A standard piece of textbook economics is that if a country cannot devalue, it must cut real wages to increase labour productivity and make its exports more attractive. Indeed, it is argued quite plausibly that the main reasons for Germany’s successful export performance in the past decade is that real wages have remained flat, despite a strengthening euro which has made it more difficult to export to the rest of the world.

But some economists – not just German economists – argue that although the Greek economy has grown over the past decade, the gains in Greek productivity have been spent either on raising wages or on raising social benefits, or else have been squandered on wholly unproductive government spending. The argument boils down to saying that the Greek trade deficit can be cured in either of two ways: Either Greece must leave the Eurozone and devalue its ‘new’ drachma, or retain the euro and squeeze wages to boost export competitiveness. This argument is then generalised to cover all Club-Med countries.

There are several problems with this type of argument. For one thing, while the argument may be valid in normal circumstances, the current economic climate is far from normal. Severe cuts in Greek public spending are sending the economy into recession, a recession compounded by the ‘deficit hysteria’ currently sweeping Europe like the plague. It seems likely that we shall soon see a double-dip not just in Britain but in much of the Eurozone. Let us imagine Greece wants to increase its tourism (an export industry). It is of no use cutting real wages and public transfers (pensions, social benefits and so on) to make Greece a cheaper holiday destination if all other Europeans are losing their jobs and cancelling their holidays.

More generally, there is a simple, logical reason why cutting wages will not make Greece (or any other Club Med country) a new Germany. At the moment, Germany runs a large trade surplus with the Eurozone – about two-thirds of its exports go to the Eurozone – while Greece and the other Club-Med countries together run a large trade deficit. This in not because Mediterranean citizens work less hard or are less thrifty. It is because one county’s exports by definition must be another country’s imports. Keynes recognised this problem in 1944 at the Bretton Woods conference where he proposed that an international bank or fund should be set up both to help finance those countries running a trade deficit, and also to limit the size of trade surpluses. His proposal was rejected by the Americans who insisted on setting up the IMF on quite different lines, but that’s another story.

Where does that leave Greece and other Club Med countries? Should Greece accept the dramatic budget cuts demanded by the northern Europeans; should it leave the Eurozone and adopt a new devalued drachma; or should it stay in the Eurozone but renegotiate its debt? All these options will be painful. We know that dramatic budget cuts will prolong recession and lead to high unemployment and a lower real wage. On the other hand, defaulting on sovereign debt and leaving the Eurozone would involve a very large devaluation of the ‘new’ drachma, driving up import prices, causing inflation and leaving many with high private euro debts.

My own guess – and I stress the fact that it is a guess – is that Greece will not leave the euro, but nevertheless will be forced sooner or later to renegotiate much of its sovereign debt in order to improve its terms of repayment – as indeed will Spain, Portugal and others. Although Spain’s debt/GDP ratio is well within the Maastricht limit, much of its sovereign debt is relatively short-term. In this case, the loss will be borne by German, French and other banks – to use the jargon, they will take a ‘haircut’. But debt restructuring resolves only part of the problem. The cuts agenda remains!

In truth, in the short term there is no painless way out for ordinary hard-working Greeks or other southern Europeans. In the long term, the Eurozone will need to establish a strong federal budget like the Americans and affect intra-Eurozone transfers if it is to survive. But as Keynes famously remarked, in the long term we shall all be dead.