Greece and the Eurozone: Problems and Implications for the EU.

09 March 2015

Greece and the Eurozone: Problems and Implications for the EU.

The recent, successfully concluded, initial renegotiations on the conditions of the previously agreed ‘bail out’ provisions for Greece, have been problematic for all parties concerned. Nor is it clear what exactly has been agreed or not agreed and what might be anticipated as the end-game in June 2015.

Partly the reason for the confusion has been procedural and partly ideological. Both aspects of the problem have lessons for the Eurozone (and indeed the EU more broadly).

It has been said that the Eurozone is a political experiment which may yet fail. Certainly there is a great deal riding on the successful prosecution of the Eurozone structures and functioning. There are many sceptics – both within the Eurozone and in the wider EU (including a wide range of UK Eurosceptics, and also those who may otherwise support the EU) – who have already condemned the Eurozone to collapse and failure. Greece (and earlier Cyprus) has been a test-case. If the problems of Greece, representing only 2% of EU GDP, and whose debt to the EU could be written off tomorrow without any major repercussions, cannot be resolved then a larger country problem could well threaten the whole enterprise. In the end it is this existential threat to the Eurozone itself which should produce a compromise political solution to the problems of Greece.

The Procedural Issues

If we start with the procedural problem, it seems clear that ‘burning the midnight oil’ and multiple drafting of position papers from the various national positions has not been an efficient decision-making process. A more formalised and disciplined mechanism seems to be required.

The Eurogroup, comprising the finance ministers of the euro area countries (one of whom is elected to be the president), the European Commission vice-president for economic and financial affairs, and the president of the ECB, is an informal inter-governmental body, within the EU, as acknowledged by Protocol 14 of the TFEU. In fact, since its inception in 1997, and particularly since the global financial crisis in 2008, the importance of the euro area Heads of State has emerged, as has been evident in the recent Greek renegotiations.

Since the various ‘bail-outs’ have taken place, the IMF has been added to those attending meetings. The so called Troika of the European Commission, the ECB, and the IMF (responsible for monitoring the country ‘reform’ programmes) has also been established. Paradoxically, as the Greeks have found, the Troika (not being inter-governmental) has been easier to negotiate with! The current inter-governmental operation of the Eurogroup makes it hopelessly inefficient in terms of decision-making (and hence, inevitably, dominated by Germany).

The institutional problem is exacerbated by the various elements of the ideological problem (see below). There are at least three ideological factions mixed in with the dysfunctional institutional set-up. The German finance ministry position, reflected in its dominance in the Eurogroup discussions. The Spanish, Italian, France position now, at least partly reflected by the new Commission position. The IMF and ECB positions (though there are nuances here) tend to be technocratic and hence less overtly political. Outside these positions, but inside the Eurozone, is then the Irish, adopting a sanctimonious position which says that we did austerity so why cannot the Greeks? And then there is the UK, outside the Eurozone, self-interestedly supporting any deal if it helps the UK’s main export market. 

Ironically, to avoid the problem of too many competing narratives, and with the agreement of Greece (despite their initial rejection of the Troika), the negotiations have been ceded, again, to the Troika. Within the Troika – which the IMF will be leaving in April 2016 – the Commission has the major influence. This is because the IMF is an outside body, represented only because it is a creditor, and the ECB is constrained by its legal rules (as Draghi frequently points out). In a sense the Troika, with the Commission having major influence, is a way of avoiding the multiplicity of competing Eurogroup country views being injected into the discussions, as indicated above. However, it is hardly an appropriate solution to the inadequate Eurozone decision-making structures.

A move to a confederal system of decision-making, with the Commission only being responsible formally for preparing the papers for the Eurogroup meetings would be preferable to the current position. Such a move – in effect to move the Eurogroup into the formal EU decision-making process – would, of course, have implications for the UK, given its increasing concern about being disadvantaged, in terms of the single market, by being outside an increasingly integrating Eurozone, within the current set of EU institutions and decision-making processes.

