Was it worth it?

By R.A. | WASHINGTON

STEVE WALDMAN asks the burning question:

Suppose that Greece had never adopted the Euro and the terms of its external borrowing had remained subject to “market discipline”, as it had been in the 1990s. Would Greece today be better off or worse off, in real terms, looking forward?

The question is impossible to answer, obviously, but it's worth thinking about all the same. As Mr Waldman indicates, Greece was able to borrow on unrealistically good terms for most of the last decade; somewhat surprisingly, national interest rates converged in the wake of the adoption of the euro. This contributed to Greece's accumulation of debt, and only when market forces began to reassert themselves and peripheral yields diverged from core yields did it become clear that Greece's debt burden was unsustainable.

Of course, market discipline isn't the only discipline around. Entrance into the euro zone was contingent on Greece's accomplishing certain reforms and achieving a required level of macroeconomic prudence. Greece clearly fell short of the standards of good behaviour other euro-zone members had in mind, but economic research indicates that even when fiscal rules don't strictly bind they can nonetheless have a positive effect. The process of entering the euro zone didn't turn Greece into Germany, but it may have left Greece in better institutional shape than it otherwise might have been.

As a euro-zone member, Greece gave up monetary independence. As it turned out, the super-responsible ECB spent the 2000s making a monetary policy that fit the laggardly German economy, and which was actually too loose for Greece's economic situation (according to a simple Taylor rule). On the other hand, from 1999 to 2010, Greek inflation topped 4% only twice. Between 1980 and 1998, by contrast, Greek inflation was never below 4%. Indeed, for all but 4 of those years, inflation was in double digits. Would Greece have contained its inflation problem outside the euro zone? And if it hadn't, what impact might that have had on growth?

The current austerity plans being foisted on Greece are too severe, but they nonetheless include many needed reforms. Greece will probably make it through this episode with a smaller and more manageable state, a broader and more reliable tax base, and a less encumbered private sector. Without heavy outside pressure, the Greek government might never have undertaken these measures.

I don't claim that this all amounts to a clear positive answer to Mr Waldman's question. Greece's outlook may well be worse than it otherwise would have been. But for all the current pain, it's not obvious that the euro zone hasn't been a net plus for Greece. Consider this chart:

This image compares the path of real per capita output for Greece with that for Britain and Denmark—two countries in the European Union but not the euro zone. These levels are normalised; in absolute terms, Denmark and Britain are a bit richer than Greece. But Greece clearly enjoyed catch-up growth during its euro stint. And while some of that growth has been given back during the brutal recession years, it remains (and is projected by the IMF to remain) closer to British and Danish income levels than when it joined the single currency. Might it have caught up anyway? Certainly. This is simply to show that the decision to join wasn't obviously a big mistake.

What is certain, however, is that Greece's outlook should be better and would be better within a better euro zone. But you don't build good supranational institutions overnight. Today, Americans are celebrating a federation that, after 235 years, only mostly works and then only some of the time. Whether Greeks should be heartened or discouraged by the American experience is another very good question.