So, bondholders (if they “agree”) will give Greece more of a fighting chance to tackle its debt burden. But Greece will also have to pull its own weight.
In a sensible world, the southern states would devalue to become competitive – but they cannot. They are locked in a single currency. And because they cannot devalue their currency, they must devalue their living standards and promote reforms to enhance efficiency. This will take years. Meanwhile, wages must fall, unemployment will rise and social unrest will increase. The severity of this medicine may not be bearable in a liberal democracy.
Most obviously, this has an impact on Greece. Of course, it has behaved foolishly. But that does not mitigate the present pain. As salaries are cut, new taxes are imposed and other taxes rise. It is no wonder people are frightened. Some ask: why is Greece in the eurozone at all? The ease of her entry exemplifies the follies of the founders. France insisted: “You cannot say no to the country of Plato.” Maybe not, but every European is now paying the price for admitting an economically unfit nation to compete in the eurozone.
The similarities between Greece and Latvia have been argued extensively elsewhere and are certainly striking.
The Baltic state became overly indebted (gross external debt to GDP of 133 per cent in 2007) and uncompetitive, after years of soaring labour costs and a growing current account deficit (at 22 per cent in 2007). As a result of its currency peg to the euro, Latvia could not re-gain competitiveness and adjust external imbalances through currency depreciation. Sound familiar?
The only option was to cut domestic costs by slashing wages, pensions and social benefits. Resultantly output contracted by 18 per cent in 2009, while unemployment surged to over 20 per cent. Yet two years down the line, Latvia is pushing growth of 5 per cent as external competitiveness and confidence are restored.
Internal devaluation is a killer, but it works.
Is it really an option for Greece though? One consideration here should be the difference in temperament (and willingness to accept austerity measures) between the fiery Greeks and their ‘stoic’ northern neighbours.
And there are bigger factors at play here too, according to Charles Robertson of Renaissance Capital:
The Latvian internal devaluation model is tremendously misunderstood by those suggesting it as a template for southern Europe. Despite an 18% GDP decline in 2009, and a massive jump in unemployment from 6% in 2007 to 19% in 2010, Latvia has cut its budget deficit from 8% of GDP in 2009-2010 to an estimated 4.5% in 2011. If Latvia could take this economic and fiscal pain, why can’t Greece? But what this misses is that while Latvian per capita GDP fell sharply, it had risen hugely in earlier years. If per capita GDP in cash terms was 100 in the year 2000, by 2007 it had risen to 324, and by the end of this year will still be around 304. And this with a currency that has basically been pegged to the euro since the 1990s. Latvians (with jobs) remain vastly better off than they have been within recent memory.
So where does that leave us? Robertson proposes that Ireland, the new poster child of austerity, could be a better model for Greece to follow:
The Irish model is more appropriate, but may be exceptional. Despite its steep 7% of GDP decline in 2009, and massive jump in unemployment from 5% in 2007 to 14% now, they have cut their budget deficit from 14% of GDP in 2009 to10% in 2011. They have endured more pain than any other county, if we take per capita GDP in 2000 to have been 100, it was157 in 2007 and has fallen 22% since then to 123 in 2011. This is the steepest fall by far of any EU economy. Irish per capita GDP in cash terms is up by only a fifth since the year 2000, and in real terms is up just 5% since 2000. So, why can’t the Greeks be more like the Irish?
The answer is simple, Robertson goes on — they are poorer:
Perhaps this pain has been bearable for the Irish because they are still richer than the Germans. In 2000, per capita GDP was 12% above Germany, in 2007 it was 48% above Germany, and in 2011 it is still 9% above Germany. We are all emotionally more sensitive to a loss than to a gain, but we are all also relativists. Maybe what is most important is that the Irish remain 20% richer than the British.