The train of European monetary union now not only has two speeds, it has two classes. Moreover, it may yet be derailed.
Greece has sealed the deal. In return for additional fiscal measures and more structural reforms, Athens gets the second installment of a bailout package designed to prevent a disorderly default and possible exit from the euro zone. Agreement came after a marathon negotiating session in Brussels. And it came at a significant cost to Greek pride: news reports indicate that a permanent European Union monitoring mission will be established in Athens.
The train of European monetary union now not only has “two speeds,” it has two classes. Moreover, it may yet be derailed. The agreement must be approved by parliaments in the three countries most critical of the bailout package – Germany, the Netherlands and Finland. Assuming that it is approved, however, there is still the matter of the debt burden. Even with the “haircuts” to private sector investors (reduction in the value of their claims), the deal would cut the debt to “only” 120.5 percent of GDP by 2020. By any measure, therefore, Greece faces a long period of difficult fiscal adjustment, social unrest and, now, resentment stemming from the oversight of Brussels.
The burden of such adjustment is obviously easier to bear in an economy that is growing and creating employment opportunities. It is far more difficult in an economy that is contracting and in which even future prospects for growth are dimming. Unfortunately, that seems to be the outlook.
To get growth with fiscal austerity, Greece needs a boost to competitiveness (real exchange rate depreciation) and it needs it quickly. However, in Brussels on Monday/Tuesday, Greece was offered, in effect, the choice between “financing” and real exchange rate “adjustment” through internal devaluation – the reduction in wages and prices through sustained high unemployment – or “no financing” and real exchange “adjustment” through an exit of the euro zone and a massive depreciation of the re-introduced drachma, which may or may not lead to hyperinflation. Needless to say, it was not a particularly appetizing menu from which to choose.
It is possible that Greece will persevere on the path of financing and adjustment through internal devaluation. But I worry about the longer-term consequences of that path: young Greeks face a future of higher tax burdens to repay debts increasingly held by the IMF and the European Financial Stability Facility. If you had an option of migrating to another part of Europe, which is a supposed right under Article 20(1) of the Treaty on the Functioning of the European Union, would you stay? The mobile will move; of course, those most able to move are those with skills and education valued elsewhere. The rest will see their tax burdens rise – not to put too fine a point on it, fewer workers mean less output and higher taxes to service the debt.
This is not a particularly encouraging outlook. It is the kind of outcome that can lead to bad politics, which produces bad policies “destructive to national and international prosperity” and even worse economic outcomes. And it is situations like these that influenced the design of the IMF. But the Fund was intended to assist its members correct their balance of payments through an appropriate mix of “financing” and “adjustment” in a world of capital controls that limited the size of balance of payments. That world vanished as country after country eliminated capital controls in the 1980s-1990s. The Fund is now called on help its members deal with capital account crises; not current account problems.
To assist its members strike a felicitous balance between “financing” and “adjustment”, the IMF needs support. A framework for the timely, orderly restructuring of sovereign debt held by private investors would help.
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