Greek Crisis in Perspective: Origins, Effects and Ways-Out

Abstract

In 2011 the Euro faced its toughest challenge since its introduction as several of the participating Member States faced unprecedented financial problems. Greece was the most severe case requiring intervention from the EU and IMF to stabilize its economy and repay debt obligations. This article explains the debt process in Greece from the 1980s to date, and describes its main causes and episodes. It also assesses the IMF-EU Memorandum and argues that the collapse of growth inhibits the prospects of debt stabilization. An alternative scenario is discussed showing that stabilization can become more effective and realistic if recession is tackled first and reforms follow on a steadier path.

Introduction

In the aftermath of the global financial crisis of 2008, a number of Eurozone countries were engulfed in a spiral of rising public deficits and explosive borrowing costs that eventually drove them out of markets and into bail-out agreements jointly undertaken by the International Monetary Fund (IMF), the European Union (EU) and the European Central Bank (ECB). Greece was by far the most perilous case with a double-digit fiscal deficit, an accelerating public debt which in GDP terms was twice as much the Eurozone average and an external deficit near 5,000 US Dollars per capita in 2008, one of the largest worldwide. No wonder that Greece was the first to seek the bail-out assistance and the last expected to exit its ever-changing conditionality terms.

Two and a half years after the bail-out Memorandum was signed, the situation remains highly uncertain. The economy faces an unprecedented recession, unemployment is rocketing, social unrest undermines the implementation of reforms and the fiscal front is not yet under control, despite extensive cuts in wages, salaries and pensions. In the summer of 2011 uncertainties multiplied at such a rate that the possibility of Greece exiting the Eurozone was widely discussed either as a punishment mechanism from abroad for not accepting the pains of adjustment or as a quick fix from within to avoid them for good. In two subsequent EU summits, held respectively in July and October 2011, the Memorandum agreement was substantially broadened to include a radical debt reduction, a second round of bail-out loans by IMF and the EU and a generous release of European structural funds to assist the real economy. The agreement was conditional on being approved by the national Parliaments of the lender states as well as by the European Parliament. Finally, the conditionalities of the Memorandum were approved by the Greek Parliament in February 2012 and the debt-cutting process was concluded in May. However, most of the envisaged measures were delayed for the third quarter of the year, as two round of elections took place to provide new legitimacy for carrying on the program and implementing reforms. The prolonged electoral uncertainty meant that most of the adjustment measures were weakened or postponed, leading to new tensions over Greece’s determination. A coalition Government was finally formed in June by parties vowing to apply all policies deemed necessary for the country to remain in the Eurozone, though at the same time seeking some relaxation of the time frame from European authorities.

It is tempting to note that the economic capacity of the country to adjust and the social endurance are diminished exactly when the European environment is becoming more helpful for stressed countries, This makes the Greek problem an unusually interesting case for analysis, not only for understanding its origins and causes but also for devising a realistic strategy to solve it.

The purpose of the present article is twofold: First to provide a historical account of debt accumulation, identify the main difficulties of fiscal stabilization and explain the factors that led to the present crisis and the failure to prepare for it. Second, to assess the main reasons for missing the targets set by the Memorandum agreement and the need for encompassing a growth strategy in order to make reforms acceptable and more effective to achieve debt sustainability in the longer run.

Section “The Period of Debt Escalation: 1980–1993” describes the main episodes of debt escalation in the 1980s, section “Debt Stabilization and EMU Membership” the stabilization effort on the way to EMU and section “Unprepared for the 2008 Crisis” the toxic combination of fiscal irresponsibility, external deficits and political indecision during the more recent period that led to the present crisis. Section “Two Important Policy Facts” describes some recurrent facts on fiscal policies that repeatedly hinder stabilization and growth. Section “An Ex Post Assessment of the Memorandum” attempts an ex post assessment of the policies conditioned by the Memorandum agreement to correct the economy while section “The New Memorandum Conditionalities and Ways-Out of the Crisis” argues why exiting the Eurozone should not be an option for Greece. An alternative scenario based on higher growth is shown to be more credible in achieving fiscal consolidation and stabilizing the debt over the medium term. Section “Conclusions” concludes with the need to fight current recession as the only way for Greece to regain social coherence and debt sustainability in the new landscape of the Eurozone.

The Period of Debt Escalation: 1980–1993

In 1980, Greece became a full-fledged member of the European Union and this marked a wholly new period for the economic and political developments in the country. Greece was one of the first non-founding countries to start accession talks with the Common Market as early as 1961, but the process was abruptly suspended with the advent of the military dictatorship that lasted until 1974. Membership of the European Union was rightly viewed as an anchor of political and institutional stability for the newly restored democracy, but nonetheless it also fed and multiplied uncertainties over the economy.

