Greece would have been better off to have defaulted on more of its debt and left the Euro five or six years ago. Greece needed to reduce wages and pensions in order to restore competitiveness and bring spending down to sustainable levels. Dropping the Euro and going to a (devalued) Drachma would have contributed to both of those goals at one stroke. It would have been painful (and Greece would have been reliant on emergency foreign shipments of medicine and food for a time), but sticking with the Euro has only extended the pain and delayed recovery.
Greece’s government chose staying in the Euro and accepting creditor terms that involved an “internal devaluation”. That meant that Greek workers in the private sector would have to accept nominal wage cuts through market processes (to the extent that labor market regulations allowed nominal wage cuts rather than layoffs). It also meant legislated nominal pension reductions and wage cuts for the retired and civil servants. The problem is that wages are downwardly “sticky”. Both employers and workers prefer cutting jobs to wages in the short and medium-term. As for the politics of legislating nominal cuts in pensions and civil service salaries… well the politics was what you would think.
The result was that the process of restoring competitiveness and a sustainable state was much slower than it might have been under going to a devalued Drachma (though tax policy, labor market policy and an state general government dysfunction were also important factors). It likely delayed recovery by years.
So why didn’t Greece leave the Euro? There are many reasons. Probably the most important reason was the widely shared sense that, if Greece just played the right “card” at the right time, Greece could con or intimidate the creditors into forgiving the debt and getting the EU to subsidize Greece to the levels that Greek voters found acceptable. There was the belief that, if Greece hung in there, they could (by some combination of pretending to reform and threatening to blow up the currency union) get to stay in the Euro and everything else too. Successive Greek government have failed to deliver on those hopes.
But a more interesting question is why Greece’s most free market-oriented voters and politicians (liberals, in the parlance of Greek politics) were the strongest proponents of staying in the Euro. Why did supporters of free market policies support a currency regime that discredited free market politics? I will suggest several reasons.
First, the Greek constituency for free market economics was largely made up of middle-class savers in the less rent seeking sectors of the private economy. Going to a devalued Drachma (basically converting their Euros into less valuable Drachmas) would have devastated the savings of this group.
Second, Greek liberals believe that Greek institutions are corrupt and incompetent (true) and that the Greek electorate is foolish (also true). In Greek political parlance, laikismo (populism) is a smear word that means dishonesty, extremism, intolerance, and obtuseness. That tells you what the political class think about the laos (the people). The Greek liberals, being the most consistent (and most powerless) critics of the welfarism and clientelism of Greek politics are as anti-populist as anybody.
For Greek liberals, the Euro (and membership in the European Union generally) was supposed to put a floor under the corruption of the Greek state and the electoral extremism and selfishness of Greek voters. It would mean that Greece would more often play by the straighter rules of Northern Europe and less often play by crooked Greek rules that Greek liberals despised.
But the Greek liberals were horribly wrong. Greek membership in the Euro allowed for a borrowing spree (and then a crash) that would not have been nearly so large if creditors had not assumed that the EU backed Greece’s bonds and had been afraid that the bonds might be paid back in devalued Drachmas. Staying in the Euro and opting for internal devaluation helped radicalize Greek politics such that an extreme left party of schismatics and eccentrics just won a general election while, as of this writing, Greece’s Neo-Nazi party (called Golden Dawn) was set to finish third even though its leaders are in jail.
The liberals don’t deserve much blame for what happened to Greece. Greece’s government has not been run by principled supporters of free markets and an effective, efficient state. Greece’s liberals were (and are – now more than ever) an alienated minority within an indifferent electorate and a set of hostile economic and governmental institutions. The Euro could not do the work of Greece’s liberals. If liberals are ever going to reform Greece (at least as long as Greece retains elected government*) they will need to win over the Greek laos.
* Even if the radical left Syriza party makes things even worse, I don’t expect that Greece’s democratic institutions to collapse. Greece’s foreign relations and the lack of a credible domestic alternative to constitutional government mean that Greece will almost certainly muddle through with either elected governments or (in those case of a hung parliament) with temporary gove