Economic Reform Is Best Path for Greece

Greece has no good Plan B’s. Its only rational course of action is to work with its eurozone creditors to reform its economy.

Political Economy

The New York Times – By HUGO DIXON | REUTERS

Alexis Tsipras, the prime minister, is in a bind. He agreed to a short-term deal with other eurozone governments last month. But he has found it difficult to sell this to hardliners in his radical-left Syriza party back home, who accuse him of making a U-turn.

Some of the rhetoric since that deal from Mr. Tsipras’s ministerial colleagues, such as promises to cancel privatizations, has been troubling. So have decisions such as raising the salaries of electricity workers.

Meanwhile, Yanis Varoufakis, the finance minister, has sent a rather thin list of proposed reforms to his eurozone counterparts in advance of a meeting on Monday. He will have much explaining to do.

If Greece is to secure a long-term pact with its creditors by the end of June, Mr. Tsipras will have to abandon most of his election promises. Given his difficulties in delivering on even the short-term pact, there is a temptation to cast around for alternatives.

Some members of Syriza want Greece to regain its financial independence by defaulting on its debts and cutting loose from the euro. Meanwhile, pundits like Wolfgang Munchau of The Financial Times want Greece to threaten to default while staying within the single currency and to use that as a tactic to secure a better deal from its creditors.

Mr. Tsipras should resist these siren voices. Their advice would lead to disaster.

Look first at the option of default combined with leaving the euro. This is superficially attractive because Greece’s debt would be cut to more manageable levels, while bringing back the drachma would allow the country to devalue its currency and lift its competitiveness.

The snag is that the transition would be nightmarish. It could be managed only by imposing severe capital controls until the new currency was introduced, a process that would take several months, given the need to jump through political, legal and logistical hoops. Otherwise, the Greek people would merely take their money out of the banks, knowing that their euros would be replaced with devalued drachmas.

Capital controls were introduced in Cyprus two years ago when its banks were restructured and are due to be lifted only this month. But if controls were imposed in Greece to coincide with a default, the Cypriot measures would look like a walk in the park.

After all, Cyprus did not default on its debt and was working with its creditors toward a mutually acceptable solution. As a result, the European Central Bank flew in piles of cash, people were allowed to take 300 euros, or about $325, a day out of their accounts and companies were able to pay for imports.

By contrast, Athens would stop paying its creditors, including not just other eurozone governments but also the E.C.B. It is pie in the sky to suppose that, in such circumstances, the central bank would feed the cash machines or supply liquidity so businesses could bring in vital commodities such as oil and medicines. The economy would sink into a new recession.

It is not just that the transition to the drachma would be terrible. The aftermath would also be appalling, because taxes would have plummeted and the newly busted government would not be able to borrow abroad.

In such circumstances, a responsible government would tighten its belt, cut spending and run a balanced budget. But what chance is there that Syriza, which was voted in on a promise to increase spending, will do that? Instead, it might take the irresponsible option: printing drachmas to fill the hole in its finances and so fueling inflation and, ultimately, hyperinflation.

What, then, about the other supposed Plan B: defaulting while staying in the euro? This would be miserable, too.

Such a move would bankrupt the Greek banking system, as it is exposed to the state. Because Athens would no longer be able to get funds from its eurozone partners to recapitalize the banks, the only option would be to “bail in” depositors — converting a portion of the money in their accounts into shares in the banks, on the lines of what was done in Cyprus. For the duration of such an operation, capital controls would have to be introduced.

The government, meanwhile, would have to balance its budget. This would be hard, given that the depositor bail-in plus capital controls would deaden economic activity.

The state might, therefore, be tempted to pay salaries, pensions and the like with i.o.u.s. This would be extremely unpopular, as the recipients would view them as worth a fraction of real euros. The i.o.u.s would start to circulate as a parallel currency, trading at a discount to euros and seen as the probable precursor to the reintroduction of drachmas.

Given that none of the supposed Plan B’s is any good, Mr. Tsipras’s best bet is to convince his creditors of his good faith and push ahead with vigorous reforms in the hope that they will cut him some slack. If that means breaking with his far-left faction and perhaps calling a new election, so be it. His duty is to the Greek people as a whole.

* Hugo Dixon is editor at large of Reuters News.