Three essential problems remain, and leaving the eurozone may be the answer.
By Alan S. Blinder
July 16, 2015 6:59 p.m. ET
A shopping street in Athens on Thursday. Photo: Matthew Lloyd/Bloomberg News The modern Greek tragedy isn’t over—after an interlude, there will be more acts. The deal struck with European leaders on July 13 will, with luck, avert an immediate financial collapse.
But three underlying problems remain: Greece must escape from the current depression, reduce its debt burden and restore its competitiveness. All three trace to fateful decisions made in the early days of the euro.
Back when the euro was just an idea, many economists warned that the countries involved weren’t suited to using a single currency because they weren’t what economists call “an optimum currency area”—a group of nations with similar business cycles and substantial political unity, labor mobility and cross-country fiscal transfers.
The euro’s founders did not dispute this judgment; they played down its importance. The order can be reversed, they insisted: First we’ll create the common currency, then we’ll create the conditions that make it work.
Germany’s Helmut Kohl and France’s François Mitterand went further, subordinating the economics to a big political idea. What’s the theory of optimum currency areas compared with ensuring that Germany and France never go to war again? Hard to argue with that, but it doesn’t repeal the laws of economics. The eurozone still isn’t an optimum currency area, and that explains much of the Greek problem.
Start with “similar business cycles.” The Great Recession was a world-wide event, but it hit Greece especially hard. Countries have three main weapons to fight recessions: fiscal stimulus, monetary stimulus and currency depreciation. Membership in the eurozone forecloses the latter two. Greece’s large pre-crisis debt—so large that it shouldn’t have been in the eurozone in the first place—starkly limits the first. Hence Greek Problem No. 1: a depression worse than the Great Depression in the U.S.
The latest agreement looks likely to make this depression worse. Several previous bailouts held things together with chewing gum and baling wire. But in return for loans, Greece’s creditors demanded ruinous fiscal austerity. Successive rounds of austerity spread misery and ushered in the left-wing government that Europe and the IMF find so ornery, but did not reduce Greece’s debt-to-GDP ratio.
According to myth, stubborn Greece has done little to fix its budget. In reality, Greece’s structural budget balance (that is, correcting for the business cycle) moved from an Olympian 17% of GDP deficit in 2009 to about a 1% of GDP surplus in 2014, according to OECD estimates. That’s a swing of 18% of GDP in five years. But the Greek economy shrunk so much that the public debt rose as a share of GDP, to 181% from 135% over those five painful years.
Hence Greek Problem No. 2: unpayable public debt. Some sort of write-down, restructuring or default is inevitable. Sooner and smoother (e.g., a mutually-agreed restructuring) seems better than later and messier (e.g., a unilateral Greek default).
But Greece’s creditors are so far unwilling to offer much debt relief because that means that some third parties must pitch in money or relinquish claims on Greece. And that brings up the second departure from an optimum currency area: The eurozone is not a country; its mechanisms for fiscal transfers across borders are underdeveloped and contentious.
Compare the U.S. I live in New Jersey, one of the richest states. We New Jerseyans have been making fiscal transfers to poor states like Mississippi, funneled through the federal government, for decades. But few of us notice it, and we don’t vote on it. The transfers happen automatically because New Jersey and Mississippi are in the same country. Germany and Greece are not. Angela Merkel is right to worry that Germans oppose transfers to Greeks.
Would Americans vote for transfers to Mexico?
Greek Problem No. 3, restoring competitiveness, may be insoluble. One of the most remarkable developments since the founding of the euro has been the extent to which Germany has outpaced the pack in competitiveness. According to data compiled by the ECB, Germany’s unit labor costs have fallen 19.5%, relative to its trading partners, since the end of 1998—leaving the rest of the eurozone in the dust.
And here’s a surprise. After Germany, which eurozone countries do you think are running second and third in competitiveness? Eureka! It’s Cyprus and Greece, where wages have crumbled under the weight of ferocious unemployment. Greek unit labor costs are down 7%. But that still leaves them further behind Germany than when Greece joined the euro.
How do you fix that? Under floating exchange rates, some semblance of parity would be restored by currency depreciation. But that can’t happen with a single currency. The answer could be either huge wage hikes in Germany or more devastating wage cuts in Greece—a terrible solution.
So the Greek problem may never be over as long as Greece remains in the eurozone.
Mr. Blinder, a professor of economics and public affairs at Princeton University and former vice chairman of the Federal Reserve, is the author of “After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead” (Penguin, 2013).
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