Can Europe Make It?

Three myths behind the case for Grexit: a destructive analysis

Any hope of a radical change in the economic direction of Europe requires international solidarity, and that solidarity in turn requires the euro.

Photis Lysandrou
11 August 2015

Part of the port of Piraeus - Europe's largest passenger port. Wikimedia/Nikolaos Diakidis. Some rights reserved.

This is an excerpted version of a speech given at Panteion University on May 12 and at the University of Athens, May 13, 2015.

The Syriza government was elected in January, 2015, on the promise that it would tear up the deeply unpopular memorandum imposed by the Troika while at the same keeping the euro. It was a promise that it could not keep. After several months of tough negotiations it has become clear that Greece’s creditors, led by the German government, have no intention of accepting a renegotiated deal that substantively lightens Greece’s debt burden and thus the need for the type of harsh austerity measures contained in the memorandum.

The question, therefore, is what does the Syriza government now do? Given that it must make  clear to the Greek people that it cannot fully carry out its election promise to have it both ways, does it:

(a) make further compromises with the Troika and thus keep Greece in the eurozone or

(b) reject any further compromises and take Greece out of the eurozone?

While there is strong agreement within the Syriza party that both options are bad, there is an equally strong disagreement over which option is worse. The Left Plank of Syriza, which is supported by about 30% of the party membership, argues that (b) is by far the superior option. Three basic claims are advanced in support of exiting the eurozone and returning to the drachma:

  1. That it would enhance Greece’s international trade competitiveness
  2. That it would give Greece’s government more scope for policy autonomy
  3. That it would enhance Greece’s international solidarity with other European countries that also exit the eurozone.

As is well known, the first two claims are not unique to the Left. They are essentially the same claims as put by the European Right, stretching from the Golden Dawn in Greece to the National Front in France. However, when vehemently opposing the euro, the European right wing parties only invoke national self-interests, never international solidarity considerations. It is precisely for this reason that in order to distinguish themselves from the European Right, the eurosceptic European Left invariably emphasises the ‘solidarity’ argument in making its case against the euro in addition to the ‘sovereignty’ and ‘competitiveness’ arguments.

In what follows it will be shown that when set in successive stages against the current global, European and Greek economic realities, each of the above three claims turn out to be false: (i) from a global economic perspective, it becomes clear that Grexit would lead to less policy autonomy for Greece’s government; (ii) from a regional, European perspective it becomes clear that Grexit would weaken any meaningful international solidarity between Greece’s progressive forces and those of other European countries;  (iii) from a local, Greek perspective it becomes clear that Grexit would seriously derail any real prospects of restoring Greece’s economic competiveness.

The global perspective

The two most striking trends characterising the contemporary world economic landscape are globalisation and financialisation. The first trend essentially consists of the stretching of the commodity principle along the horizontal axis of geographic space: virtually all countries in the world today (North Korea being a notable exception) are now part of the global division of labour operating to the rules of market exchange. The second trend essentially consists of the stretching of the same commodity principle along the vertical axis of time (see table 1): with the vast and continuing accumulation of debt and equity securities, tradable claims against the future income streams generated by governments and corporations, the future is in effect being colonised, annexed as an extra space of economic activity.

Table 1


Click to enlarge

The governments and corporations issuing securities never see them as commodities but only as financing instruments that help to facilitate the production of commodities. The contrary is now the case, however, for the large institutional investors that dominate the demand side of the world’s securities markets. For the pension funds, mutual funds, insurance companies and the asset management arms of banks, securities are financial commodities whose use values are to serve as portable stores of value into which clients’ monies can be poured and from which monies can extracted to repay clients.

Once it is observed that securities have become commodities in their own right, and once this observation is combined with the fact that financial commodities now completely dominate the material commodity base (world GDP) on which they ultimately rest (compare the top and bottom halves of table 1), it becomes easy to understand the huge scale asymmetries that characterise the contemporary global currency markets.

From about $1.5 trillion in 1998, daily turnover in the global foreign exchange (forex) markets had grown to $5.5 trillion by 2013 and now probably exceeds $6 trillion. Of this vast sum, only about 1% to 1.5% has any connection to cross border trades in goods and services or to foreign direct investments.  While a substantial proportion of the remainder can be traced to purely speculative currency trades, the majority part is associated in one way or another with trading in financial securities. This latter fact explains why just four national currencies, led by the US dollar, account for over 155% (out of 200%) of daily forex trading.

