Scott Sumner  

A few thoughts on Greece

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Over the past 6 years I've repeatedly warned that monetary policy is the Achilles heel of the right. Perhaps the most famous example was the US during the 1920s, where small government policies under Harding and Coolidge were ruined by tight money under Hoover. Tight money that was strongly supported by conservative economists. That opened the door to a left-wing government full of counterproductive statist ideas such as the NIRA, the Wagner Act, minimum wage laws, and one really good idea--monetary stimulus.

Now it just so happens that in the short run cyclical factors dominate structural factors (except in the most extreme cases.) Although the recovery from the Great Depression took longer than it should have (8 years), growth rates were pretty high, and things looked good in a relative sense, especially given the abysmal performance of the economy during the early 1929-33 period. The left got credit.

Exactly the same dynamic played out in Argentina, just replace 1929-33 with 1998-2002. Argentina also saw a cyclical recovery under a new left-wing government, despite really bad statist policies. It is only recently, more than a decade later, that the heavy price for economic mismanagement by the left is becoming apparent. Greece is far and away the Western European country that most resembles Argentina, right down to the dysfunctional electorate and extremely low levels of civic trust. So will Greece repeat the pattern of Argentina? My guess is that it will almost certainly do so to some extent. The new government will probably be viewed as relatively successful, even if it does a poor job in an absolute sense.

I think it's always a mistake to think in terms of "victims and villains", although that's how almost everyone approaches these issues. In this case, Greece is both victim and villain, as in Germany. The Germans are to blame for a tight money policy that is partly (but by no means entirely) responsible for a resurgence of extremism in Europe. The European left is also partly to blame, as their ignorance of monetary economics has resulted in the right dominating the debate over ECB policy. The Greek electorate is to blame for electing one corrupt and inefficient government after another, and in this election a particularly nasty party has taken power.

I do not know how this will play out. In a logical world the troika would go into the negotiations demanding concessions from Greece. After all, the earlier debt forgiveness was conditional on painful structural reforms. Now that Syriza has abandoned those reforms, the troika should offer less aid, demand more debt repayment. Instead they seem likely to reward this bad behavior with even more concessions, which would be basically telling the Spaniards that they'd be fools not to elect Podemos.

I suppose we should not be surprised by any of this, as ISIS is financed by tens of millions of dollars in aid from European governments. I think it's fair to say that Europeans are not especially aware of the incentive effects resulting from bailing out bad behavior. However the new Greek government is so extreme that it's quite possible a deal will not be reached--as the Germans clearly won't agree to the sort of massive bailout required to meet Syriza's campaign promises.

So a "Grexit" is certainly possibility, even if a bit unlikely. And here's another irony, a Grexit may be the best outcome for Syriza. There would probably be six months to a year of financial chaos (as occurred in Argentina), followed by many years of very strong RGDP growth for which Syriza would get credit (as in Argentina.) The new Greek currency would immediately lose half of its value, creating a huge boom in industries such as tourism. Are the Greek leftists aware of this? Is that why they seem to be making demands that cannot be met? I have no idea.

More broadly, I see the rise of extremists on the left and right as the end of the European Dream. Here's an analogy that may or may not be useful. In the 1960s, America had a dream of a color-blind society. We passed civil rights laws. But it never happened, and at some point over the next few decades the dream was quietly abandoned. In recent years blacks have been falling further and further behind whites, and it's is now more or less accepted that the problem won't be fixed in the foreseeable future. Oh sure, the left still talks about the curative powers to Head Start, but I can't believe anyone really thinks it would make much of a difference. In Europe, there was also a dream that people would stop thinking in nationalistic terms, and start thinking of themselves as "Europeans." Now it's back to victims and villains. Like many black, Hispanic and Native Americans in the US, people on the southern and eastern periphery of Europe increasingly think of themselves as victims of an unjust system. In contrast, rich countries in the north and west of Europe increasingly "blame the victim" and see "cultural problems" that seem almost intractable.

Instead of supply-side reforms to bring Greece up to the level of Switzerland, there is resignation that the task is impossible, and talk of "fiscal union," a code word for a permanent program of welfare-like transfers to the countries with dysfunctional governments.

That's what I see happening in the foreseeable future. In the very long run the European Dream may succeed (as may the American dream.) But we are far from that goal, indeed in Europe (as in America) governments are not pursuing the sorts of policies that would even begin to move us in the direction of an equal society. In neither place have they gotten beyond the "victims and villains" mentality, toward constructive utilitarian reforms where there is no place for "blame" and "deserve."

PS. Just to be clear, although this post focused on monetary policy, I believe the European economic model was unsustainable even with good monetary policy. However, it would have taken longer to become apparent, and the crisis would have been more gradual.

