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A Way Out for Greece after the "No" Vote

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A Way Out for Greece after the "No" Vote

July 5, 2015

This article originally appeared in Forbes

The "no" vote in Athens shows that Greek voters want other Europeans to continue to pay for their unsustainable high living -- no news there. The more interesting story is that Greeks want to leave the euro by way of a public choice rather than a market shove. Even if the Greeks had voted yes, it was doubtful that they could have remained in the eurozone. Greece's problems are not just its unsustainable debt burden and its ongoing insistence on fiscal deficits generated in large part by extremely generous pensions. It has three other fundamental problems. First, it cannot reopen its banks given their apparent insolvency and the ongoing risk of devaluation -- both of which would prompt continuing withdrawals. Second, Greece is not competitive in its exports -- compared, for example, to Spain -- and a protracted process of adjustment to an "equilibrium" real exchange rate will keep the economy from recovering quickly. Third, Greece's lack of competitiveness reflects institutional flaws that the Greek people have shown little interest in fixing -- inflexible labor laws that discourage hiring, anti-competitive business licensing laws and regulations that protect inefficient cronies, and little will to tackle corruption, which acts as a tax on business, albeit one that does not enrich government coffers.

One could also add that there is no evidence of potential political leadership that is capable of articulating these problems much less credibly confronting them. Former leaders have little appeal to a population that is all too familiar with their history of failure and their complicity with corruption. Current leaders display a combination of juvenile thinking about economics, a strange rapture about Cuban communism, and a counterproductive need to put a thumb in the eye of Germany at every opportunity (a political strategy that has resonated within Greece, given anti-German feelings that go back to World War II). That anti-German posturing is far-fetched; even if Ms. Merkel wished to concede everything to the Greeks, there is no chance that Spain and Portugal would acquiesce -- doing so would spell suicide to governments who have made opposite choices to those of Mr. Tsipras. And although Germany could offer money to Greece, they are not able single-handedly to fix the key long-term problem of Greek non-competitiveness that lies at the heart of all of Greece's troubles.

Is there a way out for Greece, which would allow it to stay in the eurozone and still resolve its various problems? Yes, but not one that its government is likely to be able to recognize or execute, especially in light of its ideological bent and the referendum's result. Nevertheless, in case anyone in Athens is listening I offer a plan for them to consider.

My approach combines two policy initiatives ("redenomination" policy and competitiveness reforms), which together would resolve current fiscal and banking system problems, put Greece on a sustainable long-run economic trajectory both fiscally and competitively, and be greeted favorably by its European partners as the beginning of a basis for cooperation in writing down Greek debts.

My proposal begins with government action to write down the value of all euro-denominated contracts enforced within Greece. This "redenomination" would make all existing contracts -- wages, pensions, deposits, and loans -- legally worth only, say, 70% of their current nominal value. This policy would kill several birds with one stone. It would significantly reduce pensions, relieving fiscal pressure and satisfying troika demands for fiscal sustainability. It would do so in a way that would also mitigate the purchasing power consequences for pensioners, because an across-the-board redenomination would lower prices throughout the economy, making the reduction in nominal pensions more bearable. By applying redenomination to deposits and loans, banks' health would be revived -- their loans would now be payable and therefore more valuable, and their net worth would consequently rise. The 30% wage reduction would further reduce fiscal problems and make Greek producers competitive, and operate as an "internal devaluation" to raise demand for Greek products and tourism. Most importantly, this internal devaluation -- by solving the problems of fiscal deficits, non-competitiveness and bank insolvency -- would inspire confidence in Athens' ability to stay within the eurozone, which should bring deposits back into the banking system to fuel a rebirth of lending.

Although redenomination would accomplish a great deal, by itself it is not enough. As simple economic theory (formally known as the the Balassa-Samuelson Theorem) tells us Greece will only be a viable long-term member of the eurozone if it can match the long-term productivity growth of Germany and other members. To do so requires it to undertake major reforms to labor laws and competition policies, and to wage a credible war on corruption. The latter is often regarded as hopeless, but that view is wrong. Hong Kong's example in the 1970s showed how to tackle corruption. In the case of Greece today the key is to involve its European partners (who would play the role of the UK in Hong Kong in the 1970s) to establish a separately funded and administered anti-corruption commission with full legal authority. The first goal of such a commission would be a thorough reform of Greece's corrupt courts and civil service.

If Greece took these steps, its European partners, the IMF and the ECB no doubt would be willing to reschedule its debts to substantially reduce Greece's unbearable debt burden, as the IMF has recognized is necessary, and also provide the short-term liquidity to allow its banks to reopen. But Greece cannot reasonably expect to put the aid cart ahead of the reform horse.


Charles W. Calomiris is a member of the Shadow Open Market Committee and the Henry Kaufman Professor of Financial Institutions at Columbia University.

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