The heart of the matter, as illustrated in figure 1 below, is that country size as measured in global commodity space, and as denominated in currency terms, is now primarily determined by a country’s contribution to global securities stocks rather than by its contribution to global material output. Thus the continuing primacy of the US dollar as an international currency rests on the fact that the US continues to account for over 50% of the world’s supplies of debt and equity securities, while the subordinate positions of the Chinese yuan and of the Russian rouble and of the hosts of other national currencies comes down to these countries’ negligible contribution to securities stocks.  

Figure 1


The huge size asymmetries in global financial commodity space have equally huge asymmetrical practical and policy implications for the countries occupying this space. Consider the implications of any sharp gyration in the exchange rate between, for example, the US dollar and the currency of a country that has a relatively small domestic capital market. The huge mass of financial securities behind the US dollar acts as a currency shock-absorber in the event of any exchange rate change triggered by developments in the underlying production and trade base. By contrast, in the case of a country with a small domestic capital market, any investment shifts across securities triggered by the impact of any exchange rate change on exporting and/or on importing firms will likely also take the form of cross-currency shifts that will potentially further aggravate the initial exchange rate change and its effects on the underlying real economy. In other words, the very smallness of the capital markets of most countries occupying global commodity space potentially cause them to be currency shock amplifiers.

The asymmetric effects of exchange rate gyrations on countries with different currency masses translate into asymmetric policy implications. On the one hand, the monetary authorities of a country that has a large currency mass such as the US can conduct their monetary and interest rate policies without having to pay any regard to the effects of these policies on the US dollar’s exchange rate against any other national currency or group of currencies - because they know that any such exchange rate change will have little if any substantive aggregate effect on the domestic US economy. In other words, they can treat the dollar’s exchange rate with “benign neglect”: any upward or downward movement in the dollar’s rate against another country’s currency is always the other country’s problem, never the US’ problem. On the other hand, no such luxury can be enjoyed by the monetary authorities of a country that has a small currency mass: knowing that any sharp upward or downward movement in their currency’s exchange rate against a leading currency such as the dollar will have potentially destructive effects on their domestic economy, they have no choice but to conduct their monetary and interest policies in ways that always keep in mind the effects of these policies on their currency’s international exchange rate.

Fear of the destructive effects of exchange rate gyrations explains why at the present time some 66 countries peg their currencies to the US dollar in one form or other while a further 27 countries peg their currencies to the euro. While large exporting countries such as China can use their trade surpluses to build up substantial dollar reserves to protect their currency’s informal dollar peg and thus be in a position to retain a certain degree of domestic policy autonomy, no such option is open to small countries that struggle to maintain an overall trade balance let alone generate trade surpluses. In their case, pegging their currency to a foreign currency such as the dollar or the euro means having to adapt their domestic monetary and interest rate policies in line with the corresponding policy actions of the US Federal Reserve or the European Central Bank. To put this point as a formal proposition:

There cannot be any policy autonomy, or any meaningful economic sovereignty more generally, for a small exporting country that chooses to occupy global financial commodity space but can only do so as a financial colony orbiting a huge currency mass such as the US dollar.    

This proposition about commodity mass and gravitational pull is exactly that which captures the political-economic rationale behind the euro by the time it was formally established on January 1, 1999. In its report “One Market, One Money” published in 1990, the European Commission listed the following four major objectives behind European Monetary Union (EMU): as 1.reduce transaction costs; 2.reduce exchange rate risks; 3. increase price transparency; and 4. stimulate an EU wide capital market.

From this list it is clear that the Commission’s original focus of attention in the initial stage of the EMU project was on GDP-related criteria, as the principle goal behind the first three of the four objectives of the project was to remove the currency-related obstacles to the creation of a genuinely integrated European market for material goods and services. Indeed, it was precisely because the original focus was on the material product markets that there was strict adherence to the central tenets of Optimum Currency Area (OCA) theory (namely, that only countries with broadly similar economic structures and production profiles should merge their currencies together). There was such adherence to this tenet that even as late as 1997 it was expected that only 5 or 6 of the then 15 EU member states would join the euro, with the remaining members following at a much later stage.

However, the summer of 1997 marked a structural break in the thinking behind the euro project, the cause of that break being the Asian currency crisis. When the French and certain other European governments saw what happened across South East Asia that summer - when one Asian currency after another, from the Thai baht to the South Korean won, was subjected to massive speculative attack and forced off its dollar peg and into free-fall devaluation with catastrophic domestic economic effects – they realised the importance of currency mass in the new global financial reality.

