The eyes of Europe are once more focused on Greece. Once again the meetings of the European Council and the Euro Group are dominated by the ongoing crises in Athens. I have spent some eight years in the Ecofin council discussing Greece – here are my personal reflections.
It is important to realize that the roots of the problems are long-term and can be traced back to some characteristics of the Greek society. The OECD, the European Commission, the IMF and the World Bank have pointed, in report after report, to a fundamental inability of the Greek model to produce a long-term sustainable growth rate. I have read all the assessments and country reports. Productivity growth has been low. The results of the Greek education system is sub-par, the spending on education is low, the resources dedicated to R&D is low, the engineering tradition in industry is weak, the export sector is small as a share of GDP, all according to the OECD.
Heavy regulatory burden, well described in the World Bank’s report on the cost of doing business, means that the barriers to entry in new sectors are high and many sectors, industries and occupations have been closed to competition (Greece ranked 109 before the crisis). The dynamic ability of the economy to reallocate resources is low, the cost of opening a new production plant is high and the labour market institutions are rigid.
The best option for Europe
When Greece was allowed to enter the euro system, the convergence of interest rates, combined with inflated property prices, increased household indebtedness and an overheated construction sector put the economy on an unsustainable path. In the years before the Lehman crash, growth rates hit 4.3%, but this was built on an unsustainable convergence bubble and accumulated current account deficits.
Public expenditures increased rapidly due to an increasing wage bill and lack of cost control, while the ability to extract tax revenues was weak. A culture of tax avoidance, broad tax fraud and a dysfunctional tax administration has been a major theme from the European Commission. Public expenditures rose to Swedish levels, while tax revenues remained Mediterranean.
I served on the Ecofin council with seven colleges from Greece. All of the Greek ministers reassured the council, drawing on their academic merits, their experience in the OECD, their background in central banking or political experience, that deficit numbers once again had to be revised upwards. Always for the last and final time. Every time this happened, the council’s level of distrust grew. At the end the pre-crisis deficit for 2008 was revisited to 9.8% of GDP, more than 5% higher than the original figure.
The fundamental problem is Greek society’s unwillingness to modernize. My reading of Greek history is that trust in government institutions has been undermined by the long domination of the Ottoman empire, the strong position of old political and economic networks and a dependency culture and lack of a meritocratic bureaucracy.
Given this frank assessment of Greece from the IMF, the OECD, the European Commission and the World Bank, one can ask– is the Grexit the best option for Europe and Greece? I argue against this idea. Greece belongs to the European Union and should remain in the euro system. It is in the interest of Europe to save Greece.
Why Europe needs Greece
I’m not more optimistic about the state of the Greek economy than the IMF, the Commission, the OECD or the World Bank. But, at the end of the day, Grexit will be a political decision. I believe that there are European values at stake that trump the economic considerations.
First of all, a Grexit would be very costly in terms of welfare. Without the support from the ECB, the Greek banking system would be shut off from access to international markets. The overall use of the euro-system liquidity assistance to Greece came close to €90 billion in early 2015. The government would have to close the banks for a week or two, print emergency currency, impose strict limits to household access to deposit accounts and introduce capital controls and, when the market opens again, the new drachma would depreciate by about 30%-40% before finding equilibrium.
If we look at the Icelandic example – sometimes cited showing the benefits of a weaker currency – this would mean a steel bath for the economy. Consumption and investment will collapse. Increased import prices will undermine the purchasing power and push consumption into free fall. The epic increase of uncertainty will freeze all investment. The welfare cost of a Greek collapse will be severe.
Secondly, there is a clear and present danger that an economic crisis would escalate into a political meltdown. Already during the period of fiscal restructuring – which was not exactly front-loaded with the deficit going from 9.8% of GDP in 2008 to 8.9% in 2012 – the political violence has been quite pronounced in Greece. One of the reasons the country ended up in deep economic problems is the dysfunctional political system, with a low trust level and clear institutional deficit. It is clear that the impact of an even deeper economic crisis would be problematic. Trust levels would deteriorate even further and it cannot be ruled out that political violence would escalate.
Thirdly, Europe also needs to take into account the changed geopolitical environment. The increased geopolitical tension in Europe after the escalated conflict in Ukraine would risk destabilizing a part of Europe that desperately needs stability. The conflict level in the Balkans has decreased, not least due to a clear ambition to make the European Union a real option for the post-Yugoslavian states. To push Greece into an unstable political situation could obviously make the region more vulnerable to others that have an interest in a less unified and weaker Europe.
Fourthly, there is a clear risk that the necessary reforms of the political and economic system in Greece will get stuck in political chaos. Sometime it is argued that lack of political pressure has made the Greek government less willing to do the necessary structural reforms. Clearly, reforms so far have been less than satisfactory.
My personal view is clear. Greece doesn’t have a moral right to be rescued by European taxpayers. But there are fundamental European values that are common to the whole of Europe. Europe is more European with a stable democracy in Athens.
Author: Anders Borg is a Swedish economist and politician who served as Minister for Finance in the Swedish government. He chairs the World Economic Forum’s Global Financial System Initiative.
Image: People visit the archaeological site of the Acropolis in Athens March 14, 2012. REUTERS/Yiorgos Karahalis