Will Greece Finally Exit The Euro? – Economy Is Too Weak – Current Austerity Focused On Higher Taxes, While Keeping A Huge Public Sector Makes Things Worse – Expect No Growth

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By Paolo von Schirach

May 24, 2012

WASHINGTON – The unmentionable is now openly talked about. Greece may have to leave the euro after all. Until recently this was considered a complete impossibility. Even talking about it was akin to blasphemy. The common currency agreements, we were told, do not contemplate an exit. Once in, you are in, for ever. But now there is at least talk.

Monetary union among unequal members was a bad idea

I am not sure of how a Greek exit, now often referred to as “Grexit”, a term coined by Citigroup analysts, could be arranged with manageable levels of pain and not too much market confusion. But I am sure that the whole concept of a monetary union linking together vastly unequal members was and is a bad idea.

Weak economies, bloated public sectors

The problem is that in Southern Europe the economies are not productive: there is hardly any innovation and no dynamic investment environment, while labor and other costs are too high.

At the same time, the political systems favor notoriously inefficient and bloated public sectors because public sector jobs are a way to soak unemployment while rewarding political friends. So we have the unhappy combination of weak economies and large public sectors that are both too expensive and totally unproductive.

After joining the euro, Greece and the others did not think even for a moment that they would need to reform in order to catch up with the more energetic Northern European countries so that they could actually stay and prosper in the common currency. No, absolutely not. They kept doing exactly the same, only borrowing a bit more to finance larger public deficits.

Wrong way to fix the problem

Now we are at the point in which the systemic weaknesses cannot be kept hidden any more. But the crazy answer is to rebalance the books through austerity that hits society and not by shrinking the bloated governments. A pro-growth austerity program, as David Malpass points in a WSJ op-ed piece, favors enterprise and the creation of new business activities, while shrinking the state via cuts in public employment and asset sales.

Well, in Greece they have done exactly the opposite. The state not only did not shrink, it actually grew a bit more, while it tries to get new revenue through impossible levels of taxation that are suffocating whatever economic vitality was left. And so the unproductive state with all its coteries of politically supported friends prospers, while society and the private economy, already in terrible shape, suffers even more.

This is a recipe for economic suicide. The idea that one can engineer economic recovery by taxing companies and people to death, (the same complaints can be heard in Italy and Spain), is ludicrous.

Southern Europe could adopt the Northern model

In theory it would be quite possible for the Southern European members of the eurozone to adopt the Northern models. There is nothing mysterious about recipes aimed at reforming public administration and taxation, while creating a new investor friendly environment. The Republic of Georgia did this. Some African countries have made significant progress towards this.

A matter of values and psychology

But I doubt that Greece and the others are willing to adopt Northern ways. The problem in the South of Europe rests in values and psychology. For most people a public sector job for life is much more appealing than taking a chance in the private sector. Nobody really considers the aggregate consequences of this collective predilection. A large and inefficient public sector consumes resources rather than producing them. High labor costs and rigid labor rules discourage investments.

With this approach, no solution

Unless something gives, the result is exactly what you see. Out of control debt that cannot be repaid because the economy is too weak. But instead of reversing course by cutting the public sector while encouraging new enterprise, they make the problem worse by adding to taxation while keeping the state just as large and unproductive as it was.

If this is the approach, I cannot see how these countries, starting with Greece, can share the same monetary union with more enlightened countries. Time to plan for Grexit.


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