Greece May Remain in the Euro Zone with a New Rescue Plan

Capital.gr, May 18, 2012.

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In an interview with Helen Artopoulou (DailyFX.gr/FXCM) that was posted on Capital.gr, Dimitri B. Papadimitriou, president of the Levy Economics Institute, discusses the failed policy of austerity that the European Union opted to enforce on Greece, and what it may take for Greece to overcome its current crisis.

Q. The political impasse in Greece, largely the outcome of the recent elections, had led to some reconsideration of the austerity policy measures being currently implemented in the indebted countries of the Eurozone. In fact, it seems that a number of public officials have shifted their position, calling now for a growth-oriented economic policy. Given the reality of Greece, how easy is to stir economic growth, and why didn’t the EU follow the growth path to economic recovery in the first place but relied instead on fiscal consolidation and draconian austerity measures?

Economic growth is dependent on public policy aiming at deploying the resources available, that is, labor and capital. Presently, in Greece, there is an abundance of labor, but no capital from either the private or public sectors. It will be some time before the economy becomes friendlier to private investment, markets offering increasing liquidity, and for the private sector to gain confidence in the country’s economic stability. The time horizon for these things to happen will be long so, the responsibility falls on the public sector to do the investing in the key sectors of the Greek economy. But the public sector is on the brink or bankrupt, and in effect restricted by the EU, ECB and IMF in investing for growth. When they call for a growth-oriented economic policy in response to the overwhelming election results in favor of the anti-austerity platform, they simultaneously insist on the implementation of the imposed austerity. This joint policy prescription, that growth and austerity can coexist, is the new “austerian” economics—a new frontier of economic nonsense. North European leaders believe that all member states in the Eurozone can be similar to Germany’s competitive export-led growth economy. But Germany’s competitive advantages that yield intra Eurozone better trade balances are dependent on other Eurozone’s countries worse balances.

Austerity programs were imposed, first, to discipline the eurozone’s profligate citizens and, second and most importantly to calm the financial markets, both of which have failed miserably. The medicine of austerity has worsened the patient’s condition and markets, as has been observed time and time again, have a mind of their own.

Q. Greece is facing once again the prospect of a forceful exit from the eurozone. How likely is this frightening scenario and is it manageable? Also, would it be as disastrous for the country as most people fear it would be?

I don’t believe thus far, all options have been explored. Greece can remain in the Eurozone with a reworked out bail out plan. Reasonable people can be convinced, if serious alternatives are presented. Everyone in the EU recognizes the harshness of the austerity measures and their most disproportional burden to the Greek people. Many proposals has been suggested from very serious economists, but have not made their way to the negotiating table. So there may be still time to avoid doing the unthinkable.

At the end, when all other options are exhausted then, the possibility of Greece exiting the euro remains the only options. This maybe a frightening scenario but it will have to be manageable, the inexorable difficulties notwithstanding. Exiting the euro will be accompanied with very serious challenges. We should expect to witness the workings of a dysfunctional economy and society characterized with bank runs, resulting in banks being nationalized, rapid devaluation of the domestic currency, immediate repudiation of all public debt and lender retaliation, closed financial markets for many years to come, and strong inflationary pressures. An economy with an under developed industrial base, like Greece, would be hard-hit on import prices, especially oil, natural gas, machinery and other necessary imports.

On the positive side, having its own currency the government can embark on large emergency employment programs, as those presently in place for public service works, and others used by other countries, i.e., the US New Deal-type programs, South Korea’s programs during the Asian crisis as well as those implemented in some countries in Latin America. More importantly, there can be public investment and promotion toward exporting agricultural goods, technical services to non-European countries, etc. And, there maybe still structural funds available from the EU. What is absolutely critical, however, for the country to ultimately find its way to growth and prosperity is spectacular and visionary leadership.

Q. The ECB has managed through different means to avoid a European credit crisis and to restore somewhat investors’ confidence in sovereign bond markets. Still, a lot of peripheral banks are on very shaky ground, with Spanish Bankia being the most recent case. What’s your assessment of the efforts undertaken so far by the ECB towards solving the eurozone crisis?

The ECB has done a lot less that it could have to calm the markets. For it is unfortunate that its charter—a version of the German Bundesbank—limits its functions as a central bank. Central banks have the ability to use tools at their disposal at times of financial crises, one of which is functioning as lenders of last resort (LOLR). The ECB is prohibited in doing so even though, its LTRO program is nothing more than a timid attempt to function as a LOLR, too little and too late to significantly calm the financial markets. The spreads for Spain and Italy continue to be under assault and the urgings from the Bundesbank to exit from the program earlier than its original time horizon worsen matters. European policymakers are well aware that the European financial institutions are severely undercapitalized and shaky, but hope that their intended private recapitalization will be a satisfactory solution. But as it has become obvious by now the method of solving Europe’s problems is to get each country’s fiscal house and banking sector in order by applying a band aid that helps kick the can down the road and somehow grow its way out of trouble. But even if the omens are clear, the willingness to deal with them effectively is not.

Q. It seems that the crisis in the European periphery is widening and deepening. Spain is set to be the next victim, but the bailout funds are hardly adequate given its size. Moreover, Germany continues to insist on the fiscal pact treaty as the only way out of the crisis. Is the European Union facing a dead-end? And is the current crisis essentially a structural crisis?

The euro project is an incomplete project. It is impossible to have a monetary union of countries with very different fiscal structures and earnings potential that are yoked to the same currency without a fiscal union. Germany’s insistence on a fiscal pact treaty is simply thoughtless and will sooner rather than later lead to euro’s dissolution. Aside from Greece, Portugal and Ireland—Chancellor Merkel’s poster children are not meeting their deficit targets and both Spain and Italy, two very large economies are in recession and their citizens are refusing to take the austerity medicine. Consequently, the end of the euro may be near and it will be a blow not just to European pride but, to the whole idea of Europe.

Q. During the last months the markets (including the US equity market) are showing signs that they are not in tune with the real economic conditions, which is to say that their performance does not seem to reflect what’s going in the global economy. Why is this happening, and have we faced a similar situation in the past?

As I indicated earlier, markets have a mind of their own. As the late Paul Samuelson once quipped, financial markets forecasted five of the last three recessions. Financial markets are globally interconnected and what happens in Europe affects the US markets and in their turn the Asian markets irrespective of the prevailing economic conditions. For example, the recent run-up in the US equity markets was due to some marginal improvement in the US economy, and more importantly, the sizable increase in corporate profits. This and last weeks volatility is attributed to the results of the Greek elections and the chorus proclaiming the country’s impending exit from the euro and the possible contagion to the rest of the Eurozone with spillover effects to the US economy.