Can Greece be more like California?
Over at VoxEU, Jacques Melitz, a professor of economics at Heriot-Watt University in Edinburgh and a CEPR Research Fellow, argues that the Greece problem is, to a large extent, all in the EU's head. In particular, he says, the European Union has been so committed to the idea that "the Eurozone is founded on fiscal discipline and the Stability and Growth Pact" that we're now in the bizarre position where "the possible default of a country engaged in irresponsible fiscal policy and accounting for only 3% of the Eurozone’s GDP can raise questions about 'saving the euro' and the survival of the entire monetary system."
As comparison, Melitz says, look at California.
In June 2009, the state of California handed employees IOU’s, so-called vouchers, for payment. The incident has not been recognized as a default only because banks have honoured the vouchers thus far; but costlier and incontestable default still lies ahead as a significant probability.
This is reflected in the spreads on the credit default swaps on state bonds and the credit ratings of the bonds. The Californian economy is four times larger relative to the U.S. than the Greek one is relative to the Eurozone. Yet nothing remotely resembling the concern and turmoil in Europe about Greece has occurred in the U.S. regarding California.
Neither California’s recent or prospective future breaches of contract have caused a ripple in the U.S. financial sector, not even the part of it heavily implanted in California. Upon examination, it is difficult to explain this difference without invoking the self-inflicted damage of the doctrine that any default would be anathema for Eurozone.
Melitz suggests that the EU adopt a doctrine saying that "if any individual member government engages in irresponsible fiscal conduct, contrary to the Pact, its taxpayers and the creditors will bear the consequences. The Eurozone will only act to assure the stability of the financial sector in the Eurozone and the lack of any repercussions of undisciplined government spending behaviour on the risk premiums that the rest of the governments in the Eurozone need to pay."
I don't know how that'll actually work in practice, but Melitz is right that the EU needs to seriously rethink the core terms of its union now that Greece's problems have exposed not just the fragility of the pact, but the tensions threatening to tear it apart.
Photo credit: By Pascal Rossignol/Reuters
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