Greek Lessons for the World Economy

Dani Rodrik
CAMBRIDGE The $140 billion support package that the Greek government has finally received from its European Union partners and the International Monetary Fund gives it the breathing space needed to undertake the difficult job of putting its finances in order. The package may or may not prevent Spain and Portugal from becoming undone in a similar fashion, or indeed even head off an eventual Greek default. Whatever the outcome, it is clear that the Greek debacle has given the EU a black eye. Deep down, the crisis is yet another manifestation of what I call the political trilemma of the world economy: economic globalization, political democracy, and the nation-state are mutually irreconcilable. We can have at most two at one time. Democracy is compatible with national sovereignty only if we restrict globalization. If we push for globalization while retaining the nation-state, we must jettison democracy. And if we want democracy along with globalization, we must shove the nation-state aside and strive for greater international governance. The history of the world economy shows the trilemma at work. The first era of globalization, which lasted until 1914, was a success as long as economic and monetary policies remained insulated from domestic political pressures. These policies could then be entirely subjugated to the demands of the gold standard and free capital mobility. But once the political franchise was enlarged, the working class got organized, and mass politics became the norm, domestic economic objectives began to compete with (and overwhelm) external rules and constraints. The classic case is Britains short-lived return to gold in the interwar period. The attempt to reconstitute the preWorld War I model of globalization collapsed in 1931, when domestic politics forced the British government to choose domestic reflation over the gold standard. The architects of the Bretton Woods regime kept this lesson in mind when they redesigned the worlds monetary system in 1944. They understood that democratic countries would need the space to conduct independent monetary and fiscal policies. So they contemplated only a thin globalization, with capital flows restricted largely to longterm lending and borrowing. John Maynard Keynes, who wrote the rules along with Harry Dexter White, viewed capital controls not as a temporary expedient but as a permanent feature of the global economy. The Bretton Woods regime collapsed in the 1970s as a result of the inability or unwillingness it is not entirely clear which of leading governments to manage the growing tide of capital flows. The third path identified by the trilemma is to do away with national sovereignty altogether. In this case, economic integration can be married with democracy through political union among states. The loss in national sovereignty is then compensated by the internationalization of democratic politics. Think of this as a global version of federalism. The United States, for example, created a unified national market once its federal government wrested sufficient political control from individual states. This was far from a smooth process, as the American Civil War amply demonstrates. The EUs difficulties stem from the fact that the global financial crisis caught Europe midway through a similar process. European leaders always understood that economic union needs to have a political leg to stand on. Even though some, such as the British, wished to give the Union as little power as possible, the force of the argument was with those who pressed for political integration alongside economic integration. Still, the European political project fell far short of the economic one. Greece benefited from a common currency, unified capital markets, and free trade with other EU member states. But it does not have automatic access to a European lender of last resort. Its citizens do not receive unemployment

checks from Brussels the way that, say, Californians do from Washington, DC, when California experiences a recession. Nor, given linguistic and cultural barriers, can unemployed Greeks move just as easily across the border to a more prosperous European state. And Greek banks and firms lose their creditworthiness alongside their government if markets perceive the latter to be insolvent. The German and French governments, for their part, have had little say over Greeces budget policies. They could not stop the Greek government from borrowing (indirectly) from the European Central Bank (ECB) as long as credit rating agencies deemed Greek debt creditworthy. If Greece chooses default, they cannot enforce their banks claims on Greek borrowers or seize Greek assets. Nor can they prevent Greece from leaving the eurozone. What all this means is that the financial crisis has turned out to be a lot deeper and its resolution considerably messier than necessary. The French and German governments have grudgingly come up with a major loan package, but only after considerable delay and with the IMF standing at their side. The ECB has lowered the threshold of creditworthiness that Greek government securities must meet in order to allow continued Greek borrowing. The success of the rescue is far from assured, in view of the magnitude of belt-tightening that it calls for and the hostility that it has aroused on the part of Greek workers. When push comes to shove, domestic politics trumps foreign creditors. The crisis has revealed how demanding globalizations political prerequisites are. It shows how much European institutions must still evolve to underpin a healthy single market. The choice that the EU faces is the same in other parts of the world: either integrate politically, or ease up on economic unification. Before the crisis, Europe looked like the most likely candidate to make a successful transition to the first equilibrium greater political unification. Now its economic project lies in tatters while the leadership needed to rekindle political integration is nowhere to be seen. The best that can be said is that Europe will no longer be able to delay making the choice that the Greek affair has laid bare. If you are an optimist, you might even conclude that Europe will therefore ultimately emerge stronger. Dani Rodrik, Professor of Political Economy at Harvard Universitys John F. Kennedy School of Government, is the first recipient of the Social Science Research Councils Albert O. Hirschman Prize. His latest book is One Economics, Many Recipes: Globalization, Institutions, and Economic Growth.

Rodrik on Greece: Get It Over With

Dani Rodrik in the Room for Debate at the NY Times: Get It Over With, by Dani Rodrik: When Argentina defaulted on its debt a decade ago, the country became a pariah in the eyes of foreign bankers and bondholders and was shut off from international financial markets. Yet its economy recovered quickly and experienced rapid growth thanks to a large boost in external competitiveness provided by a vastly depreciated currency. The lesson is that default can be the better option when the alternative is years of continued austerity. In the case of Greece, this scenario is greatly complicated by the countrys membership in the euro zone. Greece would have to exit the euro zone to be able to engineer a currency depreciation. Since this is something for which euro zone rules do not make any allowance, a unilateral exit will

unleash huge uncertainty about the rules of the game. And a Greek default will almost certainly be considered a hostile act by Greeces European partners never mind that German and other euro zone banks were equally at fault for having over-lent to the Greek government. Unfortunately, the current strategy seems destined to force Greece to this outcome. It is predicated on protecting German and other European creditors and bondholders while Greek workers, retirees and taxpayer pay the bill. This makes no sense economically, and will not work politically. One way or another, Germany, France and other euro zone creditor countries are on the hook. If Greece eventually defaults, they will have to pay for their banks mistakes. It would be far better for them -- and for the future of the euro zone -- if this reality were recognized quickly. A coordinated, agreed-upon reworking of the rules will not be easy. But it will do less damage than insisting on politically unsustainable levels of austerity and having default and exit from the euro zone forced on the Greek government by protests on the streets.