Two years ago, when it was acknowledged that Greece had been faking its financial statements to Brussels, the crisis in Greece has started. Afterwards, Greece found itself hobbling with rising debts,and without the possibility of devalued currency to help the situation. Since then, many have asked what would happen if Greece leaves the euro zone.
Even though it might seem a reasonable idea to think about, it is scary in its essence. If Greece were to leave the euro zone, it would mean a collapse of the banking system in the country and inflation would explode. The real danger would be the possibility that Greece's woes spread to other high-risk countries. In the worst case scenario, Greece's exit could lead to the destruction of the Euro itself. Therefore, Europe must stand together and keep Greece a part of it, thereby showing that it is stronger and more united than ever. Instead on focusing on Greece's currency, member nations should focus on the country's real problems, such as corruption, tax evasion, and its still deeply class divided society.
Supporters of Greece's exit from the euro zone argue that the benefits would soon cover the loss. Moreover, they claim that re-gaining the control over its currency would increase the competitiveness, outweighing the cost of leaving the euro zone and fiscal default. However, in the case of Greece, this will not work, because the country is a small economy. Although Greece is an open economy, it still faces real rigidities. According to Keynes, currency depreciation can have an impact on competitiveness, if rigidities are in place. But, in the case of a relatively small Greece-type economy, further economic and political structural reforms would be key, firstly, if the goal is to gain sustained competitiveness using the currency valuation mechanism. Otherwise, the currency devaluation would lead to only limited short term competitiveness gains before domestic prices adjust again and lead to competitive disequilibrium. Supporters of Greece's exit ignore the greater chaos that might arise if their idea becomes reality, as well. Furthermore, if Greece left the euro, its debt would still be denominated in that very currency. Afterwards, an utterly painful devaluation of Drachma would take place, pushing it down further and killing every potential growth prospect.
Interrelated euro zone economies will have many problems if Greece leaves the euro zone, as well. Most European banks hold Greek bonds, and Greece's exit from the euro zone would cause a significant domino effect, in both political and social terms, all across the European Union. This analysis published in the Guardian estimates that the cost of the Greek exit would be around 1tn euro, which is as high as 5% of the EU's GDP, or around 10% of the American public debt.
Greece was living beyond its means even before it joined the euro zone, and that is the core of the problem. After it adopted the single currency, public spending increased immensely. The wages in the public sector rose 50% from 1999 to 2007, which is much faster than in other euro zone countries. Prevalent tax evasion hit the government’s coffers, making them empty. The budget deficit spiraled out of control.
Therefore, what Greece actually needs is a thorough modernization of the inefficient public sector. Secondly, the heavily protected private sector needs further liberalization. Thirdly, as Ms. Lagarde from the IMF has bluntly said the other day, the Euro countries most fight against tax evasion. It is undeniable that Greece is about to have many years of hardship. However, leaving the euro zone would mean leaving the European family. Moreover, it would open the pandora’s box for Spain, Italy, Portugal and Ireland. It might mean the end of European integration as we know it, and the final victory of Euro skeptics. That is why Europe must not allow it.
In 2010, the European Union and IMF provided 110bn euro in the first bailout package to help the government pay off its creditors. It became apparent that that is not going to be enough and soon after, the IMF agreed on a second package of 130bn euro earlier this year. Moreover, the vast majority of Greece’s private creditors agreed to write off more than half of the debts. They have also agreed to replace existing loans with the new ones at a lower interest rate. With all the measures already being taken, it is crucial to realize that Greece will have problems no matter what the currency is. Moreover, it is arguable that it will have more problems with its own currency, as the survival of euro in the whole zone is at stake if the Greeks leave and the cost of its exit is tremendous. Therefore, it is better to reach for the solutions that are not going to create a whole new specter of problems, such as Greece's leaving the euro zone.
Moreover, technically and legally speaking, leaving the euro zone is not an option defined by the contract. Making a monetary union was intended to be an irreversible process that will be the finest diamond in the crown of the European integration. This precious stone still has a potential to become the diamond it was meant to be. It just needs some brushing.