By Matias Vernengo
The referendum that just took place in Greece in which 61.3% of voters rejected the terms of an international ‘bailout’ package should not be read as a vote in favour of leaving the euro. The ‘No’ vote – όχι in Greek – is, as correctly pointed out by James K. Galbraith, the only hope for Europe. On the other hand, it may very well be used by the Troika – the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF) – as an instrument for expelling Greece from the monetary union. If that happens, we have a Grexpulsion and not a Grexit, the more common name for the abandonment of the euro. After all, it is very clear that SYRIZA knows that the costs of leaving the euro may very well outweigh the advantages, and that Greece is not Argentina, as noted by its Finance Minister Yanis Varoufakis recently.
The relationship between West European powers and the Greek Left has been problematic for a long while. In the aftermath of World War II, the British and then the Americans, sided with collaborationists, rather than with the resistance, which had communist leanings, and was seen potentially allied to the Soviets. As Tony Judt says of Greece in Post-war: A History of Europe Since 1945, “despite a significant level of wartime collaboration among the bureaucratic and business elites, post-war purges were directed not at the Right but the Left. This was a unique case but a revealing one.” The British and Americans preferred a conservative government, even if it meant dealing with businessmen who had collaborated with Fascists, rather deal with a communist or socialist threat.
What has been at stake since the election of SYRIZA – a left-of- centre party with no ties to the old and more traditional left (i.e. the Socialist party, PASOK) – is exactly that: a struggle of power between groups within Greece that want to collaborate with European institutions even at the cost of continuing to impose its failed policies, and the possibility of a new, reformed integration with Europe. What has been missed in most discussions in the Western media is that SYRIZA is not against Europe, and not even against the euro, the badly designed common currency that has caused so much pain in the European periphery.
What Caused the Greek Crisis
But before we get to the results of the referendum and what can be expected now, it would be important to briefly understand why the crisis occurred in the first place. If you believe the Troika, the crisis results from a Greek government, not the current by the way, that spent too much, lied about it, and accumulated too much debt. The European institutions are just trying to get their money back, and that is why austerity is necessary. The crisis, according to them, is fiscal in nature.
While it is true that the previous government had fudged some of the numbers, and that some of the spending, in particular the military spending, was superfluous, it is hard to agree that the crisis in Greece was fiscal in nature. Neither the size of the deficits or of the debt, nor the relative size of the public sector in Greece, could account for the dimension of the crisis. Even now, Greek debt at about 317 billion euros represents only about 2.3 percent of the EU’s Gross Domestic Product (GDP), or 3.1 percent of the Eurozone GDP. What is essential in the Greek story is that the debt is in an essentially foreign currency.
Monetary unions usually occur after a more organised political and fiscal union has taken place. The big difference in those cases is that there are two mechanisms by which sub-national units can function in a currency union without being forced to limit their ability to spend. First, there are significant intra-state fiscal transfers, and more importantly direct federal transfers. For example, according to The Economist, the state of Mississippi received in a 20-year period (1990-2009) more than 250 percent the size of its own 2009 GDP. That is an average of almost 13 percent of its GDP per year. Further, central banks can continue to provide liquidity to banks in sub-national units, avoiding localized runs and maintaining the stability of the financial sector. The euro has none of these characteristics. Not only is the size of inter-European fiscal transfers insignificant, in comparison to transfers within countries with fiscal unions, but the ECB also cannot buy bonds from member countries. The latter would allow countries in difficulty to borrow at low rates of interest. And although it could provide liquidity to banks in member countries, the ECB has not pursued this policy option.
Lack of Liquidity
The crisis, then, was not caused by excessive spending per se, but by the inability of the system to provide liquidity to the banking sector of member countries in periods of crisis. So much so that countries with no fiscal problem, like Spain, also suffered after the 2010 crisis, and were forced to adjust, leading to a hard-hitting recession and ballooning unemployment. In other words, after the global crisis started in the United States, followed by the global recession, the liquidity problems of the financial sector in the European periphery led to higher interest rates, which the ECB did not promptly eliminate by buying bonds. This led to liquidity problems in the national banking sectors, that were absorbed by the national governments. The liquidity crisis thus led to a public sector problem.
The counterpart of the liquidity problems of domestic banks was the deficits in the current account of peripheral economies, mostly with Germany. The conditional lending by the Troika and the austerity it imposed, preserved the solvency of the banking sector, and reduced the current account deficit, but at the cost of reducing GDP by about 25 per cent, and leading to an unemployment rate of 26 per cent. Note that this was accomplished with a reduction of government spending of more than 30 per cent, that is, with a draconian fiscal adjustment. Also, average real wages have been significantly reduced. The external accounts have been adjusted, and a current account balance achieved, essentially by a collapse of imports. All of this suggests, contrary to what is often argued, that Greece has already undergone a brutal, almost unprecedented tightening of ots belt. And yet the crisis was not solved.
