Towards a political economy analysis of the Greek and Irish crises

Overall, in the period leading up to the crisis, it was not obvious from macroeconomic and financial information that Greece would face a more severe sovereign debt crisis than Ireland, although the Greek situation subsequently deteriorated significantly as the crisis unfolded. Indeed, Greek and Irish bond yields were at similar levels for much of 2008 and 2009; tellingly, in their quantitative analysis of Eurozone bond spreads between January 2003 and March 2009, Sgherri and Zoli (2009) find that "a sizeable part of the actual change in spreads since September 2008 remains unexplained, notably in the case of Greece" (p. 15). Indeed, macroeconomic fundamentals at the onset of the crisis cannot by themselves fully explain the relative timing and overall severity of the crisis in each of the two countries under consideration. This suggests that other factors may have come into play to determine market attitudes vis-a-vis each sovereign. Thus,

Table 3.2 Comparing political economy variables in Greece and Ireland

Notes: Except for No. of general strikes, reference year for data ranges between 2007 and 2010, depending on availability.

Sources: World Bank, Eurostat, Kelly and Hamann (2010), Eurostat, United Nations Conference on Trade and Development, Bank for International Settlements, OECD.

the Greek and Irish sovereign crises represent a good test of the theoretical framework of this book, which suggests a role for political economy factors and thus has considerable potential to contribute to explaining the residual differences. The two countries display considerable variation in terms of the independent variables identified by our theoretical framework. The key features differentiating the Greek and Irish political economy backdrops in the context of our theory are summarised in Table 3.2.

First, the theoretical framework of Chapter 2 highlights the role of the domestic veto-player constellation - including both formal and de facto veto players - in influencing sovereign credibility in financial markets. There is no agreement among political scientists on exactly how to count veto players, so estimates from different experts may vary. That said, while these differences mean that individual country figures cannot be compared across different databases, countries can be compared within each database. In order to ensure a reliable estimate of the relative number of formal veto players, this book refers to the data from the World Bank DPI, which includes information for both Greece and Ireland in the period under consideration (2009 and 2010). Specifically, we use the CHECKS index,²⁰ measuring both constitutional and veto players and accounting for the ideological orientation of the parties in the government coalition (Keefer, 2010). Moreover, in the context of the case studies, additional nuances not captured by mechanical counts will be highlighted. According to both metrics of veto players, Greece and Ireland are rather differently positioned along the Eurozone (and developed democracies) spectrum. On the one hand, the number of checks and balances in the Greek political system is at the low end of the spectrum for developed democracies. The DPI assigns Greece a CHECKS score of 3 in both 2009 and 2010, among the lowest in Western Europe. On the other hand, in Ireland the number of official checks and balances built into the system is among the highest across both the Eurozone and developed democracies. The DPI assigns Ireland a CHECKS score of 5 in both 2009 and 2010. Moreover, Greece and Ireland are diametrically opposed in terms of the polarisation of the political system along the left-right continuum, and specifically in terms of social contestation. On the one hand, Greece has a history of a strongly polarised ideological system on the right- left continuum. Meanwhile, the Irish social and political landscape features exceptionally low cleavages along the right-left continuum and low levels of social contestation on economic issues. As a metric of the overall degree of social contestation, it is remarkable that Greece accounted for almost half of all the general strikes held in Western Europe in the period 1980-2008, with a total of 38, while no general strike took place in Ireland over the same period (Kelly and Hamann, 2010).

The second set of factors that the theory identifies as meaningful in driving sovereign risk perceptions of financial markets pertains to the international sphere. In particular, the theory highlights the role of "proximity" between the sovereign borrower and its creditors. Here, too, Greece and Ireland are at opposite ends of the spectrum in terms of trade and financial integration with the rest of the EMU and the global economy. Ireland is highly integrated with the rest of the global economy, and Europe in particular. It is, in fact, one of the most open economies in the world. It has very high levels of both exports and direct investment in relation to GDP: 101% and 123% of GDP, respectively, in 2010.²¹ Ireland is a preferred location for US multinationals' hubs in Europe, and over the last 20 years has attracted large investments in high-technology export-oriented sectors and finance. Greece is at the opposite end of the spectrum in terms of trade and financial integration with the rest of the EMU and of the global economy, with a very small export sector and relatively low international direct investment in the country. Total exports were 23.5% of GDP before the crisis,²² with tourism accounting for a significant part and merchandise exports amounting to a mere 7.7% of GDP. Inward foreign direct investment flows were also modest over the years, with inward foreign direct investment reaching only 16% of GDP in 2007. Moreover, EMU and international banks were much more exposed to Ireland than to Greece by the time of the sovereign debt crisis, particularly due to the risk of market contagion in the event of bank failures. Also, the overall exposure of the global banking system to Ireland was almost double that in the case of Greece, in spite of Irish GDP being about two-thirds of Greek GDP.