The Greek Debt Crisis: A History of Preventable, Now Fixable, Mistakes

​The 21st century began with the dot-com bubble. Growth was marked by soaring stock prices and IPOs that benefited investors, not the companies they valued. The debate following the burst was a simple one: did young entrepreneurs fool the financial market into buying millions of shares of shell companies with no viable business plans or did investors dupe entrepreneurs into selling those same shares at peak prices for maximum profit creation? Now, the dot-com bubble’s burst is a distant memory; our economic faculties currently transfixed east towards the once mighty Greek peninsula. What began as a lackadaisical response to the United States’ Great Recession, soon transformed into an exposé on lack of government control, statistical misinformation, and a country unable to escape their burdening debt. In order to better understand the historic Greek debt crisis, this paper will provide background on the Greek economy before and after the euro, examine the origins of the debt crisis and its global implications, and finally observe steps taken to solve the crisis while providing recommendations for Greek debt relief.

In the 1990s, a Greek economist, Miranda Xafa, continued to notice the handiwork of the head of the of the statistical agency of Greece, dubbed “the magician.” In order for the Greeks to move from their old currency, the drachma, to the Euro, it had to abide by several stipulations set by the EU member states. The fiscal treaty that 25 of 27 EU member states agreed to ensures that no country have a budget deficit of 3% of GDP (Gross Domestic Product) or greater, this rule was created in the 1992 Maastricht Treaty. But, this magician helped the Greek government alter records in order to fit this subjectively unattainable benchmark. Xafa uses the example of the Greek state railroad, losing a billion euros a year with more employees than passengers. In order to hide the failure of this branch, the railway company would issue shares the government would buy, counted not as an expenditure, but as a transaction and therefore not on the budget balance sheet (Little 3). While this anecdote provides ample backdrop for the government’s deceptive statistical practices, it also illustrates that the Greek economy was not ready to take on the euro. In fact, the former head of Bundesbank, Ernst Welteke, stated that “Greece should not have joined the EU;” it only accounts for 3% of the economic output in the Eurozone (“Greece was not ready” 2).

The origins of the Greek debit crisis began in 2001 following the introduction of the euro as common currency in the European Union (EU), when reduced trade costs led to an increase in trade volume. While central Eurozone countries saw a decrease in labor costs, outlying countries, like Greece, saw their competitive advantage in exports decline. Both the Greek trade deficit and budget deficit rose from less than 5% of Gross Domestic Product (GDP) in 1999 to 15.5% of GDP in the summer of 2008 (see above). Following Greece’s membership to the EU, the subsequent increase of investments into the country due to lower yields on government bonds spawned concerns that Greece was in reality, a higher credit risk alone than it was as a Eurozone nation (Klein 4). After the United States’ Great Recession spread to Europe, cash flows from the central Eurozone countries, like Germany and France, came to a halt. 2009 reports claiming poor fiscal management, fraud, and duplicity in Greece led to an increase in debt financing costs and suddenly, Greece could no longer support its trade and budget deficits (Hale 6). Typically, a country facing a sharp decline in private investment and high debt could allow the currency to depreciate, encouraging investment and allowing the nation to pay back “cheaper” debt. This was not an option as long as Greece used the Euro. 

In an attempt to create artificial deflation and earn a competitive advantage over their central European counterparts, Greek wages were lowered by nearly 20% from 2010-2014. The drop in wages further reduced income and GDP, resulting in a severe rise in the debt-to-GDP ratio, up to an enormous 177.1%, nearly double the average Eurozone country. Greek citizens also tend to work one third more hours over their lifetime than their German counterparts (Majka 4). Despite unemployment more than doubling in the past decade, up to 25%, Greece was able to produce a budget surplus in 2014 due to substantial spending cuts (Kashyap 3).

​In early 2010, the watershed Stability and Growth Program 2010 report was published by the Greek Ministry of Finance, listing several reasons for the debt crisis. First, the GDP growth rates were lower than the originally reported. The report cited the need to improve competition by reducing salaries and the need to forward spending from non-growth sectors of the economy, like military and social security, into positive growth sectors. Second, the government deficit that developed in 2004 and accelerated through the Great Recession was exacerbated when “output increased in nominal terms by 40%, while central government primary expenditures increased by 87% against an increase of only 31% in tax revenues” (“Update of the Hellenic Stability and Growth Programme” 14). Next, the Ministry of Finance described the most important cause of the national debt to be the government debt level. Previously discussed as a percentage of GDP, the Greek recovery effort appeared to rest on the shoulders of simple austerity measures that would focus on the government deficit. Finally, budget compliance and statistical credibility are two reasons outside of direct financial causes. Both issues were caused by poor management, an inability to develop accurate metrics, and a lack of proper risk assessment. Data was so inaccurate that despite retracting several reports due to underestimating national debt, reports from 2005-2010 had to again be revised in the summer 2015 edition of the Hellenic Statistical Authority’s quarterly report (“Greece in Figures” 37-39). Tax income has been below expected level in each of the past 20 years and tax evasion in 2010 cost Greece approximately $20 billion in lost revenue (Torchia 5). While there were several exogenous factors worsening Greece’s debt, it should become clear that the government’s spending and lack of growth were to blame. Despite being the source of the Great Recession that impacted nearly every developed nation across the globe, the United States’ conservative spending plan shortly after the financial crisis is responsible for the GDP growth push needed to escape a worsening hole of debt, the same hole that Greece finds itself in today.

