Romesh Vaitilingam: Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam and today I am talking with Vicky Pryce, former joint head of the UK’s Economics Service and author of a new book called Greekonomics: The euro crisis and why politicians don’t get it.
Vicky and I met at the Bristol Festival of Economics in late November 2012, and she began our conversation by explaining her orignal skepticism about Europe’s single currency.
Vicky Pryce: Yes, I didn’t think that it was an optimal currecy area at all. I had great concerns about the ability of a number of the countries to be able to respond to any crisis that would come their way from any external forces because, of course, once you remove the ability to do anything about exchange rates and monetary policy itself, after you have already taken away the balance-of-payments constraints and countries have also done sort of weird things in the process not worrying about their own productive capacity and competitiveness, you’re left with countries with serious, serious problems and they would have, inevitably, to go and borrow a lot from the markets if they could and they would be left with a very high debt-to-GDP ratio.
So I always thought it was a pretty tricky thing to embark on, and it depended a lot on political will to start it and then to keep it going in terms of whether the euro would survive in the future. So I was certainly cautioning against it and worked, in fact, with the UK Government when they were putting together the five economic tests, I was already working for the DTI at the time and contributed to the Treasury’s work.
Romesh: Greece is painted as the villain by many commentators in terms of causing the crisis – “it all sprung from southeastern Europe” – but your book very much wants to argue against that and you have the experience, as originally born in Greece, and a much deeper knowledge of the way their economy and society work. Give us a flavour of what’s wrong with that perception.
Vicky: Well, the problem of course did no originate with Greece. What happened with Greece is that all the problems that were already inherent in the euro creation and the fact that there was no real institution to ensure lender of last resort, there were no transferable resources from the rich to the poorer countries in the time of crisis, none of these things was anticipated.
And of course you still had a banking system that was very different from country to country, that all of course meant that countries like Greece, which had lost in terms of competitiveness over the period, would be hardest hit, and probably much earlier than many others.
But, of course, remember that a lot of the credit expansion that took place in the periphery countries, whether it’s Greece you’re looking at or whether it’s Spain, was financed by the German and French banks. So they actually benefitted very significantly from this and encouraged this type of behaviour by those countries – the house-building booms in Spain, the household credit expansion in Greece, and the sort of construction boom there too, frankly.
And then, of course, the lower interest rates that governments had to pay for their debt, since the markets assumed that everybody was equally risk-free and rates were so low for everyone, encouraged governments to not worry too much about how much they were spending.
Originally, of course, they benefitted from having low interest rates in terms of their own deficit figures, but then of course when the crisis hit and the markets realised that actually all countries were not the same and there was no real lender of last resort there, those interest rates rose so significantly that a number of these countries found it unable to keep going. And of course they were facing, basically, bankruptcy. The only was out was bailouts or being financed by the European Central Bank, and that’s what happened.
So Greece was perhaps a bit of an outlier in the sense of having done fewer structural reforms over the period, being more uncompetitive than many other countries as a result of this having basically not worried about its balance of payments and buying lots of German goods, and really doing nothing about improving its own sustainable production process, or even serious encouraing inward investment. It was very bureaucratic, had a very inefficient public sector and a very large number of civil servants who weren’t really doing an awful lot at all. And of course all that needed to be tackled.
But the worst thing about Greece is that it just had no room for manoeuver at all. Inflation was still going up because it had to start raising taxes after the IMF moved in and the troika of the ECB, the EU and the IMF started giving it some cash at least to keep it going. But they insisted on tax rates going up, so we have ended up with a country which could only react by reducing very substantially its wages, and hence living standards, but with inflation still higher than the rest of Europe’s.
So obviously it went into a very sharp decline, nobody could spend anything, nobody would invest, the public sector was not paying its contractors. The result has been a reduction in GDP which has been greater than any other country’s – five years of decline, a 20% reduction in GDP over those five years, and more to come next year.
Romesh: Is policy going in the right direction now? Is the new Greek government making the right policy, are the conditions being imposed on them by the troika going in the right direction? And is there any way we can see a positive turn in Greek growth that’s going to happen before social unrest really starts to build much more?
Vicky: Well, the difficulty with Greece now is that all those years of decline have meant that the population is just fed up and actually showed that in the elections that we have had recently. And if can’t take an awful lot more.
If your unemployment rate is 26% and your youth unemployment rate 58%, practically one of the highest – I think it’s alongside Spain as being the highest in Europe – then there is despair that sets in. Banks don’t lend to you. And it is important for the government to get the trust of the people that it can implement some things that they have said they would, and also the trust of the Europeans that they can do it.
But also they need to demonstrate themselves that they are not corrupt, that they are doing the right things. But in reality, more austerity for Greece would simply mean a lot less growth in the future again and, at some point I think, things will turn quite nasty. We are already seeing the growth of right-wing and left-wing parties, concerns about the continuation of democracy, the sort of things that Europe is now beginning to worry about.
And the interesting thing is that Greece has been a bit of a catalyst for the change in thinking by the IMF. It has recently come out and said “actually, austerity measures, particularly at a time when everyone is cutting back around you, may not lead to what we expected it would”, in the sense that actually the reduction would be even bigger, which really means that your deficit is just not going to improve and your debt will, if anything, continue to go up. So maybe something else needs to be done.
And the something else – I think we are reaching the stages where, in my view, it’s inevitable – has to be writing down more debt. There’s already been a haircut, by which I mean a reduction in what particularly the private sector can get back from its lending to the Greeks, which happened a few months ago. We’re probably going to see another one, and also some other measures to also reduce the value of debt which is being held by public bodies, whether it’s the ECB or any other soverign bodies that hold debt.
So basically we are talking about a serious reduction in the debt position of Greece to move it back to something sustainable like the 120% or 122% people are talking about now, and perhaps an extension of the period in which the Greeks need to be delivering various things. Particularly on structural reform, but also on deficit areas.
And that, I think, has to be the way forward and I think we are getting quite close to it, but I don’t think it’s going to be just Greece. In my view, similar things will have to happen in possibly Spain and Ireland and Portugal, where you are talking about possibly the terms of those loans being improved.
I think without that, there is just no light at the end of the tunnel for any of those countries and, if anything, the Eurozone will move into further recession in the years ahead rather than the improvement that people are hoping for. And that will be