Monday, June 4, 2012

Greek austerity

The above clip (at the 7 minutes 35 second mark) features a debate between Paul Krugman (Nobel laureate) and George Papaconstantinou (Greek Minister of Finance).   Paul Krugman thinks Greece should leave the euro area in order to have a chance to grow.  Krugman acknowledges that leaving the euro would be very destructive for Greece, far worse than the current austerity package. Nonetheless he advocates exiting the euro so that Greece has a chance to grow (presumably by devaluing currency). George Papaconstantinou argues that Greece is better off staying in the euro area, assuming Greece can negotiate a growth package from the rest of the euro area. This is clearly a big assumption.

If the countries in the euro area could miraculously and quickly agree to trade sovereignty for financial security ( The Economist (5-26-2012)), perhaps a deal could be brokered in which Greece adopts more market oriented policies in exchange for a generous growth package. Greece would have to overcome political resistance to later retirement, fewer vacation days, smaller pensions, less guaranteed employment, and a smaller government sector.

Both Krugman and Papconstantinou agree that austerity alone (cutting government spending and raising taxes) is not going to get Greece growing.

The following Forbes article notes the parallels between the European Union and the early United States. Warren notes that in the early 1800's many states were unable to pay their debts and defaulted. As a result the U.S. economy plunged into severe recessions.  The U.S. relied on high import tariffs to promote domestic industry and to recover from the state debt crises.  Warren ponders whether high import tariffs could help Greece stay in the euro area.

Forbes (6-4-2012) "Looking For Euro-Saving Ideas In U.S. History" by Randy Warren

There is at least one major drawback with this suggestion. The high tariff strategy would require rewriting EU treaties and would likely lead to disputes with other members of the World Trade Organization (WTO).

Alternatives to high import tariffs that would also result in import substitution industrialization (ISI) include: cheap currency (i.e. exit euro and devalue the drachma), quotas on imports, and government investment in infant industries. The case for fiscal and regulatory ISI policies has grown less compelling. India started dismantling its ISI policies in the 1980's, leading to rapid growth. Many countries in Latin America have also abandoned ISI, at the urging of the IMF.  Corruption and inefficiency plague this strategy.

 If European politicians fail to act decisively and very soon, the cheap currency option grows more likely.