[p2p-research] on the greek crisis (must-read)

[Michel Bauwens]

 A Baltic future for Greece?

Latvia and Estonia show us what Greece may look forward to if it follows the
advice it gets from the IMF and European Union

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   - [image: mark] <http://www.guardian.co.uk/profile/markweisbrot>
   -
      - Mark Weisbrot <http://www.guardian.co.uk/profile/markweisbrot>
      - guardian.co.uk <http://www.guardian.co.uk/>, Wednesday 28 April 2010
      21.00 BST
      - Article
history<http://www.guardian.co.uk/commentisfree/2010/apr/28/greece-financial-crisis#history-link-box>

 As I have noted
previously<http://www.guardian.co.uk/commentisfree/cifamerica/2010/jan/15/latvia-economy-eu-imf>,
Latvia <http://www.guardian.co.uk/world/latvia> has experienced the worst
two-year economic
downturn<http://www.cepr.net/index.php/publications/reports/latvias-recession-cost-of-adjustment-internal-devaluation/>on
record, losing more than 25% of GDP. It is projected to shrink further
during the first half of this year, before beginning a slow recovery, in
which the International Monetary Fund
(IMF<http://www.guardian.co.uk/business/imf>)
projects that it will not reach even its 2006 level of output by 2015 – nine
years later.

With 22% unemployment, a sharp increase in emigration, and cuts to education
funding that will cause long-term damage, the social costs of this
trajectory are also high.

By keeping its currency pegged to the
euro<http://www.guardian.co.uk/world/euro>,
the government gives up the opportunity to allow a depreciation that would
stimulate growth by improving the trade balance. But even more importantly,
maintaining the peg means that Latvia cannot use expansionary monetary
policy, or expansionary fiscal policy, to get out of recession. (The United
States has used both: in addition to its fiscal stimulus, and cutting
interest rates to near zero, it has created more than 1.5 trillion dollars
since the recession began).

Some who believe that doing the opposite of what rich countries do – ie
pro-cyclical policies – can work point to neighbouring
Estonia<http://www.guardian.co.uk/world/estonia>as a success story.
Estonia has kept its currency pegged to the euro, and
like Latvia is trying to accomplish an "internal devaluation". In other
words, with a deep enough recession and sufficient unemployment, wages and
prices can be pushed down. In theory this would allow the economy to become
competitive again, even while keeping the (nominal) exchange rate fixed.

But the cost to Estonia has been almost as high as in Latvia. The economy
has shrunk by nearly 20%. Unemployment has shot up from about 2% to 15.5%.
And recovery is expected to be painfully slow: the IMF projects that the
economy will grow by just 0.8% this year. Amazingly, by 2015 Estonia is
projected to still be less well off than it was in 2007. This is an enormous
cost in terms of lost actual and potential output, as well as the social
costs associated with high long-term unemployment that will accompany this
slow recovery. And despite the economic collapse and a sharp drop in wages,
Estonia's real effective exchange rate was the same at the end of last year
as it was at the beginning of 2008 – in other words, no "internal
devaluation" had occurred.

Yet Estonia is being held up as a positive example, even
used<http://www.ft.com/cms/s/0/f0624d74-0d07-11df-a2dc-00144feabdc0.html>to
attack economists who have criticised pro-cyclical policies in Latvia.
The reason is that Estonia has not had the swelling deficit and debt
problems that Latvia has had in the downturn. Its public debt of 7% of GDP
is a small fraction of the EU average of 79%, and its budget deficit for
2009 was just 1.7% of GDP. It is therefore on its way to join the eurozone,
perhaps adopting the euro at the beginning of next year.

How did Estonia manage to avoid a large increase in its debt during this
severe downturn? First, the government had accumulated assets during the
expansion, amounting to some 12% of GDP; and it was also running a budget
surplus when the recession hit. And it has received quite a bit in grants
from the European Union <http://www.guardian.co.uk/world/eu>: in 2010, the
IMF projects an enormous 8.3% of GDP in grants, with 6.7% of GDP the prior
year.

Greece <http://www.guardian.co.uk/world/greece>, unfortunately, is not being
offered any grants from the European Union or the IMF. Their plan for Greece
is all about pain and punishment. And with a public debt of 115% of GDP and
a budget deficit of 13.6%, Greece will be forced to make spending cuts that
will not only have drastic social consequences but will almost certainly
plunge the country deeper into recession.

This is a train going in the wrong direction, and once you go down this
track there is no telling where the end will be. Greece – like Latvia and
Estonia – will be at the mercy of external events to rescue its economy. A
rapid, robust rebound in the European Union – which nobody is projecting –
could lift these countries out of their slump with a huge boost in demand
for their exports, and capital inflows as in the bubble years. Or not:
Western European banks still have hundreds of billions of bad loans to
Central and Eastern Europe from the bubble years. Some big shoes could still
drop that would depress regional growth even below the slow recovery that is
projected for the eurozone. And Germany, which has been dependent on exports
for all of its growth from 2002-2007, could continue to soak up the regional
trade benefits of a eurozone and/or world recovery.

No matter how you slice it, these 19th-century-brutal pro-cyclical policies
don't make sense. They are also grossly unfair, placing the burden of
adjustment most squarely on poor and working people. I would not wish
Estonia's "success" on any population, simply because they avoided a debt
run-up and are on track to join the euro. They may find, like Greece – as
well as Spain, Ireland, Portugal, and Italy – that the costs of adopting a
currency that is overvalued for a country's level of productivity are
potentially quite high over the long run, even after these economies
eventually recover.

The European Union and the IMF have the money and the ability to engineer a
recovery based on counter-cyclical policies in Greece as well as the Baltic
states. If it involves a debt restructuring – or even a haircut for the
bondholders – so be it. No government should accept policies that tell them
they must bleed their economy for an indeterminate time before it can
recover.


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