A way out for Greece

Mark Weisbrot says the only solution for Greece's economic and financial woes is to leave the Euro zone. Paul Krugman applauds Weisbrot for the sentiment but argues that in doing so Greece would give up numerous benefits from being a member of the Eurozone such as access to cohesion funds from the rest of Europe and the "hard to quantify but probably important things like the stabilizing effect, economically and politically, of being part of a grand democratic alliance." Is there an alternative? I think so.

First, a recap of Greece's problems. Greece has an excessively large government sector and byzantine system of commercial and labor market regulation that retards the efficient allocation of resources and investment. It needs structural reform. Greece has a high internal price level that makes its goods uncompetitive in the rest of Europe. It needs a devaluation, but it can't as long as it's in the Euro system. The alternative to devaluation is "internal devaluation," i.e. a recession big enough to push down prices and wages so that the economy is competitive once again. No one wants that. Greece has a monstrous foreign debt that it is unlikely every to be able to repay. It needs significant debt relief. But foreign lenders don't want to offer the relief, especially if Greece is going to continue to manage (if that's the right word for it) its economy as it has in the past.

Ok, so how about this. Greece stays in the Euro system and retains all the benefits thereof. The Greek government implements a law mandating a uniform reduction in prices and wages by, say, a third, or whatever amount is necessary to regain international competitiveness, followed by a temporary price freeze. This stimulates the economy, which improves the government's fiscal situation and gives it breathing room to implement some much needed product and labor market reforms. To reward Greece for these efforts (in an explicit quid pro quo - this won't work otherwise) Greece's creditors forgive a large portion of Greece's foreign debt (as much as a third, or the amount of internal devaluation Greece is implementing). Voila, we have a more flexible, competitive, and most importantly growing economy, still a member of the Euro zone, working through its remaining debt problems.

Crazy? Quite possibly. But there's plenty of historical precedent for price controls during times of economic crisis. Price controls worked well in the US during World War II, not so well in 1971-73. They've also worked with mixed success as part of Brazil's and Argentina's stabilization programs in the 1980s. Price controls have typically occurred in an inflationary environment. When they haven't worked it's tended to be because the monetary authorities continued to expand rather than contract, resulting in suppressed inflation that burst out when controls were lifted. This is a different environment - the problem is deflation rather than inflation, and monetary policy is in the hands of the ECB rather than the Greek government.

Furthermore, all of the other possibilities seem worse. Desperate times call for desperate measures.