You can’t buck the market

The Greek flag

Margaret Thatcher’s famous aphorism echoes down the decades, and is heard nowhere more clearly at present than in Greece. The Greek government is struggling to convince the bond markets that it can pay its debts. The interest rates it has to pay are up to 4 percentage points above the rate charged to Germany, the excess arising from the perceived greater risk of default.

Why is Greece thought to be more at risk? Its public deficit this year will be around 13 per cent of GDP and its accumulated public debt is now as high as 110 per cent of GDP. The convergence criteria in the Maastricht treaty specified that countries could only join the euro with deficits less than 3 per cent and debts less than 60 per cent (or falling towards that level). However Greece managed to get within the Maastricht criteria when it joined the euro in 2001 (and there is a lot of dispute about the validity of the figures on which it achieved that feat), it has failed to maintain anything close to them now. Every country in Europe has suffered during the current financial and economic crisis, but Greece has it much worse.

The point is that membership of the euro does not in itself solve a country’s economic problems. It might reduce them a bit, and it certainly makes it easier to solve them, but it is not in itself a solution. Joining the single currency should have been followed by a series of further economic reforms, but in the Greek case these next reforms did not follow. The Greek tax system is still too weak, the Greek public sector is still too large and inefficient. These will be problems, whatever the currency regime in place.

The Greek government’s need to borrow will continue to remain great until these underlying problems are dealt with. These are economic and political problems not with a European origin, but arising at national level.

There is a school of thought – see Peter Oborne in the Daily Mail (“Heroes who spared us from a Greek tragedy”) – that argues that, had Greece retained its own currency and not joined the euro, it would be able to assist its economy to recover through devaluation. This is what Britain has done, devaluing by 20 per cent since August 2007.

But what kind of an economic solution is it that impoverishes the country by 20 per cent? Everyone in Britain has seen their income fall by 20 per cent and the value of their house and other assets fall by 20 per cent. OK, their debts have fallen by 20 per cent but so has their ability to pay off their debts. A massive devaluation of that kind is not a solution: it is a problem in its own right. In the case of Britain, the pre-crash estimation of the strength of the British economy was so wildly excessive that some kind of substantial correction was needed.

The advantage of reforms within the euro over reforms outside the euro is precisely that they are within the euro. In the case of Greece, this will have two clear benefits.

First, there are considerable advantages to business in operating in the same currency in different countries. Were Greece not in, or to leave, the euro, businesses in Greece would be placed at a permanent, structural disadvantage compared with their competitors in countries within the eurozone when trying to trade with eurozone-based companies. And given that companies in the eurozone are by far the most important foreign trading patterns of Greek business, this disadvantage could over time prove to be substantial.

The second beneficiary of Greek membership of the euro is the Greek government itself. For Greece to make a recovery from its economic difficulties is going to require the support of other European governments, and that support is going to be much easier to elicit as long as Greece itself is committed to the central projects of the European Union. A Greek devaluation might deliver a short-term boost to the economy but at the cost of harming the competitiveness of other countries. Membership of the euro prevents these rounds of competitive devaluation within Europe, from which all countries benefit. A Greek decision not to do harm to the rest of Europe is a constructive decision which should attract constructive support. The extent of that support will depend, of course, on Greece’s ability to introduce domestic reforms: why should people in other European countries support public sector inefficiencies in Greece when they would not tolerate them at home?

The lessons from Greece apply in Britain, too. An economy that was not nearly as productive as was generally thought is going to need more profound reforms than can be found by adjusting the exchange rate downwards. It is strange that it is conservative voices in British politics that are proposing a course of action that involves postponing dealing with underlying economic problems rather than forcing us to address them openly and straightforwardly. Rather than bucking the market, we should learn its lessons and deal with the problems that it reveals. Among them is the fact that we do not share the same currency as our major trading partners.

About the Author