Greece: How do you save an economy from going bust?

  • 23 June 2011
  • From the section Europe
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The answer is, as in the old music hall joke, "I wouldn't start from here". But this is exactly the question the Greek finance minister, Evangelos Venizelos, is having to fight over today, as are the European Union leaders, the Greek centre-right opposition and (in a weak echo) UK Chancellor George Osborne and his shadow Ed Balls.

Looking at the Greek "Medium Term Fiscal Strategy" here are the obvious problems:

•the size of the fiscal contraction is 12% of GDP between 2011 and 2015

•it is front-loaded, triggering an immediate further V-shaped recession

•it is heavily reliant on tax measures: half of the 28bn euros is raised through increased tax take

•it is also heavily reliant on privatisation - they need at least 30bn euros, possibly 50bn, to plug the gap

If Greece were able to devalue this would be mitigated by a growth spurt as exports and tourism came back, but there is more than one obstacle to this.

First it is in the euro so it can't. But even if it could, the relatively closed nature of the Greek economy, and the large amount of business off-shoring that has gone on, mean a simple devaluation will not have the same benign impact as for example the UK's sterling devaluation did after 2009.

And there are other problems. The IMF-peddled solution to this is "internal devaluation" - wages fall, prices fall, asset prices fall. But while this works in Latvia, a relatively marketised economy, in Greece there is a lot of friction - and not just because of organised labour resistance.

People react to austerity by falling back on their family and village networks. Many Greeks are going back to the villages to sit this out; many families are becoming like extended families. So the formal and informal parts of the economy do not mesh - you don't get a pure market reaction to falling wages and prices.

In any case it is all theoretical until they leave the euro, and here several other problems kick in: first with privatisation. If you are China, and you are about to buy the railways, motorways, ports and airports, why buy them in euros only to face instant asset price devaluation?

Also, of course, if you leave the euro, suddenly all debts are denominated in euros, but all income is in relatively less valuable drachmas: you get an instant debt spiral.

The problem is Greece cannot compete or trade or produce its way out of this crisis during the Medium Term Fiscal Strategy: you get structural reform, but at the end a country that cannot borrow or pay its debts, only now its debts are bigger.

To solve this problem the Greek right proposes the following: to combine the spending cuts with bigger privatisation and less tightening in terms of tax. Indeed they would cut taxes to give an instant boost to the economy.

Seeing the New Democracy MPs storm out of the Greek parliament on Friday, and refuse to back the MTFS, has got their leader Antonis Samaras instantly crossed off the Christmas card list of every centre-right party in Europe.

Hearing them talk of tax cuts in a country whose tax take is among the lowest in the Western world likewise has not gone down well under the dour skies of north Europe.

However the Greek right's reasoning is similar to that of the UK government - you can survive austerity if you pump prime business investment with tax cuts aimed at stimulating it.

Of course there is also a cui bono issue here: the small business class and the poverty stricken consumer benefits if VAT is cut, and that is where New Democracy's electoral base lies.

However, right now it is hard to find middle class supporters of the austerity package, because of the size of the hit they are taking both through one-off tax measures and through the crackdown on tax dodging.

So the centre-right's answer is: you rip up the current austerity plan and demand forbearance from the EU; in return the EU gets a lot of cheap assets in a knockdown privatisation sale, assuming the Chinese and the Arab monarchies don't buy it all with cash.

I only bring Osborne and Balls into it for illustration: having emphasised the need to soften spending cuts, Ed Balls last week tried to outflank the UK government by calling for immediate tax cuts.

So even Social Democrats can embrace the tax route to growth within austerity, and there is no reason why Greek Prime Minister George Papandreou, inside a national unity coalition, might not do the same.

What's the alternative?

If you want to pull out of the euro you have to start thinking of the practicalities. During the Irish crisis there was a fabled visit to the Mint by cabinet ministers which provoked rumours that they were there to view what the new Irish punts might look like.

Costas Lapavitsas, the left-wing Soas economics professor who has been pushing inside Greece for the "default and leave" strategy, says there are three problems you need to solve if you leave the euro:

First monetary: you have to shut the banks and ATMs for a week, impose capital controls, and re-open them with new currency.

Second, you have to avoid a simultaneous banking crisis or bank run: so you need to nationalise and rationalise the banks. This of course can only be done with some help from the EU or IMF, or some other body, and they are not currently in a mood to do that. On the morrow of a default and amidst a euro-wide banking crisis they may feel differently.

Finally there is a trade problem. What you want is a massive boost to trade from the devaluation, but short term you have no reserves of your own currency and no liquidity so you have to design measures to keep trade alive; meanwhile you probably have to impose price and supply controls on food, energy and gasoline.

Putting it like this, what a default/euro exit looks like is really bad: closed banks and ATMs, price controls and rationing, outright bank nationalisation. And that is before we even discuss contagion.

That's why everybody is trying to avoid it.

We'll see today what the Pasok version of Plan B is: Minister Venizelos is to introduce his "changes" to the plan on Thursday afternoon. With a five seat majority in the Greek parliament, the unspoken assumption in Europe is that whatever the parliament approves cannot be executed this side of a big crisis and a national unity government.

Contemplation of some of the facts above is what's making some EU politicians, above all Manuel Barrosso, begin talking about a "Marshall Plan" for Greece. It is getting harder and harder to see how it survives without one; but also hard to see who pays for a Marshall Plan.