Photo Jonathan Blair

Monday, September 12, 2011

Lessons from Latin America: Greece must dump the Euro and the world should approve

[This piece was written with my colleague Yiagadeesen Samy, a conflict and development economist at Norman Paterson]

A few months ago, the economic powers that be chose France’s former finance minister Christine Lagarde over Mexico's Agustin Carstens to lead the International Monetary Fund.  One factor often mentioned in her favour was her better acquaintance with the tribulations currently shaking Europe's financial system, with Greece in particular, but also Ireland, Portugal and Spain on the brink of disaster.  Arguably, however, the relevant knowledge to face the crisis lies not in Europe but in Latin America, where Carstens and ilk in the region's finance ministries have literally grown up with hyper-inflation, brutal devaluations, humongous external debts, massive structural adjustments, huge and often violent social resistance to those, and debt repayment suspensions. 

Much of what is unthinkable in Europe today has been thought and tried many times in Latin America; for example, Argentina defaulted on its debt and devalued its currency in 2001/2002, which ultimately led to increased exports and economic growth later on.  Latin America, accustomed to debt crises, is now a continent going through a period of growth with quickly decreasing poverty and inequality.

Three relevant lessons can be drawn from Latin America's experience: overly strong currencies kill growth prospects; the poor are the ones who pay for adjustments; and lending and investments always come back if there is money to be made.

Right now, richer European countries, Germany in particular, are trying to save their banks by bailing Greece and company so that the latter can keep paying those banks.  The idea is to give as little as possible and to force local governments to draw as much as possible on their own countries’ resources, essentially by cutting services and putting people, especially public servants, out of work.  The outcome will be a massive recession in those countries that will make the weight of debt service even larger for governments whose tax base shrinks, imposing further cuts, and so on.  Social resistance will understandably ensue, as is already the case in Greece, limiting the ability of the government to implement those cuts, forcing in turn richer European countries to invest a bit more in the bail-outs.

There is another solution: Greece could move out of the Euro and reintroduce its own currency, possibly followed in that movement by Portugal and perhaps even Spain.  The new currencies would not be worth much, making it impossible for those governments to pay their debts, which will continue to be in Euros.  This, however, would only introduce a dose of reality in current discussions: Southern European countries, which face not only a problem of liquidity but also of solvency, cannot pay what they owe, they will not do it in the end, and the world needs to deal with it.

The flip side of the Euro exit, moreover, is that local governments won't have to make as deep a cut in their spending, lessening the social cost of the crisis and the political instability that results.  Meanwhile, local products and services will suddenly become competitive as these economies move from being high-cost but low-productivity holes, to low-productivity but also very low-cost heavens. The world would flock to Southern Europe's beaches and their agricultural products would flood global markets, all for the good of the local economies and, for agricultural markets, for the good of the world. Oh, and by the way, investments would follow and if Europeans are not interested in a suddenly competitive tourism sector, well, Asians and Latin Americans will be.

Meanwhile, Germany and other creditor countries would be confronted to saving their banks, which is basically what they are trying to do right now anyway. The only difference is that the checks, instead of going through Athens (and possibly Lisbon and Madrid), would move directly from Berlin to Frankfurt and Dusseldorf.