The Ideological Problem

If we turn to the ideological problem then the next four months are going to see further confrontation between the German position – with its emphasis on austerity and primary budget surpluses as the only mechanism to achieve efficient national economic efficiency – and the Greek position – arguing, essentially, in favour of real wage increases and social solidarity, rather than targeting an unsustainable primary budget surplus, as the way forward. The problem is this insistence on Greece running almost permanent and substantial budget surpluses, intended, together with the proceeds of privatizations, to be used to pay back the debt capital. Such a policy will simply lead to a continuation of the recession. Ironically, the debt itself is not the main problem as the majority of Greek, debt, after this year, will be of 30-year maturity at low rates of interest. If Greece is allowed to avoid running primary surpluses then economic growth will resume; the debt will be serviced, and over the 30 –year period paid off.

However, one should not under-estimate the short-term debt issues as they impinge directly on the negotiating positions of Greece and the other main ideological factions, led by the Germans. The debts to be paid this year amount to€2.5bn in March, mainly to the IMF, €1.7bn in April-May, then €3.5bn to the ECB and European governments in June. Unfortunately, the Greek economic and financial situation is worsening. The primary budget surplus this year is substantially currently behind its level of last year, because of substantially falling tax revenues. Moreover the financial position, exacerbated by the capital flight is also constrained. The sale of Treasury Bills, controlled by the ECB, has reached its €15bn limit and the ECB is unable, according to Draghi, to lift the ceiling. Despite this constraint the ELA (Emergency Lending Arrangement) whereby the Greek central bank can fund the Greek government is still operational. Private Greek banks appear to be in a satisfactory condition, despite a significant fall in deposits, so that there should be no need for any internal bail-out from the Greek government.

It is to be hoped that other Eurozone countries, particularly the Southern European countries and France, will realise that the German position is inimical not only to the ability of Greece to return to growth, but also to the prosperous economic development of the Eurozone. A substantial easing of austerity and growth of internal consumer demand is essential for the Eurozone if it is to avoid damaging deflation (already being experienced by Greece) and resume economic growth. Germany’s preferred ‘mercantilist’ economic model of maintaining its growth through under-priced exports, and not domestic demand, is not only dysfunctional for the Eurozone, but is not a model which the rest of the EU should emulate or even aspire to.

For the countries such as Spain and Ireland who have experienced austerity, painful though it has been, it is not on the same scale of that of Greece. To say that Greece is suffering from a humanitarian disaster is not an exaggeration. Greece needs the strong support of the southern European countries, and France, and Ireland. Certainly, for Greece to have any chance to negotiate a deal which provides at least adequate room for the Greek government to pursue a reasonable proportion of their economic plan, they need the anti-austerity ‘camp’ among the other Eurozone countries to come out more strongly than they have done so far in support of the Greek position. This partly depends of whether an atmosphere of trust between the new Greek government and the rest of the Eurozone governments can be established. Some progress has been made by the Greek government on achieving this. The next few months are critical in strengthening that trust. The trust is as important as the details of the programme.

Trust between Germany and Greece is, of course, paramount. This is problematic, because Germany, perhaps above all EU countries, dedicated to the rule of constitutional law, almost obsessively so. The concept of the Rechtstaat is fundamental to German governance, and this conceptual framework is transferred to the EU and the Eurozone. For Wolfgang Schauble, in particular, the importance of Greece sticking to the legally binding bail-out contract is crucial. Any subsequently agreed modifications will have to be even more rigidly maintained; hence the issue of trust is all important.

If the criticism of German macro-economic policy (and its constitutional legal propriety) above seems harsh, or even counter-intuitive given Germany’s economic performance, it should be recalled that from 2000 to 2007 Germany generated a massive trade surplus with the rest of the Eurozone, and particularly the Southern Eurozone countries. This trade surplus Germany achieved, not by some astounding productivity feat, but by under-pricing exported goods and services, enabled by substantial downward pressure on wages in Germany. This behaviour piled a balance of trade and balance of payments crisis on top of the global financial crisis. It should also be noted that countries running permanent trade surpluses, such as Germany, are dysfunctional for the global trading system. The IMF is enabled take measures to deal with these countries, but has never invoked its so-called ‘hard currency’ clause.

