A growing number of voices are saying that a Greece unwilling to pursue reforms has no future in the euro zone. They argue that by exiting the euro, the Greeks will take responsibility for their economic and monetary policies and that will make the euro zone more stable in the medium term. Meanwhile, other nations would be forced to exercise more discipline to avoid Greece’s fate.
These arguments often overlook the costs that would arise from a Grexit, not only for the Greeks but also for the euro zone. In view of these risks, the political price for compromise between Athens and its creditors would be manageable.
Greece has been wrestling with international creditors over debt for four months. So far, the government has shown little willingness to accept creditor demands for reforms in the areas of value added tax, pensions and the labor market. Additionally, Athens announced more spending that will add more red ink to the national budget. Under those circumstances, it’s unlikely the €7.2 billion ($8 billion) in additional bailout funds will be released.
The long-term success of the Greek economy isn’t dependent on currency, but rather on reforms and modernization of the economic system.
Yet Athens is in desperate need of a fresh financial injection. In June alone, Greece must pay back loans from the International Monetary Fund totaling €1.6 billion. Unless political leaders soften their stance, the country faces bankruptcy.
Given the unwillingness to reform, a mutual agreement on rescheduling debts can’t be expected. Without massive support from European partners and the European Central Bank, a Greek bankruptcy would be almost inevitable if it leaves the eurozone.
While Greece’s insolvency and exit from the monetary union would bring considerable burdens and risks to the remaining member states, the eurozone will not break apart.
Other countries with deep financial problems have implemented reforms in recent years and greatly reduced dangerous imbalances such as current account deficits. Ireland and Portugal successfully completed their E.U. bailout programs while the banking sector in Spain has recovered. Countries on the edge have moved back onto the path for economic growth.
In addition, European crisis mechanisms have been strengthened and institutional reforms embraced including the introduction of the European Stability Mechanism, adoption of the European Banking Union and the strengthening of regulations for economic policy coordination.
The willingness of the ECB to purchase government bonds through Public Sector Purchase Programme or the Outright Monetary Transactions is helping limit the risk of “infection” for other countries on the periphery.
Even if the existence of the euro isn’t endangered, a Grexit would be accompanied by setbacks in financial markets and temporary burdens for the real European economy. Taxpayers in creditor nations should expect considerable burdens, too.
In the wake of an expected devaluation of a Greek currency, Greece would be unable to fully repay €240 billion in bailout loans. Meanwhile, the ECB must expect additional losses from the Greek government bonds it holds as well as the liabilities the Greek central bank has run up in the eurozone.
For Germany, that would total €90 billion in accounts receivable without including private sector debts. There is much at stake for Germany, even if only a portion of debts were cancelled.
A Grexit would have a much more dramatic effect on Greece itself. It would be the proverbial tragedy if the country were to exit now, just as the painful reforms and cost-cutting efforts of the population have begun to show results.
In 2014, Greece made a successful return to the capital market. The national mood improved, the labor market stabilized and the economy grew for the first time in six years. A state insolvency and exit from the euro again would demand tremendous sacrifices from Greek citizens.
Government bonds and the new currency would drop in value while banks would become insolvent without additional capitalization. Buying power would be reduced and savings devalued for the average citizen. Since those with savings accounts would recognize the danger, they likely would withdraw savings from banks and deposit it abroad, making comprehensive capital controls necessary.
Certainly, the Greek economy would get back on its feet eventually, even with a weak currency. But the long-term success of the Greek economy isn’t dependent on currency, but rather on the unavoidable reforms and modernization of the economic system. This should be obvious by now.
What conclusions can be drawn from this analysis? A Greek exit from the euro is not in the interests of its European partners and certainly not in Greece’s best interest. The Greek government must be cognizant of what insolvency and a Grexit would cost, at least in principle, and ultimately draw back from this scenario. Thus, no lame compromises are necessary by creditor nations or the IMF.
Greek political leaders must be able to explain exactly how they plan to finance their desire for more social spending without creating a national deficit, whose financing they would expect from abroad.
Greece should decide what strategy works best, whether it’s an increase in value added tax, the long overdue collection of taxes on high levels of wealth or spending cuts in other areas of government. The ruling Syriza Party promised to fight tax evasion and corruption while improving the legal and political systems. Those promises correspond to reforms sought by international creditors.
An agreement is surely be possible. The costs of failure are simply too great.
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