21 Jul 2015 18:59 IST

Would Greece have been better off exiting the EU?

It could then have focussed on increasing exports to rebuild its economy

For almost as long as humans have existed, the idea of borrowing has too. And in its essence, not much has changed over time. Trust continues to be the cornerstone of the creditor-debtor relationship.

At the lowest end of the lending business, this trust is built on the lender personally knowing the borrower. Lovers of 1980s Hindi cinema may recall Saeed Jaffrey’s character in the 1981 hit, Chashme Buddoor, regularly offering cigarettes to Farooq Shaikh’s character and his two roommates, on loan, logging each transaction in a small book. When the debt limits reached uncomfortable levels, the three men were warned that they were no longer entitled to additional credit until they began paying back what was already owed.

At the other end is the example of Greece.

Two key tools

Students of macroeconomics know that governments use two important policy tools — fiscal and monetary — to manage their countries. Fiscal policy revolves around tax revenues and spending. Monetary policy is all about managing the money supply. For most countries, these two goals are often closely aligned and executed through concerted actions of their parliaments/executive branches and the mostly-independent central bank. Think the Indian government and the RBI.

When the Euro zone was first formed it was seen as a bold new experiment with a combined GDP that could counter the might of the US in the west and Japan/China in the east. The Euro was seen as a currency that could one day become an alternative to the US dollar and Japanese Yen — perhaps one that could even attain reserve currency status. And it is remarkable that the Euro is today the second most-held reserve currency (after the dollar) by countries around the world.

But the Euro as a currency idea is fundamentally flawed. There are 28 countries in the European Union with 28 parliaments and 28 heads of state. Each country has its own culture, tradition, language and, most importantly, fiscal policy. But they have only one central bank — the European Central Bank (ECB) — to manage monetary policy. The near-fatal flaw of the Euro construct is that for many countries in the Eurozone, their fiscal policy of taxing and spending is misaligned with the monetary policy of the ECB. And this is what is playing out in Greece.

Huge budget deficit

All member states of the EU, including Greece, promised to keep their fiscal deficits to no more than 3 per cent of their GDPs each year. In fact, for the first eight years of the EU experiment, Greece was great at managing its budget deficits responsibly.

But by 2007, Greece had become used to cheap, borrowed money from around the world. Its government spending increased steadily (pensions, salaries), corruption allowed rich Greeks to escape the net of taxation, and as the global economy began to shrink, Greece’s deficits as a percentage of a falling GDP rose. From 2007 to 2012, Greece’s annual budget deficit grew at a whopping rate of about 12 per cent a year - four times the EU approved average.

Greece is so indebted today that its total debt as a percentage of its GDP is 178 per cent. This is the world’s highest debt/GDP ratio (if you discount Japan where almost all the money is owed to Japanese citizens). The Eurozone average is slightly less than 100 per cent.

Debt relief

In dollar terms, Greece has a total debt burden of nearly $400 billion. In effect, it has zero ability to repay its existing loans because it has to continue to borrow to operate its government. In the latest drama, other EU countries have agreed to loan Greece an additional $100 billion if Greece agrees to drastically cut its public spending, grow its economy and bring deficits under control. Good luck with that. And recognising that Greece will never pay back what is already owed, these countries have grudgingly agreed to debt relief — that is, writing off forever what Greece ought to pay back. They are doing this to protect the Euro and the EU itself.

The consequences of Greece’s rash behaviour will have ripple effects across the EU and perhaps, the world. For example, which country is next? If the EU could save Greece, why can’t it save Spain or Portugal? Is it moral for citizens of rich nations like Germany to have to pay more in taxes to subsidise the freewheeling spending programmes of other countries which openly violated the very rules that they agreed to? Is the EU experiment even worth it?

Who’s to blame?

Some people argue that Greece is not the only party that is at fault here. The big banks which lent it money unceremoniously are to blame too. While there is some truth to this statement, the fact remains that in a creditor-debtor relationship, the onus is always on the borrower. Each one of us understands this every time we walk into a bank to apply for a loan.

Greece knew the rules but violated them repeatedly. It decimated the trust people had in it so that it could continue to spend money that it did not have. And it is no party for the Greeks now either. They will have to sign up for really severe austerity measures — reduced pensions, higher taxes, reduced salaries and benefits — simply to stay in the EU.

Would Greece have been better off exiting the EU, returning to the drachma, dramatically devaluing it in the process and then increasing exports to rebuild its economy? At a minimum, the country would have been in control of both its monetary and fiscal policies rather than be subject to the idiosyncrasies of 27 other member-states. Time alone will tell.