In spite of the internal and external forces pushing Greece into debt, it appears that stability is approaching and the United States is not following Greek footsteps. Half of all loans in Greece, an estimated €107 billion, are in arrears. Conversely, only 2% of loans are at risk of being unpaid in the United States. Despite sustained GDP growth since the recession, GOP officials have used the small European country’s massive debt as an excuse to call for more government cutbacks. In July of 2015, Louisiana Governor Bobby Jindal (R) claimed that “the United States could be the next Greece, if we’re not careful” (Benen 1). The Republican party saw an opportunity to call for a bigger reduction in government spending, but did so for all the wrong economic (perhaps for political) reasons. As previously noted, Greece’s primary cause of debt is due to excessively poor borrowing and irresponsible lending, but the euro prevented Greece from exercising fiscal austerity. The United States proved during the aftermaths of the Great Depression (and subsequently, the Great Recession) that the key to climbing out of debt is a focus on increasing GDP and decreasing the unemployment rate, something Greece has failed to accomplish since the 2008 crisis began (see below).

In spite of the internal and external forces pushing Greece into debt, it appears that stability is approaching and the United States is not following Greek footsteps. Half of all loans in Greece, an estimated €107 billion, are in arrears. Conversely, only 2% of loans are at risk of being unpaid in the United States. Despite sustained GDP growth since the recession, GOP officials have used the small European country’s massive debt as an excuse to call for more government cutbacks. In July of 2015, Louisiana Governor Bobby Jindal (R) claimed that “the United States could be the next Greece, if we’re not careful” (Benen 1). The Republican party saw an opportunity to call for a bigger reduction in government spending, but did so for all the wrong economic (perhaps for political) reasons. As previously noted, Greece’s primary cause of debt is due to excessively poor borrowing and irresponsible lending, but the euro prevented Greece from exercising fiscal austerity. The United States proved during the aftermaths of the Great Depression (and subsequently, the Great Recession) that the key to climbing out of debt is a focus on increasing GDP and decreasing the unemployment rate, something Greece has failed to accomplish since the 2008 crisis began (see below).

While the effect on the United States is negligible at worst and nonexistent at best, the future of Europe’s economy is likely in Greece’s hands. Prime Minister Alexis Tsipras acknowledged his country’s massive drop in GDP, 25% unemployment and 50% youth unemployment, but remains uninspired to alter the conditions of lending in his country (“Europe’s future” 1). The prime minister believed that creditors would relent on the promise of protecting fellow euro members, but they would not support delinquency and maintain the system should have some degree of discipline (“Europe’s future” 1). European leaders do not support a system of unconditional transfers in which crises are inevitable, particularly with the Eurozone’s reliance on bailouts. This downward spiral can be seen in the ruination of politics through forgiveness of debts from Italy or Portugal or austerity demands in Finland or Germany (“Europe’s future” 2). A stable currency is a fair tradeoff for fiscal sovereignty and Eurozone nations must create mechanisms to channel funds to countries in case of recession – a pooling of debt responsibility. While five of Europe’s leaders have issued papers on improving the euro, the aftermath of the Greek debt crisis shows the world that European leaders must face the contradictions of the euro and place the region on a path of consistent commitment or suffer consequences in other risky nations.

The July 2015 €86 bailout package to solve the debt crisis, proposed by the International Monetary Fund, comes with several stipulations, including €50 billion in government assets to be collected into a privatization fund that will be used to recapitalize Greek banks (Thanki 1). In addition to a transfer of national assets, Greece must also “improve long-term sustainability of its pension system,” a system that has been seen as too generous, which would allow Greece to save .25-.5% of GDP in 2015 and 1% of GDP in 2016 (Wearden 2). Greece would also need to reform value-added taxes, which discount up to 30% for the Greek islands, a major tourism draw, legislate spending cuts which would create a 1% budget surplus in 2015 and a 3.5% budget surplus by 2018, repay the European Central Bank to help cover debt repayments, restructure debt to ensure payment to the ECB and IMF and a host of more radical reforms to ensure that the Greek oligarchy make a fair contribution and modernize its economic thinking (Wearden 4). While austerity measures and radical reforms continue to take shape, the idea of a Greek exit (or “Grexit”) from the Eurozone persists in international media. With Greece’s ECB payments of over €10 billion in June and July of 2016 placing a strain on the country’s already burdended debt relief funds, the argument for the Greeks abandoning the Euro has never been stronger (Chrysoloras 1).

