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The 'Demerging' Greek Economy

Marc Champion writes editorials on international affairs. He was previously Istanbul bureau chief for the Wall Street Journal. He was also an editor at the Financial Times, the editor-in-chief of the Moscow Times and a correspondent for the Independent in Washington, the Balkans and Moscow. He is based in London.
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Greece may need a category of its own as it struggles with unmanageable debt and the prospect of falling out of the euro: That of a "demerging" economy.

The idea of emerging economies -- formerly poor, badly run and closed markets that open up and reform to produce rapid catch-up growth -- is well-known. We have acronyms such as BRICS and MINTs to group them.

QuickTake Greece’s Fiscal Odyssey

Within the European Union, the concept got a different name, convergence, because it also involved aligning laws and standards. Former dictatorships such Greece, followed by Portugal, Spain and then the penniless nations of the ex-Soviet bloc, were able to create democracies, reconstruct their economies and expand their per capita wealth toward the levels of France or Belgium.

Greece has been converging since before it joined the EU in 1981. After that, it got a huge amount of assistance to converge further -- between 3 percent and 4 percent of gross national product in EU funds annually. That assistance was less transformative in Greece than in other countries such as Ireland because the funds were wasted, largely by financing the country's current account deficit instead of investing in infrastructure. Still, it made a difference.

After the creation of the euro in 1999, Greece got another enormous boost from cheap borrowing. Greek 10-year bond yields started the 1990s at around 24 percent, three times the average for countries that would join the euro with Greece. By 2002, the costs of long-term borrowing for Greece and the other euro members had converged, at about 5 percent. They fell even further, until Greece's borrowing tore away from the pack again in 2010.

That borrowed money was used poorly, creating an overweight public sector, low productivity and corruption. But the result of this sustained cash windfall was, nevertheless, wealth. We can't know what would have happened to Greece had it remained outside the EU and euro area since 1980, but a reasonable approximation would be to follow the pattern for its larger neighbor, Turkey.

Greece began richer than Turkey in 1980, as the chart below shows. But once in the EU, Greece went on to become a rich developed economy, leaving Turkey -- now an emerging economy -- well behind. This looked like a one-way street, but it wasn't: Greece's economy may now be approaching the size it would have been if the country had never joined Europe.

Once in the euro, Greek economic output per capita not only rose more quickly, but the country also lost its propensity for inflation, because profligate governments could no longer print drachmas to cover spending:

They didn't, however, learn fiscal discipline. Public spending soared, paid for by borrowed euros, which produced a boom in personal wealth -- a boom that wasn't experienced by, for example, the Germans. A brutal reversal followed:

Nicholas Economides, an economics professor at New York University's Stern School of Business, thinks a process has begun that will be hard to stop. If the European Central Bank stops subsidizing Greek banks, Greece will quickly be forced to print its own money or IOUs to pay wages. When it does, devaluation will shrink domestic demand by as much as 50 percent within weeks, he says, making the previous 25 percent loss of GDP over five years seem gentle. 

Perhaps surprisingly, Greek Finance Minister Yannis Varoufakis agrees. He doesn't think Greece would be able to pull off a typical Argentine-style rebound from devaluation. Not only that, but once out of the euro, he thinks Greece would also be forced to leave the EU. This is a doomsday -- and I hope unlikely -- scenario for Greece. It would become a much poorer, badly run market closed off by capital controls. 

The ramifications of demerging would go beyond economics. "Greece would become a small country in the Middle East," Economides said. "Instead of being in center of Europe, it would be subject to the larger powers of the Middle East, in particular its biggest neighbor Turkey, which would be a national disaster."

Varoufakis's solution is that Greece should default but keep the euro. But that decision wouldn't be in his hands. Prime Minster Alexis Tsipras was badly mistaken when he told Greeks this week that the euro area wouldn't dare to let Greece go. If his last-minute letter to creditors looking for a way out doesn't succeed, I hope Greeks vote to stick with Europe on Sunday.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Marc Champion at mchampion7@bloomberg.net

To contact the editor on this story:
Christopher Flavelle at cflavelle@bloomberg.net