Saturday, December 29, 2012

Greece’s national fate in view of the mounting Italian challenge to present Eurozone system

I have long maintained that Greece is so chronically dependent on the EU that its fate in the Eurozone will be determined by events in the larger periphery Eurozone members, particularly Italy and Spain.  Italian elections in two months’ time may prove a significant catalyst.  The Italian PDL under Silvio Berlusconi appears to have thrown the gauntlet to the Eurozone establishment, withdrawing their support from the Monti government and provoking the resignation of Mario Monti with early elections.

Berlusconi is openly attacking German mercantilism and threatening to leave the Eurozone.  Monti is forming an alliance with the centrist parties with tacit support from the Italian socialists favoring continuity of austerity. The outcome of these elections will be crucial.

Franklin Allen of the Wharton school at Penn has long maintained that leaving the Eurozone albeit temporarily with a national currency and devaluation is a faster road back to economic growth that the present hair-shirt forced deflation programs of the European Union. He foresees the risk of a populist politician in Europe, who effectively pulls the plug on Eurozone and leaves the system.

This situation seems to be brewing presently in Italy not only with Silvio Berlusconi but also two other major Eurosceptic political groups: the 5-star movement of Beppe Grillo and the Legha Nord. Historically, Italy was instrumental in the break-up of the 19th century Latin Union.

Unlike the smaller Eurozone members under TROIKA programs like Greece, Spain and Italy as larger countries with more leverage have resisted this type of work out program as degrading to their national sovereignty. They also have considerably more debtor leverage with the core EZ countries.  An Italian Eurozone exit and debt repudiation would leave the EZ core countries in serious financial problems.  The French have already suffered a minor downgrade.  Germany - a country with two major debt defaults over the last 100 years - is not necessary invulnerable.

Spain is presently in limbo for months now, trying to resist entering the Draghi-proposed OMT funding trying to survive with ad hoc austerity measures in mounting social and regional turmoil. The Brussels elite effectively created a putsch in Italy installing Mario Monti to lead a technocrat government. This was at the same time that they deposed the Papandreou government in Greece leading to present coalition government under Antonis Samaras, totally submissive to austerity policies and forced integration.

Monti was not unaware of the risks of austerity by the Greek example. He was instrumental with his compatriot Draghi in the creation of the ECB OMT program that has stabilized financial markets for the time being, despite many question marks concerning viability and never actually tested in practice. The Monti program entailed massive tax increases and Italy has fallen into a deflationary tailspin that is causing havoc and mass discontent.

Italy unlike Greece is an industrial country with a productive goods and service economy. There are significant economic interests open to challenge German mercantilism in the Eurozone system and its persistent policies to promote trade surpluses at the same time punishing the deficit countries with hair-shirt austerity programs. There is a rising Italian anti-European Union sentiment in reaction to the hardship from the imposed austerity conditions and movement to exit the Eurozone system. The Greeks by contrast are terrified of losing the EU transfer money and bailout loans, so they are willing to suffer like former Soviet satellite states to remain in the Eurozone.

Silvio Berlusconi, a self-made business man, is the antithesis of a European politician. The European (and Greek) political class is largely an idle rich, who have made politics their sole career or former labor union leaders. Antonis Samaras, the present Greek PM, like most key European politicians never held a normal job in his life. Indeed, he married into a wealthy family to subsidize his political career just as his socialist coalition cohort, Vangelis Venizelos.

In Europe there is a firewall that keeps people from the working world outside of key political positions. Democratic representation of the productive classes is scant, indeed virtually non-existent in Greece for example. It is rather disconcerting that European politicians – bereft of any practical work experience - engage in top-down economic central planning programs without any real skin in the game in terms of their own economic livelihood related to the success or failure of their policies, affecting millions of their hapless citizens.  For all the moral hazard issues in business transactions, the European Union with its enormous and non-transparent lobbies is one of the most dangerous examples of excess and lack of restraint from concentration of power.

Clearly, the European political elite seem to be betting the house for economic recovery in 2013 with every Eurozone politician from the all-powerful Wolfgang Schäuble down to humble and subservient Antonis Samaras, seeing the crisis over by the second semester and the Eurozone back to economic growth.

