Everything New Is Old, Everything Old Fades Away

The Grexit as a Product of Fundamental Flaws which Could Break Up the European Union

by Jeffrey Ding, undergraduate at the University of Iowa


 Grelections, Grexits, and Greepartures

 On Jan. 25, the election pitting Prime Minister Antonis Smaras’ conservative New Democracy party against AlexisTspras’ Syriza opposition party, which has promised canceling austerity measures, could determine whether Greece leaves the euro zone. Unnamed sources in Germany’s government have said Greece’s creditors, led by Germany, would view the reneging on bailout promises as incompatible with Greece staying in the monetary union.  Thus, the Great Grelection of Jan. 25 could lead to the Grexit – a decision by the European Central Bank to cut off Greek banks from its liquidity operations and payment systems.  To start, can we reconsider the term Grexit?  I humbly submit the Greeparture as a worthy alternative. It conveys a more elegant version of impending doom.


Only in the EU – A Greek Dilemma

Let’s actually begin with an odd proposition. Could Greece exit the euro zone while still remaining in the European Union? This may seem weird, but the German news magazine Der Spiegel offered an enlightening explanation by quoting a currency expert saying “resourceful lawyers” would provide a clarification. What would the world come to without resourceful lawyers? Perhaps a resourceful undergrad will have to suffice for now.

To better understand the distinction, let’s take a look at the European Union in a historical and global context. Over the past couple of decades, global free trade agreements have given way to more regional groups, in the form of customs unions (EU, Mercosaur and Andean Community of Nations in South America) and free trade areas (NAFTA, the TPP— which can be considered a prequel to the proposed Free Trade Area of the Asia Pacific). But the EU is special, because it transformed from the European Economic Community (solely a customs union) to the European Communities (establishing a single set of institutions that encouraged economic cooperation between the communities) and then culminating in the politico-economic union of 29 member states fondly known as the EU (developing a single market and common currency along with supranational institutions that determine economic and foreign policy). In other words, the EU has established governance in 28 distinct sovereigns. It’s sui generis incomparable. One of a kind.

But with sui generis comes lack of precedent. And that’s where the interesting LESE (leave Eurozone stay EU) situation comes into play. One prominent barrier to this scenario is Article 140 of Treaty on the Function of the European Union, which says members must “irrevocably” replace their old money with the euro.  Still, while I poked fun at the resourceful lawyers quote earlier, there could be a possibility that Greece convert their obligations to the drachma while staying with the EU. And then there’s always the possibility of completely withdrawing from the European Union. Many Greek economists and politicians believe this would be the better longer-term policy and that joining the EU was a mistake, given the structural deficiencies in the Greek economy at the time.

In fact, Greece was the only country whose per capita GDP would have been higher if it had not joined the EU in 1981, according to a model based on synthetic counterfactuals method to estimate EU membership benefits.


Two Contagions, One Fundamental Problem

 I won’t go further in to the will-they-or-wont-they leave the EU question, leaving that up to the anonymous sources in the German government and poll projections (as of Jan. 9, Syriza held a 4% lead in the polls). The more salient question is what would be the effect of the Greeparture?

Merkel and her Finance Minister Schaeuble seem to believe the effect on the euro zone would be manageable. The main concern is the contagion effect – Greece’s departure leading to other distressed countries like Portugal, Ireland, and Spain following suit. Germany has negotiating power with the tools like quantitative easing through the European Central Bank along with the European Stability Mechanism, the euro zone’s bailout fund. But the negative perceptions due to political uncertainty may be taking place before these policy proposals to quell them.

The outflow of capital from the Eurozone, spurred by investors concerned about value of financial assets after redenomination of bank accounts and bonds, is preventing the transition from austerity policies toward growth and economic reform.  It’s a nasty feedback loop in which fears about these countries leaving the EU cause these countries to have to continue to adopt the austerity measures that are causing political unrest, ultimately resulting in even more capital flight. So the simplified litmus test for whether the Eurozone would be able to weather the storm of Greece’s departure is to compare the offset policy tools to the detrimental impacts to the banking sector. Catherine Dobbs, a Wolfson Prize finalist, and Michael Spence, a Nobel Laureate, argue that while the Eurozone would likely be able to offset a country the size of Greece, it is less clear whether they could handle the exits of countries nearly 10 times the size of Greeze, such as Italy or Spain.

Lost in the focus on the sovereign debt crisis has been the fundamental contagion in the Eurozone economy that comes from its sui generis beginnings. Germany’s hegemony in Europe is restrained by its obligations to the EU collective at the cost of austerity measures. The EU’s obsession with austerity, marked by the balanced budget golden rule spearheaded by Germany, can be traced to Germany’s preference for the low inflation/high unemployment tradeoff. This trend is sustained by Germany’s dominant position in the EU as the largest population, economy, and, most importantly, creditor.

Here’s a scary sampling of quotes from Roman Prodi, the ex-president of the European Commission. “Germany is exercising an almost solitary power…President Obama telephones Mrs. Merkel, not the British prime minister…the bureaucracy is adapting to the new correlation of forces.”

