Grexit

The extent to which the Greek electorate was buoyed by the country's advance to the quarterfinals of the 2012 European football championship is unclear. In any event, the outcome of the elections on June 17 has bought a moment of respite that now must be put to good use.

The notable progress that Greece has made in restructuring its public finances contradicts often-voiced perceptions. Between 2009 and 2011 Greek's financial deficit in relation to GDP fell by approximately 7 percentage points. If fiscal consolidation efforts and their success alone are the subject of discussion, then the cyclically adjusted deficit without interest payments on public debt is a suitable metric for measuring progress. And indeed, between 2009 and 2011 this deficit was reduced by approximately 12 percentage points. The success of this reduction should not be underplayed, particularly when one imagines the waves of protest that such deficit reduction measures would incite in Germany. Readers should recall the minor earthquake of public upset that was triggered in Germany just two years ago on the occasion whether the long-term unemployment benefit should be increased by five euros a month. Furthermore, with regard to measures for enhancing Greek competitiveness, readers should recall the protracted and agonizing process associated with Germany's Agenda 2010 reform programme. In specific terms, the troika will assess the progress Greece has made in implementing a functional tax system as well as in flexibilising its product and labour markets. It appears that Greece has a lot of catching up to do in these areas.

If the new Greek government were to tackle these structural policy issues (which would trigger little in the way of new spending) in a credible and energetic manner, then the EU could grant Greece a little bit more time to consolidate its finances. Indeed, earlier forecasts of Greek economic growth were excessively optimistic. Furthermore, it would be economically ill-advised and politically dangerous to further exacerbate the mutually reinforcing negative trends of fiscal consolidation and recession. The shockingly high unemployment rate, particularly among the young, is already a political powder keg. A departure from the eurozone (or "Grexit") would have hugely destructive consequences for Greece and would cost the remaining countries of the EU a considerable amount of money. Forecasts predict that Greek GDP would fall by at least another 20 per cent, and inflation and unemployment would each rise by around 30 per cent. While a new drachma would be heavily depreciated, a wage/price spiral would be almost sure to take effect, reducing the benefits to international competitiveness associated with a weak currency. Furthermore, Europe could not sit idly by as Greece implodes, but would seek to help, and for good reason, as the EU is partially based on the principle of mutual solidarity. The cost of a Greek exit would be huge for the eurozone due to losses on credit extended by the ECB as well as on Greek bonds held by European banks. Contagion effects for Spain and Italy could easily be dire, with consequences that are difficult to foresee. As expensive as it may be, keeping Greece in the eurozone is likely the somewhat less risky option.