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Not all Greek­

18 February 2015 By Edward Hadas

If Greece had its own currency, the country’s crisis would attract little attention. On the contrary, the economic news from Athens would be all too familiar to followers of countries which have trouble increasing their citizens’ average annual income to much above $25,000. Such middle-income countries have a habit of running into fiscal or financial trouble.

Such difficulties can usually be addressed without much trouble. When governments or banks run out of money, some lenders take losses and international institutions help the hapless authorities with financial aid and sensible economic plans. Unfortunately, the euro zone is different.

The guiding assumption of the single currency and its single central bank is that all the members’ governments and financial systems will stay solvent and behave responsibly. Greece has done neither, and the result is a series of crises. But all the urgent negotiations, not to mention the intellectual, verbal and sartorial abilities of Yanis Varoufakis, the new Greek finance minister, can easily obscure the real issue.

In a phrase, economic modernisation is hard. Greece is struggling on that long road between predominantly agrarian economies and the post-industrial arrangements of truly rich countries.

Of course, it could be worse. Average incomes in Greece are still about as high as in much of southern Italy, and are far ahead of most of former Communist Europe. But Greece certainly suffers from what development economists call weak institutions. Corruption and tax evasion are far too rife. Big investments are often badly organised. Quality control is poor. Insiders who are not necessarily competent land too many jobs. New legal hiring is pointlessly hard. Private employers show little initiative. And so forth.

Europeans talk of structural reforms, but Greece is not merely a malfunctioning welfare state like France and Italy. Its relative poverty stems from a much deeper weakness – a shortage of the habits and practices needed to run sophisticated industrial complexes, and complex educational and healthcare systems, or at least to run them well.

Outsiders can help establish those habits and practices. The European Union has done that for Greece. If it were not for the standards set by the EU, the country might look much more like neighbouring Turkey, with per capita GDP a quarter lower and a drift towards autocratic government, or like the much poorer countries on the other side of the Mediterranean, from Egypt to Morocco.

Still, Greece has a long way to go, starting with its government. That problem is unsurprising since governments are usually right at the top of the list of weak institutions. One sign of such weakness is big budget deficits. These are the result of a fundamental political deficit. The authorities, whether democratic or autocratic, are too ineffective to collect taxes but feel compelled to spend to maintain insider loyalty and buy off restive outsiders. Such spending may help maintain political peace, but it rarely does much for development.

Greece need not stay a prisoner of its own troubled history, which has moved from a civil war in the 1940s through an incompetent military dictatorship to decades of weak democratic governments. If the Europeans could step back from the brink, they might appreciate and encourage the new Syriza government’s commitment to significant institutional reform. Success on this wide front is far more important than the precise size of next year’s fiscal deficit.

Still, financial problems matter. In particular, Greece has suffered from a problem which can plague even rich nations: excessively rapid capital flows in and out of the country. In the boom years, too much foreign money came in, supporting trade and fiscal deficits of more than 10 percent of GDP for several years. Structural economic weaknesses meant these flows were used badly. Their disappearance has been even more harmful.

Again, Greece is typical. The free flow of capital can reinforce bad behaviour anywhere, while the withdrawal of capital causes pain anywhere, but developing countries are particularly vulnerable. The smart ones increasingly run trade surpluses and use bank regulations to try to sterilise hot money as it comes in. The weaker ones – such as Greece, Turkey and South Africa – take their chances.

The great lesson of the Greek crisis is not that the euro is flawed. It is no more flawed than any system which allows capital to cross borders too freely. The great lesson is what might be called the first law of development economics: without strong institutions and well-entrenched governments, economic development will be continually thwarted.

That truth extends far past Greece. Institutional improvement is the greatest economic challenge in India and China, and from Argentina to Zambia. There is a second, related lesson. Foreign experts and example can help with advice, standards, money and opportunities for trade. The EU has done that for Greece. At the end of the day, however, countries must do the hard work on their own.

 

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