Roger Bootle is the founder and chairman of Capital Economics in London, a specialist adviser to the House of Commons Treasury Committee and a regular columnist for The Daily Telegraph. He is the winner of the Wolfson Prize in Economics for his proposal as to how a eurozone member-state could safely manage an exit from the euro. The following is an interview with him.
Michael Nevradakis: What do you make of the latest agreement that was reached between the new Greek government and the European “institutions?” Is this a victory for Greece, as the Greek government is proclaiming?
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Roger Bootle: I think this is a game of smoke and mirrors. It looks to me as though Greece has conceded an awful lot, and I have concerns about how the Greek government is going to present that to the Greek people, bearing in mind what was said during the election campaign. But there’s a lot of maneuverings yet to be made.
Let’s take a closer look at the eurozone and the way that it has been structured and that it has developed. What structural problems do you identify with the eurozone in your view?
Quite simply, it exists! The fundamental problem began right at the beginning. That’s to say, it was a mistake, because it unifies two groups of countries which are fundamentally different. So this isn’t just about Greece versus the rest, it’s essentially about the northern countries on the one hand, and the southern countries on the other. The exchange rates, before, played a very useful role on a number of occasions, which is why, of course, they existed for so long, and which is why we don’t have a common world currency. What countries of the eurozone have done is abolish exchange rates between themselves, and these problems facing Greece and other countries now are a direct result of that.
Stockholm Syndrome … What you have here is a political class that’s invested an enormous amount of political capital in membership of the euro.
In the past, countries that have been in that sort of position have typically resorted to a weaker currency, which now they can’t do. The other half of the problem is that in the northern countries, you have a mindset which is dominated by the urge to oversave and export without importing commensurately, to run current account surpluses. If you have an exchange rate, it’s like a hinge. These two could live side-by-side, as they did before the euro. Fix the exchange rate rigidly between these two groups of countries, and you end up with a disaster.
Do you believe that a “Grexit” would be the best solution for Greece?
Yes. In fact, I think it’s probably the only solution for Greece. It doesn’t surprise me that Greek governments have rejected it. Indeed, in the world of psychology and psychotherapy, it’s known as Stockholm Syndrome, a situation where a captive becomes so emotionally involved with his captor, that when the cage is opened, he doesn’t want to leave. What you have here is a political class that’s invested an enormous amount of political capital in membership of the euro.
There are two British examples I could give you, and I’ll admit Britain isn’t Greece, but there are strong similarities. In 1931, Britain was on the gold standard, along with most of the world, and the then-British government did everything it could, public spending cuts, wage cuts, to try to keep Britain on the gold standard. Finally, the pressure became irresistible, and Britain was forced off the gold standard. Disaster! Except, what then happened was the fastest rate of growth in Britain’s whole industrial history, as a direct result of that so-called disaster of 1931.
Second example: In 1992, Britain was in the forerunner of the euro, the European Exchange Rate Mechanism (ERM). We were in for two years. We had chronically high unemployment, a depressed housing market, the economy was on its knees, and yet here was Britain clinging on to this ridiculously high and demanding exchange rate and imposing very high interest rates. The government fought tooth and nail to [stay] in the ERM. They told everybody it would be a disaster if we were forced off. On September 16th, 1992, what happened is that we were forced off the ERM. What ensued? Well, funny enough, just about the second-fastest period of industrial growth – we had a strong recovery – and that day now has gone down in the common recollection of recent British history as “Golden Wednesday.” Opposed by just about everybody at the time, the Bank of England, the Treasury, the whole commentariat.
There are many who insist that a departure from the eurozone is not even possible under existing EU treaties, or that a eurozone exit also means a departure from the EU. What do these treaties actually foresee, and what does international law have to say regarding a sovereign right to withdraw from treaty obligations?
I’m not an international lawyer, but my reading of the agreements and treaties is that it’s perfectly possible to withdraw from the eurozone without being forced to withdraw from the EU, and indeed, I think it’s arguable that it would be illegal for the other members of the EU to try to force Greece out of the EU simply because it withdrew from the eurozone. Don’t forget, there are plenty of countries belonging to the EU that don’t belong to the eurozone: Britain, Denmark and Sweden. So you can be in the EU and not be a member of the eurozone. The other thing to say is that I don’t think the history of European law is a particularly distinguished one. When it comes to political and economic reality, the lords and masters in Brussels, Frankfurt, and Berlin do what suits them and work out the law afterwards.
There’s lots of fear in Greece over what a eurozone exit would mean for the country. Would there truly be a risk of hyperinflation or of a catastrophic devaluation?
