Debt crisis 2.0: Facing default, Greece must ditch the euro and rethink its welfare state

Just a year after wealthier European governments rescued Athens from default with $157 billion in loans, Greece is slipping into crisis again.

After seeing its credit rating sharply downgraded on Monday, and unable to meet deficit-reduction targets laid down by Germany and others, Greece is getting desperate – and Europe is getting anxious.

Officials are floating euphemistic phrases like “voluntary restructuring,” but make no mistake: The painful concessions Greece would probably require from creditors amount to a default. If that happens, the broader European economy will be on its knees, its credibility shattered. So what should Greece do?

The only real solutions are for Greece and other low-income countries to abandon the euro and for Europe as a whole to rethink its welfare state.

Cutting government stimulus or raising taxes further is not viable. Either would slow growth, and growth is already too anemic in Greece and other troubled European countries to support pensions and other social benefits.

The dangers of excessive coddling

In a modern market economy, only ideologues do not acknowledge the necessity for balance between welfare – aid for the truly needy and aged – and efficiency – incentives to work and invest productively. Excessive coddling and taxation discourage people from fully productive lives, innovation, and building wealth.

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Multiyear unemployment and huge severance benefits, guaranteed healthcare for able-bodied citizens who refuse to work, and other features of Europe’s sympathetic face of capitalism surely cross those lines. However, like an alcoholic that must quit the bottle, Europeans have avoided genuine cures for decades and instead embraced bogus elixirs to rekindle growth.

The 1992 Maastricht Treaty, which considerably harmonized product and safety standards and methods of taxation across the continent, was supposed to remove untold barriers to growth. It didn’t, because European labor laws and social benefits still make individual ambition and investment in Europe about as sensible as my still yet unfulfilled dream to be Italy’s premier.

A bogus elixir

The single currency, the euro, introduced in 1999 to facilitate commerce across borders from Ireland to Greece, was heralded the next great elixir.

The single currency addressed a problem that didn’t truly exist and created new ones. Prior, the European Currency Unit (ECU) linked at fixed rates the national currencies of many of today’s euro zone countries. The dollar and the ECU were accepted in international commercial transactions.

However, each country could print its domestic currency and occasionally devalue or revalue against the group as circumstances required. With the euro that flexibility was taken away from poorer countries like Portugal, Spain, Greece, and Ireland. Tough European Union restrictions on national budget deficits, reminiscent of US state constitutional requirements for balanced budgets, were supposed to avoid that necessity.

Sadly, although Germany, like New York, greatly prospers by participating in a huge single continental market, Brussels cannot tax Germany to subsidize Greece’s welfare state in the same way Washington taxes New York to subsidize Mississippi’s Medicaid. And that is not likely to happen anytime soon.

With all that wealth to itself, Germany provides gold-plated employment security and jobless benefits, short work weeks and the like, portrays itself a model of Euro-efficiency, and lectures Greece on Teutonic frugality.

Germany can afford those benefits only because it doesn’t share its wealth with Greece. Athens can’t scale back social benefits to truly affordable levels without political upheaval, because its population does not understand why they can’t enjoy the same perks as Germans.

Europe must address the welfare state

Europe’s welfare state is much more efficient than America’s – health costs in Germany are half the US norm – and hence can give its citizens more than Washington can. However, no government can – or should – give citizens all they would like. Just as affluent families frequently risk robbing children of their ambition and prosperous futures by giving them too much, over-generous welfare states tend to sap a nation’s “can do” spirit.

Once upon a time, the European Economic Community – remember that quaint post-World War II institution – thrived without a single currency. A now much larger European Union can again, but it needs to jettison the fantasy that the benefits of capitalism can be accomplished without adequate incentives to work hard and invest. If it does make that shift, it’ll serve as an important lesson for politicians in Washington, who are so far in denial about the severity of America’s own mounting debt.

Free market capitalism maybe the greatest engine of progress conceived by man – unless, of course, it was divine inspiration – but it cannot survive with the heresy that the benefits of capitalism can be accomplished without individual responsibility, risk taking, and rewards.

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the US International Trade Commission.