Would a Return to a National Currency without Institutions Work?
Nikos Miserlis // 7 February 2017
Some economists like Stiglitz claim that Greece should give up on the eurozone and exit the common currency. But even if Greece did abandon the euro and was able to reintroduce a heavily devalued version of the drachma to regain competitiveness, the country would still not have solid institutions to allow for a level playing economic field that would lead to long-term economic growth. It would still have a huge shadow economy and free riding, only they could become even larger.
Most importantly, the economic actors would still have little incentive to invest in the long-term, and little trust in the rules of the economy and the state. The new currency and its subsequent devaluations would be adding more uncertainty. The immediate upheaval that would follow the exit would make this distrust for the state even worse requiring even longer time to heal.
There are growing voices around the world both in politics and business that call for action on what one can control rather than consuming time and energy to tackle external events that countries and businesses cannot influence directly. Greece will need to put its house in order and create a modern state and solid institutions in order for the country to get back to a prosperous trajectory and the currency is not the single biggest dependency for it.
The Path to Building Stable and Solid Institutions
Nobel laureate Douglass North claimed that “only when it is in the interest of those with sufficient bargaining power to alter the formal rules will there be major change in the institutional framework”.
The analysis so far has shown that special interest minorities, put together, are deciding elections and the political direction in Greece. This hinders the modernization of the state and is exactly what needs to change for Greece to come out of this crisis.
However, rebuilding and modernising institutions is a lengthy process that by definition will challenge the status quo and hurt the interests of specific groups. Therefore, the process needs to start first with a strong message of inclusive change. This message will have to be about providing short-term incentives to the broader electorate along with a promise of modernisation through institutions that will benefit everyone in the mid- to long-term. The right short-term incentives will mobilise voters outside special interest groups to go back to the ballot box and reduce abstention that allowed organised minorities decide the election outcomes. For Greece to change it needs to give incentives to majorities and get them to vote for it.
To incentivise and mobilise the majority, policies need to be designed and communicated that increase the private and social rates of return. Judging from international experience and history the most effective way to increase private and social returns in the short term is a well-designed tax incentives framework (tax cuts, investment tax breaks etc). Such framework would directly reduce the cost of doing business and increase the disposable income of households that will kick-start in the economy. Lower taxation will also increase incentives to invest and hire new people out of unemployment which will directly add to government revenues and the GDP.
A coherent tax incentives strategy will help create a sense of recovery and gradually restore trust in the prospects of the economy. This will give space to the government to start the long term process of rebuilding and modernising institutions and make the people receptive to them.
But how do you reduce taxes and increase rates of return in an economy that is in recession and under strict supervision by its lenders to produce consistent budget surpluses? The answer to this question will be attempted to be addressed in a subsequent essay.