Greece is in financial straights that threaten the stability of the Euro. The proposal from center-right politicos? Dramatic wage reductions and other cuts in the social safety net. The question is begged, then, are these the primary source of the problem and, thus, the legitimate place to apply the most pain?
Overspent or underfinanced?
Yes, Greece has a serious current government deficit about which it cooked the books (12.5% of GDP in contrast to 10% of GDP in the US). But the public stock of debt as a percentage of GDP is around 40% of GDP, well below the Eurozone norm.
The problem in Greece has been wrongly portrayed as one of overspending. And although some Greek public sector expenditure is nepotistic and unnecessary, most of it goes to low-paid teachers, nurses and other public servants.
The real problem lies elsewhere; namely, in a poor tax collection system allowing the rich to move money to tax shelters. Half of the Greek economy remains untaxed, be it shipping or oil revenues, safely declared in tax heavens or “convenience flag countries,” or simply through the huge parallel economy. Most of these untaxed revenues originate not from the lowest income persons, but the richest people and firms.
Poor tax collection is greatly compounded by the collapse in government revenue resulting from recession, and these matters will not be put right overnight.
Mr Papandreou must be given time if he is to bring about fundamental structural reform. He does not need the sort of labour unrest which will follow a massive wage squeeze.
Devaluation not the answer
Several British economists writing in the Financial Times have suggested that Greece might briefly leave the eurozone in order to devalue. But devaluation is not the answer.
The view that devaluation has been good for Britain (for which there is still scant evidence) cannot be applied to the eurozone as a whole.
Had the eurozone not existed, the markets would certainly have attacked the eastern european national currencies, possibly unleashing a round of competitive European devaluations of the sort experienced in the 1930s. Moreover, in the unlikely event of Greece temporarily leaving the eurozone, its euro-denominated debt would rise in value relative to the new currency, thus exacerbating the country’s problems.
The key question to be asked is how rich eurozone members can help the poorer ones guard against currency speculators.
There are two types of actions to be taken: short-term and long term.
The short-term solution
The short term solution is for the European Central Bank (ECB) to extend beyond next January its refinance operation in which government debt rated at less than A- is accepted as collateral. The ECB engages in weekly “refinancing operations” to add liquidity to the European banking system. Banks that need cash can trade in bonds in return for fresh euros, the ECB then charges them interest in return for what is effectively a secured loan. On January the 1st 2011, the ECB will return to the old A- standard floor. It is the fear that Greek Eurobonds cannot be traded for cash—not the fear of the Government ‘going broke’—that is at the heart of the refinancing problem. Postponing a return to the old A- standard beyond next year would solve the crisis. It would not cost the German taxpayer anything, and it would not cost ordinary Greeks their jobs.
The longer-term solution
The longer term solution involves changing the economic architecture of the eurozone in two critical respects. The eurozone needs a proper Federal Budget enabling the centre to help the regions, such as a Federal ‘rainy day fund’ and a genuine Federal Budget—perhaps 5% of Eurozone GDP initially—could easily be funded by a small Tobin tax on euro foreign exchange transactions.
What is also needed—and here I recall the argument advanced by Keynes at Bretton Woods in 1944— is a mechanism whereby countries such as Germany spend their surpluses in deficit countries in a matter which increases the productivity, and hence the repayment capacity, of the latter.
The powerful nations of the eurozone have generously bailed out their banks using ordinary people’s money. It is time for them to support the ordinary people who are most at risk from swingeing cuts in Greece’s government expenditure being called for by these same financiers.