What happens in the eurozone crisis could determine UK economic prospects for the next decade, says Graeme Leach
The euro crisis never went away, but even for those who thought it had recent weeks have been an ugly reminder of the downside economic risk to the UK. In 2011, I forecast that Greece would exit the euro this year, probably just in time for some cheap holidays.
For many, this statement was a step too far but subsequent events have only confirmed my view. Of course, an exit hasn't happened yet – and I might still be wrong – but let's examine the case for and against, and look at what Britain could do to protect its businesses, including the IoD's joint initiative with the TaxPayers' Alliance aimed at boosting growth prospects.
One solution to the euro crisis could be a much deeper economic and political union, with a single fiscal policy, transfers from north to south and greater mobility of labour and capital. But even if this was to happen it most definitely won't be on any timescale to deal with the difficulties. Going further and faster on economic and political union is a dream of many in the EU, but it won't solve the crisis.
The potential solutions lie with fiscal and monetary policy. On the fiscal side, in the wake of François Hollande capturing the French presidency, talk of mutual obligation and eurobonds has been revived. But Germany and France have conflicting ideas about what fiscal union means. To Germany it means hard, binding rules so that the Club Med economies don't get into this mess again. For France fiscal union means Germany opening her chequebook.
These differences are not going to be reconciled soon. Germans like giving money to Greece when they go on holiday, but they tend to frown on transfers by any other means. Now it could be argued that at one minute to midnight Germany will blink and baulk at the prospect of a Greek exit and financial contagion, capitulating to demands to ease the austerity programme.
This argument is appealing but flawed. Germany has had ample opportunity to ease the pressure for austerity but has failed to do so. Anybody reading newspapers in Germany will know that there is no political will in the country to go easy on Greece. Moreover, problems of moral hazard arise quickly. If you let one country off the hook, who's next – Portugal, Italy, Spain?
The fiscal solutions appear to be blocked, but what about monetary options? I've written before that the ECB's decision to lend more than €1.2trn (£960bn) to eurozone banks over the past six months has partly fixed the problem by easing liquidity constraints in the banking system.
But to solve the crisis completely this money needed to pour into the bond markets of the Club Med economies to drive down yields. This hasn't happened, and is highly unlikely to occur. The one-minute- to-midnight argument applies here, too. Faced with a Greek exit and the consequences of financial contagion, the ECB could decide to undertake quantitative easing on an epic scale, hoovering up every Greek, Spanish and Italian government bond it can find. But if it was going to do that, why hasn't it started already?
The second Greek election is on 17 June and it looks as though anti- austerity parties will prosper. But further austerity measures are not sustainable in Greece. With 50 per cent plus youth unemployment and an adult jobless rate approaching 25 per cent, the writing is on the wall. Greece will run out of money, default and crash out of the euro.
But what next? This is where the uncertainty lies. On one side is the school which sees bank runs, contagion, soaring Portuguese, Spanish and Italian bond yields and Club Med departures from the euro.
On the other side are those who see massive central bank liquidity injections, an equity market surge and only limited bank runs. In other words, the rot stops with Greece. But I'm not so confident – I believe all the Club Med economies will exit the euro at some stage but the timing of the second wave of departures is less clear. It could be quick, but it might not be if the ECB decides to act on a truly massive scale.
The uncertainty on the continent clearly adds to the gloom at home in the wake of the UK falling back into technical recession in the first quarter of this year. What business needs now is the confidence to invest and recruit. After all, UK plc has the cash – around £750bn at the last count. But as the euro crisis deepens, the longer companies delay hiring staff and investing.
We're entering the end game for Greece. What happens over the next six months could largely determine economic prospects in Britain for the next decade. This is why the IoD is taking such a strong position on the need for radical supply-side reforms. The launch of our 2020 Tax Commission with the TaxPayers' Alliance shows how we could transform the incentives to work, save and invest, and drive up long- term growth prospects significantly.
Every cloud has a silver lining. If the consequences of a Greek exit is recognition in the UK of the need for a supply-side revolution – to free up taxation, planning, regulation and employment law as well as investing in key infrastructure – we'll all be better off in the long term.
Graeme Leach is the IoD's chief economist and director of policy