Making a crisis out of a Greek drama
ESSAY: To overcome the Eurozone crisis, we should declare war on the fatalist notion that sluggish growth is the ‘New Normal’.
The crisis in the Eurozone has been lurching from one country to another over the past year or so. After bailouts for Greece, Ireland and Portugal, and with a second bailout for Greece in the offing, the financial markets this week turned their attention to Italy, a far larger economy than those previously affected. Spain, another country struggling to pay its way, has also been hit by austerity measures and political turmoil. But while it is easy to get caught up in the specifics of each new stage of the crisis, it is worth taking a step back to understand what is going on and the possibilities for the future.
The Euro crisis, like just about every other economic story these days, has a three-fold character. It is not, in fact, a single crisis; it has three inter-related elements: financial, economic and political.
Of the three, the financial crisis is, paradoxically, the least significant, even though it is the most prominent of the three and the one which threatens to spin out of control with serious broader consequences. Alongside the financial, the economic aspect is the most entrenched and material of the three, while the political crisis – that is, the failure of the political elites to get on top of the other two challenges – is the most critical, as it is, or should have been, the key to the resolution of the other two. The shift in focus to Italy, the Eurozone’s third largest economy, indicates that time may have run out for effective containment. The Euro genie is probably out of the bottle.
Let’s look at each of these three aspects in turn, focusing on Greece as the catalyst of the wider European turmoil.
The financial crisis
First, the financial aspects, which encompass both the high level of Greek state indebtedness and also the fragility of the various private banks that lent to Greece. In 2009, Greece hit a budget deficit – the difference between state spending and tax receipts – equivalent to 15 per cent of GDP, bringing total government debt levels to €300 billion, the equivalent of 127 per cent of GDP, after years when government debt had hovered around 100 per cent of GDP. Of this outstanding debt, about 70 per cent is held abroad (other governments borrow a greater proportion domestically), mainly elsewhere in Europe, which adds to the anxieties about debt management.
Despite the introduction of sweeping and deeply unpopular austerity measures, the Greek annual budget deficit is still running at nearly 10 per cent; government debt is expected to rise further from 142 per cent last year to over 150 per cent this year, with every prospect of further annual increases. With high and rising debt, no one in the markets sees how Greece can avoid debt default of some type. As a result, the interest rate on two-year government bonds has shot up to over 25 per cent, an unrealistic level for raising fresh short-term debt.
Why the shift in crisis thinking to sovereign debt? Since the Western financial crisis of 2008-09, we’ve seen many Western governments attempting to limit the short-term impact of the crisis by getting their states to take on even more responsibility for the running of their economies. This has gone from taking over some of their banks and/or responsibility for their bank’s bad debts (Ireland has gone further than most in this direction), to pumping money into their economies to limit the economic fallout. This form of state economic intervention is known variously as demand management, fiscal deficit spending, or Keynesian pump priming: the US administration has been among the most open about pursuing this approach.
In short, as a result of all these state counter-crisis activities, one credit crisis seems to have metamorphosed into another one. The focus in the West has shifted over the past three years from a private debt/credit problem – catalysed by the sub-prime borrowing crisis of the US – to a public debt concern, the ‘sovereign debt crisis’. Greece is in the forefront, but many other governments have been moving in and out of the spotlight, too: from the other members of the Eurozone ‘PIGS’ – Portugal, Ireland and Spain – now to Italy, with Britain, Japan and, the biggest government debtor of them all, the US, occasionally in the frame.
Greece’s debt is certainly very large relative to the size of its economy. Today, the way things are economically and politically, the Greek government can be called ‘insolvent’: it looks unable to be able to earn enough, or even to borrow enough over the medium- or long-term at low enough interest rates, to pay off the debts that will fall due over the next few years. Only the state of denial by Europe’s political class prevents this harsh fact from being far more widely recognised and acted upon.
However, a consoling note from history is in order: relatively large debts do not automatically translate into economic catastrophe. Many economies have coped well with debt greater than GDP in the past. Japan debt levels today are over 225 per cent, yet few seriously question Japan’s ongoing capacity to service such levels of borrowing. UK debt levels also topped 200 per cent of GDP after the Second World War, but fell steadily to under 50 per cent by the early 1970s.
What matters for the sustainability of any particular debt level are the current and, more importantly, the potential future capacity of an economy to service it, to make the payments.
The economic crisis
This brings us to the second more substantial leg of this crisis: the dire state of the economic fundamentals. Greece’s budget deficit and national debt began to explode after 2008 not, as some assert, because of the effect of some suspect spending initiatives, but because the economy went backwards fast: recession-related welfare spending rose, while tax and other revenues fell away as economic activity contracted swiftly. But Greece’s economic problems go back long before the onset of the recent global slowdown, and it is these that have made a crisis out of Greece’s debt drama.
