Greece should never have joined the euro

A short-term fix is possible, but finding long-term stability within the single currency will be a harder task

June 24, 2015
Presidential guards march while demonstrators sit on the kerb during an anti-austerity protest in Athens on Tuesday. ©  Daniel Ochoa de Olza/AP/Press Association Images
Presidential guards march while demonstrators sit on the kerb during an anti-austerity protest in Athens on Tuesday. © Daniel Ochoa de Olza/AP/Press Association Images

As doubts start to emerge about how much can be achieved in the EU summit this week there is still hope that, despite some recent wobbles, the Greek drama might be drawing to a temporary close. The new proposal put forward by the Greek government to bridge the gap between what the creditors have been demanding and what the Greeks had been prepared to offer—such as VAT increases, increased pension contributions, faster elimination of early retirement pension support and extra spending cuts—had been mooted before but no progress was made.

But, as the end of the current bailout period approaches, and Greece's ability to meet forthcoming debt repayments is called into question, the economic and financial implications of a continued standoff have become clearer. Greece is running out of money to pay back what it owes in the short term, not only the €1.6bn to the IMF due by 30th June but also an extra €3.5bn and €3.2bn to the European Central Bank in July and August.

Money to pay public sector wages and pensions is also running out as tax receipts have collapsed and the economy has gone back into decline. Most importantly, the financial sector is being drained of liquidity as Greek savers panic, fearing “Grexit”, and withdraw vast sums of cash from the banks. The ECB has been stepping in with almost daily additional help through its Emergency Liquidity Assistance to keep the banks afloat and reassure the population that their deposits are safe.

The Greeks have had no option but to offer more cuts and tax increases to meet the creditors' demands. At the same time, with the international markets increasingly unsettled, the creditors' mood for reaching a deal appears to have shifted to a more positive one. There are still grumblings from some euro Finance Ministers who attended the meeting on Monday. Christine Lagarde, the IMF's Director General, is still pushing for more changes and there are doubts about the longer term sustainability of what the Greeks have proposed. Discussions continue and the deal is not confirmed yet but the statement by the head of the eurogroup on Monday was more upbeat than ever before that a solution can be found.

The Greek people have repeatedly made clear in opinion polls their unwillingness to leave the euro or the European Union. Were this to happen, by accident or design, it is doubtful whether the Greeks would forgive their young new prime minister, leader of the radical left wing party Syriza and head of a coalition which has ruled since January, for getting Greece to that point. The outcome would almost certainly be huge political turmoil.

The apparent willingness to use what the Greeks put forward as a further basis for discussion is about much more than economics. The differences between the creditors and Greece never amounted to more than €2bn. This is a relatively small sum. It is less, for example, than the estimated cost of repairing the Houses of Parliament in the UK (up to £7bn).

Yet until recently it looked like the Europeans were prepared to let Greece default and leave the euro over this small difference. The Greeks made u-turn after u-turn, for months abandoning most of their pre-election pledges, but these had little impact, possibly due in part to the Greeks' aggressive negotiating tactics.

If a solution is now found it will be because Angela Merkel, in agreement with François Hollande, is not prepared to risk any of the likely costs, both political and economic, that ejecting Greece might entail. Neither leader, representing the largest and most powerful countries in Europe, would want to leave that legacy. And a Greek exit, by demonstrating that the euro was in reality reversible, could spell the beginning of the end of the euro project.

Should Greece have entered the euro? With hindsight the answer is probably no. The austerity measures imposed on its people since the crisis have resulted in a drop of 25 per cent in GDP and severe cuts in incomes and living standards. Unemployment has soared to 26 per cent. And yet competitiveness and productivity has hardly improved.

This, though, is not because there is something exceptional about Greece. True, its administrative system is opaque and the market can hardly be described as open. Many areas of the economy need urgent reform to become competitive—such as agriculture, industry and even its success story, tourism.

Greece's membership of the euro, however, has so far done nothing to drive economic reform.

The problem for Greece, and other countries in the eurozone, is that a single interest rate and exchange rate do not allow easy adjustment to external crises, and leave domestic devaluation through cuts in wages and prices as the only other option. The lack of institutional support for weaker members from the centre when the euro was created placed the entire burden at times of need on individual Euro governments. That came at huge cost to their economies.

The eurozone’s flaws are well documented and have led to the creation of new institutions needed to ensure stability in the future, such as the European Stability Mechanism, and the strengthening of others, including the European Central Bank.

A short-term solution to stave off Greek bankruptcy and keep Greece in the euro, maybe even involving an extension of the bailout period, might still be reached this week. But finding a way for Greece to return to sustainable growth within the current single currency region will be a much harder task.