​But, there are several reasons why a Grexit would be detrimental to the Greek economy and a failure. First, the short-term effect would be hyperinflation, as Greece would have to print its new currency continuously (Thanki 3). According to analyst Ruben Segura-Cayuela, growth would only occur in the Greek economy in the long term if Greece could administer the reforms that would be necessary to avoid a Grexit altogether, but these reforms have not been implemented (Thanki 4). Inflation would also soar into double digits and a GDP contraction would occur, similar to Argentina’s 11% the year following its devaluation (Thanki 4). A currency devaluation may not increase GDP in Greece, a country not export-driven and could cause import prices to rise and the cost of living to increase. Ireland, Spain, and Portugal all increased exports to adjust to the euro, while Greece contracted its imports, making it an outlier and a turnaround through devaluation unlikely (Thanki 5). The government is not only unsure it could survive a Grexit, according to Prime Minister Tsipras, but it’s liquidity shortage shows that the ECB is so unwilling to add capital that the government may have to start paying in IOUs, now becoming a parallel currency to its near-worthless refinancing (Thanki 7). Political and social unrest in the country would undermine any effort to stabilize imports and weaken tourism to the point of re-elections of new leaders with unknown consequences. Greece should not abandon the Euro.

Greek Prime Minister Alexis Tsipras. Source: http://www.businessinsider.com/greece-alexis-tsipras-prokopis-pavlopoulos-presidential-candidate-2015-2?r=UK&IR=T

Since it appears that previously described efforts to bail out the Greek economy are not succeeding in providing Greece with long term economic solvency, more radical and holistic changes to the Greek economic philosophy and implementation strategy are required. According to RBS Economics, Greece’s 25% fall in real GDP is among the worst of any advanced economy since 1870, occupying the only top spot not directly war related. Many have suggested that Greece’s best option lies in escaping the ironically restrictive holds that the euro places on allowing currency to close the debt gap. It seems unlikely that the Greek Parliament would chose to leave the group of countries responsible for lessening the debt burden on the small Mediterranean country. Milton Friedman, Nobel Prize winning economist, previously warned that Europe’s 60-year integration project to form the European Union wouldn’t work for countries with different economic needs, all sharing one monetary policy. Greece’s interest rates were too small in the early 2000s, leading to an interest rate below sustainability. But, the crisis was made worse with currency that was too strong. Investors treated Greece, a risky country, the same as Germany, a country with much less risk, simply because they are both part of the Eurozone (O’Brien 5). Following the debt crisis, investors leaned towards less-risky financing, including German and U.S. Treasury bonds, and away from risky, Greek bonds. Instead of being able to devalue its currency, Greece was forced to shrink their economy through cutting wages, further increasing unemployment. The gold standard that developed in the 1930s created similar attachments, but Europeans hold the euro to a higher, moral standard than the U.S. held gold before the Great Depression (O’Brien 6). It seems like the solution doesn’t lie with Greece “escaping” the Eurozone for greener, much more expensive pastures. It’s been made clear that Greece’s debt problem begins with a lack of GDP growth and a lack of exporting, and the solution lies in rectifying both causes. According to Yannis Ioannides, a Tufts University economist, “debt is ultimately the lesser problem. Productivity and the lack of competitive exports are the much more important ones” (Surowiecki 1). Half of all Greek manufacturers have less than fifty employees, creating a productivity and efficiency chokehold. Strict regulations limiting competition with existing firms coupled with an environment discouraging investment leads to statements from Prime Minister Tsipras like “[we plan to] liberalize the market for gyms” (Surowiecki 2).

The good news is that Greece has already made reforms in the past three years to combat these issues, jumping 111 places in the World Bank’s “ease of starting a business” index from 2013-2014. In terms of increasing exports, Greece has a litany of goods it has yet to fully exploit in the world market. Greek olive oil is world renowned, yet 60% of it is sold in bulk in Italy for massive markups. The same could be said for cheeses and yogurts. Tourism is 18% of GDP, but a majority of Greek tourists are, in fact, Greek. Through an increase in marketing and infrastructure investment, Greek could cut itself a large share of the growing global tourism pie. Simply put, Greece’s current economic problem is completely sustainable and through intelligent spending and productivity growth, completely surmountable. The nation of Greece must reform its political institutions to increase trust with its citizens, the chief cause of the nation’s incredibly high tax evasion rate. Through open economy reform, citizens would be encouraged to buy in (literally and figuratively) into the same markets that are currently making them hold on to what they have left. Ideas to close the debt gap and possibilities for restructuring the economy are easy to find throughout Greece and their fellow EU counterparts, but the government and the public need to own the reform that’s sitting in the financial ether.

There’s no debating that Greece’s current hole has a multitude of institutions and exogenous variables to blame. But, the triumphant return of this former Mediterranean powerhouse rests squarely on the shoulders of its people and newly elected Prime Minister. While Tsipras asked for a second chance preceding a third electoral vote in nine months, he must now readjust to be the leader the Greek people need him to be in order to pull the country, at least partially, out of debt (Foster 1). The United States’ dot-com bubble and the Greek debt crisis appear to have little in common, but both nations, with histories of economic success were faced with deciding crossroads. Will Greece turn this deficit into an opportunity for reform both politically and economically, like the U.S. accomplished while adjusting to the newly exploited internet? Or will Greece become a member of a not top-10 of failed economies following crises? The clock is ticking; while Greece has taken a few steps forward to combat its self-inflicted wounds, it now relies on its people to enact change in production and perception.
 

 
Works Cited

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