After a long period of growth, Greece entered a period of recession in late 1970s, not only as a consequence of worldwide stagflation, but also because – on its way to integration with the common market – it had to dismantle its preferential system of subsidies, tariffs and state procurement by which several companies were kept profitable without being competitive. Soon after accession, many of these companies went out of business and unemployment rose for the first time in many decades.

The Government opted for a massive fiscal expansion that included demand–push policies to boost activity and the public underwriting of several ailing companies to maintain employment. The effect was quite predictable: private debts turned into a chronic hemorrhage of budget deficits without any supply-side improvements. Similarly, the expansion of demand simply led to more imports and higher prices. Activity got stuck and Greece ended up in a typical stagflation, perhaps the quickest assimilation to European practices of the time.

As a result, accession to the Promised Land strangely coincided with the unleashing of a nightmare thought to be in dormant thus far: public debt.

Looking at Fig. 1, there are three distinguishable phases for the dynamics of debt: The first covers the period 1980–1993 during which public debt rose from slightly above 20% of GDP toward 100% in 1993. The second phase spans the period 1994–2005 in which public debt ends up again at around 100% of GDP after two mild reductions in between. The third phase covers the period 2006–2011 when public debt surpasses the 100% threshold, accelerates after 2008 and ends up exceeding 160% of GDP in 2011.

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 1

Greek public Debt as %GDP for the period 1980–2011 (Source: Debt of General Government, ESA95 definition, Ameco Eurostat 2011. GDP at market prices, IMF WEO Database 2010)

The above periodicity broadly coincides with substantial shifts in the context of economic policies, as suggested by developments in the fiscal patterns shown in Fig. 2 and in the Current Account depicted in Fig. 3 and briefly discussed below.

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 2

Primary public expenditure and total revenues (incl. privatisation proceeds) as %GDP in Greece, 1980–2011. Election years denoted by (E). Dotted line denotes public receipts net of privatizations (Source: Budget Reports. GDP at market prices, AMECO Database 2012)

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 3

Current Account in Greece as % of GDP, 1980–2011 (Source: IMF WEO Database 2011)

Regarding fiscal developments, the main characteristic of the first period was the substantial expansion of public spending and the concomitant rise in budget deficits and government debt. Revenues increased as a proportion of GDP, but were outpaced by the steadily growing expenditure. Both fiscal components appear to be volatile in the election years 1981, 1985 and 1989, suggesting the presence of a strong political cycle in public finances, as will be discussed later in more detail.

To maintain competitiveness, authorities had adopted, since the mid 1970s, a real exchange-rate target with a crawling peg. After the Government adopted an automatic wage indexation scheme in 1982, the only effect of the exchange rate policy was to fuel price increases and aggravate trade deficits. To break the vicious cycle of depreciation and inflation, a discrete devaluation combined with a temporary wage freeze was implemented in 1983, but it was superseded by a new phase of expansion as elections were approaching leaving public debt at even higher levels.

The external deficit approached 8% of GDP in 1985, an alarming threshold as several Latin American economies with similar imbalances were serially collapsing at that time. A coherent stabilization program was called for in October 1985 enforcing a discrete devaluation by 15%, a tough incomes policy and extensive cuts in public spending. The program achieved a rise in revenues by beating several taxevasion practices and replacing previous indirect taxes with the more effective VAT system adopted by the European Union. Public debt was stabilized, but only until the program was finally abandoned in 1988, after being fiercely opposed from within the Government and the ruling party.

The First Fiscal Crisis

Two general elections in 1989 failed to secure majority, thus leading to the formation of coalition Governments, an event that was hailed as a confirmation of political maturing and an opportunity to overcome partisan differences on major issues. But self-indulging admiration was short-lived, as stabilization policies are notoriously difficult to implement through party coalitions because each party tries to avoid the cost falling on its own constituency. Greece was no exception to the rule and the economy suffered a major setback in 1989, far more serious than previous fiscal failures.

Two episodes are characteristic of how a rhetoric designed to please everybody in combination with naïve policies can lead to disaster: Despite looming deficits, in 1989 the coalition Government decided to abolish prison terms for major tax arrears hoping to induce offenders to repent and reconsider their strategy. Expectedly, the move was interpreted the other way around as a signal of relaxed monitoring in the future, thus encouraging further evasion.

Another bizarre policy was to cut import duties for car purchases by repatriates returning to Greece after the collapse of the Soviet Union. The measure was viewed as a gesture to facilitate mobility back in the motherland, but it was quickly turned into a black-market scheme. At a small bribe, immigrants were purchasing luxury cars only to immediately resell them to rich clients who could thereby avoid the duty tax. The Budget was deprived of badly needed revenues and evaders had yet another reason for celebration.