Greece had a narrow and relatively insubstantial base for wealth generation, based largely on tourism and shipping, when it became part of the Eurozone in January 2001. (Greek entry was delayed two years from the Eurozone launch due to it not meeting membership criteria with respect to debt levels. It is now clear that it will never qualify to join the club.) Its weak economic fundamentals remain today.
The extent of its economic deficiency is evident when we look at productivity levels. Even after the subsequent decade of growth that stood out as being statistically much faster than the European average, Greek productivity levels (measured as output per hour worked) remain only 60 per cent of those in Germany and France and two-thirds of the Eurozone average as a whole.
Cheap financing during the past decade made possible by Eurozone membership – a benefit for all the weaker peripheral Euro economies – disguised the continued backwardness of Greek productive capabilities. Government borrowing, primarily from French, German and Swiss banks, financed persistent budget deficits of approaching five per cent per year that helped keep the economy growing at a similar pace.
The little remarked downside of this buoyant GDP growth was a steady rise in the balance of payments deficit, making the economy as a whole increasingly dependent on inflows of foreign capital. In relation to GDP, the current account deficit – effectively the amount of wealth a country is ‘borrowing’ from the future – rose sharply. In the late 1990s, the Greek current account deficit was about three to four per cent of GDP – generally perceived by the markets to be sustainable for a developed economy that is growing each year at a similar rate. But during the Noughties, this rose to a more challenging rate of six to seven per cent. Since 2006, the rise of the external deficit to double-digit levels should have been a stark enough warning of the paucity of the domestic productive component of those impressive GDP-growth figures. Greece was consistently and increasingly importing more to live on than the amount of goods and services it was able to sell abroad. This widening imbalance could not persist for ever.
However, it was only when the recession precipitated by the Western financial crisis struck in 2008 that the phoney nature of much of Greek economic growth began to be more widely recognised. The balance of payments deficit hit 14.5 per cent in 2008. The foreign debt markets and the Euro establishment began to worry, setting in train the events leading to the initial €110 billion EU-IMF Greek bailout in May 2010.
The political crisis
This brings us to the third and most critical leg of the triple crisis: the political element. The biggest problem of this crisis, and the one that could have been the easiest to resolve (though the train may have left the station for that possibility now), has been the political elite’s prevarication and dithering. It’s hardly a novel point to make that putting off resolving financial crises tends to make them worse, but the unfolding of the Eurozone crisis is almost a textbook instance of this error of financial crisis management.
Given the elite’s recent proclivity for procrastination, it is perhaps not surprising that William Rhodes – the Citi banker and globe-trotting troubleshooter who helped advise governments during a succession of financial crises over the past 30 years – made the elementary requirement for quick and decisive action a key lesson in his recently published memoirs, Banker to the World. It’s a message Europe’s leaders have still to take on board. Instead, for the past two years we have had one delaying tactic after another, culminating in last year’s bailout with a repeat bailout still under earnest consideration today. ‘Once bitten, twice shy’ doesn’t seem to rate in Europe’s stock of homilies.
One explanation for the irresolution of Europe’s political leaders is that they have been trying to grapple with two issues simultaneously: containing the Greek debt crisis from causing economic turmoil across the rest of Europe, while at the same time seeking to avoid any public setback to their grand pan-European project. This dual mission has added to their sense of quandary and uncertainty and their failure so far to act decisively.
Technically, though, these two goals are not incompatible: one can conceive of a Greek rescue package without requiring Greece to leave the Euro. However, the two goals appear to be at odds for Europe’s leaders. Firstly, Europe’s leaders have exaggerated the initial debt crisis, making it seem more daunting to them than it really was, and, secondly, the European project that they remain at least rhetorically attached to has already come to the end of the road. In reality, their dithering was to a great extent self-imposed. There appears to be a congenital tendency within the Western elite to make more of crises than they warrant.
Meanwhile, their other concern is somewhat anachronistic and futile; the drive for European unity is already exhausted. Ironically, there have been no serious pan-European initiatives since the launch in 1999 of the now crisis-ridden Eurozone. Even the relatively minor changes embodied in the Nice and Lisbon treaties provoked a considerable backlash from voters, while a proposed EU constitution was abandoned. This itself shows the absence of any real recent momentum behind European integration. The way the Greek and other debt problems have been handled, or mishandled, is more a sign of the fraying of the European project than the existence of the debt problem itself.
Of course, the underlying economic underdevelopment of Greece, and of other peripheral Eurozone economies, shows the intrinsic difficulty of imposing a common monetary union on such an uneven economic aggregation, without the pre-existence of a common political entity with real popular legitimacy. Having lost the use of key national management tools like national interest rates and control over national currency levels, and in the absence of a popularly recognised and accepted fiscal union, the weaker countries in the common monetary union were bound to suffer disproportionately when economic times got hard.
