Greece had been considered a post-war growth miracle: economic growth was much higher than the Organisation for Economic Co-operation and Development (OECD) average in the 1960s and 1970s as Greece industrialized, according to Tsafos (2013). During the 1980s the state expanded sharply and state spending increased radically, as subsidies for state-owned enterprises and social transfers grew. Incentives to increase productivity declined, as did the process of industrialization. Growth prospects therefore declined.

Greece joined the eurozone on January 1, 2001. Greece’s living standards were low in comparison to the rest of Europe in the early 2000s. State expenditures were only rising and increased greatly in 2009. Greece was also on a path of expanding neoliberalism before the crisis hit. Morales et al. (2014) argue that the crisis presented a critical juncture, at which Greece might have abandoned its neoliberal track, but that rather than doing so, Greece chose to consolidate the neoliberal agenda. In addition to short-term austerity measures, long-term neoliberal structural changes were recommended. An increase in labor market flexibility and emphasis on the tradeable rather than the non-t radeable sector was stressed. However, wages in the tradeable sector rose by 5.5 percent between 2000 and 2009, and 16.5 percent in the non-tradeable sector, indicating that adjustment should come from internal devaluation in the non-tradeable sector (Kouretas 2010). Much of the wage growth occurred in the public sector, and was coupled with an increase in the number of public sector employees. As such, Tsafos (2013) classifies Greek debt as a symptom of its structural economic problems, which arose from its inefficient civil service, excessive spending on pensions, corruption, tax evasion, a poor business environment, and an overregulated private sector. Greece also faced a current account deficit before the crisis began (Figure 8.4), revealing problems with its fixed exchange rate regime as well as a decline in competitiveness.

Greece’s current account balance (% of GDP)

Figure 8.4 Greece’s current account balance (% of GDP)

Greece’s government sector was tied to the private sector, since most business contracts came from the government. This system failed to promote competition and innovation in the private sector. Tax evasion was rampant, limiting government revenues. Furthermore, the government preceding the crisis, from 2004 to 2009, even decreased capital taxation by 10 percent.

When the new Greek government announced a higher-than- realized government budget deficit in 2009, it became clear that Greece’s case was serious. The country was at first not allowed to receive a bailout, to attain interest rate relief, or to default. The no-bailout clause was a component of the Maastricht Treaty. This posed an insurmountable barrier to debt reduction, as Greece was forced to borrow at very high interest rates to fund its deficit. Greece aimed to correct its own deficit by cutting bonuses and raising taxes. The aim was to reduce the deficit to 2.8 percent of GDP by 2012, from 12.7 percent of GDP in 2009. However, the results of these actions were relatively disappointing, and it had become clear that Greece would need a bailout to improve its debt position. After a liquidity crunch in global bond markets, finally, in May 2010, Greece received bilateral loans of €80 billion pooled by the European Commission to be disbursed between May 2010 and June 2013. The IMF financed a standby arrangement of €30 billion. Loans were to be aimed at covering the government’s fiscal and medium to long-term liabilities until the end of 2011, and less thereafter. Greece attempted to eliminate some of its debts by reducing social security spending and pensions and privatizing public assets. The alternative to accepting a bailout and embarking on austerity measures was to default, which would most likely result in the collapse of the financial system and a severe depression. However, the market response to the bailout remained pessimistic, and the public response to austerity measures turned violent at times.

One of the major issues after the crisis began was that Greek labor markets increased in flexibility. Dismissal notice periods were shortened, permanent employees were replaced with part-t ime workers, collective dismissals (firing a large number of workers) were freed of restrictions, and employment protection declined. Gialis and Tsampra (2015) find that the negative impact of the crisis on national employment was severe and homogeneous across almost all regions. Closing businesses did not help matters either. Many skilled workers lost their jobs with little job growth to compensate for the losses. The Greek people voiced their dissent through protests, as well as through the promotion of the leftist, anti-austerity political party Syriza.

George Papandreou was not up to the task of saving Greece. Papandreou created political crises in November 2010, in June 2011, and in October 2011. In 2010 he made the elections about his premiership and the bailout agreements, declaring success after the ambiguous first-round results (Tsafos 2013). In 2011 Papandreou offered to the leader of the opposition to step down from his premiership but later announced a cabinet reshuffle. In October 2011, after a debt restructuring with the private sector, Papandreou requested a vote on the debt restructuring plan. All of these moves undermined confidence in the Prime Minister’s ability to lead the country out of crisis. In November 2011 Papandreou resigned and Lucas Papademos became the new Prime Minister.

