness in the periphery. Redistribution would be necessary in Germany, with a significant raise in wages. There would also have to be debt forgiveness for the periphery as well as a system of fiscal transfers to ease short-term pressures. The financial system would have to be thoroughly revamped and an overarching European authority created to guarantee its solvency.
Heading for an exit
Not only are these enormous changes unlikely to happen, but for the periphery it is probably too late already. EMU disintegration has brought worsening social unrest and peripheral countries are heading for an exit, Greece first. The bailout policies have pushed the Greek economy into an unprecedented depression: cumulative GDP contraction during 2010-12 is likely to be about 20%, while unemployment might reach 25%. The impact on wages and pensions has been devastating and there is a humanitarian crisis unfolding in cities.
Aggregate demand is extremely weak as investment has been falling for five years and consumption is on a downward path; exports showed some dynamism in 2010-11 but have hit a ceiling in 2012. The debt restructuring in March offered only minimal relief, and public debt remains insupportable in the long run. The troika of the EU, the IMF and the ECB demand further public expenditure cuts of €11-12bn for 2013-14 to achieve a substantial primary surplus. (Those whom the gods wish to destroy, they first make mad.)
The destruction caused by “hard” money has spread unevenly across Greek society. The ruling elite has suffered minimal damage, while the impact on wage labour has been devastating. Farmers have also been badly affected, but the gravest threat to social and political order has come from the demise of the middle class, including small and medium businesses, the self-employed and public employees. Not surprisingly, there has been persistent unrest and opposition to the austerity policies, including mass strikes, rallies, civic disobedience and a refusal to pay (tolls, official fees).
The May elections have shown that Greeks overwhelmingly oppose bailout policies, yet wish to stay in the EMU. The country is splitting into two political camps, one coalescing around the rightwing New Democracy, the other around the leftwing Syriza. New Democracy attracts those who have escaped the worst of the crisis, including the ruling elite; Syriza is fast becoming the mass party of wage labour and the impoverished middle class.
Both camps insist that they would like to stay in the EMU, but political instability is intensifying the pressure to exit. Unfortunately, it looks as if Greece will exit in chaotic conditions, and the trigger might be a bank run as depositors finally crack. But the basic elements of an exit are clear.
The first step would be to denounce the terms of the bailout agreements and default on the debt. Greece needs to get out of the vice of austerity, and it must stop chasing its tail by seeking to service an insupportable debt. Greece needs to take over the decision-making process, to confront the crisis and reshape its economy. It then needs to write off debt through an aggressive process, with an audit commission to examine the odiousness, legitimacy and social viability of the debt.
Default ought to be followed by reintroduction of the drachma, suddenly, probably over a weekend, with a short bank holiday. It would be necessary immediately to impose capital controls. The change of currency would cause a storm with monetary, banking and commercial aspects, which should be kept separate as far as possible.
There would be simultaneous use of the drachma, the euro and probably other forms of fiat money issued by the state. This would mean altering the accounting systems of banks and changing the denomination of contracts, which would cause a wave of litigation. The banks would be unable to support their balance sheets as some assets and liabilities issued under non-Greek law would remain denominated in euros. Banks would also lose access to ECB liquidity and would be hit by losses on defaulted public debt, so it would be necessary to nationalise banks immediately, issuing a blanket guarantee for drachma deposits; state guarantees should also be used to support private enterprises exposed to foreign debt. The capacity of the Bank of Greece to generate drachma-denominated liquidity should be re-established immediately.
On the commercial side, the exchange rate of the new drachma would collapse. In the short to medium term a falling exchange rate would boost competitiveness, allowing Greek goods and services to recapture the domestic market as well as expand exports. This is a vital step in reviving the Greek economy and strengthening employment. But in the very short term, there would be shortages of goods in which there is a trade deficit, including oil, medicine and some foodstuffs. It would be necessary to manipulate the exchange rate and use administrative measures to tackle the problem until the current account balance recovered.
The short-term shock of exit is part of the cost of escaping from the trap of the EMU. Greece would subsequently need an extensive programme of redistribution of income and wealth as well as industrial policy to steer its economy towards long-term growth. It would need to restructure its state, cleansing it of corruption.
A Greek exit would be a major event, probably opening the way for other peripheral countries to leave the EMU. The attendant changes would seriously damage the neoliberal institutions and ideology currently dominant in the EU. It is impossible to tell whether the euro would survive, but there is no doubt that Europe would face enormous costs, entering a period of turmoil with unclear outcomes. Much would depend on the organisation and self-confidence of the social layers that have taken the brunt of the failed experiment of “hard” money. But there is no reason why Europe could not move towards growth, with an alternative narrative of unity.