The Greek Tragedy
July 6, 2015
As you read this, you have information that we Matts did not have at the time of writing: how the Greek people ended up voting on the (somewhat abstruse, 72-word) referendum. The pre-referendum polls indicate a substantial chance that a “no” vote would prevail, which in turn might precipitate some combination of further Greek defaults beyond its missed payment last week to the International Monetary Fund (the largest such missed payment in IMF history, and the first ever by an advanced country); bankruptcies of one or more of Greece’s four main banks, all of which are on European Central Bank life support; or Greece reintroducing its own currency, the drachma.
Whatever happens, all of this is tragic: the economic hardship millions of Greek citizens are enduring, the leadership failures in Greece and arguably beyond, and the uncertainty this turmoil creates for the global economy. To help make sense of all this, one of us testified recently before the U.S. Senate Committee on Banking, Housing, and Urban Affairs at a hearing, “Economic Crisis: the Global Impact of a Greek Default.” You can read the testimony in full here; we excerpt its three main points below.
There are many fluid and undefined issues about the immediate situation, none of which this testimony will address. Rather, I will make three main points about the consequences of a Greek default: one focused on the short term, one focused on the medium term, and one on the long term.
In the short term, a Greek default would surely trigger additional short-term pain on the Greek economy. In the past five years Greece has sustained a Great Depression-scale contraction. In whatever form it might take, a default would contract the Greek economy further. A main contractionary mechanism would likely be a wave of bank runs and thus bank closures, with knock-on bankruptcies beyond the financial sector, amidst the turmoil of reintroducing the Greek drachma with no treaties, laws, or precedents for how to reconvert all payment flows, assets, and liabilities out of euro denominations. This turmoil would sharply curtail consumption and investment demand in Greece, which in turn would drive down short-term output and employment.
This Greek economic contraction would very likely dampen overall economic activity in Europe—and thus, albeit to a lesser extent, the rest of the world. Through the usual linkages of international trade and investment, however, the scale of this worldwide dampening would be slight. The basic reason for this is that the Greek economy is quite small. 2014 GDP in Greece was about $244 billion (down from a pre-crisis peak of about $342 billion). This was about one-third of 1 percent of worldwide GDP in 2014 ($77.3 trillion, according to the IMF). Greece is about the size of the economy of Louisiana or Connecticut. As such, however large a default-induced contraction in Greece might be, it simply would not be very large relative to the overall world economy. A further 10 percent contraction of the Greek economy would be about one-thirtieth of 1 percent of the total world economy.
The one possible economic impact of a Greek default that paradoxically might be most important yet is most difficult to quantify is there is the small but non-zero chance that default triggers another financial crisis of the magnitude of the World Financial Crisis of 2008-2009 triggered by the default of the U.S. investment bank, Lehman Brothers. There are sound reasons not to expect such a crisis. For example, today the majority of Greek sovereign debt is owned not by banks and other private investors but rather by public entities: other sovereign governments, the IMF, and the ECB.
All this said, no one really knows what will happen in global capital markets if Greece defaults and/or exits the eurozone. All of the world’s analysis, meticulous and thoughtful though it may be, simply has no historical precedent as a guide. Before Lehman Brothers, as its stock price slid and as creditors and other counterparties jogged, wise voices intoned that a medium-sized U.S. investment bank could do only so much damage. Those wise expectations were proven very wrong.
In the medium term, a Greek default would raise the risk of additional highly indebted and struggling countries exiting the eurozone. A Greek default accompanied by an exit from the eurozone would set a precedent that had been intended to be an impossibility: a eurozone member reverting to its own sovereign currency.
Currency unions such as the eurozone function much like regimes in which member countries fix their currency values yet maintain separate currencies. The main advantage of currency unions is—or so it is often hoped by their creators—irrevocability that eliminates the possibility of the speculative attacks that so often have bedeviled fixed-exchange-rate regimes. Indeed, a major impetus for creating the euro in the late 1990s was the early 1990s turmoil of waves of speculative attacks against the Exchange Rate Mechanism (in which many member countries effectively chose to fix the value of their currencies to the German deutschmark). The British pound, for example, was ejected from the ERM and floated in September of 1992 when speculators such as George Soros forced the Bank of England to relent its fix after sustaining losses of tens of billions of pounds.
A “Grexit” would shatter the intended permanence of the euro and would revive the idea that eurozone countries can create and print their own currencies. Quite simply, afterward no government official could credibly claim that the Grexit was a one-off event never to be repeated. Investors and politicians alike would focus more on the actions of the Grexit, not on any words thereafter.
In the long term, a Greek default is largely irrelevant to the fundamental challenge still facing Greece and every other advanced country: how to foster growth of jobs, incomes, and output in societies with aging populations and looming entitlement pressures. In this sense, the default question is not the most important question facing Greece today. Rather, that honor goes to a different question: Will the Syriza government—or any government after it—be able to foster growth in Greece’s labor force, capital investment, and productivity?
Regardless of how Greece and its creditors resolve their differences, the country will still face long-term growth challenges that must somehow be addressed. For example, its total population fell by about 200,000 people between 2001 and 2012 (and has surely declined even more since then)—a function of low birthrates, low immigration, and high out-migration. The median age is also projected to be 43.5 this year (an increase of 10 years since 1970), which is one of highest in the world. Demographically, Greece has quickly become like already-shrinking Japan. And who is fleeing Greece are almost surely the more talented, more dynamic of its workers.
Greece has a glorious past. If it can use the ongoing crisis as an opportunity to transform its economy, and unlock economic opportunity, it could have a glorious future as well. Debt discussions of today must not obscure the deeper reforms that are needed for attaining that future. The current Greek crisis, however it is resolved, does nothing to address the fundamental long-term problem of how to accelerate economic growth. Indeed, by crowding out the attention of policy and business leaders, the current crisis aggravates this looming long-term problem.
Wise leaders will reflect on Greece, not as a unique outlier but rather as a sobering leading indicator for the challenges that are approaching so many other advanced countries in the world.
Articles © 2015 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2015 Trustees of Dartmouth College. All rights reserved.