When a Crisis Never Ends

22 september 2015

Greece: A Lesson, Not a Problem

Sergei Pavlenko is an economist; he headed Russia’s Federal Financial and Budgetary Supervisory Service in 2004-2012.

Resume: The most important lesson to be learnt from the Greek crisis is the understanding that a never-ending socioeconomic crisis can also be possible in a modern European country. The Greek example shows that at a certain stage of a socioeconomic crisis the possibility of a positive development disappears even in mature democracies.

The history of Greece’s relations with the European Union is a remarkable saga of human ambitions, cultural and personal collisions, clashes of social communities and political affiliations. The Greek crisis is important for Russia insomuch as it already affects, and will most probably continue to affect, the economy of Europe, which is Russia’s leading trade partner. And for that reason, Tsipras’ artistic somersaults should be of interest to many in Moscow, not only to his sympathizers.

Another remarkable aspect, which has been largely overlooked, is that Greece is teaching a lesson to the Russian authorities, who are fervently building new integration associations in the post-Soviet space. In light of the Greek events, simultaneous establishment the Russia-Belarus Union State and the Eurasian Economic Union, which has not been going smoothly as it is, needs to be reevaluated. 

DEVALUATION POLICY AS A SUBSTITUTE FOR STRUCTURAL REFORM

One could frequently hear in the past two to three years that Greece’s accession to the eurozone was a gross mistake, and that there is allegedly no non-catastrophic solution to the problem of Greece due to miscalculation of risks and advantages of this step by all EU decision-makers.

One kind of logic has been replaced with another: initially, Greece’s admission to the eurozone was viewed as a way to reduce transaction costs, which is especially important for a country where a large portion of GDP is generated by tourism. It was also believed that if Greece had no possibility to solve its current problems by pushing inflation, it would hopefully begin structural reforms and develop its economy. This logic worked partially not only in Greece: Spain and Portugal, with similar GDP structure, also experienced a shock and could not overcome it quickly because they did not control the exchange rate. In fact, the transition to a common currency did not create proper conditions for structural reforms on the fringes of old Europe.

The Russian economic authorities went to another extreme and tried to solve all (or almost all) economic problems in the country by manipulating the exchange rate. Devaluation was used to correct budget imbalances, increase the competitiveness of the oil sector, and develop agriculture and even the local tourism industry.

But Russia is not the only country that resorted to devaluation as an economic policy tool. Eastern European countries did the same, with Poland and Hungary being the most vivid examples of this approach. The results are rather questionable, but one thing is clear: where the economic authorities attempted to solve structural and institutional problems with the help of devaluation (like in Hungary), they did not succeed but only drove inflation up, creating a real problem for the central banks to deal with. And devaluation certainly failed to make Eastern European industry more competitive.

Devaluation by itself, even a drastic one, cannot spur local economy. This would require tighter import restrictions similar to the sanctions imposed on Russia and its counter-sanctions. But European countries have no economic policy instruments that would allow them to close up their internal market. As a result, exchange rate manipulations produced only limited effect.

What would have happened if the Greek government had such an instrument? Devaluation of the conventional drachma would most likely not help to significantly reduce the external debt and would meet internal liabilities only in terms of pension payments. Industrial production would hardly grow fast enough to absorb the shock, and there would be no considerable rise in agricultural exports since the European market remains oversaturated. As for tourism, the need to convert the euro to the local currency would in all probability reduce possible gains from a favorable exchange rate.

Regarding Russia’s economic allies, the situation varies. Until 2014, Belarus regularly devalued its national currency, while Kazakhstan took efforts to curb the excessive strengthening of its tenge. However, the devaluation of the Russian ruble has put them all in the same difficult situation as neither country is prepared to absorb inflationary shocks from similar exchange rate fluctuations.

A POSSIBLE EXIT FROM EUROZONE AS A POSITIVE ALTERNATIVE

Another noteworthy point in the Greek saga is the discussion of how Greece could leave the eurozone and get its own currency. It turned out that the founding fathers of the eurozone (and united Europe as a whole) had not foreseen such a possibility. In the absence of appropriate regulations, several controversial proposals were made as to how to move to the drachma or a dual currency system using various combinations of promissory notes, debt securities and other fiscal instruments, which are usually invoked at a time of economic disasters. There is still no macroeconomically acceptable and technically implementable solution, but the search for one goes on.

This should be of interest to the Russian economic authorities since a common currency has been proclaimed a long-term goal for the Eurasian Economic Union, and a short-term necessity for the Russia-Belarus Union State as Moscow has repeatedly suggested. In other words, before introducing a common currency with such different countries as Belarus, Armenia and Kyrgyzstan, it would be prudent to think of a secession procedure.

