Michael Keating. Greece’s Predicament

Jul 8, 2015

The front page news story for weeks now has been what is happening to Greece and what will happen. The markets, the various authorities and the media all treat Greece’s predicament as if it were solely a matter of excessive debt. Therefore austerity is justified as being essential to bringing the debt back under control, and gradually paying it back.

But this is very much a financier’s view of Greece’s problems and those Governments whose views are coloured by their involvement in arranging and/or guaranteeing the finance. What has so far escaped attention is how Greece, while locked into the Euro, has become completely uncompetitive.

Competitiveness is best represented by what has been happening to Greece’s unit labour costs, and since 1990 unit labour costs have risen by almost 300 per cent in Greece compared to only 36 per cent in Germany. Even if we assume that Greece was fully competitive when it entered the Euro in 2001 – and it almost certainly wasn’t – then between 2001 and 2010 Greece’s unit labour costs rose by 48 per cent compared to only a 4 per cent rise in Germany. These are massive differences in the evolution of costs between the two countries, which have now made Greece completely uncompetitive.

Furthermore it has been this loss of competitiveness that has mainly been responsible for driving Greece into debt. Thus as imports became less expensive relative to Greek products, the higher Euro denominated wages that Greeks were paying themselves allowed the Greeks to buy more than they were able to sell. And the sad fact is that this loss of competitiveness and markets not only led to increasing debt but also to rising unemployment as both Greek and foreign customers switched away from Greek products.

So where to from here? One thing we can be certain about is that while Greek costs continue to be uncompetitive there is little hope that full employment and stability can be restored.

Instead the present policy response with its focus on increased “austerity” is intended to reduce consumption by the Greek’s, and their living standards, and in that way reduce the Greek national debt. The burden of this strategy, however, falls almost entirely on those who don’t have jobs – be they pensioners or workers and their families who can no longer gain employment.

Over time there is of course a chance that the rising unemployment may lead to lower costs and thus a slow improvement in Greek competitiveness. Indeed since 2010 unit labour costs have fallen a little in Greece and risen a little in Germany, thus reversing a small part of the previous loss of Greek competitiveness. But as Keynes pointed out in a similar situation in the Great Depression, in such a long run we will all be dead before full employment is restored.

Frankly as was discovered a long time ago, the reality is that fixed exchange rates usually cannot be maintained indefinitely , and they have no hope of working unless there is much more policy coordination than has been apparent in the Euro Zone to date. Instead Greece would be much better off if it devalued and thus restored its competitiveness. The resulting reduction in Greek costs would enable Greece to sell as much as it can produce, while imports would become less affordable. The overall result would be lower debt and an increase in employment.

This devaluation would, however, only work if it led to a genuine reduction in Greek labour costs, which implies a comparable reduction in living standards. The difference between this and continuing austerity is that the reduction in living standards following a devaluation would be widely shared instead of falling largely on the increasing number of Greeks who do not have a job.

The sad thing is that the Greek Government having won a referendum against the austerity package, still seemed determined to avoid a Grexit, although that is the only strategy that will actually succeed. Nevertheless, a Grexit is not without its dangers, but these dangers multiply if preparations for it are postponed. The worst outcome would be for a Grexit to effectively be forced by markets after a disorderly capital flight, and the longer the delays the greater the risks.

Finally for those who regard a major devaluation and a writing-down of a country’s debt obligations as akin to a disaster, it is worth remembering that this is what Argentina did not so long ago, and it was generally conceded to have worked then. But it only worked while the authorities maintained a strong discipline on costs and accepted the loss of borrowing capacity and the implications for living standards. This is the message that the Greek leadership should be delivering, and again the delays are not propitious.



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