By Arvind Subramanian
Default will be disastrous for Greece
and the resulting contagion would be damaging for Europe. So goes the
conventional wisdom. The only debate has been about the strength of
contagion and the appropriate response of vulnerable countries and of
the cheque-writing country. Might the debate be misguided because the
premise is flawed? Expelled from the eurozone, Greece might prove more
dangerous to the system than it ever was inside it – by providing a
model of successful recovery.
There is an overlooked scenario in which default is not a disaster
for Greece. If this is the case, the real, more existential threat to
the eurozone might be a very different one, in which the Greeks have the
last laugh. Consider that scenario.
The immediate consequences of Greece leaving
or being forced out of the eurozone would certainly be devastating.
Capital flight would intensify, fuelling depreciation and inflation. All
existing contracts would need to be redenominated and renegotiated,
creating financial chaos. Perhaps most politically devastating, fiscal
austerity might actually need to intensify, since Greece still runs a
primary deficit, which it would have to correct if EU and International
Monetary Fund financing vanished.
But this process would also produce a substantially depreciated
exchange rate (50 drachmas to the euro, anyone?) And that would set in
motion a process of adjustment that would soon reorientate the economy
and put it on a path of sustainable growth. In fact, Greek growth would
probably surge, possibly for a prolonged period, if it adopted sensible
policies to restore rapidly and sustain macroeconomic stability.
What is the evidence? Just look at what happened to the countries
that defaulted and devalued during the financial crises of the 1990s.
They all initially suffered severe contractions. But the recessions
lasted only one or two years. Then came the rebound. South Korea posted
nine years of growth averaging nearly 6 per cent. Indonesia, which
experienced a wave of defaults that toppled nearly every bank in the
entire system, registered growth above 5 per cent for a similar period;
Argentina close to 8 per cent; and Russia above 7 per cent. The
historical record shows clearly that there is life after financial
crises.
This would also be true in Greece, even allowing for the
particularities of its situation. Greece’s low export-to-GDP ratio is
often said to preclude the possibility of high export-led growth. But
that argument is not ironclad because crises can lead to dramatic
reorientations of the economy. India, for example, managed to double its
similarly low export-to-GDP ratio within a decade after its crisis in
1991, and doubled it again in the following decade even without a big
currency depreciation.
Greece, moreover, would experience a mega-depreciation, like the
countries mentioned above, not a modest one. Such a change would
necessarily create new opportunities for exports and convert marginally
non-tradeable activities into tradeable ones. What these exports might
be will, by definition, be unpredictable. But the strong incentives that
will be created by a super-competitive exchange rate are undeniable.
Suppose that by mid-2013 Greece’s economy is recovering, while the
rest of the eurozone remains in recession. The effect on
austerity-addled Spain, Portugal and even Italy would be powerful.
Voters there would not fail to notice the improving condition of their
hitherto scorned Greek neighbour. They would start to ask why their own
governments should not follow the Greek path and voice a preference for
leaving the eurozone. In other words, the Greek experience could
fundamentally alter the incentives for these countries to remain in the
eurozone, especially if economic conditions remained grim.
At this stage, politics in Germany would also be affected. Today,
Germany grudgingly does the minimum needed to keep the eurozone intact.
If exit to emulate Greece becomes an attractive proposition, Germany
will be put on the spot – and the magnanimity it shows in place of its
current miserliness will be the ultimate test of how much it values the
eurozone. The answer might prove surprising. The German public might
suddenly realise that the eurozone confers on Germany not one but two
“exorbitant privileges”: low interest rates as the haven for European
capital and a competitive exchange rate by being hitched to weaker
partners. In that case, Germany would have to offer its partners a much
more attractive deal to keep them in the eurozone.
Such a scenario would be rich in irony. Greece is viewed as the
pariah polluting the eurozone; its expulsion might make it a far bigger
threat to the single currency’s survival. If a eurozone exit creates the
conditions for a rebound in Greece, it may prove an infectious model.
The ongoing Greek tragedy could yet turn out not too badly for the
Greeks. But tragedy it might well be for the eurozone and perhaps for
the European project.
The writer is a senior fellow at the Peterson Institute for
International Economics and author of ‘Eclipse: Living in the Shadow of
China’s Economic Dominance’
http://www.ft.com/cms/s/0/4bdda8a0-9dad-11e1-9a9e-00144feabdc0.html#axzz1vJeepOS4
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