The last of the above four listed objectives behind EMU, the stimulation of an EU-wide capital market, suddenly became the first and overriding priority objective, and it was because of this that the invitation to join the euro was thrown open in 1998 to 14 of the 15 EU member states (Greece alone was not invited).  After the Asian crisis of 1997 the central rationale behind the new currency was to give it sufficient weight and mass as to enable it to resist the gravitational pull of the US dollar and thus give Eurozone governments the same kind of latitude over monetary policy as that enjoyed by the US government.       

In light of the above observations, it is not at all advantageous for progressive forces in the eurozone countries to give up the euro in favour of a return to separate national currencies. In the new global financial reality of asymmetric commodity masses, exiting from the euro would not mean the restoration of economic sovereignty for small countries such as Greece or Portugal, so much as their exposure and subjugation to even harsher external financial pressures and constraints.  Given that the very essence of the euro’s existence is to serve as a protective hub providing shelter against these external pressures, the point is to keep the euro but fight to turn it round so that it supports a very different European economic agenda.

If the right wing governments and other forces of Europe can pool their sovereignty together to pursue a neo-liberal economic strategy, as manifested in the current rules and structures of the eurozone, so should left wing governments pool their sovereignty in order to pursue a more progressive economic strategy.  Any attempt to change the rules of the eurozone to accommodate and help promote such an alternative strategy will not be easy. On the contrary, it will be extremely difficult, as left eurosceptics constantly point out. Difficult as this task may be, however, it has to be pursued because the alternative is worse.

If countries such as Greece or Portugal or Spain give up the euro and return to their separate national currencies, any hope of a radical change in the economic direction of Europe will be crushed, because that change requires international solidarity and that solidarity in turn requires the euro. The next section explores this issue.

The European perspective

One of the preconditions for an alternative European economic strategy is government financing to boost investments in infrastructure, welfare services and other growth and job generating projects. In the wake of the damage done to government finances by the bank bailouts and other crisis-related emergency public spending measures, such a finance for growth agenda requires as one of the top priorities an EU-wide harmonization in tax structures.  At the present time, this does not exist in any significant degree in the EU, and least of all in the Eurozone where the trend fall in corporate taxes and the trend shift away from progressive (income) taxes towards regressive (VAT and excise) taxes has been as sharp as anywhere in the world. Clearly, while the member states of the eurozone have prepared to pool their sovereignty in monetary and interest rate matters, they have been far less willing to do so in taxation matters, even while being subject to the strict debt and budget deficit ceilings as laid down in the Stability and Growth Pact.

Part of the reason for this state of affairs is political: for eurozone countries to give up national control over their domestic tax structures would be tantamount to full political union.  Another part of the reason is ideological:  for every theoretical argument in favour of tax harmonization (a notable one being its redistributive effects) there is a counter-argument in favour of tax competition (the most notable of which for neo-liberal economist concerns is fiscal discipline).

While the EU commission has broadly remained neutral between these two opposing positions, it has on occasion come out strongly against “harmful” tax competition. Thus in 1996 it published a report on taxation in the EU in which warned against the most harmful effects of a tax competition race to the bottom which included the “erosion of the tax base” i.e. the “degradation of revenue due to the use of the ‘exit option’ by certain taxpayer groups”. Specifically, it highlighted the “differential economic power of productive factors” i.e capital’s use of its “mobile” propensity to shift the tax burden on to “immobile” tax bases such as labour. As is well known, the Commission has more recently set up investigations into the tax affairs of Ireland, Luxembourg and other jurisdictions that appear to have arranged ‘sweetheart’ tax deals with global corporations.

While the EU commission has shown some important initiatives in redressing harmful tax competition, much more needs to be done if national governments are not to be forced into making further deep cuts in welfare and social spending and if the tax burden is again to be shifted back on to the richest sections of societies. 

It is here that we come back to the question of the euro in relation to international solidarity, which, in concrete economic terms comes down to such specific issues as tax harmonisation. Does the existence of the euro place those countries that are members of the currency union in a better position to coordinate their tax structures to prevent tax competition to the bottom?  Or does the removal of the euro and a return to separate national currencies place countries in a better position to attain this objective?  To answer this question let us briefly look at 2 case studies, those of the Republic of Ireland and Cyprus.