I think it’s likely that inflation would go significantly higher for a time, and indeed that’s part of the way through which Greece finds some sort of salvation. Coming out of the euro and letting the currency devalue is not a magic wand which is bound to succeed in all cases. You could make a mess of this, and plenty of countries have made a mess of it. They let inflation run riot; they’ve failed to restrain government spending, and the result has been the devaluation has done no good at all. This is a process that has to be managed, that demands strong government with a vision of the end result.
As long as the government doesn’t blow it, far from causing increased misery or depression, a devaluation, an exit from the euro, can bring the economic equivalent of salvation.
But on the positive side – something I think that really has not come across at all in this debate – you listen to people and get the impression that coming out of the euro, having your own currency and letting that currency fall on the exchanges, is almost like some appallingly nasty medicine which might even kill you. This is, frankly, economically illiterate. Greece has suffered a loss of GDP of 25 percent. There is enormous spare capacity in the Greek economy. We can debate exactly how much it is, but it’s very large. When the exchange rate falls, the effect of this is to deter domestic consumers from buying goods and services imported from abroad and to encourage foreigners to buy goods and services produced by this country. In a number of cases historically, it’s been very difficult to enact that process without enormous inflation because there haven’t been the spare resources in the economy to be diverted into increased net exports. But that’s not the Greek situation. There’s hardly any example since the 1930s of a country having suffered a drop of its GDP of 25 percent.
As long as the government doesn’t blow it, far from causing increased misery or depression, a devaluation, an exit from the euro, can bring the economic equivalent of salvation. The key thing about sustainability is income. If Greece could recover its previous level of income, then the primary surplus would soar way beyond the numbers that are trying to be imposed upon it, and similarly, the debt-to-GDP ratios would plunge. The key to all this is getting economic growth. If you get that at a decent level, this problem will be solved.
There is also a logistical issue about how Greece would be able to plan a transition to a new currency and whether the planning as well as the printing and the minting of the new currency should take place in secrecy or with public knowledge. What are your thoughts on this?
In an ideal world, you’d keep things secret. That would minimize panic and disruption and the need to impose capital controls and to close banks. However, I think this crisis is so far advanced, the chances of keeping it secret are pretty slim.
So, if Greece is to come out of the euro, what I think will happen is that at some point, probably a weekend, but not necessarily, an announcement will be made to the effect that the banks are now closed; there are capital controls, and whatever was previously held in a whole series of financial instruments, including bank deposits, as so many euros, was now held as so many drachmae.
With regard to the printing and minting issue, I think this has received too much attention. A majority of transactions by value in a modern economy are in some sense done electronically: credit cards, debit cards, bank transfers – many ways of making payments. Cash payments are a relatively small part of an economy, and all of those other things can take place without the use of notes and coin. For those transactions which had to take place by notes and coin, I suggest and I suspect that what would happen is that euros would continue to be used for those transactions, and you might, for a time, have a dual pricing system where traders would give a certain price for payment in cash with euros, and another price for payment with a debit or credit card in drachmas. That’s by no means ideal, but then we don’t live in an ideal world. You can’t print and mint overnight. We’ve done a study to suggest it’s going to take two to six months to have a full supply of notes available, but I don’t think that’s a problem that’s insurmountable.
What kinds of policies could be enforced to bring about strong economic growth, and what would the impact of a return to a domestic currency be on businesses, wages, and pensions?
The first impact of a new currency and a devaluation will be to raise the price of imported goods and services, so a lot of people would suffer an immediate decline in their real incomes. Actually, I think there will be quite considerable scope for the Greek government to offset some of that effect by lower taxes or increasing benefits for vulnerable people, and not just because they will no longer be subject to the austerity regime imposed by the troika, but also because of the benefits of real economic growth.
One of the consequences of growth is that money flows in to the exchequer. So in the Greek case, the troika is trying to get you to focus on getting up the primary surplus to 4.5 percent of GDP. If the Greek economy were to grow over the next several years very strongly, you will go way past 4.5 percent, not through austerity, but simply as a result of more taxes coming in. So there’s scope to offset some of this initial squeeze on real incomes. But it will be important that the government didn’t go all the way.
Certain parts of society have been able to escape without paying a full amount of tax, there’s been considerable waste in the management of government spending and public employment.
In terms of the effects on Greek industry and business, Greek industry and service providers would immediately become much more competitive. Let’s say the exchange rate falls by 25 percent, which is plausible. To a foreigner buying Greek output, it’s now 25 percent cheaper. So I think you will find a surge in tourism. Also, within the Greek economy, you will find Greek consumers trying to find Greek alternatives to goods that they were importing from abroad. So lots of businesses would, before very long, experience much stronger business conditions, and that will, in time, lead to increased employment. It will also lead to higher wages in those sectors. Again, it’s important that wages don’t go shooting up, otherwise you’ll offset the benefit of the devaluation. But there would be scope for increased wages in those industries which are growing as a direct result of the improvement in competitiveness.
