The sad fact is that no one outside officialdom (who are duty-bound to talk nonsense when sense is too embarrassing) seems to regard the recent privately held debt write-down and second Greek bailout as likely to offer an exit to Greece from its nightmare, even in the long run. The reason is simple: Greek competitiveness has slipped. There is no sign of internal devaluation working to remedy this on present policies. (According to the International Monetary Fund’s latest figures, Greek competitiveness deteriorated vis-à-vis Germany by a further 9.9 percent, or 10.0 percent vis-à-vis the euro area average, since the Greek rescue program was launched.) It is true that Latvia improved its international competitiveness by 15 percent through internal devaluation, but Greece does not have as flexible an economy as Latvia.
The obvious conclusion is that Greece needs to exit the euro. The short-run consequences would be unpleasant for Greece, especially given that the latest figures suggest it still suffers from a primary fiscal deficit. But eventually it could expect an Argentine-style rebound. One hears the usual stories about how Greece doesn’t export anything, or the elasticities are too low to enable devaluation to work. These arguments deserve the customary contempt. The more serious consequences would probably be felt by the remaining euro area, which would face grave difficulties in preventing a progressive erosion of the entire euro area (and conceivably of the single market).
Is there an alternative which would allow Greece to remain in the euro but would still remedy the Greek loss of competitiveness (see figure 1)? Economists, at least in Europe, used to hope that there was an alternative to austerity in reducing prices. It was called incomes policy. It did not work very well when it was used in the 1970s in the attempt to reduce wage rises from 5 percent to 3 percent, because people were focused on relative wages and the changes sought were seen as impinging on relative wages. But if the problem is perceived to be that of reducing everyone’s wages equiproportionately, it is just possible that the answer would be different.
The program that the troika (consisting of the European Central Bank (ECB), the International Monetary Fund (IMF), and the European Commission) is foisting upon Greece in fact contains some elements which are directed at improving Greek competitiveness. Unfortunately they are generally regarded as a part of austerity rather than offering an alternative to it. For example, I recently came upon an analysis from the (Washington-based) Center for Economic and Policy Research whose summary said in part:
The Greek government has agreed to reduce public employment by 150,000 workers by 2015, to cut the minimum wage by 20 percent (and by 32 percent for those under the age of 25); and to weaken collective bargaining. All of this will have the effect of reducing living standards for workers and redistributing income upward.
Reducing public employment (austerity) is here equated to a reduction in the minimum wage (despite the fact that the Greek minimum wage is comparable to that in the United States, 17 percent above that in Spain, and no less than 55 percent above that in Portugal).
Imagine therefore that the Greek government announced that as from Friday, everyone’s wages would be 65 percent (say) of last week’s wages, and similarly that prices in the non-tradable sector would be reduced by 35 percent. The prices of tradables would be left alone: some might be lowered competitively, but others would be determined by international factors and would remain essentially unchanged. This would place great pressure on living standards in Greece. Yes, that is unavoidable, and will happen exactly the same if Greece exits the euro. The advantage to this approach would be that Greece could stay in the euro while giving long-run hope and avoiding greater losses in the process of forcing prices down.
Could Greece police such a decree? Not perfectly of course. But it would have the advantage that everyone whose wages and prices were reduced by 35 percent would share the pain equally. Greeks would help the policing by squealing over prices deemed to be illegitimately high. Another advantage of acting through an explicit incomes policy is that one would be consciously aiming at avoiding the redistribution of income that normally occurs with “internal devaluation.”
If the Greek government were to adopt the suggestion, and if the Greek people were to welcome it (two uses of a small word with a big meaning), then long-term the Greek outlook would be transformed. There would be a renewed chance of growth. Whether this would also impress the bond market in the short term is anyone’s guess, but it is a mistake to get hung up on a market that was lending happily to Greece at a few basis points over Germany only weeks before Greece acquired a relatively honest government.