As uncertainty simmers in Greece over how best to handle widespread financial crisis in the Eurozone, Stergios Skaperdas, a UC Irvine professor of economics, offers sobering advice: “Greece needs to default on its public debt and exit the Eurozone,” he told attendees late last year at an Athens conference hosted by The Economist. The strategy may prove prudent for others in the financially strapped 17-member-state union, he added.
“Simply said, it is very difficult – if not impossible – for so many heterogeneous countries to have a common currency.”
An authoritative voice on how governance and conflict affect the economy, the Greek native turned his attention to the Eurozone in 2010.
“The near absence of serious policy debate within Greece and the Eurozone among economists forced me to pay close attention,” Skaperdas said.
The results of his research are summed up in his recent paper, “Seven Myths about the Greek Debt Crisis.” It has been cited in more than a dozen publications – including The New York Times, The Guardian, National Public Radio and CNN – and is a key referent in the ongoing debate and in policy circles.
Media and policy professionals seek him out for his solution-driven intervention on the region’s financial crisis. Here, Skaperdas explains what’s happening in the Eurozone, how a departure from the collective euro currency could affect international markets, and what lessons decision makers worldwide can learn about the relationship between economic policy and politics.
Q. What factors contributed to the current debt crisis in Greece and the larger Eurozone?
A. Greece had high public debt when the worldwide slowdown occurred in 2007, which resulted in more public borrowing. By the beginning of 2010, the country could no longer borrow in the international bond markets. Mainly in order pay bondholders and avoid default, the other Eurozone countries and the International Monetary Fund loaned money to Greece in exchange for increasingly draconian budget cuts. This led to a depression that has made debt even less sustainable than it was at the beginning of the crisis.
Other countries got into trouble for different reasons. Ireland, despite having the lowest public debt relative to its income in the Eurozone, suffered from very high private debt, a significant housing bubble, and collapsing banks that the government took over after guaranteeing their deposits. Spain had similar problems, while Portugal had no apparent immediate problem, aside from low growth for the past decade, but the international bond markets decided against funding it. Italy has had low growth and high levels of public debt.
These factors are symptoms of the more general problems with the Eurozone and its institutional structure. In short, it is difficult – if not impossible – for 17 heterogeneous countries to share a currency. The absence of a common fiscal policy (i.e., common taxing and spending), low labor mobility, fragmented bank supervision and deposit insurance, and a weak Central Bank, all are institutional holes exposed by the first serious recession. And they are the cause of problems that have cropped up from one country after another.
Q. Is the U.S. economy facing similar problems?
A. The U.S. does not have these deep institutional problems; they have been largely resolved over more than two centuries. The federal government centrally administers fiscal policy, bank supervision is less fragmented (though certainly problematic), and bank deposit insurance and a strong Central Bank has existed since the 1930s.
In the U.S., the main problem is that the financial sector’s inordinate political influence prevented reform of our fragile financial system after the 2008 crisis. This is the primary reason, in my view, for lingering economic problems and low job growth.
Q. What solutions exist for Greece – and possibly the entire Eurozone? What impact will these actions have on international markets?
A. Greece needs to default on its public debt and exit the Eurozone. Debt will then become sustainable. With its own currency, Greece will regain credit and liquidity in the domestic market, something severely lacking given that the European Central Bank controls the money supply. Greece once again will be competitive internationally as devaluation will increase exports and tourism, reduce imports, and thus stimulate domestic production and reduce high levels of unemployment. It will also restore some semblance of democracy. On the other hand, if Greece remains in the Eurozone, no decision of economic importance will ever be made in the country.
The other solution to the Eurozone’s problems is establishing a “United States of the Eurozone” and that’s not in the cards. So it makes sense for all Mediterranean countries to exit the Eurozone. Beyond that, there is too much uncertainty to predict what will happen. It is important that the unwinding of the Eurozone is orderly and that care is taken to maintain the European Union and enhance democratic accountability within it.
What happens in the Eurozone will affect international markets and economies because the world financial system is fragile. Many financial institutions – in Europe and in North America – will likely collapse and be taken over by their governments, and recession can be expected in most countries.
Q. What can we learn from this?
A. Think seriously before trying a monetary union that includes many countries without politically unifying first. Also, the financial system is too important to be left without effective, independent regulation and supervision.