What is difficult to reconcile is how this is going to happen with the doubling up of heavy taxation that will inevitably increase fiscal drag. The debt overhang is not being serviced because of increased tax revenue from new economic activity, but rather governments are closing their primary deficits by taking a larger chunk out the GDP in increased taxes. Will this concept of hopefully borrowing ‘cheaper’ in spite of massive debt overhang In Eurozone periphery countries address the issue of deep recessions and shrinking GDP at alarming rates?

The issue of debt restructuring down to credible levels (below 90% GDP) in the Eurozone periphery countries or the matter of the trade balance surpluses in the core countries is still very much politically taboo in Europe, making this a mounting challenge from Italy a very interesting political development. Certainly if Italy gets into an open dispute with the European Union on German trade balance abuses and the merits of aggressive deflationary front-loaded austerity measures on deficit members leading to ultimate withdrawal from the Eurozone, Greece is ill-prepared to face the consequences.

On the positive side, the Italians may force the Germans into a corner where they are constrained to give up their export privileges and forced to close their trade balances, creating a more equitable system. This would benefit smaller Eurozone periphery countries like Greece if they all remain in a new reformed system with Germans at bay. As noted above, there are many issues that would have to be addressed for this to be workable. Generally, European experience has shown that regions like the Italian mezzogiorno living on transfer money from richer areas are not happy places and tend to remain laggards, which is not at all encouraging for Greece even under this favorable scenario.

More likely in my view is that the Eurozone becomes smaller and more coherent in terms of Mundell optimum conditions. How Greece would fare locked into the Eurozone system in a perennial hair shirt with major countries like Italy leaving and devaluing their currency is a big question mark. Historical practice has been that those countries first out and in devaluation are the ones who gain the most economic benefit.

My view is that Greece really needs an entirely new developmental model that follows the pattern of Far East emerging market countries or even better, neighboring Israel. Israel and Greece have parallels in terms of a large diaspora and the concept of the national homeland. Israel has been extremely successful in harnessing the energy of its diaspora and its people for viable economic growth. Greece has been a disaster in this regard. To the contrary, the country has become a Mecca for unskilled immigrant non-Greeks. Presently there is over 50% Greek youth employment. 61% of Greek youth are looking to emigrate according to latest polls. Greek economist Yanis Varoufakis warns that Greece could evolve into another Kosovo.

Israel, only two thirds the size of Greece, exports twice as much goods and services with much higher added value. It is also successfully engaged in energy development with its off-shore gas fields in operation. Greece is mired in dysfunctional European Union infrastructure projects that have created a bloated construction industry. The lion share of private investment has been rent-seeking real estate projects. The Eurozone entry has removed any concern to earn foreign exchange by gaining new markets abroad to export goods and services.

Greece needs its own currency that follows the US Dollar (which was the Greek policy of the 1960’s and early 1970’s) and a viable developmental model to promote its shipping franchise, regional exports and encourage invisible inflows from its large Greek diaspora. This would not be possible without further deep haircuts, reducing its public debt to 90% GDP or below and with IMF credits to finance the transition and advise structural reforms on a bilateral basis. 

Above all Greece must guard its national shipping franchise and promote ancillary industries as well as off-shore energy and tighter political integration with Cyprus as a regional economic hub. It could remain in the European Union (albeit an external free trade agreement following the example of Switzerland might be preferable) to benefit from the customs union.

Unfortunately, present Eurozone and Greek policy seems to be moving in the opposite direction with mounting pressure to abolish the free off-shore status of Greek shipping and impose taxation, further eroding any competitive advantages.  Greece gambled its entire future on EU integration, having no coherent national development policy. Further, most of its public debt is currently in the hands of the EU with Germany the largest creditor so that any negotiation is a highly political subject where the EU and particularly Germany currently have total hegemony over Greece.   

How Greece in this position is to avoid becoming another Kosovo -an impoverished and ethnically divided protectorate - is a big question.  Greece is far from the enviable position of other European countries like the UK or Norway, who can debate the merits of joining or leaving the EU.   A financially and politically weakened EU and downgraded Germany from an Italian EZ exit might well prove a salvation in the long run for Greece.

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