Greece: Competitive with Euro?

There is an incredible amount of misinformation about the implications of Greece leaving the Eurozone. Commentators make flawed arguments and there is a need to make clear what is true and what is false. Greeks will vote on Sunday's referendum. Unfortunately, both choices that are being given are bad. The program proposed by the creditors will further reduce consumption and investment suppressing GDP as previous ones have done. But rejecting it would push Greece outside the Eurozone, a path that cannot be managed by its political leaders.

The fact that we got to this disastrous place is no surprise. I wrote a few months ago that the new government will turn out to be deeply destructive about the country (as previous governments have proven to be). Also, that the negotiating practices of the government are founded on the deeply flawed argument that Greece represents an economic threat to the Eurozone and that this will turn out to be unproductive. Unfortunately, the programs imposed by the creditors have been deeply flawed themselves concentrating on the wrong type of reforms. They concentrated on increasing taxes and decreasing wages. There was room for that but they went too far. And they lost an opportunity to focus on the most important reforms:

A. Reforming the functioning of the courts to improve protection of property rights. Legal protection of investors is extremely poor.

B. Increasing government accountability by asking the government to adopt high quality accounting standards and publish financial statements. The Greek government still does not prepare a balance sheet and has no inventory of assets and liabilities. No wonder public assets are mismanaged.

C. Providing access to finance to Greek corporations so they can grow and become competitive. High cost of capital constrains the ability of Greek companies to grow and even survive.

Some important facts given the coming referendum:

1. Drachma means loss of wealth not competitiveness

Some argue that Greece should go back to the drachma to restore its competitiveness. But they fail to specify how this will happen. The vague argument relates to labor costs. But wage adjustment has already happened after a series of labor reforms. The vague argument also relates to making tourism, one of the major industries of Greece, cheaper and as a result attract more tourists. But proponents of this argument refuse to see the data. In the past four years Greece had on average about 16 million international tourist arrivals according to the World Bank. In the late 1990s when Greece had still drachmas, the number was just 10 million. While within the Eurozone, tourist arrivals in Greece have increased by about 60% (the respective number for neighbor Italy was about 35% and for Spain about 38%). And this is even after all the negative publicity and instability that the country has experienced.

A drachma would start trading at 1-1 with Euro and soon would be devalued by close to 50% given the need to print vast amounts of money. The exact number is hard to predict but my sense is that it would be very large given that Greece has now depleted its cash reserves. This loss of wealth would dramatically affect the ability to import products and goods as zero trade credit will be given by suppliers and imported products will become much more expensive for Greek consumers.

2. Drachma would mean worse governance

The European Commission is realizing (unfortunately very slowly) that a monetary union is not possible without strengthening the institutions of a country to promote good governance. Many countries in Europe have high levels of corruption, bureaucracy, and poor governance procedures. This needs to be improved and the first thing to do would be for European countries to adopt high quality standards for governmental accounting. Producing financial statements based on accrual accounting rules would increase accountability of government officials and facilitate better management of government assets and liabilities.

Outside the Eurozone, Greek government officials, who have a notorious history for opposing accountability and transparency, will likely suppress any efforts that promote good governance and will perpetuate cronyism.

3. Competitive with Euro

Some commentators argue that Greece has no chance to be competitive within the Eurozone. They are wrong.

Their argument goes that the Greek economy cannot seem to grow, even after assistance from the European allies and IMF, within the Eurozone. Given that most of the changes that have been implemented in the last seven years have to do with tax increases, reductions in salaries, and restructuring of the debt, it is no surprise that the Greek economy has been contracting. Liability management does not lead to growth. Any serious student of management knows this. It just enables growth if assets are productive and effectively managed.

Greece has tremendous potential to improve its economy. Foreign investors understand this; many of them are eager to invest in Greece. But they do not because necessary conditions are:

• no currency risk,
  
• a government that can be trusted, and
• strong rule of law that protects property rights

Addressing the innovation gap will also be key in putting Greece on the long-term path to prosperity.

THE WAY FORWARD

It is with Euro as the national currency. It will be hard though. There is such a negative sentiment within the Greek government and creditors that it is tough to imagine how the two sides could cooperate.

Going back to the drachma could be a way forward only under strong political leadership and charismatic politicians. We lack those.

But most importantly it is about moving forward all Greeks together united. Current efforts to divide the country need to fail.