One of the rational solutions in the current situation faced by Greece could be using some kind of “private money” instead of the drachma, that is, legal tender issued not by the Central Bank of the country but by other organizations such as a consortium of private banks, regional administrations or even individuals. In this case the country would get a dual currency but not a national currency; risks would not be assumed by the state, which should calm down foreign creditors; and a part of internal turnover (primarily at the sub-national level) could be serviced for some time.

The Russian government has generally been critical of “private money” and often spoken against the use of any payment instruments in internal operations other than the ruble. Attempts to use receipts or private debt securities as legal tender have led to court proceedings. Meanwhile, some Russian economists have been repeatedly calling for returning to the gold standard as “real money” instead of the “worthless American greenbacks.”

But it is not quite clear how Moscow should react if private banknotes are put into circulation by a local issuer (a bank or even a large enterprise) in any of the states that participate with Russia in integration unions. Should they be ignored, that is, not allowed in settlements with Russian legal entities, or taken into account when calculating the allies’ monetary base?

THE PROBLEM OF MULTI-SPEED DEVELOPMENT

Does the Greek experience prove that the European project to equalize levels of economic development has failed? No, but too much hope was pinned on speedy convergence of development rates. The initial choice was theoretically correct: creating possibilities for accelerated economic growth in the relatively backward Southern European countries by implementing large infrastructure projects there. Theoretically, such projects boost economic growth. In real life, however, they caused tremendous moral harm that outweighed economic gains. Infrastructure construction led to corruption and degradation of government institutions (including political parties), which killed the initial development impetus halfway. The subsequent decline in the average annual economic growth rates in the Southern European countries was not situational, but reflected a deep divide in the quality of social institutions in Northern and Central Europe and in the south of the continent.

“EUROPE OF REGIONS” AND THE RUSSIAN FEDERATION

The development of the regional component of governance was one of the focal points in the new Europe concept. It was believed that this would create new opportunities for inter-regional cooperation between the adjacent regions of various European countries and solve the following tasks:

  • Opening up national borders, thus making them less significant as such.
  • Creating new regions of growth – border-lying regions of European countries are generally poorer than central ones, and the low base effect would have facilitated the leap.  

It must be said that the “Europe of regions” concept ran counter to the idea of free economic space in Europe. In fact, if the movement of capital and labor is no longer restricted, transboundary development projects lose their demonstrative significance and become regular territorial development projects with ineffective management.

  • Transferring to the sub-national level responsibility for the implementation of social aid and public service programs.

It was assumed that this would create incentives for backward regions and allow central governments to cut transfers from the national budgets (which is always the most politically sensitive item in national budgets). But the results were the opposite: instead of reducing (“rationalizing”) expenses, regional authorities increased borrowing and began to encourage the development business.

The central governments tried to regulate borrowing at the sub-national level, but could not control development projects. The crisis of 2007 both in the United States and Europe was a result of macro- and microeconomic imbalances, but it was the overheated real estate market that triggered the systemic collapse. Spain, Ireland, and Portugal were hit the hardest, but Greece suffered too. The real estate bubble was caused mainly by the absence of proper bank control over quasi bank institutions such as thrifts in Spain patronized by the regional authorities. But the role of regional development programs aimed at broadening the tax base (real estate tax) and directly linked to corruption schemes (which makes them personally attractive) should not be underestimated. Poor regulation and supervision in Greece manifested itself at both the national and sub-national levels, causing much more serious consequences than, for example, in Spain.

In Russia, broader financial and administrative powers for regions have been discussed for a long time, with these powers being actually cut instead. Nevertheless, until recently, the federal government encouraged regional and even municipal borrowing to close seasonal gaps. But this policy became unstable after the deficit of regional budgets, which began growing in 2011, was compounded by loan interest rate hikes in 2014. Moreover, some regions, which had borrowed in foreign currencies (to be more precise, their loans were pegged to foreign currencies) suffered an additional shock from exchange rate jumps.

 Russia’s partners in integration associations were less affected by the regional budget crisis – mainly because of the lesser economic differentiation of their regions than in Russia. And yet the Greek experience shows that regions can be given broader powers only if there is confidence that governance at the national level is good enough to make up for the regional authorities’ mistakes and failures.

SECESSION OF PART OF THE UNION

The European Union is not yet a full-fledged union and its interim state (monetary union but fiscal autonomy) allows European experts to say that crises in the eurozone cannot be overcome quickly. The Greek crisis, and especially the uncertainty of the country’s future in the eurozone, has brought the dilemma closer: a fiscal union or a mechanism for secession/expulsion from the eurozone.

The former is extremely difficult to realize since fiscal sovereignty is the basic element of modern European democracy, and even its partial rejection would rock the foundations of European life. As a matter of fact, the current political system emerged under the “no taxation without representation” slogan as part of the Westphalian system of national sovereignty.