It was not just the critics of the increasingly authoritarian and undemocratic nature of the Brussels-led project of European unification who saw this flaw in European Monetary Union. Many Euro-advocates were equally aware of this intrinsic contradiction when the Euro was launched, but took comfort that when this latent tension exploded, as it was bound to do at some time, the inevitable crisis could be an opportunity to force forward with further imposed political integration. Well, the crisis has now happened, but most of the elite’s political will to move forward has petered out in the meantime. Instead, national interests have become more pronounced over the course of the past decade, not least since the financial crisis struck. Even the Greek bailout last year, while painted by Germany and France as the act of good European citizen-states, served more to pre-empt the potential national bailouts of French and German banks in the event of a serious Greek default.
Hence all the vacillation, delaying and shifting infighting that we’ve seen throughout the past year from the key players: the French and German governments, the European Central Bank (ECB) and the European Commission. A supposedly intractable financial problem has got itself mixed up with the exhausted political project of contemptuously imposing political unity on the people of Europe. The result is double muddle and dilly-dallying from Europe’s political class. Public anger and hostility to the austerity and sacrifices being demanded, explicitly and implicitly, across the European Union only add to the elite’s sense of uncertainty about what to do.
The most important political lesson of this whole affair is that it confirms that the detached and aloof European elite has lost its bearings in general and, in particular, its internal impetus to move forward with the ‘ever closer union’ envisaged by the various European treaties. The chimera of a top-down, united and integrated Europe has happily fallen apart. Unfortunately, the reversion to the squabbling, and potentially greater conflict, between national politicians has no more to commend it.
Let’s conclude on the economic implications of this mess. First, for all the laboured debates going on in Europe at the moment, the particular form of the Greek restructuring of debt is of little import. Restructuring has to happen and as a result existing creditors will lose out in some way – that’s a given. Unfortunately, this also means there is no painless way out for the Greek people. From the perspective of stopping market anxieties from spreading, the timing of the restructuring was, and maybe still is, more important. As America’s Second World War general, George S Patton, recommended: ‘A good plan violently executed now is better than a perfect plan next week.’ In the case of Greece, any full-blooded plan for debt restructuring would have been better than the current tactic of hoping that the financial challenges will dissipate simply through the passage of time.
Secondly, while it is promoted by some, even the devaluation of a revived Greek drachma, following a possible Greek exit from the Eurozone, would not be a solution to economic weakness. Currency devaluation automatically makes a country’s exports cheaper and imports more expensive. This can give a leg up to a country’s exporting industries: imports become more expensive, exports get cheaper. Economists often recommend devaluation as a way of getting out of an economic hole, but this is getting relationships upside down.
Currency levels are followers, not drivers, of the economic fundamentals. They tend to follow relative movements in productivity. Devaluation by the government of a relatively unproductive economy is recognition, often overdue, of that weakness, not a way of overcoming it. Relative economic decline is generally not an episode but a secular trend; it’s unlikely to stop spontaneously. Unless other more radical steps of economic restructuring and rebuilding are taken to stem and reverse the decline in relative productivity, acts of currency devaluation provide only temporary respite.
Which brings us to the potential solution that is both least discussed and most important: a progressive and proactive growth strategy has to be part of the solution to any debt crisis. Kicking the can down the road again and again is not a strategy that can work. More debt on its own cannot be a way to resolve high debt levels. If a country is living beyond its means, then taking on more debt only postpones an inevitable reckoning. On the other hand austerity, the favoured approach to Greece from the IMF and the European oligarchies, brings huge pain and tends to produce a spiral of decline. Governments spending less combined with falling living standards – assuming people accept this regressive step backwards – can appear to work arithmetically in the short term. However, over time an austerity programme is a recipe for self-feeding decay and decline.
Ruling out more debt and a cycle of deepening austerity only leaves the solution of generating more income, which ultimately means the economy has to produce more wealth. This requires more investment for future wealth production. Creating a new dynamic of productive growth in Greece or any other indebted country – something sadly lacking across most of the Western world for many years now – would give existing Greek creditors the assurance their debts would be repaid and make it easier and cheaper for Greece to borrow more for the growth-enhancing investments required.
Faster economic growth has become an unfashionable, and to some a seemingly unattainable goal for the West. Instead we are told to expect and adapt to what many call a ‘New Normal’ world, characterised by sluggish growth and near stagnant, if not falling, living standards.
On the contrary, Greece, and the West generally, is consigning itself to a grim future unless we reject this fatalist mood. We need a decisive and radical programme to restructure not just debtor country government finances but their whole economies in order to generate expanding wealth creation. The PIGS could fly economically if they seized this opportunity. If not, not only will the European government debt crisis continue to fester and unravel, but the Great Divergence between a decaying Western economic world and the rising Eastern one will also continue to widen.
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