Prof. Matthias Matthijs of Johns Hopkins University: Greece and the Eurozone Crisis

Today I’m sitting down for a conversation across a continent and an ocean. Our guest is Professor Matthias Matthijs of the Johns Hopkins School of Advanced International Studies (SAIS). He is the editor of the renowned and timely book “The Future of the Euro,” and two-time recipient of the Max M. Fisher award for excellence in teaching at SAIS. We will talk about the Eurozone crisis and the lessons small-state economies can learn from Greece’s situation.

Charles Johnson - Professor Matthijs, thank you for sitting down with me. As your former student, it is exciting to chat with you in a professional context.

Matthias Matthijs – Absolutely. It’s an honor. It’s great to see former students do well and move up in the world!

CJ -Let’s start with what analysts are calling the “Graccident” and the subsequent deal made with Greece’s creditors. What’s the short and fast history here?

MM – The basic story is that the Eurozone, for political reasons, was set up in a minimalist fashion in the early 1990s. Europe’s leaders constructed a common currency in a mainly technocratic fashion, around a powerful and independent central bank with a narrow mandate to conduct monetary policy and fiscal rules to keep member states from diverging too much from one another. Currency unions only function if they are embedded in broader economic, financial, social, and political institutions.

As capital started flowing from North to South in the mid-to-late 1990s, financial imbalances started building up across the Eurozone. Investors did not believe the ‘no bailout’ clause of the Maastricht Treaty, and assumed Greek debt was as good as German debt. Once Angela Merkel’s government made it clear in late 2009 that there would be no easy bailouts, markets panicked. The euro crisis has been ongoing since then, largely as a result of the EU’s response, i.e. a combination of fiscal austerity and structural reforms with painstakingly slow progress towards building those missing unions. So far, real progress has only been made in building a banking union. But the EU’s policy in austerity has been particularly damning in Greece, where the economy has shrunk by 25%. All indicators point towards a Greek economy that is shrinking even further right now.

CJ - Let’s go to those typical questions of political economy: As the crisis continues who stands to lose? Who stands to benefit? Who is to blame?

MM – In broad terms, the Northern creditors countries have had a relatively good crisis. The main losers of the crisis in Southern Europe so far have been the weakest, i.e. the unemployed who see their benefits cut, workers who experience falling real wages, and contractual service workers. However, the crisis has also been painful for elites in those countries, as they stand to lose their privileged and protected positions in the political economy due to structural reforms. However, if the crisis continues, the main losers may well be the EU elites and technocrats who have gained most from European integration.

CJ – In your book “The Future of the Euro” you and Mark Blyth are heavily critical of austerity. Can you explain why you think it is a poor policy decision?

MM – The main issue with austerity is that it makes political sense, but is very poor economics for countries that are experiencing recessions. It is simply disastrous for countries like Greece, who have been in a depression. Don’t take my word for it, but listen to Olivier Blanchard at the IMF, or my colleagues Carlos Vйgh and Guillermo Vuletin at SAIS. They have shown that the multiplier effect – i.e. the effect on the real economy of fiscal policy – is much larger during downturns. If Greece cuts government spending by 100 billion euro, it will do damage to its economy by shrinking national income by 300 billion. If the goal is to cut the Debt-to-GDP ratio, we cannot focus on the numerator. Over the past 70 years, we have seen that most countries have lowered their debt-to-GDP ratios by growing out of it (expanding the denominator) and less by cutting deficits and debt (lowering the numerator).

CJ - Now Austerity has its fans as well. What would you say to them? Is there a third way to what seem to be intense polemics over cutting or raising government spending?

MM – Don’t get me wrong. Austerity is not always and everywhere bad. The main problem in Europe is that everyone has been turning to austerity at the same time. There is a fallacy of composition here and a paradox of thrift. Since everyone cutting back also means people’s incomes (and therefore their demand) will be cut. Many Germans seem to believe that Southern Europe can become its own export powerhouse like China or Japan. But Berlin forgets that it can only be an export powerhouse because others are not.

CJ –Now what about structural reforms in Greece? Should more money be transferred to Greece even if structural reforms are lacking?

MM – I think there has actually been a lot more progress on structural reform than many people give the Greeks credit for. The Syriza government of Alexis Tsipras is committed to do this, and is in a much better position than his predecessors to take on vested interests. Even though, of course, a leftwing group like Syriza has its own sacred cows! If you look at the Greek civil service, for example, its employees have been cut by almost one third from roughly 900,000 workers to about 600,000. The problem with structural reform is that they only pay off in the longer term. Combined with austerity in the short term they also tend to make things worse rather than better. The only way structural reforms can work – like they did in Germany in the early 2000s – is if they are combined with short-term fiscal and monetary stimulus to soften the blow, and if the rest of the country’s trading partners are growing at healthy rates.

CJ – I’ll put you on the spot somewhat. Is the monetary union still a worthy experiment, or is it proving too complicated a beast to manage?

MM – If Europe is willing to build the missing unions – financial, fiscal, and political – to make the common currency work, then it will prove to be a worthy experiment. For better or worse, democratic legitimacy today remains with the nation states. If the European Union is not able or unwilling to take a giant leap forward in political integration, I do not see how the euro can ever be on a solid footing. Then the Eurozone will stumble from crisis to crisis. That does not mean the euro will collapse, as the political will to keep it together is much stronger than many analysts sometimes believe. But there are limits. And we are pushing at those limits right now in Greece.

CJ - I’m sure small-state economists will be analyzing Greece for a long time, but what could Georgian policymakers learn from this crisis when it comes to managing Georgia’s sovereign debt? My research shows that Georgia hovers around 37% of GDP, which is not too bad all things considered, but how can small states be proactive in preventing sovereign debt crises?

MM – The main difference between Georgia and Greece is that the latter cannot print its own currency. Sovereignty therefore still matters a great deal. So, Georgia should think twice before it considers joining any future monetary unions!

CJ – One more, and perhaps the most important question: Any plans to visit Georgia soon? The wine and khatchapuri are waiting!

MM – I would love to, since I’ve never been. The Caucasus region is one I do not know much about and would love to learn a lot more. So, I will be waiting for an invitation from smart former students!

CJ - Our guest today was award-winning professor and author, Matthias Matthijs of the Johns Hopkins SAIS. Professor, thank you so much for your time and excellent analysis.

MM – You’re welcome. The pleasure was all mine! This was fun.

Interview conducted by Charles Johnson