The Greek Syriza government is not the only Eurozone country that has drawn up its ‘red lines’ which it cannot cross in its negotiations with the troika.  When the Irish government was similarly forced into seeking financial help from the Troika following the massive bailout of its collapsed banks, it too drew up a ‘red line’ that it would not cross when receiving financial aid, namely, an outright refusal to increase its corporate tax rate from 12.5% to the EU average of 25%.

Ireland’s creditors never officially pressed for such a policy, but it is interesting to note when the French government raised this prospect it was met with howls of protest from Dublin. At the time of writing, every major political party in Ireland supports this corporate taxation policy and this includes Sinn Fein. Of all the Irish parties, this has the most radical, anti-austerity economic programme, and yet it too not only refuses to oppose the 12.5 corporate tax rate as set in Dublin but also pushes for its introduction into Northern Ireland.  When it is pointed out that Ireland’s tax structure has a negative externality effect on working people not only in other parts of the UK but also in other parts of Europe, Sinn Fein’s official reaction is the conventional one: we are a small island economy and we need a favourable corporate tax rate to attract foreign investment on the scale needed to survive as a small economy.  “Our first and foremost responsibility is to our own people”.  

A similar situation characterises Cyprus.  Up to the 1980s, Cyprus’s main export industries were tourism and agriculture.  From then to the present time, however, there has been a dramatic structural shift in its export profile towards financial services as evidenced in the fact that by 2010 some 75% of the working population were employed in finance-related sectors ranging from the accounting and legal professions on the one hand to banking and insurance professions on the other. 

Key to this recent structural transformation of the Cyprus economy has been the implementation by successive Cypriot governments of corporate tax policies aimed at making Cyprus one of the most foreign-investor-friendly off-shore tax havens in the European region.  The reduction of the corporate tax rate from 25% in 1998 to 10% by the early 2000s, combined with other foreign investment friendly measures such as no capital controls and double tax treaties with other countries have caused Cyprus to become a favourite destination for Russian and other overseas investors. 

From the late 1990s through to the outbreak of the Cypriot financial crisis in 2011-1013, Russian monies by the billions flowed through Cyprus, with a substantial proportion of these billions remaining in Cyprus to take advantage of the relatively high returns offered by Cypriot private banks, and another substantial proportion returning to Russia as ‘foreign capital’ that would thus be exempt from domestic Russian taxes.  When the AKEL government took office in 2008 there was absolutely no change in these foreign (ie Russian) investor-friendly policies.  When asked whether it bothered their conscience as a left wing government that the Russian billions flowing through Cyprus were benefiting Cypriot law, accounting and insurance companies at the expense of investments in services for the Russian working people, the answer was invariably the same: we are a small island economy and we have to do everything possible to survive. “If we do not offer Russian investors the type of offshore financial services they need, some other country will do so and therefore why not us?”   

The cardinal lesson that one has to take from the above two cases is that if progressive parties in Ireland and Cyprus can forego any sign of international class solidarity in the area of tax policy harmonisation when their countries are in the Eurozone, and thus enjoying a strong measure of protection from global financial pressures they are hardly any more likely to show such solidarity if their countries exit the eurozone and thereby lose this protective shell. If anything, the contrary will be the case. To put this argument in the form of a second formal proposition:

Small exporting countries that struggle to survive in the contemporary global economy while retaining their own currency will adopt whatever economic policy measures that are required to secure this survival, even at the cost of prioritising self-national interests over the national interests of other countries.

Will this proposition apply to Greece if it exits the eurozone? Those on the Greek left who loudly call for a return to the drachma will just as loudly deny this possibility. However, the hard facts that show with remorseless and unforgiving clarity the parlous state to which the Greek economy has been reduced in recent decades point to a very different answer.

The Greek perspective

In the final analysis, the issue comes down to this: can Greece exit the euro and remain sufficiently competitive as to be to able stand on its own feet? Put another way, the question is: if Greece returns to the drachma at a competitive rate of, say, 500 to the euro, can it maintain this rate over time and thus avoid a continual depreciation/inflation spiral? Greece’s recent historical experience provides little basis for any optimistic answer to this question. Over the 23-year period between 1978 and 2001, the eve of Greece’s entry into the euro, the Greek drachma’s rate against the European Currency Unit (the euro’s predecessor) fell from 46.8 to 340; in other words, the drachmas value against the ECU in 2001 was about one eighth of its value in 1978. Furthermore, the consequence of the drachma’s precipitous decline in the two decades before being substituted by the euro was an equally precipitous increase in Greece’s differential inflation rate as compared with the EU average. It is noteworthy that even after euro entry in 2002, Greece still managed to have a domestic inflation rate of between 2-3% higher than the EU average. Given that this differential could not, by definition, have been caused by currency depreciation and given that the percentage increase in nominal hourly wage rates in Greece was actually lower than the increase in most other EU countries, it becomes clear that the cause lay in deeper structural problems in the domestic Greek economy.