Events in 2011 cast a negative light on Greece’s economic situation. Greece’s 2009 deficit was revised upward to 16 percent of GDP, while the eurozone announced that crises after 2013 would require bailout participation of private creditors. Greece’s implementation of austerity measures, strong through 2010, slackened in 2011 (Ardagna and Caselli 2014).

On March 14, 2012, the Second Economic Adjustment Programme for Greece was approved, with an additional €130 billion to be used for 2012-14, financed by the European Financial Stability Facility. Greece carried out a bond swap, swapping privately held bonds for longer maturity bonds at lower nominal values. Internal devaluation required the productive sector to devalue incomes, in an attempt to improve export performance. Elections held in May 2012 resulted in no overwhelming majority. A second round of elections was held in June 2012. Unemployment rose from 9.5 percent in 2009 to 24.2 percent in 2012, and surged to 27.5 percent in 2013.

A far-left, anti-austerity government headed by Syriza’s Alexis Tsipras was elected in January of 2015, widening the gulf between Greek officials and European creditors. In June 2015, Greece defaulted on a loan payment to the IMF. In a referendum held on July 5, 2015, Greek voters rallied to reject austerity measures. One week later, Greece was given a third bailout package and Greece agreed to continue on the road to reform (Nelson et al. 2015). Reforms were to continue in the same vein of austerity as before, aiming to improve tax collection, expand market liberalization, and reduce spending on pensions.

Observers have searched for an explanation of why Greece and the eurozone failed to function in a healthy manner during the crisis. A dominant explanation is that within Europe, there were necessarily deficit and surplus nations with Germany being the most powerful surplus nation of all. Deficit nations had joined the eurozone in order to avoid constant devaluations. However necessarily low levels of inflation, required by the Maastricht treaty in exchange for joining the eurozone, led to a stagnation of wages in peripheral countries. Varoufakis (2013) makes the case that because Europe lacks an effective currency recycling mechanism in contrast to the United States its currency union has faced major issues. This is because Germany has relied upon peripheral countries as last resort sources of demand. In a deficit country the crisis would have an impact of requiring countries to reduce debt, cut spending; as a result, overall demand would decline, increasing unemployment and depressing prices; thus creating a cycle of debt and deflation.

To some degree, the problems with Greece were inherent to the eurozone. Because eurozone politicians guaranteed that no eurozone countries would default, Greece’s debt was initially overvalued to begin with, as Greece was allowed to borrow at German-t ype low-l evel interest rates (Soros 2012). This allowed Greece to run up its debt to begin with. What is more, the eurozone lacked a common Treasury, so that individual countries were forced to take care of their own banks. Greece was unable to do so, even though Prime Minister George Papandreou insisted external assistance was unnecessary, and other countries were unenthusiastic about bailing Greece out.

Parallels have been drawn between the pre-1914 gold standard and other currency union crises, and the European monetary crisis occurring after 2008. Bordo and James (2014) identify similarities between the pre-1914 gold standard and European monetary union today. The authors note that both currency structures are based on fixed exchange rates, monetary and fiscal orthodoxy, and a relationship between peripheral and core countries. In the case of the gold standard, countries were able to temporarily devalue their currencies, but the European monetary union lacked such a recourse. Bordo and James also make the distinction between pre-1914 countries that were able to borrow in their own currencies versus countries that were unable to borrow in their own currencies, the latter which was dubbed “original sin.” Financial centers without “original sin” and strong fundamentals were able to avoid financial crises. Similarly, core European countries remained stable during the current crisis while peripheral countries, particularly Greece, found it extremely difficult to absorb debt.

Another imbalance generated by the eurozone union was the inability of countries to alter exchange rates. Papanikos (2015) argues that the euro was overvalued, resulting in low levels of growth in Greece since Greece could not devalue the currency to promote exports and tourism.

When the eurozone crisis hit, European banks found they had a great deal of eurozone debt without a common European banking union. In response, the European Commission and the European Central Bank socialized bank losses and turned them into public debt. The makings of a public debt crisis were brought about by the surge in demand for credit default swaps taken out against peripheral countries like Greece.

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