Ruth Lea: If Greece cannot face social costs of austerity, then it must dump the euro

Two years on, we are really very little closer to a permanent solution for the beleaguered Greek people and the monumentally dysfunctional Eurozone.

Since February 2010 there have been three bailouts in the Eurozone – E110bn for Greece (May 2010), E85bn for Ireland (November 2010) and E78bn for Portugal (May 2011). It now seems that a second bailout, initially formulated in July 2011, has been provisionally agreed for Greece. And there may be more for Portugal.

Greece will receive another E130bn, a huge amount of sticking plaster, to avoid defaulting on its debts this March, if it can deliver the package of public spending cuts recently agreed by the Greek Parliament (a very big “if”, by the way).

It may even receive more – E145bn has been mooted. All in all Greece may receive E240-255bn in bailouts compared with GDP of about E230bn. But note that, even though Greek GDP may be relatively modest, its government debt at 160 per cent of GDP is a staggering E370bn.

Assuming the latest bailout package goes ahead, which includes some debt write-offs, Greece’s debt burden will still probably be unaffordable.

Greece would have a better chance of getting on top of its debt if the economy could grow. But the picture here looks very bleak. GDP fell by over three per cent in 2009, 3½ per cent in 2010 and probably tumbled by over six per cent last year. Moreover, the OECD is expecting a three per cent fall this year, but this is probably a gross underestimate.

Unemployment is rising fast, jumping from just over 18 per cent in October to nearly 21 per cent in November. Greece is in a vicious circle of dreadful growth prospects, worsening public finances and tough austerity packages.

Where can Greece turn? What avenues are left to it? Well, one possibility is that German Chancellor Angela Merkel will soften her determination that troubled Eurozone members should don the hair shirt of austerity.

But a great deal of political capital has been sunk into this policy. The latest treaty, the fiscal compact treaty, is basically about hammering home fiscal rectitude. So there is little chance of a U-turn.

Another road to possible salvation would be if the Eurozone took deliberate and definite steps towards genuine fiscal union with pooled government bonds and large fiscal transfers from the rich north to the poor south. But the political resistance from Germany and her northern allies appears to be unbending.

So Greece is faced with a stark choice. The country either soldiers on with austerity packages, a deteriorating economy and social unrest or leaves the Eurozone.

Two years ago the latter option was totally dismissed, but as the painful saga has proceeded this option is increasingly being discussed.

There are of course precedents for break-ups of currency unions, the USSR and Czechoslovakia to name but two. And one can only hope that in the depths of the Commission, the German Ministry of Finance and/or the Greek Ministry of Finance, plans are being developed for Greece.

Departure from the Eurozone would be disruptive. For example, the country would almost certainly default on many of its debts, damaging its creditors.

The banks may have to be nationalised and there would have to be tough capital controls in the short-term. But, to quote Macbeth: “If it were done when ‘tis done, then ‘twere well it were done quickly.”

If Greece is to leave the Eurozone, then get on with it before there is any more damage to the economy and the social fabric of the country.

The new currency (presumably the new drachma) would fall dramatically in the exchanges, 35-40 per cent cannot be ruled out, giving the economy a much needed competitive boost. Growth could then resume.

Of course, Europe’s political elites will suck on their teeth. So much political capital has been sunk into this great vanity project. But as economies struggle and people riot, it is time to face reality. Let Greece go.

And if Greece goes then others may leave too. Portugal is the next obvious candidate. It may even start making sense for Ireland, Spain and Italy.

The truth is that, even though the European Central Bank has calmed tensions recently with huge assistance for the banks, fundamental economics are continuing to tear the Eurozone apart.

At the heart of the problem is the crevice between the competitive northern economies (primarily Germany) and the uncompetitive southern ones. Until this is addressed the Eurozone crisis will continue to dog us all. Even after Greece’s departure.

• Ruth Lea is economic adviser on the Arbuthnot Banking Group.