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Thesis & Antithesis

A critical perspective on energy, international politics & current affairs

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Location: Washington, D.C.

greekdefaultwatch@gmail.com Natural gas consultant by day, blogger on the Greek economy by night. Trained as an economist and political scientist. I believe in common sense and in data, and my aim is to offer insight written in language that is clear and convincing.

28 April 2010

The Greek crisis

It is hard for your country to be plastered on the front page of major newspapers. But what has become plain to the world has been obvious to Greeks for many years – that the country has been headed towards a crisis. The global financial crisis triggered this downfall but it did not cause it. Blame lies with those who governed Greece – on the left and on the right – over the last three decades. And while much pain lies ahead, it is hard to have expected reform without crisis. If Greece can manage to pass some common sense reforms, and if the EU or the IMF can act as lighting rods to diffuse pressure and ensure change, then this could be beneficial for Greece.

A crisis long in the making

A few numbers illustrate precisely the roots of the current crisis. Greece has not had a balanced budget or a balanced current account in a long time. From 1980 to 2009 its budget deficit was 7.5% of GDP, while its current account was 5.2%. The last time Greece almost balanced its current account was in 1994, while its lowest budget deficit was in 1980 at 2.1% of GDP. So the closest that Greece has come to balancing its budget was in 1980 and its current account in 1994.

By themselves, these numbers are indicative but not indicting. Countries can run deficits without much hassle. This does not mean, as Dick Cheney put it, that “deficits don’t matter.” Rather it means that a deficit in itself is no guarantee of crisis. But breaking down the numbers reveals much more to worry about. The Greek government spends as much on goods and services as other European governments (50.4% of GDP in 2009), although it ranks 11th on that measure (meaning ten European governments spend a greater share of their GDP than Greece). In terms of revenue, however, it’s a different story. Greece’s revenues were 7.1 percentage points below the EU average: the Greek government took in 37% of GDP while European governments on average took in 44%.

Greece therefore, had a welfare state on par with Europe but without the revenues to support it. Greece also spent much more than its peers on defense (second highest after Britain) and general services, while devoting less on the environment (ranked 16th in Europe), health (19th), public order and safety (24th) and education (27th). So the Greek government spent a lot of money but mostly to provide services rather than investment or quality of life.

This system represents patronage and corruption. The imprints of both are deeply embedded in my mind – from politicians helping secure a job in the highly coveted public sector with its lifelong employment, to getting a painless transfer in the military, to being told what the price of a good is “with and without a receipt,” to leveraging political connections to get a second phone line, to bribing doctors to do their jobs, to payments made to tax officials so that they eschew imposing whatever penalties they wished. Little moves without corruption.

Having a welfare system but not paying for it meant that Greece’s debt was rising. The data on government debt paints a bad picture, but not a worsening one, at least until 2009 rolls around, with debt hovering around 100% of GDP. The data on household debt show a rapidly deteriorating position from a debt level of 17% of income in 2000 to 71% of income in 2008. Greece’s position relative to other European countries was much worse in terms of government debt than household debt: Greece has had the second worst government debt-to-GDP ratio in Europe since 2004 (after Italy). For household debt, it ranks 14th in Europe with its 71% debt-to-income ratio comparing favorably with a Euro-area average of 93.2%.

This indebtedness would have sparked a crisis sooner had it not been for the Euro, to which Greece was admitted in 2000. Once in the Euro, Greece borrowed at low interest rates – in fact, the spread to German bonds all but disappeared. This is hard to explain since the Eurozone agreement disavowed the bailing out of any insolvent Euro member. Currency was common but debts were national. Lower bond yields meant markets had ruled out devaluation (rightly, since Greece had no control over monetary policy to devalue) but they also discounted default. What could have been an orderly nudge to the Greek state to contain its deficits became an abrupt push when markets lost faith in Greece.

The Greek government was hardly alarmed at the ballooning deficits. I remember asking George Alogoskoufis, then Greece’s finance ministry, during a visit to Washington about Greece’s current account deficit, which at the time was around 13% of GDP. His response: “this shows the faith that foreign investors have in the Greek economy.” Effectively, we was taking a chapter from the debate on the US current account deficit and applying it to Greece, arguing that it was a capital inflow rather than imports running amok. To close the deficit meant painful and unpopular reforms – and who wants that? In fact – and my memory may be faulty here – it is hard to think back to any major structural reforms that have been implemented in the country in the recent past.

In that sense, an external force to implement reforms can be welcome. I realize that there is much quarrel in the world with the IMF and the conditionality it attaches to its loans. But there is also something frustratingly simple about the Greek crisis – it may be a political minefield but it is an economics plain-field. What Greece needs is Econ 101 – not much more than that.

Why Greece matters

The Greek crisis has two components: first, there is a short-term liquidity issue as Greece needs to raise about of €50-€55 billion per year in the next few years from a market that is unwilling to lend it money at low rates; and second, a long-term structural crisis which hinges on the Greek government producing a credible plan to reduce spending and raise revenues.

Greece matters economically and politically. Economically, it matters because a Greek default would spill over in two ways; first, it would make Greek debt almost worthless (or create much uncertainty around its value). Banks using Greek debt as collateral will need to post new collateral, triggering a potential sell-off that pushes other prices down as well (this may have been accomplished already as Greek bonds were given a junk rating by S&P). According to the Bank for International Settlements, foreign banks had a $216 billion exposure to Greece at the end of 2009 – of which French and German banks held more than 50%.

Second, markets are worried that other European countries may follow soon. Fear can raise borrowing costs for other EU members: Ireland, Spain and Italy have already seen their spreads relative to German bonds spike, although nowhere near Greek levels (around 651 basis points). Higher interest rates could mean other countries may seek a non-market solution (a bail out) for their borrowing needs.

The political reason that Greece matters is that this is Europe’s first crisis and there is much interest to see how it deals with it. The Eurozone agreement had an explicit decree to prevent the Eurozone countries from assuming each other’s debts. This was a precondition for approval for countries such as Germany which feared they would be called to bail out profligate members (and this is the main reason why the German public is so opposed to a bail-out for Greece).

Against this, however, stand two ideas: first is the idea of solidarity, which says that Europeans need to stick with and support one another. Second, there is the broader question of relevance – what is the point of being in the European club if it cannot assist you in a crisis. This is not the first time that Greece has felt this way; in 1974, it pulled out of NATO’s military structure after it felt that the alliance had done little to assuage its fears of a Turkish attack. So for a second time in forty years, Greece is in a crisis, and its main allies are wavering or cannot help it.

More importantly, what kind of Europe emerges from this crisis? The Eurozone agreement had an unsustainable compromise. Countries pledged to a common monetary policy, but they retained control over fiscal policy. Since Europe has no powers to tax people, the bargain makes sense. But Europe also lacked powers to police and punish members whose fiscal policies were excessive. Clearly, markets did not differentiate between German debts and Greek debts so “market discipline” was insufficient. Since 2002, one to six countries have had annual budget deficits exceeding the recommended 3% of GDP ceiling, and yet Europe was powerless to do anything.

In other words, the bigger question for Europe is whether it will implement measures that give it some authority over fiscal matters – and whether in doing so it will seek the support or approval of the European public. It may well look for new powers without new mandates, in which case, the greatest implication of this crisis may have been to redraw the boundaries between core and periphery in Europe, shifting a great deal of power from nation states to the center.