To Euro or not to Euro?

 

by Costas Azariadis

Posted on Saturday November 5th, 2011 by C_Azariadis
In two interviews with Hurriyet Daily News (Oct. 11) and The Saint Louis Post-Dispatch (Nov.4), Costas Azariadis advocates a suspension of all interest payments on Greek debt and a return to the drachma as a stopgap measure that will buy Greece time to debate and implement the deep reforms needed for economic prosperity.  Exiting the eurozone will instantly balance the government budget, restore competitiveness to tourism and exports and reverse the income implosion the country is going through. Default will compromise future borrowing, anger the international community and hurt the reputation of the country but costly but continued austerity makes less sense. The real risk from default is that the relief it provides will be wasted in a futile attempt to preserve the status quo and thwart the necessary reforms.

 
 

The full article of C. Azariadis:
As the Greek government teeters on the verge of collapse and the national economy is in a freefall, voters in Greece are running out of time. Despite repeated rounds of cuts and austerity, the state still cannot pay salaries and pensions to more than two-and-a-half million people whose livelihood depends on the government. Tax revenue is shrinking, international lenders insist on deep and unpopular reforms, labor unions and professional groups cling obstinately to the status quo. The most corrupt political class in Europe squabbles over power, privilege and patronage as the youth unemployment rate soars to 40%. Schools and social life are disrupted by unending strikes while crime rates shoot up and the rule of law is visibly on the wane.
Long-postponed questions are coming to the fore with an urgency that cannot be deferred. Euro or drachma? Inside the EU or out? Structural reforms or status quo? Should the public sector shrink or grow? Is the current constitution working or we need a new one? In this post we deal with the first one. Today’s big policy question is: Should Greece tighten its belt as much as its lenders dictate and stay in the Eurozone or go back to the drachma and stop paying interest on its public debt?
Luckily for voters, this question has a simple answer suggested by many independent economists like Ken Rogoff, Nouriel Roubini and by the recent experience of Argentina—suspend interest payments, drop the euro and go back to the drachma. This is a costly choice but the benefits seem to outweigh the costs. Default would save the Greece annual payments roughly equal to 6% of its GDP, and would instantly balance the government budget. Going back to the drachma at an initial exchange rate of about 600 to the Euro will immediately boost  competitiveness in exports and tourism, and reverse the economic freefall the country is going through now. Incomes will start growing again. Devaluing the drachma will also give the country breathing space to debate and implement the structural reforms that will keep it from a return to the poverty of the 1950’s.
Default is a messy business fraught with danger. Greek banks will collapse as their equity is wiped out; the state will have re-capitalize them without giving politicians or labor leaders any authority over day-to-day operations. International lenders will avoid the Greek government for many years, and the drachma will not be accepted by foreigners.  Euro deposits will be taxed or forcibly converted to drachmas or regulated by capital controls. The drachma itself will be prone to inflation because special-interest groups will pressure the government to give them bonuses, raises, pensions and other handouts. Europeans will be apoplectic for a while because their banks, too, will suffer from a suspension of payments by Greece. Worse still, fears may spread through financial markets that Italy or Spain may follow in the footsteps of Greece.  Fears of contagion can easily drive up the cost of borrowing for those two nations and thus become self-fulfilling. Dire consequences can follow for the world economy.
None of these drawbacks outweigh the obvious and immediate benefits that a suspension of interest payments would confer on the country. Greece is no more responsible for world contagion than the investment banking firm of Lehman Brothers was for the 2008-2009 financial panic. Recapitalizing European banks against default will be cheaper than bailing out Greece through a prolonged period of austerity. Argentina has recovered from its default of 10 years ago, and prospered.
The real danger of default is not that it causes friction between trading partners, domestic banks and depositors, or even international borrowers and lenders. Default is just a stopgap policy that gives borrowers time to put their affairs in order. That means spending less, working more, and planning ahead.  If Greece really wants to prosper, default will buy perhaps two years in which the country must reform itself from top to bottom, from one end to another. The real risk is that the temporary relief from exiting the eurozone will be wasted in a vain effort to maintain the status quo. This is a risk that Greece must take.