Karl Marx is said to have once said that in the end economics will always trump politics. This of course is broadly true. But the unpalatable choice facing Greece: of default and expulsion from the euro, against the current German insistence on austerity, is too often viewed through the economic prism. In truth, the scenes on Sunday showed the huge political and social implications, and there’s a strong likelihood that the next election will deliver a huge number of Greek MPs who object to the current EU-IMF-imposed economic policy.
For all the commentary of on-going events, the key point remains that little discussed or suggested from the IMF or EU will help to eliminate the core problem of the current Eurozone: huge imbalances in competitiveness between nation states – imbalances created by the make-up of the Eurozone itself. Greece’s currency is 33 per cent overvalued according to the IMF.
To understand the structural causes of the crisis grants us an insight into why the policy solution on the table can’t work. Any solution requires a mechanism to cure the imbalances. Thus far the EU has been providing credit for sovereigns via the IMF and the EFSF with conditions attached that significant fiscal retrenchment and supply-side reforms must be undertaken by Greece – the most recent of which has seen a 20% reduction in the minimum wage and a further 15,000 public sector job cuts. The Greeks are being told that they must make themselves competitive internally because they are unable to devalue their currency.
This solution is not working and is unlikely to, mainly because of the scale of the adjustment required. Greece is now locked in what Ambrose Evans-Pritchard has today described as a death spiral of austerity, a shrinking economy and an ever-increasing debt burden.
The Greek Prime Minister Lucas Papademos told the Greek people the country was just “a breath away from Ground Zero". But many external observers would claim that they are there already. Given that EU policy does not look like changing any time soon, this leaves two options: continue with the retrenchment and reforms against popular opinion, or default and exit the euro. It’s important to note that the aim of these two policies is the same: for a fall of wages in the traded sector that will real correct the gap in real exchange rates. But as Scharpf’s excellent lecture at the LSE last year highlighted, the two have very different implications in terms of political economy and distributional impacts.
Default and euro exit would entail a large devaluation – which would be very painful. So painful in fact that renowned economists like Barry Eichengreen have claimed it is not even feasible. Import prices would rise substantially, significantly hacking into real incomes. There would likely be very substantial inflation, and the risk of knock-on effects throughout Europe. But from the perspective of Greek policymakers, there’d be a significant advantage: the devaluation would be a one-time shock, after which mandates could be obtained for policies to rebuild Greece and attempt to ease the damage that would inevitably result from the exit.
This is in stark contrast to the current policy, where the process of reforms must be proposed, enacted and enforced over a longer period of time by the Greek Parliament, with fierce opposition, particularly because the policies are seen to be imposed by foreign powers for the main purpose of self-protection.
Likewise, whilst the aim is for the traded sector to benefit in each case – devaluation as a means of achieving it is much easier than continuing policies that are actively seen to make workers and welfare recipients poorer at a time of economic collapse.
Given that the social outrage at continued policy is likely to continue and exacerbate the further the Greek economy deteriorates, the Greek MPs would be wise to take these political economy factors very seriously. It remains to be seen how much more the people will stand.