Update: It was pointed out that this post was confusing in places. My fault. My point was not that countries should not be criticized for bad policy. Thus in the top part of the post I pointed out that Germany could be blamed for favoring tight money, and various Greek governments for enacting statist policies. Rather I think it's a mistake to think in terms of victims and villains. It's a mistake to try to assign overall blame to one particular actor for complex economic problems. Instead of simply blaming the Greeks, or blaming the Germans, we need to focus on specific solutions for specific problems.


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COMMENTS (24 to date)
Shane L writes:

Regarding the "European Dream", I cannot say how seriously anyone took that in central European countries but here in Ireland membership of the EU was always framed in terms of Irish national interest. I don't think there was any popular sense of shifting from an Irish to a European identity, even though EU membership was very popular (before the current crisis). It was seen as being helpful to Ireland.

I say this because I sometimes see non-European commentators talk about the failure to develop a European identity or European foreign policy. Here that seems weird since there never seemed to be any attempt to do so in the first place. Participation in the EU was always discussed in terms of its benefits for the national state, not for some European federation.

Anyway I suspect you have a point regarding Greece's direction in the coming years. Already they are experiencing a fairly steep decline in unemployment - unsurprising considering the extremely high rate - from 27.8% to 25.8% between October 2013 and October 2014. If that simply continues, the new government will probably successfully claim credit.
http://ec.europa.eu/eurostat/documents/2995521/6581668/3-30012015-AP-EN.pdf/9d4fbadd-d7ae-48f8-b071-672f3c4767dd

Nick Rowe writes:

A very good post Scott, sadly.

"Are the Greek leftists aware of this? Is that why they seem to be making demands that cannot be met? I have no idea."

I have spent a little bit of time over the last few years reading Yanis Varoufakis' blog. He is very smart. My guess is that he understands this.

Airman Spry Shark writes:
I suppose we should not be surprised by any of this, as ISIS is financed by tens of millions of dollars in aid from European governments.
You state this as an aside, seemingly assuming that the reader knows what you're referring to, but I have heard nothing about ISIS being funded by Europe (Saudi Arabia, OTOH...). Could you expand/clarify?
Scott Sumner writes:

Shane, Good points. But I do think that before the crisis there was the beginning of a European identity forming in countries within about 500 km. of Brussels (excluding the UK).

Thanks Nick.

Airman, European governments are estimated to have paid something on the order of $100m million to groups like ISIS and Al Qaeda, in exchange for the release of European hostages. The US and UK (it is claimed) refuse to pay ransom.

You are right that many people don't know this, which is pretty sad.

Athanasios Ghikas writes:

No, Grexit is not the optimum solution for Syriza. Huge majorities in Greece prefer staying in the eurozone. On the contrary, it looks to me that Grexit is the optimum solution for the future of Greece (discrediting the left being a added bonus. As for Varoufakis I am not sure whether he can be sure about anything except his self image.

Andrew_FL writes:
I believe the European economic model was unsustainable even with good monetary policy. However, it would have taken longer to become apparent, and the crisis would have been more gradual.

Is it really desirable to prop up an unsustainable system as long as possible?

I like political expediency arguments, or at least, I find them more compelling than my theoretical worldview would normally justify, but it seems to me the larger problem here is that no matter what the economic problem, the left controls the narrative. Is not the problem in the US in particular that, regardless of the role government itself plays in economic problems, the people believe the US to be a fundamentally capitalist, laissez faire country and therefore find it more plausible that economic problems fundamentally lie with capitalism itself, and not government interventions therein?

In some sense, it's very harmful for right-wing politicians to present their policy regimes as "laissez faire capitalism" when capitalism when they in fact leave in place numerous interventions. That their interventions in money are in the tighter direction in particular is just the most perverse and far reaching in consequences of interventions not done away with under the guise of laissez faire capitalism.

ThomasH writes:

The Euro Zone was always going to be risky, given the low labor market integration, but except for three mistakes, one by the private sector and two by the public sector, it could have worked.

The private sector mistake was for lenders to believe that just because a loan was denominated in Euros that the nationality (or the nationality of the repayment generation capacity) was irrelevant.

The public sector's first mistake was not to make the private sector pay for it's mistake. The public sector's second mistake was allowing markets to realize that ECB would not stick to it's inflation target.

George J. Georganas writes:

" ... a Grexit may be the best outcome for Syriza. There would probably be six months to a year of financial chaos (as occurred in Argentina), followed by many years of very strong RGDP growth for which Syriza would get credit (as in Argentina.) The new Greek currency would immediately lose half of its value, creating a huge boom in industries such as tourism. ... »
Real wages may have fallen by something of the order of 40% below their present low level by the time the "huge boom" starts. Moreover, tourism is one industry where large irreversible investment is required. How would such investment be financed, especially its import content ? Once real wages start rising again, as they have risen in every Greek drachma-era recovery, how many of those investments that will have been started will still look good ?
Argentina is really the wrong model, becuase it did have oil and significant idle production capacity in agriculture, both tradeables. The trouble with Greece is that its only significant tradeable is tourism with the shortcoming mentioned above.

