New Paper Argues Greece Should Consider Default and Exit From Euro

A new paper from the Center for Economic and Policy Research (CEPR), "More Pain, No Gain for Greece: Is the Euro Worth the Costs of Pro-Cyclical Fiscal Policy and Internal Devaluation?" looks at Greece's recent experience with "internal devaluation" and finds that there is a high risk of continued prolonged recession. Updating the IMF's most recent projections, the authors find that Greece's GDP will have shrunk by 15.8 percent before it is forecast to begin growing. This would make Greece's loss of output among the worst of financial crises going back to the Great Depression. But the paper argues that Greek losses are likely to be even worse.

"The IMF has consistently underestimated the depth of the Greek recession," said Mark Weisbrot, CEPR Co-Director and lead author of the paper. "At some point, it becomes rational for Greeks to ask, is the euro worth this kind of punishment?"

The authors argue that the most important problem with the commitments that Greece has made to the European authorities is that its fiscal policy is pro-cyclical - that is, the government has been, and is committed to, tightening its budget while the economy is in recession. In 2010-11, the Greek government adopted measures to cut spending by 8.7 percent of GDP. This is comparable to cutting U.S. federal spending by $1.3 trillion.

Greek unemployment hit a record of 20.9 percent in November and the IMF forecasts that it will still be at 17 percent in 2016. Employment as a percentage of the working age population is now less that it was in 1994.

The Greek government has agreed to reduce public employment by 150,000 workers by 2015, to cut the minimum wage by 20 percent (and by 32 percent for those under the age of 25); and to weaken collective bargaining. All of this will have the effect of reducing living standards for workers and redistributing income upward.

The economic theory behind these changes is that of "internal devaluation," in which wage costs, lowered by the recession and high unemployment, are pushed down far enough so that the economy becomes more competitive internationally and can recover through exports. But after four years of recession and reaching record-high unemployment, there has still been no internal devaluation.

The authors also look briefly at the alternative of a planned default and exit from the euro, considering that such an outcome might happen in any case due to recurrent crises and continued recession. They look at the case of Argentina, which unsuccessfully tried an internal devaluation with a deep recession from 1998-2001, as a relevant comparison. After default in December 2001 and devaluation a few weeks later, the Argentine economy shrank for just one quarter (a 4.9 percent loss of GDP), but then recovered and grew by more than 63 percent over the next six years.

"Argentina's success after its default and devaluation show that rapid recovery is possible," said Weisbrot. "It was not, as many claim, a commodities boom, or even export-driven growth. Argentina recovered rapidly because it was able to abandon the kinds of destructive economic policies that Greece is following today, and switch to pro-growth policies."

The paper notes that Argentina reached its pre-recession GDP in just three years, while Greece is expected to take at least a decade to reach that benchmark.

The authors suggest that if the European authorities are unwilling to consider other alternatives, a planned default and exit from the euro is one alternative that should be considered.