Larry Elliott Economics editor Sunday 17 May 2015
Leaving the single currency will have all sorts of economic and political costs for Athens, but Iceland’s experience after the banking crisis could prove illuminating
Before he admits he has lost the game of chicken, Alexis Tsipras, the Greek prime minister, right, should think hard about euro analysis of his finance minister, Yanis Varoufakis. Photograph: Alkis Konstantinidis/Reuters
Yanis Varoufakis rues the day when Greece joined the euro. The Greek finance minister says his country would be better off if it was still using the drachma. Deep down, he says, all 18 countries using the single currency wish that the idea had been strangled at birth but understand that once you are in you don’t get out without a catastrophe.
All of that is true, and explains why Greece is involved in a game of chicken with all the other players in this drama: the International Monetary Fund, the European commission, the European Central Bank and the German government. Varoufakis wants more financial help but not if it means sending the Greek economy into a “death spiral”. Greece’s creditors will not stump up any more cash until Athens sticks to bailout conditions that Varoufakis says would do just that.
Things will come to a head this summer because it is clear Greece cannot make all the debt repayments that are coming up. It has to find €10bn (£7.3bn) in redemptions to the IMF, the ECB and other bondholders before the end of August and the money is not there. Greece’s creditors know that and are prepared to let the government in Athens stew. They know that Greece really has only two choices: surrender or leave the euro, and since it has said it wants to stay inside the single currency, they expect the white flag to be fluttering any time soon. Greece’s willingness to go ahead with the privatisation of its largest port, Piraeus, will be seen as evidence by the hardliners in Brussels and Berlin that they have been right to take a tough approach in negotiations with the Syriza-led government.
But before he admits he has lost the game of chicken, Alexis Tsipras, the Greek prime minister, should think hard about Varoufakis’s analysis. Was it a mistake for Greece to join the euro? Clearly, the answer is yes. Would Greece be better off with the drachma? Given that the economy has shrunk by 25% in the past five years and is still shrinking, again the answer is yes. Can you leave the euro and return to the drachma without a catastrophe? Undoubtedly there would be massive costs from doing so, including credit controls to prevent currency flight, and a profound shock to business and consumer confidence . There are also the practical difficulties involved in substituting one currency for another.
In a way, though, this is not the question the Greek government should be asking itself. Greece has been suffering an economic catastrophe since 2010. It is suffering from an economic catastrophe now and will continue to suffer from an economic catastrophe if it stays in the euro without generous debt forgiveness and policies that facilitate, rather than impede, growth. So the real question is not whether leaving the euro would be a catastrophe, because it would. The real question is whether it would be more of a catastrophe than staying in.
There are both political and economic dimensions to this question. Politically, Tsipras has a real dilemma: the Greek people voted for less austerity, Greece’s creditors want no let-up in austerity. He can please one or the other but not both. Bowing the knee to Angela Merkel would allow Greece to get access to the short-term finance that will allow it to pay its debts, but it will be political suicide for Syriza. Sooner or later, Tsipras has to decide what he wants to do: continue with a populist approach that is incompatible with euro membership or return reluctantly to the policies that have been pursued by the centre-left and centre-right governments since the crisis erupted.
Wolfgang Schäuble, Germany’s finance minister, has suggested that one solution would be for Greece to hold a referendum on whether it wants to go or stay. The message coming out of Berlin is that Germany doesn’t care much either way. If Greece wants to knuckle down to structural reform, that’s fine. If Greece wants to return to the drachma, that’s also fine.
Schäuble strongly suspects that faced with the choice, Greece would vote to remain a member of the single currency. But plebiscites are funny things, and the question asked would matter. The answer to the question “do you want Greece to continue using the euro?”, would be different to “do you want Greece to continue using the euro if it means cuts in wages and pensions?”. Germany should also not underestimate how strongly resentment still burns in Greece about how the country suffered when it was occupied during the second world war and how many Greeks feel they are being deliberately punished for choosing the sort of government that doesn’t suit the rest of the Eurozone.
When it comes to the economics, the question is whether Greece would get the pain over more quickly by having control over its own affairs. Roger Bootle and Jessica Hinds at Capital Economics think that might be the case, and say Iceland’s experience after the country’s severe banking crisis in 2008 is worth looking at.
No question, Iceland had a very tough time. There were massive capital outflows from its over-extended banking sector, and its currency, the krona, depreciated by 40%. The economy contracted sharply, the IMF was called in and capital controls were introduced.
But, as Bootle and Hinds note, Iceland has bounced back. It has grown in every year since 2011 and national output is just about back to pre-crisis levels. The inflation caused by the depreciation of the krona has been tame and growth prospects are rosy.
The fall in the krona was important, since it made exports cheaper and provided a boost to tourism, where the number of visitors has risen by 60% to 800,000 a year between 2008 and 2014.
“The fall in the krona boosted net trade by enough to kick-start Iceland’s economic recovery without the need for the aggressive wage and price adjustments that have occurred in the Eurozone periphery. Iceland was also able to tighten fiscal policy less aggressively than the periphery. Iceland’s fall in GDP of about 12% was around half as short as that seen in Greece since 2008.”
Bootle and Hinds say that Greece, too, would see tourism benefit from a cheaper currency, while the vast amount of unused capacity in the economy would limit the extent of the increase in inflation caused by the devaluation that would follow euro exit.
Capital controls would harm the economy, as they have in Iceland, but might be needed even if Greece stays inside the single currency. The weaker currency that would result from leaving the euro is not a get out of jail free card, far from it. But after five years of hard labour, staying in looks like a life sentence without remission.