TallDave writes:

in recent years blacks have been falling further and further behind whites

Black incomes have been rising faster than whites since 1900 (35% of white), and since 1965 (50%). More recently they're catching up less fast. But Asians continue to outperform both. as do Jews and Arabs.

Dreams of a colorblind society fell victim to the realities of identity politics. Aside from clientele, practical differences between pro-minority and pro-white advocacy turn out to be mainly degree and technique, rather than philosophy or reasoning. Someone always has a grievance they see as legitimate.

Racial income disparities need not last another generation, though they likely will due to internal institutional incentives. One suspects miscegenation will eventually make the question largely moot.

Miguel Madeira writes:

«So a "Grexit" is certainly possibility, even if a bit unlikely. And here's another irony, a Grexit may be the best outcome for Syriza. There would probably be six months to a year of financial chaos (as occurred in Argentina), followed by many years of very strong RGDP growth for which Syriza would get credit (as in Argentina.)»

In Argentina, the government who benefited from the strong recovery was not the government in power when the austral was replaced by the peso (yes, they were both Peronistas - like, btw, the previous government that fixed the peso to the dollar - but from opposite factions).

Then, the grexit probably will led to the downfall of Syriza government, and it will be the new government that will have the benifits

Mr. Econotarian writes:

Can someone convince me that Greece has a significant macroeconomic problem?

This data says that while Greek prices are 84% of Germany, they are also 113% of Estonia (both Euro counties) and 132% of Turkey.

I'll be the first person to admit that a major part of fixing the US Great Depression was FDR's devaluation (and the concurrent Gold Clause Ban) as a response to deflationary pressures, but I suspect Greece's problem has more to do with Greece's low level of economic freedom, near the bottom of Europe, and clearly below global averages.

Regarding Estonia, its economy the 8th freest in the 2015 Index of Economic Freedom, and its GDP per capita is pretty close to that of Greece despite recently being a part of the USSR!

Ray Lopez writes:

Seems most people here judge Greece by western standards, which is a mistake, as they are more of an Arabic country. I am a Greek citizen, inter alia, and they march to their own drummer. There's no 'universal law' of economics that applies across cultures, but economics is path dependent and depends on the society it is in, see the works of Max Weber. If you look at the history of Greece they have a high default rate--I've personally talked to people who witnessed defaults--and after a hectic period life goes on. I would imagine if that happened in the USA there would be a civil war.

I did find this statement incredible: "The Germans are to blame for a tight money policy that is partly (but by no means entirely) responsible for a resurgence of extremism in Europe." Wow, the Marxists, who believed economics determines everything, would agree.

Ray Lopez writes:

@ George J. Georganas : re tourism - "Moreover, tourism is one industry where large irreversible investment is required. How would such investment be financed, especially its import content ? Once real wages start rising again, as they have risen in every Greek drachma-era recovery, how many of those investments that will have been started will still look good ?"

First, it was reported recently that Greece has record amounts of tourist lodgings, so the tourist infrastructure has already been financed; what Greece needs now are more tourists, which a new cheap drachma will help attract.

Second, investment in hotels is from local content (concrete, always made locally, and money to build is usually local too) not "import content".

Third, if real wages rise in a few years, who cares? Your cost in tourism are largely the sunk costs, the building, not the cost of the maid that fixes the bed.

In short: default is good for Greece, as Summers says.

J.V. Dubois writes:

When it comes to characterization of any large country - be it USA or "country" like EU I am always very careful. Living in penthouse in Manhattan is different experience to living in small town in Midwest or being child of Chinese family in Bay Area. The world of these people is so different that you may almost say they live in different countries.

So while for Shane it may always have been about "national interests" but for tens of thousands of Poles in Ireland EU brought something real and very personal, something they may not have in other countries.

As for my personal experience - I live in one EU country while working over the border in a different one. I have close family members and friends working and/or living in 5 different EU countries. More than ever I realized how close EU countries really are. If you live in Vienna you can wake up, take a car and have a lunch in Venice. Or in Krakow ...

I cannot say that there is something like EU identity yet. But there definitely is something. And as with other things it is younger people that you have to watch for these things.

Michael Byrnes writes:

Andrew wrote:

"Is it really desirable to prop up an unsustainable system as long as possible?"

I think Scott was making a positive statement, not a normative one. He wasn't saying that the Eurozone should be should be propped up, just that prior to this mess he thought it would be.

