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The closure of banks and violent protests in front of the Greek Parliament, have grabbed the headlines these past few weeks. Why is Greece in such dire straits? How will this crisis play out? How will the Greek crisis impact other fragile European economies like Spain and Italy?
What is the crisis all about?
On June 30th, 2015, Greece became the first 'developed' country to default on its loan obligations, when it failed to make a 1.55 billion euro payment to the IMF;putting itself in the dubious company of countries like Zimbabwe and Argentina who have defaulted earlier.The debt Greece owes its creditors stands at 170% of the GDP today and according to the IMF could go as high as 200% in 2017.
This is the third bailout package for Greece in the last five years. Clearly the Greek economy is not competitive enough to produce enough revenue to service its debts and other government payments like pensions.Why doesn't Greece reform? What ails that country?
Even more importantly, if help continues to be extended to a recalcitrant Greece, what will other countries in the same situation like Ireland, Spain, Portugal and Italy do? Will they too start asking for more? Is this bailout really the end of the crisis or merely the opening note of a new sequence of unkept promises and more instability? Will the Greek crisis turn into a 'Greek fire' and incinerate other fragile European economies? ('Greek fire' was a mediaeval incendiary weapon).
International reaction
In 2009 when the Financial Crisis developed, there was particular concern about the economic health of five countries; namely Portugal, Ireland, Italy, Greece and Spain, called 'PIIGS'. The common problem they faced was massive debt, both private and government. Structural problems embedded in their laws, along with the global downturn pushed these countries into a sharp contraction. (Washington Post, July, 13, 2015).
The problem really surfaced in 2010, when the markets began to realize how much more money these countries needed to borrow,just to keep their economies functioning. Greece was seen as an extreme problem, while other countries too were viewed with pessimism. Interest rates at which creditors were willing to lend money rose sharply. To restore market confidence and to get help from the European Central Bank and other global lenders, the countries had little choice but to go in for austerity measures. These included cutting government expenditures and taking measures to increase tax revenues, measures to reduce the 'structural deficit'.Structural deficit shows how a country taxes and spends its money and is a key measure of commitment to good economic policies.
How Greece sees it
Greece has already endured far more austeritythan any other flailing European economy, swinging from a structural deficit of 18-percent deficit to a 2-percent surplus, a change of twenty percent, more than double what any other country has done. (Washington Post, July, 13, 2015).The strict austerity measure has led to a depression - Greek GDP has contracted by a quarter - which while not as deep as the one the U.S. suffered in 1929 has actually gone on for much longer. Further, unemployment is 25%.This has led to massive protests against further austerity measures. Another down side is that with the new measures the economy would likely dwindle even further. This would impact the fisc in terms of lower collection of taxes and ability to meet obligations. Thus a downward spiral may become inevitable.
How Greece compares
Ireland has achieved a 9% reduction in the structural deficit, while Spain and Portugal have advanced 7% each. Italy's economy is the exact same size that it was in the year 2000. But Spain's hasn't been much better. Salaries in Spain remain low, and unemployment remains high at about 24%. The Portuguese economic performance is a puzzle, since it has fallen behind,even without a 'bubble' as happened in Greece and Spain. The last time it posted real growth (of more than 3%) was inthe year 2000. In the 2000 - 2008 period Greece was one of Europe's fastest growing economies.
The problem
The reality is that the adoption of the euro has prevented these countries from covering up their structural problems. When they had their own currencies, these countries could allow their currencies to devalue, thus regaining competiveness. This also ensured political stability, as nominal incomes in terms of the local currencies would remain stable, even as they would plunge in real or dollar terms.In other words, the Italian lira could fall in value making Italian exports cheaper and offering a boost to growth. It doesn't have the luxury of a cheaper lira now, though, so it's been stuck in a no-growth trap that has no sign of turning around soon. (Washington Post, July, 13, 2015).
Over-regulation breeds uncompetitiveness
There is no doubt that sound economic policies are necessary for sustained growth. Equally important is the environment in which businesses operate. Highly regulated economies become inefficient.
Take, as one small example, medications. Greece is one of the few European countries that sets prices for over-the-counter drugs, which can be sold only in licensed pharmacies, the Organization for Economic Cooperation and Development reported. Pharmacies must be owned by licensed pharmacists and they can each own only one. Other rules dictate where new pharmacies may open, as well as their operating hours. As a result, prices for consumers are higher, as are retail margins for the pharmacies. (NYT July 15, 2015).
The solution
Too often, the debate over Greek economic policy is oversimplified into a classic macroeconomic tussle between "austerity" and "stimulus" (NYT July 15, 2015).The danger is that the latest debt deal, while accepted by the political class still has many detractors amongst the general public. One huge issue is implementation of reforms. The Greek government needs to improve the judicial system, write a new civil code, fight cartels in product markets and reform public administration very quickly. Such reforms should improve the country's wellbeing, but enacting them speedily would be a tall order for even the best-organised administration, which is absent in Greece today. (FT July 16, 2015).
Yet the immediate and real problem is the very high level of debt. Most observers agree that Greece would not be able to repay its debts. Perhaps this is why the IMF, in a refreshing change from the past,has been calling for pardoning most of the debt owed by Greece. Eitheroutright, or by greatly extending the tenure of the loans.
But is this solution so simple?
Pardoning Greece's debt is however not so easy. Apart from the haircut that the lenders will have to take, there are real concerns about whether this will set an unhealthy precedent to the other countries that collectively are known as PIIGS - Portugal, Ireland, Italy and Spain. It would be very difficult for politicians in these countries to sell austerity measures to their public, in order to continue getting funding support, when one country's debts were "forgiven".
The problem with the Greek tragedy is that it is not Greece alone - there are other fragile countries within Eurozone that are eagerly watching the unfolding of events in Greece to see how they might want to react, in terms of maintaining their own austerity obligations. It is perhaps for this reason that some experts believe that the final solution lies in the break up of Eurozone, with each country going its own way. That's not a comforting thought for markets, as markets detest uncertainty. Will the Greek tragedy finally fell the Euro? That's what is keeping world markets on tenterhooks.
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