These problems find an immediate reflection in Greece’s trade balance. Greece’s imports consistently outpaced its exports right through to end 2013 and early 2014 at which point an overall trade balance was reached. Now, as this balance did not result from any discernible increase in exports but from a collapse in import volumes caused by the huge economic recession in Greece, the question arises as to whether Greece can maintain this external trade balance as and when its domestic economy recovers. In other words, can Greece expand its export volumes or, at the very least, can it expand its domestic import substitution production so as to make it less dependent on imports? Moreover, can it do all of this in a short enough time so as to maintain its 500Dr/Euro exchange rate? The omens do not look good.

During the years of eurozone membership, Greece experienced a noticeable degree of deindustrialisation: the share of services in exports (shipping and tourism) expanded while the shares of manufacturing and agriculture shrank. The shrinkage in Greece’s manufacturing base is not confined to any particular industrial sectors, but actually spans the entire set.

Of twenty industrial sub-sectors, there is not a single one where domestic production is greater than domestic absorption. Indeed, in some sub-sectors including office machinery and computers, motor vehicles and medicines and medical equipment, Greece is almost totally import dependent.

This situation is not likely to change over the short to medium term simply by switching to the drachma, because price competitiveness is not a sufficient condition for executing a much-needed radical change in Greece’s production profile. Other, more crucial conditions because more material in nature include technological and skill factors on the one hand and institutional and business environment factors on the other. In both of these cases Greece lags well behind other EU and OECD countries.

The closure of the technological and institutional gaps will require not only time but also a stable economic and social environment which can facilitate the various policy initiatives and investment expenditures aimed at strengthening Greece’s manufacturing and export base.  As a stable economic environment in the event of Grexit presupposes a stable drachma/euro exchange rate, the question that logically arises here is whether Greece can rely on shipping and tourism receipts to secure such a stable exchange rate in the interim. To answer this question let us, in conclusion, look at shipping.

The Greek merchant fleet is one of the largest in the world and accounts for about 16% of the world merchant shipping trade. The problem is that while this statistic means that Greek shipping can continue to make a significant contribution to Greece’s export earnings, there are other, counteracting statistics that explain why its contribution is also not likely to be solidly reliable in the event of Grexit. In the first place, the fact that the overwhelming majority of the 4000 ships or so under Greek control comprise of ore and bulk carriers, oil tankers and cargo ships explains why aggregate Greek shipping earnings can fluctuate wildly, rising in periods of global economic growth (as in the 2002-2007 period) and falling sharply in periods of global economic recession (as in the post-financial crisis era from 2008-9 to the present).

However, what is even more problematic than the exposure of Greek shipping to the vicissitudes of the global economic climate is the exposure of Greek politicians to the whims and dictates of Greek ship owners. Only about 21% of Greek controlled ships (or some 800 in all) are registered under the Greek flag, with the remainder registered under numerous other flags of convenience including those of Cyprus, Malta and Panama. This 21% figure is totally dependent on a host of generous concessions given to Greek shipping companies, the most notable of which are the exemption (as enshrined in Article 89 of the Greek Constitution) of any taxation other than the flat rate 8% tonnage tax (one of the most generous in the world) ; the guarantee of no capital controls on Greek shipping earnings; and the minimal bars placed on the number of personnel that must be employed in the shipping offices based in Greece (just 4 persons) and on the amount of euro deposits held in Greece (just 100,000 euros). Given the global nature of the Greek shipping industry and the consequent ease with which Greek ship owners can relocate their offices and their operations anywhere in the world, it follows that any attempt to amend or remove any one or more of the above concessions will probably lead to just such a relocation. On a further note, we should point out that if it was the case that Greek nationals employed on Greek ships always insisted on being paid in a hard currency such as the US dollar before Greece’s entry into the euro in 2002 – with these dollar earnings only being remitted back to Greece in a step-like manner as and when necessary – then it is hardly likely for the situation to be any different if Greece returns to the drachma.

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