How long will Italy and Greece stay in the Eurozone?

Possible new lira and drachma – prediction of massive devaluation

Perhaps always (however long that is) and their populations seem to be in favour, most likely knowing what would happen to a new Italian lira and a new Greek drachma – massive devaluation. I also believe in the Eurozone as a project that one can enter but not exit – leaving a monetary union is much, much more complicated than devaluation of a fixed exchange rate.

But although I am in favour of the Eurozone project – the predictability for financial markets, for employers and employees created by a credible “close-to-but-below-2%-inflation” is very useful for setting interest rates and wages and the single currency is ultra-convenient for exporters and importers of which we have very many – Italy and Greece should not be there, should never have joined and should consider leaving, however (extra) painful that may be.

The arguments are actually very simple but I have put a few graphs together that perhaps paint the picture even more vividly.

Up to the introduction of the single currency Italy routinely devalued the Italian lira to regain lost competitiveness. In fact, from 1955 to 1999, the year of Eurozone introduction, the Italian lira had devalued a combined 85% vis-à-vis the German mark. It was believed (hoped?) that the Eurozone would foster more inflation discipline in Italy but seemingly to no avail. With lost competitiveness vis-à-vis Germany but also e.g. China, Italy’s economy is in the doldrums and by GDP per capita Italy is now poorer than when adopting the euro. 18 years resulting in decline!

Figure 1 shows the rather dramatic development. Italy and Germany used to be almost equals in terms of GDP per capita – but since about 2005 a gap of more than 30% has opened up. Germany has benefited, Italy certainly has not. Add to this e.g. youth unemployment of around 40% and one has a country that lets down its people in general and its youth in particular.

Figure 1: GDP per capita, USD at PPS, Germany and Italy, 1980 – 2016

Perhaps it is not worth writing more about Greece. Hasn’t every stone been turned? But look nevertheless at Figure 2. Greece has been in recession for more than eight years (one has to be an overt Europhile to see the recent blip in growth as a success) with a cumulative drop in GDP of 28% – this beats the US experience following the Great Depression of the 1930s, otherwise usually seen as the biggest decline in modern times for a country not at war. And, yes, young people don’t get jobs easily in Greece either: 44% youth unemployment. Cold comfort for the young that general unemployment is also at a high level.

Figure 2: GDP, constant prices, 1999 = 100, Germany, Greece and Italy

Source: Eurostat

And a last comparison, closer to home. In Latvia we complain about and are concerned about the level of investment – lack of EU funds, wait-and-see reactions due to sanctions and counter-sanctions in the context of Russia, bank lending not taking off etc. In Greece, as seen in Figure 3, investment as a share of GDP is less than half of Latvia’s low level! This is not enough to keep even existing factories and equipment up to date – in Greece, investment is so low that the country’s capability to produce and grow in the future is also declining. GDP is down by 28%; more may be in store – and who anyway wants to invest in a country where the prospects of selling something are close to non-existent?

Figure 3: Investment as a share of GDP, Greece and Latvia, 2000 – 2016

A nasty calculation would be how many billions in lost GDP and how many man hours in lost work those countries have suffered from joining the monetary union but flaunting the rules for being in such a union: Inflation discipline and continuous productivity-enhancing measures to maintain and foster competitiveness.

Having had more than 15 years without learning to be in a low-inflation monetary union, one may wonder how much more they are willing to lose in terms of GDP for remaining in a monetary union where their economies and economic policies so obviously don’t belong.

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga and a member of the Fiscal Discipline Council of Latvia.