No catharsis in Grexit

Opinion piece (City A.M.)
03 July 2015

There is a growing gap between the way the Greek crisis is seen in the Eurozone and the way it is seen across the rest of the world. Everyone agrees that Greece is a poorly governed country and that Syriza has played a poor hand badly. But whereas many Eurozone policy-makers appear sanguine about the implications of a Greek exit from the euro, most outside observers suspect that Grexit would have far-reaching implications for the single currency and the reputation of the EU.

 Indeed, there is growing incomprehension around the world that Europe has allowed the Greek situation to spin out of control. Even from the viewpoint of a broadly pro-European think tank such as the Centre for European Reform, the EU does not come out well from this whole affair.

The immediate economic impact of Greece being forced out of the Eurozone would be felt mainly by Greece itself, as the Greek authorities struggled to establish the credibility of a newly introduced national currency and ward off inflation. The European Central Bank (ECB) would no doubt intervene heavily in the financial markets to limit contagion to other weaker euro members such as Italy and Spain. The implications of a Greek exit on the Eurozone would be felt in the medium to long term.

A Greek exit would end the irreversibility of membership. Unless it acted as a catalyst for closer integration among the remaining members, and there is no indication that it will, the risk is that the Eurozone will come to look like an exchange rate mechanism rather than a currency union. This will increase the likelihood of speculative attacks on the weaker members come the next recession.

The Eurozone is all but certain to go into the next downturn with interest rates close to, or at, zero, high levels of public and private sector indebtedness, and unemployment still well above pre-crisis levels. The ECB will be able to employ quantitative easing, but its effects will probably be exhausted by then. Critically, there will be little scope for fiscal policy to counter the weakness of private sector demand, especially in the countries most in need of it. And weak banks in struggling countries will still largely be back-stopped by fiscally constrained governments.

In short, many Eurozone governments could face the prospect of further deep recessions despite having barely recovered pre-crisis levels of activity, amid persistently strong support for populist parties. The politics of this will be combustible. At this point, it could be make-or-break regarding the bigger institutional questions hanging over the euro. It is possible that Eurozone governments will bite the bullet and agree a fiscal union, including a degree of risk mutualisation and transfers between participating economies. But this could prove politically impossible.

The Eurozone crisis has already been a formidable burden on Britain’s economy. It is the principal reason for the lack of rebalancing; while the value of British goods exports to the EU was lower in 2014 than it was in 2007, sales into non-EU markets rose by 44 per cent over this period. That is in no way an argument for leaving the EU: inside or outside, Britain’s economic prospects will be very closely tied to the EU. Leaving the EU would do nothing to improve the Eurozone’s prospects but it would cost the UK the advantages of membership.

The rest of the world, and particularly Britain, has a huge stake in the Eurozone getting its act together, embracing growth-orientated macroeconomic policies and resolving differences between its member states calmly and fairly. European policy-makers too often behave as though their decisions have no impact on others. But the Eurozone is too big and important a place for the political amateurism and national egoism shown by both the creditors and the Greek government over the last few months. Eurozone governments created the euro; they need to make it work properly.