The shock referendum announcement by Alexis Tsipras over the Troika’s austerity demands has radically increased the chance that Greece will fall out of the eurozone.
I am surprised that the markets, and indeed the Greek people themselves, did not give more credence to this outcome over the last few weeks. The received wisdom of most market pundits is that an 11th hour agreement would be reached.
Meanwhile, Greeks have been pulling money out their banks, but at a very leisurely pace. To me, this nonchalance appears bizarre. The chart below shows Greek bank private-sector deposits falling from 160 billion euro prior to Syriza’s election victory to around 130 billion euro at end May. The chart is made to look more spectacular by having the y-axis commence at 100 billion euro.
Even if last week you had only assigned a 5% probability to a return to the drachma, such an outcome would result in a 30-50% decline in the value of your savings when denominated in euro. Risk equals probability times effect. The probability might have been assessed—wrongly as it turns out—as small, but the impact should have been deemed as large. The prudent man or woman would have parked their money abroad until a deal was sealed and then repatriated the money once confidence was restored. And for small accounts that couldn’t justify the hassle and fees of an inter-country transfer, you could always stash cash under the bed. Yet relatively few have followed such a simple risk control strategy (Chart from Bloomberg here).
At this point, it appears improbable that the banks will open on Monday, and the Greek authorities will have to introduce capital controls and bank deposit withdrawal limits. If this is indeed the case, the likelihood of avoiding a return to the drachma looks remote.
Very soon the blame game will begin. However, from my perspective there is a certain inevitability about the outcome, which rests on long-term economic and political factors that are rarely raised by most commentators. After a political tour to Greece two years ago, I blogged about these issues here, here and here.
Front and centre of the factors driving Greece toward its current predicament is the country’s terrible demographics. Let’s look at its current and projected old-age dependency rate, which I took from Eurostat. Currently, the ratio of the elderly (65+) to working age (15-64) is 1:3. However, this ratio is rapidly moving toward 1:2 (click for larger image).
Not surprisingly, such demographics are putting a huge burden on the state with respect to pensions. Even the right-of-centre Wall Street Journal goes beyond the stereotype of greedy Greeks in recognising this fact (source: here). So while the aggregate Greek pension burden is very high in a European context when compared with GDP, it is not so high when we put pension spending on a per person basis.
With demographics like this, the only way a country can maintain living standards is through securing high productivity growth. And to do that, in a global economy, a country needs a comparative advantage in industries that exhibit high productivity growth.
Unfortunately, since entering the euro at what proved to be the wrong rate, Greek growth has been concentrated on just a few industries such as tourism, real estate, shipping services and infrastructure projects benefitting from EU regional development funding. Many of these industries got savaged in the wake of 2008/09 financial crisis, and those that have remained reasonably robust, such as tourism, are not great engines of productivity growth.
As Japan amply demonstrates, when a country enters a steep demographic transition, it is very difficult to secure high rates of economic growth. But that doesn’t mean that you can’t maintain full employment, social cohesion and well-being. Japan has partially done this through accepting declines in real wages and a depreciation of its currency. Indeed, the Japanese middle class tourist, once king of Bloomingdales and Harrods in the 1980s, is now relegated to factory outlets.
For the IMF, Greece has been pushed toward reformimg its soft infrastructure: land registry, tax collection, business licensing system, closed shops and so on and so forth. These are all noble causes—and in the course of time should bring some productivity improvements. But the IMF‘s second critical goal, internal devaluation, has proved a disaster. Adjusting wages and prices downwards without producing an economic slump is an almost impossible task. Moreover, the key demographic segment that is critical to future productivity gains—highly educated young adults—have reacted to austerity by flocking to the UK and Germany in droves. The Guardian reported on this depressing brain-drain in January this year (here)
If you are struggling with adverse demographics and poor competitiveness, the last thing a country needs is for its actual economic output to be substantially below its potential output. But this is what you get if you implement a vicious policy of austerity within the context of a lack of effective demand and a fixed exchange rate. Far better is to adjust prices through maintaining a flexible exchange rate and allowing a modicum of inflation. And the only way for this to occur is for Greece to leave the euro and return to a freely floating drachma.