Is Greece the ghost of the Eurozone future?
When European Commission President Manuel Barroso spoke to the European Parliament this morning, he ruled out a Greek euro exit. Behind the scenes, politicians and bureaucrats were meanwhile seeking a lasting solution to the country’s debt problem and to reorganise Eurozone economic governance. Raising the size of bail-out funds is planned to reassure markets, never mind previous failures on this score.
The general government gross debt of the Eurozone already stood at 85% of GDP in 2010, rising to 89% after adding the IMF’s 2011 deficit forecast. If the full amount of a stocked-up European Financial Stability Fund is disbursed, joint debt goes up to 98%. A widely mentioned increase to two trillion euros would – if fully disbursed and financed by the Eurozone – lift the region’s debt to 111% of output. Italy’s central government debt level of 109% of GDP has caused markets to worry about the country’s solvency, implying that a confidence crisis could grip the whole union, including France and Germany. Capital flight, a plunging euro and another global financial crisis are possible if the Eurozone overextends itself, possibly turning the ‘rescue package’ into a time bomb for the world economy.
Greece is a mere symbol in the battle against market pessimism, which, it is feared, may pull down Spain and Italy next. Athens’ public debt only amounts to 4% of the Eurozone’s stock of general government debt, meaning that Greek public finances could be fixed easily. But would this cure the Greek economic malaise? Unlikely, because apart from excessive public debt, the country suffers from a lack of competitiveness that holds it back from growing out of its problems.
Unit labour costs (ULC), the cost of human effort for each unit of goods and services produced, are probably the best measure of competitiveness. This indicator rose a hefty 36% in the decade from 2000, compared with a mere 6% increase in Germany. Ireland is a better comparison and saw a similar run-up in ULC (33% from 2000 to 2008). Irish ULC have been falling by about 5% in both 2009 and 2010 as wages were cut. The result has been a deep recession. However, there is some hope for the Irish economy arising from its strong export sector: exports are 106% of GDP. This is an advantage that Greece does not have, with exports just 22% of GDP. Greek ULC fell only 1% in 2010, but further falls are necessary for the ‘internal devaluation’ required to get the economy on track while staying in the euro. To bring its increase in unit labour costs since 2000 down to the Eurozone average, four to five years of Ireland-style wage cuts are necessary. The effects of the public austerity program would hamper growth by itself, but falling private consumption would aggravate the situation. This would likely throw the economy into a debt trap and bring on a recession lasting until at least 2014 – six consecutive years of falling living standards.
Such economic pain may well prove unpalatable to the Greek public, which may prefer a shorter, albeit more painful, adjustment: exiting the euro. The alternative is fiscal union with outright transfers from strong to weak economies. More ‘bail-out’ loans that carry interest obligations cannot substitute for weak demand due to austerity and labour market restructuring. Politicians in Germany, Finland and other robust economies would have to convince their electorates that gifting rather than lending money to southern neighbours is the best course of action. Cebr has said since the first half of 2010 that Greece will have to leave the euro. Given the threat of a Eurozone default, an exit mechanism would be best for everyone – including Mr. Barroso.
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