Europe needs to change too, after Greece

02.07.15 Publication:

Where does Europe go from here, after the Greek referendum on July 5th and its failure to repay the IMF? The answer is that it can go nowhere that is good, since whatever happens this has been a huge failure for the European Union as well as a huge failure for Greece and for the government it elected only in January. But thinking about where to go next needs to start now, to prevent the failure turning into a disaster.

Much still depends on the way the vote goes, and on what next steps are chosen by the Greek government immediately after the result is known. If Greek voters spring a surprise by voting “yes”, to accept the terms offered by the country’s creditors and to stay in the euro, the next step must be the resignation of Alexis Tsipras’s Syriza-led government and a new general election.

That step, however, carries a real risk of the country descending into political violence. So outsiders would be wise to intervene with generous short-term financial support as a gesture of goodwill, on humanitarian grounds.

It seems more likely, however, that the vote will be “no”, given that the government itself is campaigning for that verdict. If so, based on its recent behaviour, after the vote most probably the Tsipras government would then attempt initially to resume negotiations with its creditors while having, in effect, defaulted on its debts. It would, in other words, try to interpret the vote as a call to renegotiate while staying inside the euro.

At that point, however, events will move fast—and policy-makers will need to move fast too. With capital controls in place and limited access to bank accounts, the economy could swiftly cease to function and savers could grow more and more anxious about the destruction of their remaining wealth. In such circumstances, Greece would need to move rapidly to introduce either a new currency or a parallel currency to be used alongside the euro, and would need to nationalize Greek banks.

To do that while continuing to pay salaries and pensions of public-sector workers will require emergency finance. The best way to provide that would be for the EU and the United States together to assemble an international consortium of governments to provide funds – preferably a consortium that includes also both China and Russia. Otherwise, Greece will become a bargaining chip between the superpowers. Anything that can be done to avoid such an outcome should be done.

The best approach from the EU, and in particular the euro-zone, would be to put such aid in a framework that acknowledges Greece’s departure from the euro while keeping it in the EU, and offers it a pathway towards eventually rejoining the euro. That might be unlikely. But it would be important in political terms. And it would, after all, simply place Greece in the same status as all other members of the EU that are not members of the euro, except those (such as the UK) that have an explicit opt-out from future euro-membership.

Clearly, the immediate priority after a “no” vote on July 5th will be the stabilization of Greece. But the longer-term priority also must be the stabilization of the euro itself. For the failure over Greece is a failure that promises to haunt the euro, in two big ways.

The first way it will haunt the euro is that a Greek exit confirms what financial markets have always suspected: that membership of the single currency is not irrevocable. Indeed, if Greece passes through its economic emergency and finds a route to recovery using debt-default and devaluation, just as Iceland did after its painful 2008-09, then in any future economic crisis speculation will begin (and political debate will be permanent) about whether another country might usefully follow the same route. Since all of Europe should now be hoping that Greece finds a new path to prosperity, the euro-zone should also be thinking hard about how to deal not just with failure but with this form of success.

The second way that the Greek experience will haunt the euro lies in the failed euro-wide economic policy that lies behind it. So far, this failure is being denied, by too many people, especially in the creditor countries. But the hard fact is that seven years after the financial crisis began, the EU still has more than 23 million people unemployed while the USA (whose population is about two-thirds as large as the EU) has only 7 million. Insisting on universal fiscal austerity, even in solvent, creditor countries, is the reason for this failure.

Europe’s economic recovery is proving too slow to deal with joblessness and the loss of hope that the younger generation all over the euro-zone is suffering. The Greek shock will now make it even slower. And as long as this continues, the political backlash against existing policies, in France, Spain, Italy and many other countries, will only grow stronger. After Tsipras in 2015, we need to think about Marine Le Pen in 2017.

For that reason, the best response to the Greek shock would be to change policy, even without explicitly admitting that this is what is being done. The fiscal rules cannot now be changed, given that they have been enforced for Greece. So a new package of policies is required, one that wraps around those fiscal rules an approach that is both positive for faster economic recovery and which reinforces the solidarity and cohesion of the euro-zone.

Such a package can take two existing policies and simply make them larger and more ambitious: single-market liberalization, both for services and the digital economy; and a public investment programme, to rebuild infrastructure and especially a Europe-wide grid for electricity and gas. In fact, if such a programme could be agreed, with financing organized collectively outside the normal fiscal rules, then Greece could even be included.

In addition, however, tied to these two policies and indeed conditional on them, the euro-zone should commence a gradual programme of replacing part of euro-members’ sovereign debts with collectively-backed Eurobonds. This proposal has been resisted by Germany for many years. It needs to be made conditional on structural reforms and tied to strict fiscal rules. But it is the only way to make the single currency a genuine monetary union. All for one and one for all: that is the only slogan for the euro that will work, in the long term.