There is the matter of Greece’s debt. How would this issue be tackled upon a return to a national currency, and do you believe that an audit should be conducted of the Greek debt?
I think an audit of the Greek debt would be a good idea, but if it’s an audit just in the way that, as it were, an accountancy firm does an audit, it would be limited – its benefits would be limited to the benefits you get from that sort of exercise; you won’t get to the fundamental economics of all this.
Let me say that the troika isn’t entirely mad or even wrong. There are things that have happened in the Greek system which have been less than wonderful: the collection of taxes not being good, certain parts of society have been able to escape without paying a full amount of tax; there’s been considerable waste in the management of government spending and public employment. And the sensible for thing for a Greek government to do, after an exit from the euro, is to continue with good husbandry of the public finances.
Continued economic growth brings the debt ratio down. So if Greece was able to secure decent rates of economic growth, even though the debt level is very high, I wouldn’t think it was unsustainable.
We then come to the question of what would happen to Greek debt. I think that would be a case that it might even be necessary, after an exit from the euro, for Greece to default on some of its public debts. Greece has done this before; many other countries have done it before; it’s not the end of the world. Obviously, it’s not what you want to do in the best of all possible worlds, but Greece is not in the best of all possible worlds. The most important point is the point I’m trying to make about the state of the economy. If the economy returns to health, with rapid rates of economic growth, the debt problem is going to be transformed.
In Britain, we’ve had twice in our history a debt ratio which makes the current Greek ratio seem small by comparison. Twice, we’ve had a debt ratio of 250 percent of GDP, both times after wars. First after the Napoleonic wars, 1815, and secondly after the Second World War, and in both occasions, we worked that debt ratio down to very low levels and without default. How? The government kept tight control of its finances, but the key thing is economic growth. Continued economic growth brings the debt ratio down. So if Greece was able to secure decent rates of economic growth, even though the debt level is very high, I wouldn’t think it was unsustainable.
What would the impact of a departure of Greece or any other country from the eurozone be on the eurozone itself?
What happens to the rest of the eurozone would depend very much on how Greece managed. You can’t, as it were, hope to leave the euro, go on a spending spree and pay yourself 40 percent more and expect it to work. It, under those circumstances, would fail, but the hypothesis I’ve put forward is that a new currency and a devaluation could work for Greece, in the sense that it would bring decent economic growth and that would then start to improve the position of the government’s finances. This would have enormous implications for the other countries in southern Europe.
The voters in Italy and Spain and Portugal would look at this and say, “We can do it; there’s another way!” Growth is the key; we’re not getting growth under these austerity programs, and I think that there’s a very good chance that Greece would lead the way to a euro exit by those other countries. If that were to happen – with an exchange rate between those countries and those of the northern core – the exchange rate of the northern core would go up; their exports would become less competitive; prices would fall in the shops in those countries; consumers would become better off, and consumer spending would rise. This would be a benefit not only to the south, but also to the countries of the north.
It astonishes me the way this aspect of the issue is not generally perceived in Europe. In Germany in particular, they say, “Oh it’ll be a disaster if the euro were split in this way and the new northern currency went up on the exchanges. How would we cope?”
My reply to that is very simple: this would be, effectively, a return to the system that you had under the Deutsche Mark. That was a disaster, wasn’t it? Remind me, I’ve forgotten my German economic history, but I think under the Deutsche Mark you did very badly, didn’t you? I mean, your exports were clobbered by rising exchange rates; German consumers did very badly; wasn’t Germany at the bottom of the growth leagues in that period? That’s why you were so keen to give it up, wasn’t it? This is the point they fail to realize.
The euro is the reason why Europe has done so badly over the last decade.
Actually, having a stronger currency for them and a weaker currency for the southern Europeans is not only a benefit for southern Europeans, it’s also a benefit to them. They have a natural tendency – export very hard, save very hard – and I’m not saying that’s wrong. What I am saying is, it doesn’t work very well if you’re then chained together with a group of countries whose habits and institutions and histories are different. So in the world I’m describing, in which Greece leaves and leads to an exit from the euro by the southern European countries, and the northern ones, led by Germany, experience a higher exchange rate, what that leads to is stronger consumption growth and higher living standards in northern Europe.
One has to look at this at a world level. What’s the [one] part of the world where economic performance is worse? Quite simple: Europe. Now I wonder what reason we can possibly come up with for that? Gee, you know, I find it very difficult! What is there about Europe that makes it stand out? What could possibly explain the fact that Europe has done so badly? Personally, I’ve got an answer, and it’s quite simple: the euro. The euro is the reason why Europe has done so badly over the last decade.