A further problem is that the German people are being misled as to the role of Germany in the Eurozone. The picture painted is one in which Germany, within the Eurozone, is the ‘white knight’, whose role is to rescue, at considerable cost to Germany, those countries which, through their own failures, have created dysfunctional economic and social behaviour. In fact, it is Germany’s damaging macro-economic policies which have systematically distorted the Eurozone economy. (It should be said that Germany’s micro-economic policies are admirable, e.g. the support given to its Mittelstand via KfW, the massive state bank, in cooperation with the network of local cooperative and savings banks). Germans should not under-estimate the fact that the remaining Eurozone countries represent the major export market for German goods and services. Greece may have its own, recognised, dysfunctional characteristics, but becoming a ‘micro-Germany’ is most definitely not the way forward.

It will be argued that I am ignoring the consensus around the need for structural reform in Greece, and elsewhere in the Eurozone, (except, of course, Germany and the Nordic countries!). In fact, the attention is on labour market reform, even though capital market and product market reform are equally important. No-one would wish to deny that reform in these areas is required, though labour market reform should not be equated simply with greater ease of hiring and firing and the lowering wages. But these reforms are on-going reforms which are secular and incremental in nature. Moreover, an increase in real wages is important for two economic reasons: first, because domestic real wages represent the main content of aggregate demand, without which private production and investment will not take place,  and second, wage increases stimulate increases in labour-saving investment and hence increase productivity. It is also easier to gain acceptance for changes in labour practices in an expanding economy than in one which is shrinking, substantially in the case of Greece.

These propositions are both obvious and are backed by empirical evidence. Why they cannot be appreciated by Germany is bizarre. The reason appears to be the moralistic nature of German macro-political economic discourse. This discourse sweepingly ignores modern financial and economic institutional reality. It homes in on a Micawberish representation of economic reality familiar to followers of Margaret Thatcher. It is perhaps not surprising that the German (and Dutch) word for debt translates into English as ‘guilt’ or ‘sin’!

Lessons for the Eurozone and the EU

So what are the main lessons for the Eurozone and the EU? One lesson is obvious. There must be procedural changes in the way the Eurozone operates. The Eurozone now has 19 members, by far the majority of the EU, whether measured by number of countries or by economic weight. The Eurozone needs to be run as if it is an integral part of the EU in institutional terms. The UK’s insistence that those EU countries which remain outside the Eurozone must not in any way be disadvantaged cannot forever maintained. The single market is already bifurcated by virtue of having a single currency being used by the Eurozone countries. It is also clear that other countries will put themselves forward as Eurozone candidates over the next few years (with probably far more credibility than did Greece before its admittance !!).

In fact, each crisis pushes the Eurozone closer to remedying the one glaring deficiency of a lack of a Eurozone fiscal authority. Of course, if this deficiency is remedied, the problem then becomes what to do with those EU countries, including the UK, who will still lie outside the Eurozone? Anyone who considers this a ‘non-problem’ should read between the lines of the current UK government’s ‘balance of competences’ report on the issue of EMU, prepared by the Treasury. There is a sense in which the arch-Eurosceptics, such as Owen Patterson, may be correct to assert that the UK choice is either between the ‘UK alone’ scenario or some ‘slow-burn’, EU political and economic union, with the UK as part of that union. It is those who argue for a reformed, inter-governmental EU who may be burying their heads in the sand.

We are, of course, far from a choice between these alternative scenarios, but a resolution of the Greek crisis, at least marginally in favour of a ‘good euro’, as Varoufakis describes his favoured outcome, may see a rather more rapid development of what will become a fundamental choice of global direction for the UK. 

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