Should Greece leave the eurozone and does the country really need further debt relief? Anti-austerity party Syriza winning yesterday’s Greek election has potentially set in motion a series of events that will not only determine the future direction of Greece but potentially the long-term sustainability of the eurozone itself.
“The euro should now be recognised as an experiment that failed,” wrote American economist Martin Feldstein back in 2012. Three years on and little has changed, with the euro in crisis for around half its existence. It’s not so much a failure as a catastrophic disaster.
As we debate the Greek question over the next few months there is one thing that we should bear in mind. There would have been no sovereign debt crisis had the euro never existed -- the global financial crisis would certainly have occurred but Europe would have handled that crisis in much the same way the US and UK did.
Greece certainly wouldn’t have government debt of around 175 per cent of nominal GDP; the likes of Spain and Portugal wouldn’t have teetered on the brink of crisis; and the region certainly wouldn’t be plagued with austerity measures that have performed so poorly that government debt is actually higher now than it was when they were implemented.
By virtue of being so poorly designed, the euro is -- without considerable reform -- destined to exist in an almost constant state of crisis. The question for Greece is whether it wishes to be part of such a system or whether it would prefer to seek its independence and in the process suffer unfathomable short-term pain.
In the short term, leaving the eurozone would be more painful for Greece, even with a deficit write-down. Rates on government bonds would surge, as would rates for households and businesses, with bond rates fully reflecting the perceived riskiness of government default.
The Greek currency would fall sharply against the euro and other major currencies and stay low. In the long term, this would support domestic activity but would cause initial disruption and economic heartache. This is because there is a clear mismatch between how long it would take for a lower currency to boost domestic production, particularly off such a depressed base, and the initial impact on imports.
That path also has the benefit that Greece regains both its sovereignty and access to independent monetary policy. It does, however, place it on a collision course with its existing creditors, who may be far less likely to strike a deal in a post-euro world.
So let’s assume for a moment that Greece decides to remain in the eurozone for the foreseeable future. Can the Greek government manage and pay down its debts? Or does it require another bailout package or debt restructuring?
An excellent article from the Financial Times highlights two key points: first, the interest burden on existing government debt in Greece is around 2.5 per cent of nominal GDP -- considerably lower than Spain and around half that of Italy. Second, the average maturity of existing Greek government debt has lengthened to 16½ years -- double that of Germany and Italy.
In other words, the absolute burden of Greece’s existing debt is relatively small and the burden has been spread over a number of years. The data suggests that Greece has the capacity to pay off its existing debt but could benefit from further debt restructuring that increased the maturity of its existing debt to 20 or even 25 years.
It also begs the question of why does Greece deserve debt forgiveness when the interest burden in Spain and Italy is currently higher? How do they sell that politically?
But really that should be irrelevant to the choice of whether to leave the eurozone. That decision centres on Greece’s need to reclaim its own sovereignty, dictate its own future, and determine what is in the best interests of the Greek people.
It is clear that the country doesn’t need to exit -- at least not yet -- but who could blame it if it wanted to. The decision seems to be one of short-term pain versus long-term costs -- leaving the eurozone will be more painful in the short term but it offers a set of opportunities that simply do not exist if it stays.
The long-term implications of a Greek exit are vast -- not just for Greece but also for the eurozone itself. The biggest risk to the euro may well come in the form of a successful exit by Greece and if that occurs it could provide a viable alternative to austerity for other European economies. Alternatively, the euro could benefit by no longer subsidising the Greek economy, providing an impetus for recovery that has long been missing.