Imagine a family who has lived beyond their means for years, and, as a result, has accumulated a large debt with their bank. Imagine that the debt is so large that paying it back would be immensely painful for the family for many years to come. Then the head of the family, let us call him Mr. Tsipras, has an idea: “We will show the bank that democracy can triumph over its will to collect our family’s debt! We are going to have a vote in the family, deciding whether we want to pay back the bank or not. Vote yes, he argues, if you want us to pay back the money we borrowed and spent. Vote no, if you would like us to pay back much less, while keep on spending.” Which option do you think the members of the family would vote for?
Viewed this way, perhaps the outcome of the Greek referendum is not that surprising after all. Of course, this simple analogy ignores some important aspects of what has been happening in Greece. Why was Greece allowed to borrow this much in the first place? Since other countries in the eurozone could also borrow under similar terms, why is Greece alone finding itself in this uniquely unpleasant situation? What did the people in Greece actually vote about, and what are the consequences of the outcome of the referendum? More generally, is there a light at the end of the tunnel for Greece, and what is the future of the eurozone?
Let us take these questions in turn. In order to be part of the eurozone, a country needed to fulfill a stringent set of requirements. This qualified these countries as “reliable” borrowers in the eyes of most lenders. It is well known that Greece entered the eurozone by falsifying its accounts and that it otherwise would not have qualified for membership. While this is common knowledge, lenders still treated Greece as a reliable borrower, allowing it to accumulate an unsustainable amount of debt. The Greek position has been that the lenders deserve at least part of the blame for allowing Greece to borrow irresponsibly, and they should be partly responsible for the consequences. There is an element of truth in this. A more important issue, I think, is how Greece used the borrowed funds. Greece constitutes an anomaly within the European Monetary Union. Its economy has never been modernized. Strong unions and widespread mistrust in markets, a large and inefficient public sector, tax evasion, a Byzantine legal system and bureaucracy make the economy extremely unfriendly to investment and growth. As a result, productivity in Greece is half of what it is in some other European countries. Greece could have taken advantage of the low interest rates to modernize its economy, encourage foreign investment, and create a business-friendly environment as an engine of economic growth. Unfortunately, this is not what happened. Instead, the borrowed money was wasted on political favors, more hires for the extremely inefficient public sector, more national defense spending, etc., simply reinforcing the status quo.
Greek people want to stay in the euro zone. Which way the referendum would go depended chiefly on whether the voters would see it as a “yes” or “no” on the euro itself. There is a lot of misinformation and paranoia, as well as justified fear, as the citizens of Greece have clearly suffered in recent weeks. The Greek government argued that this was not a vote on membership in the euro. Rather, they said, the referendum was a way to increase their bargaining power during on-and-off negotiations with the creditors. On the other side, statements from EU officials were vague, often indicating that negotiations with Greece would continue, regardless of the outcome of the referendum. The majority of Greeks bought into their government’s interpretation, hence the “no” vote.
What is next? There is a core of European officials who would like to see Greece leave the eurozone and issue a parallel currency as a result of the outcome of the referendum. While this would be a disaster for Greece, it would be the best outcome for the eurozone itself, as it would get rid of its uniquely dysfunctional member. In my opinion, this outcome makes the most economic sense. In addition, relations are at a low, as the somewhat amateurish representatives of the Greek government have done their best to offend European leaders and to burn bridges with Greece’s creditors. Indeed, this is a government consisting largely of extremely left-wing ideologues who have visions of saving not only Greece, but the entire continent from capitalism. However, the political situation is more complex, and it is more likely that additional long negotiations will inevitably take place and a compromise will be reached eventually. Such compromise, likely brokered by France, will inevitably involve some debt forgiveness for Greece, hopefully with some strings attached, so that Greece will be forced to reduce future spending.
Long-term living standards in Greece will depend on economic fundamentals in the country. For decades, Greece’s preferred way of creating employment has been to hire people in the public sector, where they would do little other than enjoy job security and generous benefits. This cannot be allowed to continue. The problem is that while Greece will go nowhere without modernizing, there is not enough support for change by either the government or the people, who are stubbornly refusing to take the painful necessary steps for their economy to become competitive. Whether within or outside the eurozone, there is no doubt that there are difficult times ahead for Greece. Having lived beyond their means for years, living standards for its citizens are bound to decline.
There are also some important lessons for the European Monetary Union. First, the spirit of cooperation that created the euro can no longer be taken for granted. As the current Greek government has demonstrated in no uncertain terms, it is every country for itself. It is also unlikely that other small European countries, some of which are poorer than Greece, will continue to pay for Greece’s excesses. Second, it is important for the citizens of the richer countries in the European Monetary Union to realize that, like the residents of the wealthier states in the U.S., one way or the other they will need to make ongoing transfers to the poorer states of their union. The best they can do is to negotiate a stronger say on how these transfers are used by the periphery countries. In other words, for the European Monetary Union to be viable in the long run, elements of a closer fiscal union must also be introduced.
Ted Temzelides, Ph.D., is a professor of economics at Rice University and a Baker Institute Rice scholar. He has consulted for the Federal Reserve as well as the European Central Bank.
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