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If it won’t reform, then it should devalue

My Times column on Greece:

For an expert on game theory, Yanis Varoufakis, the Essex University-trained economics professor turned Greek finance minister, does not seem very good at negotiating. His style reminds me of the old joke about playing chess with a pigeon: it knocks over the pieces, craps on the board and struts about claiming it won.

Mr Varoufakis and his prime ministerial colleague, Alexis Tsipras, have annoyed the Germans, accepted a new four-month bailout and agreed, as they said they would not, to supervision of economic reforms by the same old Troika of the European Union, European Central Bank and International Monetary Fund. And yet Mr Tsipras claims that they have won “a battle, not the war”.

It is still just possible that today’s deadline for the Greek government to come up with a fresh list of reforms may vindicate Syriza, because they have at least won a single big concession: that the Greeks get to propose a different set of reforms this time. Syriza’s case is that it can come up with a restructuring of the Greek economy that would work better than the disastrous austerity-to-no-purpose that has happened so far.

Mr Varoufakis is on record that he thinks in some areas the previous austerity was not radical enough to encourage business investment. He wants to “bail in” creditors by swapping their loans for GDP-linked bonds, which will not pay out till growth resumes, giving them incentives to encourage growth rather than just repayment. He has also promised indefinite fiscal surpluses and reform of the corrupt tax system.

All that sounds good but given that Syriza has also promised a return to collective bargaining, a cancellation of privatisations, an increase in the minimum wage and further growth in the already bloated public sector, the promised reforms are going to have to be very good indeed.

For if they are not — and the headlines are to be agreed this week, the details by the end of April — it looks increasingly as if the rest of Europe is now almost resigned to seeing Greece drop out of the euro. Syriza seems to have spent a lot of its political capital to achieve not very much and its hand is now weak. What has changed since the euro crisis of 2011 is that the other countries have started to turn things around and have little sympathy for Greece, which failed to take its medicine.

Ireland, for instance, cut civil servants’ pay by 5 per cent for the low-paid and 20 per cent for the high paid, slashed spending and is now growing so strongly its economy will soon be larger than it was in 2008. Portugal, Slovakia and even Spain are heading in the right direction — if bumpily — after the pain of “internal devaluation”. With radical parties like Podemos in Spain ahead in the polls, these countries do not want to see Syriza’s special pleading getting Greece a softer deal.

Of course, all these countries would have recovered more quickly if they had not been in the torture-prolonging mechanism that is the euro. Iceland and Latvia demonstrate that all too well. Both had terrifying plunges into recession and insolvency in 2008, but both devalued their currencies, cut their budgets and are now booming again – albeit with capital controls in Iceland and reliance in Latvia on remittances from a diaspora abroad. Latvia has since joined the euro. There’s no accounting for taste.

Lacking the devaluation option has hampered the recovery of Greece and the other Mediterranean countries, just as joining the euro encouraged them to go on an even bigger binge of spending cheaply borrowed money in the first place. Outside the euro, with its German-dominated interest rates, they would not have been able to have such a party and would have suffered less of a hang-over.

But having your own currency is no panacea as much of Latin America has spent the past century demonstrating — and as Greece showed with its repeated defaults when using the drachma. Only with the help of undisclosed swaps from Goldman Sachs was Greece able to join the euro in the first place.

Even Greece was beginning to see signs of growth in recent months — until the election of Syriza. Now, with a lot of capital having flown, Greek banks may be effectively bust when they open tomorrow if there is no deal. That means that Syriza has to come up with genuinely credible reforms or drop out of the single currency and into chaos. Grexit is just as close as ever, perhaps closer.

Some think the Germans have effectively signalled that they are not bothered if Greece leaves the euro, but it pays never to underestimate the Germans’ capacity for guilt-driven forbearance (is there a word for the opposite of schadenfreude?). Some in the higher echelons of the German establishment believe its economy could afford to support Greece as a basket case indefinitely, just as it did East Germany.

The euro might now survive Grexit, and might even look stable for a few years until the next crisis. Inch by inch, despite German resistance, the eurozone is turning into a state with pooled debts. You can see this happening already. In 2012, the ECB began buying sovereign bonds from the stressed parts of the euro zone. That, more than anything, is why Spanish and Italian debt yields have dropped.

If so, the Germans could eventually come to accept some form of debt pooling: fiscal transfers to the poorer parts of the eurozone will become less necessary if and as those countries reform and learn the lesson that it is not possible to have German standards of living without German productivity. In Spain, unit labour costs have come down from their absurdly inflated highs in 2007, when Spanish workers were effectively being paid three times as much as Germans per unit of output.

In short, the eurozone is at last imposing the economic discipline it should have insisted on at the outset and will either fail or become effectively a country. Over the next few years, Croatia, Hungary, the Czech Republic and Romania are all set to join the euro, leaving Britain much more isolated in the non-euro EU. All the more reason for us to leave the political arrangements of Brussels and become a member of the European Economic Area, the economic union, instead. But that’s another story.

By Matt Ridley | Tagged:  rational-optimist  the-times