As a result, revenues collapsed and the country suffered a major fiscal crisis, until a majority Government was elected in 1990 and enacted a new stabilization program. Despite substantial cuts in spending and a rise in revenues, public debt as a ratio to GDP continued to rise because of the higher cost of borrowing worldwide and a stagnant output. The sharp rise in 1993 in particular, is due to the inclusion of extensive debts initially contracted by public companies under state guarantees but finally underwritten by the Budget. Except for the electoral years 1989–90, fiscal consolidation significantly improved the Current Account and such a rarity as a balanced external position was reached in 1994.

Debt Stabilization and EMU Membership

Although Greece was a signatory of the Maastricht Treaty in 1991, it was far from obvious whether, how and when the country could comply with the nominal convergence criteria required to join the Economic and Monetary Union. Public deficits and inflation were galloping at two-digit levels and there was great uncertainty about the viability of the exchange rate system; for a detailed analysis of the period see Christodoulakis (1994).

In May 1994, capital controls were lifted in compliance with European guidelines and this prompted fierce speculation in the forex market. Interest rates reached particularly high levels and the Central Bank of Greece exhausted most of its reserves to stave off the attack; for an account of the successful defense see Flood and Kramer (1996). This episode proved to be a turning point for the determination of Greece to pursue accession to EMU in order to be shielded by the common currency and avoid similar attacks in the future. Soon afterwards the “Convergence Program” was adopted that set time limits to satisfy the Maastricht criteria and included a battery of reforms in the banking and the public sectors.

International markets were not impressed and continued to be unconvinced about exchange rate viability. With the advent of the Asian crisis in 1997 spreads rose again dramatically and – after months of credit shortages – Greece finally decided to devalue by 12.5% in March 1998 and subsequently enter the Exchange Rate Mechanism wherein it had to stay for two years. The country was not yet ready to join the first round of Eurozone countries in 1998,and Greece was granted a transition period to comply with the convergence criteria by the end of 1999.

After depreciation, credibility was further enhanced by structural reforms and reduced state borrowing so that when the Russian crisis erupted in August 1998, the currency came under very little pressure. Public expenditure was kept below the peaks it had reached in the previous decade and was increasingly outpaced by the rising revenues and various one-off receipts. Tax collection was enhanced by the introduction of a scheme of minimum turnover on SMEs, the elimination of a vast number of tax allowances, the imposition of a new levy on large property and a rereorganization of the auditing system. Proceeds were further augmented by privatization of public companies and, as result, public debt fell to 93% of GDP in 1999. Although still higher than the 60% threshold required by the European Treaty, Greece benefited from the convenient interpretation that it suffices “to lean toward that level”, as previously used by other countries – such as Italy and Belgium – in their own way to enter EMU.

The Implementation of Market Reforms

In the 1980s, structural reforms were hardly on the agenda of Greek economic policy. In fact for most of the period the term was a misnomer used to describe further state intervention in economic activity, rather than market-oriented policies as practised in other European countries. Market reforms were introduced for the first time in 1986 aiming at the modernization of the outmoded banking and financial system in compliance with European directives. A major reform in social security took place for the first time in 1992, curbing early retirement and excessively generous terms on the pension/income ratios.

Throughout the 1990s, various reform programs were aimed at the restructuring of public companies whose chronic deficits had contributed to the fiscal crisis in 1989. Privatization was attempted through direct sales of state-owned utilities as the quick way to reduce deficits. Despite some initial success, the program was fiercely opposed by the trade unions of public companies and eventually led to the demise of the Government. Privatizations were conveniently brandished as sell-outs, and it took a few more years for the concept to reappear on the political agenda.

A new wave of reforms was launched after 1996 in the course of the “Convergence Program”. State banks were privatised or merged, dozens of outmoded organizations were closed down, and a series of IPOs – taking advantage of the stock market bonanza – provided capital and restructuring finance to several public utilities. Other structural changes included the lifting of closed-shop practices in shipping, the entry of more players into the mobile telephony market and a series of efforts to make the economic environment more conducive to entrepreneurship and employment.

Post-EMU Fatigue

After 2000, Greece emulated some other euro area members in exhibiting a ‘post-EMU fatigue’ and the reform process gradually slowed down. As shown in Fig. 9, proceeds from privatization peaked in 1999, but subsequently remained low as a result of the contraction in capital markets after the dot.com bubble and the global recession in 2003; for an extensive discussion of reforms in Greece over the period 1990–2008 see Christodoulakis (2012).

An attempt in 2001 to deeply reform the pension system led to serious social confrontations and was finally abandoned. Though replaced by a watered-down version one year later, the failure left a mark of reform timidity for many years. Two other mild reforms followed in 2006 and 2010, but the social security system is still characterised by inequalities, inefficiencies and structural deficits that exert a substantial burden on the General Government finances.

The fatigue spread more widely after the Olympic Games in 2004. With the exemption of the sale of Greek Telecom to the German state company and the privatization of the national air carrier after a decade of failed attempts, most other reforms were consisting of small IPOs with no structural spillovers to the rest of the economy.

