The Other Contagion: What If Greece Thrived After Euro Exit?

It is the scenario few talk of: What if Greece left the euro area and its economy thrived?

The reason for the silence may be that it’s too ridiculous a concept to even consider.

As the country’s referendum on austerity nears, economists are lining up to warn that quitting the euro and defaulting on its debts would make Greece an even bigger pariah in financial markets and push it toward a deeper depression with the bankruptcies, unemployment and social unrest that entails.

Such pain, so the conventional wisdom goes, would scare the likes of Spain and Portugal into rededicating themselves to the German-branded austerity and economic reform that membership of the single currency demands. To some, a euro zone without Greece would be smaller yet possibly stronger.

But economists at Oxford Economics Ltd. and Citigroup Inc. this week gave voice to the question of what would happen if Greece dusted itself down within a couple of years and rode a falling currency back to economic growth.

That would challenge the theory that leaving the euro was economic suicide. And it could encourage other members to consider devaluation and default more appealing than life within the euro and so pose an even bigger threat to the currency bloc’s sustainability than if Greece stayed.

Further Fragmentation

“From an economic perspective, one of the major contagion threats from a Greek exit would be if Greece left and its economy quickly started to grow strongly,” said Ben May of Oxford Economics. “In such a scenario, further fragmentation of the euro zone may be more likely than not.”

At the very least, “a noticeable economic rebound” in Greece would mean “support for non-mainstream forces in other countries could in fact be boosted,” the economists at Citigroup said, pointing to Spain’s anti-austerity Podemos party.

May’s colleagues have used recent reports to show how a so-called Grexit may not be so bad. Of the 70 departures from currency unions since 1945, only a small minority suffered steep output losses, and Greece may have scope for a rebound given its 25 percent slump in gross domestic product is already among the harshest of 137 economic crises since 1980, they argue.

At the Peterson Institute for International Economics in Washington, economist Joseph Gagnon this week wrote that if handled properly, Grexit could mean the economy is growing within six months and accelerating strongly in two to three years as a weaker currency fanned competitiveness and lured tourists.

Greek Revival

“Few forces are more clearly demonstrated in economic history than the boost to spending and growth from a large and sustained real depreciation,” said Gagnon.

For May, the chance of an eventual Greek revival means European officials would be wary of assisting the country too much if it does exit the common currency even though they will need to ensure it has enough support to avoid becoming a failed state.

“Were more southern euro-zone economies to leave the euro zone, the impact could be substantial,” he said. “The best option for the rest of Europe might be to provide Greece with enough help to avoid disaster, but not enough to make an exit seem attractive to other euro-zone economies.”