The latter is much easier to do as a purely operational task, but it challenges the fundamental principles of current European policy: irreversibility of EU enlargement and the functions of supranational bodies. In other words, before the Greek crisis, a fiscal union was viewed as the final stage of integration (after unification of technical regulations and governance practices). Now the concept is beginning to change and a fiscal union is taking center stage. It may be created by significantly increasing the share of the European Commission’s budget in the consolidated budgets of European countries, or it may be accompanied by the transfer of additional powers to the supranational level (for example, those pertaining to environmental issues). 

In the post-Soviet space, integration processes have not yet reached the level of monetary union. Even the Customs Union of Russia, Belarus, and Kazakhstan has shown how hard it can be for the three countries to coordinate their interests, leaving virtually no role for the “integration bodies” to play in this process. When economies as different as those of Kyrgyzstan, Armenia or even Tajikistan join in the game, things will hardly move smoother or faster. The Greek experience shows that flexible unions can be much more stable than those that are fixed perpetually in their interim state. 

THE CRISIS AND IMPOSSIBILITY OF REFORMS

Perhaps, the most important lesson to be learnt from the Greek crisis is the understanding that a never-ending socioeconomic crisis can also be possible in a modern European country. Classical economic and social theories, including Marxism, state that crises are inevitable as a means of solving existing contradictions and consider them an element of positive development. A decline is always followed by an upturn. Different economic schools have different views on whether a cycle of economic development needs to be corrected and how deep a possible crisis can be. Conventional social democrats believe that crises must be smoothed over; conventional liberals argue (sharing Marxists’ views) that a recession is a guarantee of a subsequent rapid growth.

The 20th century showed that the duration of economic cycles cannot always be predicted or explained. For example, the American economy at the end of the 19th and the beginning of the 20th centuries was growing for an unusually long period of about 15 years, so long as to give rise to continuous growth theories.

In the case of Greece, it is not just a long decline. There is no light anywhere in sight, and the crisis can probably last indefinitely (which in modern economy means 15-20 years). Greece can hardly be called a collapsed state since formal government institutions and economic structures obviously continue to work. Greece is certainly not the Georgia during Shevardnadze’s rule, but its situation is worse: the state is functioning, albeit perhaps not quite effectively, but it is not creating conditions for ending the crisis. Moreover, it is not at all obvious that even the smoothly functioning state will be able to cope with the task of economic recovery. At this point, it looks as if Greek sovereignty has to be substantially limited and the country has to be put under external management in order to handle the crisis. While this may be a distant cultural and integration perspective for other European countries, it is a matter of the near future for Greece.

This is an issue for the Russian elites to ponder not in terms of external control but in terms of crisis management. The Russian economy, which is spiraling down now, can probably be stabilized within three to five years. But how will it overcome a demographic and pension decline to follow immediately after that?  

This is also an opportunity for the ruling classes of the integrating post-Soviet states to think as to whether the social structures of their societies, which persevered through the severe crises of 1991, 1998 and 2008, are able to survive a drawn-out recession without clear signs of economic growth in the future.

 The case of Greece shows that deep structural problems cannot be solved with the help of labor migrants. Moreover, at some point migrants stop being a solution and become a problem. In addition to the dwindling economic input (initially, migrants pay taxes and do not receive social allowances, but then the situation changes), migration pressure brings back the problem of balance between the citizen and the taxpayer, which seemed to have been solved by the French Revolution. The “no taxation without representation” principle should continue working, should it not?  In fact, the movement towards representation can be delayed by artificial restrictions, but it is the temporary nature of these measures that causes deep frustration in European societies and fuels ultra-right and ultra-left sentiment in Greece (and Spain, too).

For the integrating countries in the post-Soviet space, the issue of migration pressure exists mainly in the economic sense (that is, whether attracting migrants is economically beneficial) since political representation in these countries is limited even for the indigenous population. A demographic crisis will become the moment of truth at least for two countries, Russia and Belarus, with unclear political ramifications.

The economic crisis in Greece has led to political polarization, but of course right-wing and left-wing political forces existed there before. As for the political configuration of the integrating post-Soviet countries, it is not just monopolized by one ruling political organization (perhaps with the exception of Armenia), it is demonstrating elements of centrist ideology – and not in order to implement it, but in order to ensure comfortable existence of the disabled right and left within a controlled quasi political system.

Will the ruling elites be capable enough to decompose monopolistic political structures amid the mounting systemic crisis? In a similar situation, the Soviet Communist Party failed to split up into “social democrats” and “conservatives” and simply ceased to exist.

Of course, the question is not who are more lasting – the strong ultras with a weak central government or strong centrist government with virtually no opposition. The point at issue is what the political configuration must be for a sober-minded part of the elites to be able to work out and implement a plan of action that would help it if not rescue the country, then at least prevent the crisis from going endlessly. The Greek example shows that at a certain stage of a socioeconomic crisis the possibility of such positive development disappears even in mature democracies.

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