It is not difficult to understand why. The banking crisis turned into a public sector crisis when the government tried to save the banks, and the solutions imposed by the Troika to provide liquidity were translated to austerity. So, as in most external crises, the current one, which was a private crisis, was nationalised. The problem is that debt crises are not solved by austerity. The historical record shows that it is only with growth that a debt crisis can be resolved. The ability to spend, and to increase output and employment, leads, in turn, to higher revenues, and to the reduction in deficits and debt. A recovery in Greece is precluded by the inflexibility of the Troika, which is demanding, in the face of a collapsing economy, even more austerity. Worse, once the economy seemed to have reached the bottom, and after a tired Greek electorate voted for change, alas from a left-of-centre government, the Troika has doubled down on its austerity policies.
A Crisis Foretold
The Greek crisis was not only predictable, it was actually predicted. Wynne Godley, the Cambridge economist, said long ago, way before the euro, when the rules related to the common currency where being designed, that the project was bound to fail. In his view, expressed in 1992:
“It needs to be emphasised at the start that the establishment of a single currency in the EC [European Community] would indeed bring to an end the sovereignty of its component nations and their power to take independent action on major issues. … the power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony. Local authorities and regions obviously cannot devalue. But they also lose the power to finance deficits through money creation while other methods of raising finance are subject to central regulation. Nor can they change interest rates. As local authorities possess none of the instruments of macro-economic policy, their political choice is confined to relatively minor matters of emphasis – a bit more education here, a bit less infrastructure there… If a country or region has no power to devalue, and if it is not the beneficiary of a system of fiscal equalisation, then there is nothing to stop it suffering a process of cumulative and terminal decline leading, in the end, to emigration as the only alternative to poverty or starvation.” [Italics added]
As I noted earlier, giving away that kind of power would be fine if there was an increase in fiscal transfers from a federal EU, and if there was the provision of liquidity and the guarantee of financial stability by the ECB. As Godley noted:
“I recite all this to suggest, not that sovereignty should not be given up in the noble cause of European integration, but that if all these functions are renounced by individual governments they simply have to be taken on by some other authority.”
In other words, Godley was not anti-Europe, and not even anti-common currency, but he was anti-euro, at least in the way the European institutions where building the common currency, and predicted its failure.
It is also worth noticing that the most virulent attacks on the European project came from the radical right that is from parties that are also rabidly anti-immigration, and furiously against the expansion of social welfare, like the National Front in France, or the United Kingdom Independence Party (UKIP) in Britain.
No to Grexpulsion, Carthaginian Deal
The question then, after the ‘No’ result in the referendum, is what will happen next. Can Tsipras and SYRIZA obtain better terms from the Troika than the greater austerity that has been offered before? Note that SYRIZA has asked for very little from Europe – a halt to the austerity program, and perhaps some development funds. It has stopped short of demanding a reversal of austerity, or the fiscal transfers needed for a recovery, or the liquidity that the ECB must provide for financial stability. The Greek government’s stand might be realistic, since the revamping of European institutions does not seem to be on the agenda. Note that if Europe chooses to see the No vote as a vote against the euro, and not against the austerity policies the Troika has imposed, then it is very likely that the European institutions will find some way, since no official one exists, to expel Greece from the euro.
As noted by Varoufakis (and also by myself here), a default and the recreation of a national currency would not solve all the problems and lead to a fast recovery like in Argentina, after the devaluation of the peso more than a decade ago. The reason is that exports would not increase much in case of devaluation, in contrast to Argentina, which had significant and positive terms of trade. Also, if Greece tries to promote fiscal expansion, it is almost certain that imports will increase significantly, since consumption has been repressed over the last 5 years of adjustment. And higher imports with no increase in exports require access to foreign currency, that is, Euros, the problem that leaving the euro is supposedly meant to solve. Besides, as the Argentine example shows, long after the default and devaluation, the powers that be – the IMF, the US judicial system, financial markets (including actors like Vulture Funds, but also rating agencies and the pink press) would have a stake in showing that going against them is not a good alternative. So Greece is indeed, like Ulysses, caught between Scylla and Charybdis. But at least, a No gives Europe the chance to rethink its Carthaginian peace policies towards Greece, and perhaps they can provide a more civilised solution to the crisis. Hope springs eternal.
Matías Vernengo is a Professor of Economics at Bucknell University