The Greek debt restructuring exercise at the end of last week was bankruptcy by any other name. This will shortly be described as a "default event" which will naturally lead to the payment of compensation because of the country’s insolvency. Greece has not formally declared bankruptcy but is in a condition which could not be described otherwise. Greek bankruptcy has until recently not been seen as a serious market risk. The country has long been considered semi bankrupt which was best evidenced by the banks cutting off financing to Greek refineries. Formal bankruptcy is now just a question of time. This will not be the end of the world, but speed up the process of final debt restructuring and help the country’s rulers to persuade the majority to make sacrifices. A long and bumpy ride lies ahead, but any shortcuts will make the situation worse.
One of the shortcuts most talked about is for Greece to leave the euro zone. The argument seems very convincing and postulates that if Greece leaves, it will rapidly recover it competitiveness and the economy will start to grow. It is also generally believed that outside the euro zone the country will no longer create problems for the remaining countries in the common currency area. Unfortunately life isn’t that simple. Whether or not Greece stays in the euro zone, it will still have to be financed – at astronomical rates. Leaving the euro zone will not revive the country, not even in the medium term, because 2010 exports totalled a mere 16 billion euro. In comparison Polish exports for the same period were 120 billion euro. By volume, Polish exports were at the current level of Greek exports back in 1995! Clearly there has been some progress in the Polish economy since then. But besides the feeble level, there is also a structural problem. Machinery and equipment constitute only 12% while food and textiles constitute the bulk of exports. By comparison, in Poland, machinery and equipment represented 41% of the export pie and food only 11%. These figures show what a hopeless situation the Greek economy is in. A weak currency obviously increases profits for exporters as long as they survive the trauma of devaluation. The way exports are structured now shows very poor results for a country that is export oriented. It is unlikely that investors will be lining up straight after devaluation. The country will still be bankrupt, the convertibility of the new Greek currency will be very high, mainly because of the uncertainty of how the economy will react to such a deep trauma which the reintroduction of its own currency would represent. And without new investments, Greek exports will in essence stay at pre-devaluation levels. It would therefore be unrealistic to expect an explosion in exports. This would take a good few years and there is no guarantee of success. Departure from the euro zone (apart from condemning industry to bankruptcy) also would mean a massive outflow of savings abroad as well as a job seeking exodus. Greece is no Argentina, it is and will remain a member of the European Union and subscribes to free movement amongst countries. If Greece were to leave the euro in the coming few years, the reaction of the markets would most likely be excessive and the currency would be drastically devalued.
There is no cut and dried answer. Greece needs radical structural reforms without which is will be hard for the country to get back on its feet. Paradoxically it is the Italian government which has successfully achieved the implementation of supply side reforms. They have managed to deregulate trade, reduce the number of restricted-access professions and trades and reduce the cost of hiring young people. Now the Italian government is tackling the most important reform of all – changes to labour laws deregulating hiring conditions. It was not easy to force through an increase in retirement age. Greece has failed to speed up privatisation and the deregulation of supply side reforms. Surprisingly Italy is currently in the lead as regards introducing reforms such as the ones just mentioned although the reduction of taxes is proceeding very slowly. And as we all know, raising taxes to limit the deficit is not a pro growth measure. This is why in Greece, before applying the last chance solution of leaving the euro zone, they should first apply some of the tried and tested methods to revive competitiveness. In the future it will be necessary to create a mechanism allowing for a controlled and formal exit from the zone but this should certainly not be attempted now with the current shaky state of the financial markets.