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Greece's dilemma

Jun 14 2012 07:17 *Hugo Dixon

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ODYSSEUS would recognise the dilemma faced by today's Greeks as they must choose either the pain of sticking with the euro or the chaos of bringing back the drachma.

The Homeric hero had to steer his ship between the six-headed sea monster, Scylla, and the whirlpool, Charybdis. Avoiding both was impossible.

Odysseus chose the sea monster, each of whose heads gobbled up a member of his crew. He judged it was not as bad as having the whole ship sucked into the whirlpool.

As Greece heads to the polls on June 17 for the second time in just over a month, none of the options it faces are attractive.

The economy has shrunk about 15% from its 2008 peak, unemployment stands at 22% and further austerity and reform are required as part of the eurozone/International Monetary Fund (IMF) bailout. But the lesser of two evils is staying the course.

Some of this misery was inevitable. Greece's current account and fiscal deficits each reached around 15% of gross domestic product (GDP) in 2008 and 2009, and had to be cut.

But successive Greek governments have managed to make the situation worse than it needed to be.

When Odysseus had to pass by the sea monster, he told his crew to row as fast as possible and not stop. That way, each of Scylla's heads only had time to munch one man.

By contrast, today's Greeks have dawdled. Confidence in the country and its political class is shot to bits, both at home and abroad. Capital is fleeing, investment has vanished and tax-dodging has become even worse than it was – which is saying a lot.

The government isn't paying its bills, nor are many companies. As a result, Scylla keeps gobbling up more men.

Terrible as things are, the current situation is not hopeless. The budget deficit, before interest payments, declined by 9 percentage points of GDP in 2010-2011.

The economy is also getting more competitive: unit labour costs, which shot up vis-a-vis Greece's eurozone partners in the first decade of the single currency, had by the end of last year recouped half the lost ground. They will have fallen further since the minimum wage was slashed earlier this year.

What is now needed is a strong government. It should embark on three main tasks. First, continue the reform programme, and get serious at last on fighting tax evasion.

Second, negotiate with the eurozone/IMF a longer period to eliminate its budget deficit and secure investment to boost short-term growth.

Third, negotiate another debt reduction plan.

If such a government were formed, confidence could gradually return and the economy could stop shrinking. The experience of the Baltic countries - Latvia, Lithuania and Estonia - shows such reforms can work.

After the credit crunch crisis, GDP in the three countries fell by between 15 and 21% but has since partly recovered.

But wouldn't going back to the drachma be better? Some commentators point to countries like Iceland, which restored its competitiveness by a massive devaluation following the credit crunch and only suffered an 11% fall in GDP.

Wouldn't devaluation be a quicker and less painful way for Greece to get back in shape?

The answer is no – for two reasons. First, the dislocation caused by bringing in a new currency would be much more severe than devaluing a currency that already exists.

The banks would temporarily run out of cash and there would be multiple legal disputes over who owes what, which could gum up the economy for years.

Second, Greece is receiving an extraordinary amount of cheap money as part of its second bailout plan: €130bn, or 88% of GDP. This gives it time to cut its twin deficits.

If Athens left the euro, it would be lucky to get a fraction of that cash. The country would then have to balance its books immediately.

An even harsher fiscal squeeze would exacerbate the vicious spiral. The alternative would be to print drachmas to fill the hole in the budget.

But such monetary financing would lead to rapidly rising inflation, which would already have been given a boost by the devaluation. Lucas Papademos, the country’s former technocratic prime minister, predicted last week that inflation could reach 30-50% in such a scenario.

Meanwhile, Greece is hugely dependent on imports not just for final consumption but also to keep its economy going. It imports oil, medicine, food.

If it had to slash imports suddenly, industry would grind to a halt. Even tourism, the mainstay of its economy, which accounts for 16.5% of GDP, could suffer if hotels promising a five-star experience delivered a three-star one. GDP might fall another 20%, according to Papademos.

Social unrest would worsen, with street battles, attacks on immigrants, vigilante law enforcement and major strikes. That would further deter the tourists. It would also make it harder to put together a sensible government.

The field would be open for populists and extremists. This way leads to Charybdis.

To avoid this menace, the electorate will need to give a strong leader the mandate to pursue the current course more vigorously. Unfortunately, neither of the front runners in next Sunday’s election – conservative Antonis Samaras and radical leftist Alexis Tsipras – is a modern-day Odysseus.

And neither looks able to secure a decisive win. Unless a third election can produce a better outcome, the drachma will probably return, and the Greeks will get sucked into the whirlpool.

 - Reuters

*Hugo Dixon is the founder and editor of Reuters Breakingviews. Opinions expressed are his own. 

greece  |  europe debt crisis
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