In Defence of the Euro and Angela Merkel

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Appeared in the National Post

It is impossible to know how the latest Greek tragedy will end, but one thing is clear. If the new government ends fiscal austerity, reverses recent reforms and exits from the Euro zone, Greece will again become the economic disaster zone it was before it joined the European Community and adopted the Euro.

The left-wing politicians who created these conditions will once more grant excessive wages and benefits to the employees of the over-staffed civil service and nationalized industries. They will encourage the power of private-sector unions and subsidize industries crippled by unsustainable wages and work rules imposed by these unions. They will use regulations to protect professionals and firms from domestic and foreign competition.

They will finance the fiscal deficits these policies created by getting the Bank of Greece to print money, which will mean the return of inflation which during the years 1973-98 averaged 17 per cent a year and caused the currency to depreciate from 30 drachmae per U.S. dollar in 1953 to 400 drachmae per dollar in 1998.

They will again index wages to inflation but will only cause higher production costs and more inflation. Tax avoidance and evasion will make the shadow economy return to its historic size, covering 30 per cent of the economy. Investors will fight inflation by purchasing gold and other assets in limited supply, neglecting productive investments needed for economic growth.

Greek politicians who in the past tried to end these destructive policies always failed because there were too many voters whose interests were at stake and who voted for the populist parties that promised to preserve their privileges.

Joining the European Community and the Euro-zone promised to end this problem by requiring that the government balance its budget, adopt free trade and deregulate and privatize industry. The financing of deficits by printing drachmae was no longer possible.

Many responsible Greek politicians welcomed these requirements because they considered them to be in the interest of the country. Greek voters welcomed them because they promised to be accompanied by financial aid from the EC and by increased tourism, trade and foreign investments.

The promised benefits from membership in the EC and Euro-zone did arrive. The economy boomed and optimism was high for several years. However, after the arrival of the global economic crisis in 2008 it became clear that the country had adopted very few of the mandated reforms. Large fiscal deficits had continued and been hidden from the public and international agencies by creative accounting. Official statistics on inflation were manipulated.

As the government of Greece in 2009 was unable to meet its financial obligations and speculation threatened the solvency of private banks, the country suffered serious economic and financial turmoil.

The EC and international financial institutions came to the rescue with large loans, making their delivery conditional upon the adoption of the economic reforms and fiscal restraint that had been mandated before. They also insisted that this time, their officials could verify the adoption of these policies.

The government enacted enough reforms and fiscal restraints to satisfy the lenders and in 2014 the economy began to recover. Unfortunately, public resentment caused by the unemployment, reduced incomes and other hardships caused by these policies brought electoral success to populist, demagogic politicians who promised to end the reforms and fiscal austerity.

It seems unlikely that the new government can deliver on these promises. Lenders will not abandon the conditions attached to further loans. Greece has little leverage to force them to do so. While Europe would suffer short-term costs from a Greek default, the country is a tiny fraction of the European economy and will have virtually no effect on the region’s growth or trade. A default on the Greek debt would put only a small dent into the balance sheets of its financial institutions, even if it were to be written off completely, which is unlikely to happen. European leaders cannot afford to allow generous treatment of Greece to set a precedent that other countries such as Portugal, Spain and possibly Italy and France, will insist on getting also, so that letting Greece off the hook on loan conditions represents a risk they are unlikely to incur.

On the other hand, the cost to Greece from defaulting on its debt, abandoning reforms and replacing the Euro with drachmae are enormous. In the very short run, economic and financial turmoil will make current public hardships seem trivial. After some time, the economy will settle down, full employment and output will be restored.

But in the longer run, the statist, socialist policies that had caused the problems will make Greece the Argentina of Europe, suffering perpetual economic stagnation, inflation, deficits, devaluations and deep political/social divisions. Before long, there may well be a musical with a hit song “I cry for you Greece,” as there has been for Argentina.

International lenders and politicians like German Chancellor Angela Merkel, who insisted on the adoption of reforms and fiscal balance should be praised, not lambasted, for their efforts to prevent Greece from going down that road.