My own opinion... the idea that a new, stronger Greece is likely to emerge from a fiery Greepocalypse seems a bit too "just so" for me. I think Greece is pretty much screwed no matter what it does, so maybe buying as much time as possible IS the right move. We really necessarily know what the state of the world will be in 2050 - maybe it will be friendlier to the Greeks if they can hold on until then.

genauer writes:

I agree with Scott Sumner, that before the crisis, especially the actions from Greece, there was something like a European identity developing in Central Europe. This is dead by now. The endless squabble between Greece and the Troika about previously agreed terms, every single 3 month term is not compatbile wthe the cultural standards here.

Like the Greek commenters Ghikas, Georganas, above, I now believe that Grexit is the best solution.

George J. Georganas writes:

@Ray Lopez
Alas, hotels and lodgings age extremely rapidly. Plus, if one wants the premium customers, one should upgrade pretty often. Therefore, there is a steady need of financing that will be rather expensive after a devaluation. One factor for record tourism in Greece in the crisis years was the turmoil on North Africa and the Middle East. Should one invest in the hope that none of those competitors will ever recover at all ? One should, also, bear in mind the strong seasonality of the tourist business, forcing one to invest in much more spare capacity than in manufacturing. Labour, too, is hard to come by in high season, forcing employers to hire people from abroad. Much of the earnings of those workers is, thus, spent outside Greece, when the seasonal workers return home.
The sum of it all is that tourism, while a very nice earner, cannot ensure the standard of living to which Greeks aspire, not, even, the macroeconomic performance one could expect by looking at the relevant revenue stream alone.

Andrew_FL writes:

@Michael Byrnes-It's an implied normative statement, in my opinion. If you're making the normative recommendation that monetary policy should be done, for other normative reasons, in such a way as to happen to prop up an unsustainable system, you are indirectly making a normative claim about the desirability of that system collapsing later vs now, which is that collapse now would be bad, and collapsing later is preferable.

Scott Sumner writes:

Andrew, You asked:

"Is it really desirable to prop up an unsustainable system as long as possible?"

It's never wise to do bad monetary policy with the hope it will lead to better policy in other areas. The vast majority of times it leads to worse policies in other areas. In Greece's case, Syriza is a side effect of the bad monetary policy.

A car that is nearing the end of its life might only have 10,000 miles left. But it makes no sense to intentionally crash the car.

George, Greece has lots of idle capacity. If I'm wrong about that fact, then you are right that devaluation would not help. And recall that even Argentina was not helped in the long run.

TallDave, I've recently seen many recent articles claiming the opposite. But yes, throughout most of the 20th century blacks were catching up.

Miguel, Good point.

Mr. Econotarian, It's long run problem is structural. But the huge fall in GDP after 2008 was demand-side.

Ray, Marxists are the only group that believes economic disasters have political consequences?

JV and Genauer, That's also my view. There was at least some movement in that direction, which halted after 2008.

Andrew_FL writes:

@Scott Sumner-That's a good argument, and at least a halfway decent analogy. My main quibble with the analogy is that no harm comes from continuing to drive a car on it's last legs, whereas bad economic policies do more harm the longer they continue. My other quibble is that continuing to use a functional car is not the same thing as actively supporting a non-functioning system.

That being said, in terms of pragmatism, I think you're correct that "crashing the car" will only cause the "owner" to go out and buy a lemon with fewer miles on it, to extend the analogy.

Floccina writes:
blacks have been falling further and further behind whites

Not in everything. In what we USA males treat as most important, NCAAA and Professional sports, they keep surging ahead. :-)

Anthony McNease writes:

My perception is that a large portion of the Greek economy consists of transfer payments (or their equivalent, i.e. gov't paycheck) to Greeks. right now the troika funds a good portion of that. If Greece leaves those Greeks will have to accept less. That would be a political crisis for a leftwing gov't.

A Grexit, I believe, is the best policy, because this would actually require the reforms that Greece has refused to take so far (and refused because their benefactors haven't made them). But this likelihood is why I don't think a Grexit will occur. The Greeks don't want to reform.

George J. Georganas writes:

@Scott Sumner
Greece has a lot of "idle capacity" in economic sectors that are not internationally (or even locally) competitive, such as stamping official documents or receiving unfunded pension payments. The euro made "investment" in those parasitical economic activities much more viable than before. But it did not invent them.
Syriza cannot be a side effect of a "bad monetary policy", since the parasite economy was flourishing in Greece, at least since 1832, long before that "bad monetary policy" existed. Abandoning the "bad monetary policy" will lead the parasite economy back into older, tried and proven methods such as obtained in the period 1932 - 1992. Greece, in that period, was the financial equivalent of a North Korea with the attendant inefficiency and corruption.
I believe you will enjoy this account that makes some serious points in a rather entertaining way :
https://unofficialdimioannou.wordpress.com/2013/04/18/stories-about-defaults/

Olivier writes:

Surely the ISIS mention was a (Freudian?) slip of the keyboard.

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