Hardly a day passes without new headlines from Greece. The country has been circling the abyss for some time now and, for many, it is only a matter of time before its demise. Wouldn’t that be the preferred option for everyone involved, after all? A Greek default would imply that the country would have to leave the eurozone, and the Greek budget problems would no longer be the eurozone’s problems. Greece itself would be able to write off its debt, adopt a new currency and keep its value low — in order for its exports to become competitive — and revive its economy. Finally, those who invested in Greek debt will be able to count their losses and move on. After all, they took a risk when they invested in Greek assets, and risks sometimes do not pay off. A default would mean that we can put the Greek debt crisis behind us, and the global economy can go forward, as it did after the Argentinian default 10 years ago. Sounds like the preferable scenario for everyone. As a matter of fact, it is not uncommon to hear both journalists and economists advocating default based on the above arguments. As there is agreement that Greece should never have entered the eurozone, many assume that the initial mistake will be corrected if Greece exits.
Not so fast! Unlike Argentina, Greece does not have a sizable export sector that would readily benefit from a weaker currency. In addition, the Greek banking system would collapse after a euro exit and any new currency adopted by Greece would likely be heavily devalued, leading to imported goods being unaffordable for most of the population. Even in the hardest of times, Greeks like to consume imported goods, and these consequences will make the new currency deeply unpopular. In addition, it is likely that inflation would creep up and erode the value of the new currency. If Greece leaves the euro and creates its own currency, an underground economy will likely emerge, where important transactions and contracts will utilize the euro, or the U.S. dollar. And what would the European monetary union look like after a Greek exit? It is unlikely that speculators will declare the end of the crisis. They will simply concentrate on betting against the next weak link exiting the common currency. After all, if one country leaves the eurozone, surely it can happen again! Portugal, Spain and even Italy could be next. And where will it all end? This is the worst-case scenario for European politicians. Hence the emphasis is on avoiding a precedent by letting Greece default.
What, then, can be done for the monetary union to survive? Here, as in many other matters, Europe can learn from the United States. What keeps our “monetary union” strong in the United States is not our common language or the uniformity of economic conditions across “member states.” Indeed, one could make the case that northern and southern countries in Europe are in many ways closer to each other than, say, some eastern and southern states in the United States. The main difference is that in the United States, we have a meaningful fiscal union. The transfers across states implied by the federal U.S. budget are far larger than current cross-country transfers in the EU. There is a tough decision to be made. If the European monetary union is to survive, Germany will have to dramatically increase its transfers to the periphery countries. At the same time, for these transfers to become fruitful, countries like Greece and Portugal ought to embrace structural reforms in order to restore competitiveness and accept that many of their national policies will need to be decided centrally, rather than by national politicians. Greece has so far not delivered on its promises of privatization and major reform, and there are signs that its partners are losing patience. But reform does not even have a chance unless Greece remains part of the monetary union. A federal union might be the only way for the continent to emerge from this crisis united.
Ted Temzelides is a professor of economics at Rice University and a Baker Institute Rice scholar. His research focuses on the intersection of macroeconomics and energy.