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Why leaving the euro is back on the agenda in the Greek election

Reuters/Yannis Behrakis

Why leaving the euro is back on the agenda in the Greek election

Reuters/Yannis Behrakis

Greece leaving the euro is old news. Since the former Greek prime minister, Alexis Tsipras, agreed to a third bailout in July, the perception of Grexit as an immediate threat has subsided – or at least disappeared from commentary.

Nonetheless, while appetite for Grexit outside Greece has abated, the traumatic seven months of wrangling over its bailout with Europe produced a significant domestic demand for a return to the national currency.

Polls suggest that a quarter of the electorate are likely to select Grexit-favouring parties including Popular Unity (the Syriza splinter group), Golden Dawn and KKE (the communist party). While the allure is there, a Greek exit from the European Union is unmistakably a bad idea.

Drachma drama

Riding the wave of popular discontent galvanised by the No (OXI) campaign in the referendum over Greece’s bailout, drachma advocates argue that shaking off the shackles of the euro will allow for an end to austerity and for national self-determination. Echos of former prime minister, Andreas Papandreou –- who campaigned in 1981 for national independence, popular sovereignty and social liberation – permeate a population oppressed by five years of economic dislocation.

But how can a return to the national currency enable Greece to achieve the dual aim of reviving its depressed economy and regaining sovereignty? Here, despite its face value appeal, the argument becomes less clear.

One of the key “advantages” of rejecting the bailout and leaving the euro is the possibility of defaulting on Greece’s debt, widely regarded as unmanageable and unsustainable. It is claimed that a comprehensive default on external debt will ease pressure on the government, which will then be able to recapitalise banks and inject liquidity into the economy via borrowing from the newly freed Bank of Greece (effectively printing money).

Three out of the seven main parties in Greece’s election advocate for Grexit. EPA

While everyone agrees (even Germany) that some type of debt relief is needed for Greece, defaulting leaves a grand problem. Cancelling sovereign debt does not mean that the government and private parties will not have ongoing payment obligations denominated in foreign currencies. Even if all sovereign bonds are scrapped, how will the government buy goods and services from abroad? Having the Bank of Greece print money only works in an entirely closed economy.

As the Greek state lacks foreign exchange reserves, it will need to prop up a new currency and the value of the drachma would drop like a rock. There is no evidence that it would even be accepted as payment abroad. And what about private parties who have external obligations? How will manufacturers buy materials (denominated in dollars or euros) with drachma that counter-parties are unlikely to accept?

The only way a new drachma could find its feet would be via loans in hard currency, probably from the IMF. Therefore, German finance minister Wolfgang Schäuble’s plan for a temporary Grexit (with generous support) is a better prospect than any unilateral exit plan. A path to the drachma with humanitarian assistance and some support for the re-introduced currency (a la Schäuble) would help ameliorate some of the dangers of Grexit.

Otherwise, a post-euro Greek finance minister would be begging for loans soon after defaulting on external obligations. Oh, and let us not forget that while this would all be happening, the value of deposits in Greek banks would be massively reduced in real terms through the re-denomination to drachma.

Attempting to overturn austerity

Austerity is the other big issue for Grexit advocates. They argue that leaving the euro would allow for a more “progressive” development plan that is not dependent on the cuts needed to balance Greece’s fiscal deficit. The plan relies on replacing foreign imports with domestic production. And, in a way, this would be the inevitable result of a return to the drachma. As imports will soar in price and trade networks will be disrupted, native low skill manufacturing may replace some imports.

But this would be limited to low-skill, low-value manufacturing. High-tech, high-value, complex manufacturing relies on significant capital investment that no private party would be willing to supply to Greek firms in the medium term. The government won’t be able to finance the proclaimed large investment projects for the same lack of capital explained above. So the conclusion is this: Yes, there is capacity in Greece for industrial development and domestic production. But this will be done at the bottom end of the production level and will generate employment and wages worse than Bulgarian standards.

There is opportunity for growth in the Greek economy and large opportunity for improvements in productivity. Nonetheless, all of these are dependant on developing and liberalising the private sector.

If a drachma development plan is based on state spending in the long run, unchecked monetary expansion will lead to runaway inflation. A South Korea-style national industrialisation plan is not possible in 21st-century Greece.

The sad conclusion is this: a return to the national currency could lead to growth eventually, but it will entail a severe drop in living standards, economic dislocation unlike anything experienced so far and (most probably) high levels of borrowing at disadvantageous rates. If, accepting these constraints, the Greeks want to choose the “freedom” of the drachma, they are entitled to do so. But a return to the national currency seems less a solution and more a Chimera.