This shouldn’t be a shocking trend, even from the beginning of the European Central Bank, its constitution was worded very closely to that of Deutsche Bundesbank. And now Germany’s focus on limiting inflation, bolstered by its current economic health and perhaps influenced by past crises of hyperinflation, has created conditions of more unemployment than is acceptable to other Eurozone members, leading them to borrow Euros, and eventually triggering the debt crises.

History tells us hegemony always triggers counterbalancing. The lesson applies just the same for economic, regional hegemons as it is for global, military empires. And while it hasn’t come from the expected rival Britain, countermeasures have definitely been occurring slowly and broadly. How else to explain the rise of Syriza? The starting point has to be the completeness of economic dysfunction in Greece where 60% of young people aged 18-24 are unemployed.

In my overview of protests as political power, I left out the occupation of squares in 2011 by Syriza, a small protest party that could, by the end of the month, take power as a coalition of socialist/ecologist/euro-communist parties. And momentum may be swinging their way. The protests spread to Spain in September of 2014, as two million pro-independence Catalans marched in Barcelona, cited as the largest demonstration ever seen in Europe.  The same month, Scotland also held an independence referendum.

Break-ups of Britain and Spain could also break up the European Union, especially when France is added to the mix. Marine Le Pen’s far-right National Front, which has received increased support for its anti-religious-extremism and pro-death penalty policies after the tragic magazine attack in Paris, will be a strong challenger for France’s presidential election in 2017. Marine Le Pen has stated, leaving the EU, we could allocate 15 billions of euros to our agriculture.”


Maybe both Grexit and Greeparture are the wrong terms. Exits and departures articulate a deviation from a certain norm or path. But the problems with the Eurozone have always existed; they were just masked by the benefits of trade and increased efficiencies from a common market.  Now, with Greece’s potential exit from the European Union, the problems are being revealed and the people are forcing elites to recognize the flaws.

Call it the Greckoning.

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Jeffrey Ding – Resident Policy Wonk

Written by Jeffrey Ding, undergraduate at the University of Iowa

As the resident policy wonk of Economics Forum (mostly due to my lack of technical knowledge in finance rather than any particular expertise in politics), I will be contributing articles at the margin (see what I did there?) of politics and the economy. But in some ways, it’s not a margin at all. It’s just one big blob, and there’s different ways of viewing that blob. One way to view that blob: all economics is political.


 

Trade policy sits at the intersection of politics and economics. On the one hand, economic models and theories – from Ricardo to Heckscher-Ohlin –seem to generally conclude that free trade results in overall gains for the countries involved. But for political scientists, protectionism seems like the reasonable norm so as to protect domestic factors and the electorate. Then one would predict an impasse, or a pendulum that swings back and forth over time, and one would be right for much of history. Yet, for the past 30 years, the overwhelming trend in trade policy has been the widespread liberalization of trade policies, resulting in economic interdependence with even more widespread effects on the part of both the global economy and global politics.[1] Milner argues for an explanation based on democratization and internationalism, but others offer a more cynical view.

 

Giovanni Facchini from the University of Illinois at Urbana-Chamapaign writes in an article, entitled, “The Political Economy of International Trade and Factor Mobility”:

 

In turning our attention more specifically to the distortions which arise in international trade, we have noticed the emergence of a paradigm, in which trade policy is modelled as the result of influence driven contributions by organized groups. Although this framework faces some theoretical challenges, it has found strong and robust evidence in the empirical tests performed so far, conducted using both US and international data.

 

The role of influence driven contributions is especially noticeable in a post-Citizens United World. Organized interest groups donate exorbitant amounts, often to both candidates, in an election to buy influence. Grossman and Helpman (1996), who wrote the seminal paper on the subject, argue that these interest groups continue to lobby after the election in order to influence policy choices.


 

With this background context, let’s examine the hot button trade issue at the moment – the Trans-Pacific Partnership (TPP). The difficulty of examining the explanations behind the TPP is that negotiations are being kept secret to the public, but not to the 600 lobbyists who are involved in the TPP negotiating process as “corporate trade advisors”. Leaked texts show key tenets – expanded patent rights for pharmaceutical companies and private enforcement actions which would allow corporations to sue governments for regulations – would serve the interests of corporate entities.[2] These “gains from trade” may end up as a net disservice to the general population. Recent estimates show the total U.S. economic gains from the TPP may only be .13% of GDP by 2025. The Center for Economic and Policy Research has found the median wage earner will probably lose as a result of the TPP, while those with the highest wages will gain more as they are more protected from international competition and gain from the expansion of terms and enforcement of copyrights and patents. [3]


 

I’ll be back with more, but that’s a little aperitif in the meantime; and keep in mind, for the sake of my role here, that all economics is political.

 

[1] http://web.stanford.edu/class/polisci243c/readings/v0002017.pdf

[2] http://www.theguardian.com/commentisfree/2013/nov/19/trans-pacific-partnership-corporate-usurp-congress

[3] http://www.cepr.net/index.php/publications/reports/net-effect-of-the-tpp-on-us-wages