Greek referendum: a "No" would bring new economic darkness

Conspiracy theorists would have us believe that Syriza’s goal all along was to get to the point where the public would vote for Greece to leave the Eurozone. There will be plenty of time to disembowel this assertion, but next Sunday Greek citizens have been promised a referendum, in which they will be in essence voting on this issue.

Given that the referendum is over whether the Greek public accepts creditor terms that might not by then exist, the vote will effectively be on whether to reject the government of Alexis Tsipras and Syriza, while trying to stay in the Euro, or support it and quit. The unpredictability of random events means that a Yes vote could still end up with Grexit. A No vote, by contrast, would be a slam dunk Grexit. This option would at least give the government the authority to carry out its programme without interference and answer to the Greek people accordingly, but it is unlikely to be the easy ticket out of economic misery some imagine.

A No vote would bring a new economic darkness. There is widespread agreement that the initial period would be characterised by default on Greece’s obligations to creditors, a chronic liquidity contraction and a solvency crisis in the banking sector, which would keep the banks shut. It would see a sclerotic blockage of most forms of economic activity. A further sharp GDP contraction would ensue. Whether or not the government chose to introduce a parallel currency to pay wages, pensions and other bills in the interim, a "new drachma" would be introduced. The currency would almost certainly drop sharply, most likely by about 50 per cent at first. Behind the wall of capital controls, the Bank of Greece would then print money. The risk of Greek deflation would disappear at a stroke. Banks would re-open, supported by the central bank and by a government programme to recapitalise them.

So Syriza would finally have re-taken control of Greece’s economic destiny. But it is unlikely to be successful in delivering a bright economic future, without help, for at least three reasons.

First, the principle purpose of a large currency devaluation is to switch resources away from the domestic economy into the export sector, so that the latter becomes the new focus for competitiveness and impetus for growth. But, other than tourism, Greece lacks the critical ingredient for success—a vibrant manufacturing sector. The benefits to shipping companies and families would accrue offshore. Refined petroleum products are hostage to low world fuel prices. Greece’s production of magnesium, bauxite, aluminum feta cheese, yogurt, olive oil and asparagus are either uncompetitive structurally or nowhere nearly big enough to make a difference. It’s possible, clutching at straws, that a large devaluation could bring the country’s textile sector, which faded many years ago, back to life.

Second, Greece would hardly be able to loosen its budgetary position or forsake austerity. Markets can be quite forgiving about countries that go through a period of debt villainy. But circumstances are important. If Greece were keen to regain the confidence of foreigners in its fiscal sustainability and borrowing capacity, the austerity regime would persist, perhaps even tougher, certainly more redistributive. Encouragingly, in a way, Greece’s primary fiscal balance is in or close to surplus, and the country runs a current account surplus.

Third, if Greece were to succeed outside the euro area in ways we normally associate with a mega-devaluation and economic independence, it would have to embrace reforms that are decades overdue and have never really figured in discussions since Syriza’s election in January. These include an overhaul of weak public administration, and a bloated civil service built on political patronage; reducing the excessive political sway wielded by the wealthy and workers’ union representatives; making everyone subject to the rule of law; and breaking the vested interests that link parliamentarians, legislators, professional associations and trades unions.

To do all these things in the wake of a Grexit seems like wishful thinking unless Europe continues to help Greece on its way. It sounds absurd now given political and trust relations have broken down. But that help would include financial assistance of some kind and above all, keeping Greece inside the EU. Without this kind of European solidarity, its is hard to see what might stop Greece become just another weak or failing Balkan state on Europe’s southeastern flank, probably characterised by political extremism and instability.