Why Debt Reduction Was Insufficient

Despite having achieved substantial primary surpluses throughout 1994–2002 – and around 1999 in particular – public debt over the same period fell only slightly. There are three reasons to explain this outcome. First, during this period the Government had to issue bonds to accumulate a sufficient stock of assets for the Bank of Greece as a prerequisite for its inclusion in the Euro-system, and this capital injection led to a substantial increase in public debt without affecting the deficit.

Second, after a military stand-off in the Aegean in 1996, Greece increased defence procurement to well above 4% of GDP per year. In line with Eurostat rules, the burden was fully recorded in the debt statistics at the time of ordering but only gradually in the current expenditure following the pattern of actual delivery of equipment. This practice created a considerable lag in the debt-deficit adjustment and, in 2004, the Government enforced a massive revision of the deficit figures by retroactively augmenting public spending on the date of ordering, prompting a major dispute over the quality and integrity of the statistics of public finances in Greece. Though a decision by Eurostat in 2006 made the delivery-based rule obligatory for all countries, Greece did not withdraw the self-inflicted revision. As a consequence, deficits were statistically augmented for 2000–2004 and scaled-back for 2005–2006 relative to what they should have been otherwise, in an awkward demonstration of political interference.

The third reason was the strong appreciation of the Yen/Euro exchange rate by more than 50% between 1999 and 2001. This significantly augmented Greek public debt as a proportion of output due to the fact that substantial loans were contracted in the Japanese currency during the 1994 crisis. To alleviate this exogenous deterioration, Greece entered a large currency swap in 2001 by which the debt to GDP ratio was reduced by 1.4% in exchange for a rise in deficits by 0.15% of GDP in subsequent years, so that the overall fiscal position remained unchanged in present value terms. Although the transaction had no bearing on the statistics for 1999 on which EMU entry was assessed, Greece suffered extensively from criticisms that mistook the swap as a ploy to circumvent a proper evaluation. Values shown in Fig. 1 are net of swap effects, and this partly explains the peak in 2001.

The Current Account

After the Eurozone became operational, hardly any attention was paid to Current Account imbalances, regarding Greece or any other deficit country. Even after they reached huge proportions, external disparities in the euro area continued to remain surprisingly unnoticed from a policy point of view. It was only in the aftermath of the 2008 crisis that policy bodies in the European Union started emphasising the adverse effects that external imbalances may have on the sustainability of the common currency (see for example EC 2009).

The reason for this complacency was not merely that devaluations were ruled out by the common currency. A widespread – and unwisely comfortable – view held that external imbalances were mostly demand-driven effects and, as such, they would sooner or later dissipate as a result of ongoing fiscal adjustment in member-states. When, for example, Blanchard and Giavazzi (2002) asked whether countries such as Portugal or Greece should worry about and take measures to reduce their Current Account deficits they “… conclude(d), to a first order, that they should not”. A few years later this proved to be just another misguided assessment; Blanchard (2006) – overturning his previous optimism – remarked that Current Account deficits were steadily increasing within the euro area and urged immediate action otherwise “…implications can be bad”. And indeed they were.

Although improved for a while after the country joined the common currency, the subsequent vast deterioration in the Greek Current Account played a crucial role in inviting the global crisis home. The reason behind the initial containment was that factor income flows from abroad increased as a result of extensive Greek Foreign Direct Investment in neighbouring countries while labour immigration kept domestic wage increases at bay. The deficit started to deteriorate after 2004 as domestic demand peaked in the post Olympics euphoria, inflation differentials with other Eurozone countries widened and the Euro appreciated further. Unit labour costs increased and as shown in Fig. 4 the relevant index rose by 10% in the period 1999–2010. As an ex post wisdom, it is worth noticing from the same figure that a similar erosion of competitiveness took place in all other Eurozone countries that are currently in bailout agreements (Ireland by 12% and Portugal 8%) or considered to be at the risk of seeking one (Spain by 9% and Italy by 8%).

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 4

Development of unit labour costs in the Eurozone 2000–10 (Source: ECB, Competitiveness indicators, 2011). For Portugal the ULC index was missing for 2010 and replaced by the CPI index adjusted for differences from ULC by using the estimates for 2011. In the more recent editions, the effect of Greek ULC on competitiveness is even less pronounced, due to the wage-cuts implemented in the last quarter of 2010 and through 2011

Compared to Germany, Greek unit labour costs increased by 27% causing significant bilateral imbalances. However, this erosion was gradual and cannot have been the single reason for the rapid deterioration experienced after 2006. Other factors affecting the investment environment, such as the quality of the regulatory framework, elimination of corruption practices and overall Government effectiveness might as well have been crucial in shaping productivity and competitiveness. Using the Worldwide Governance Indicators published by the World Bank as proxies for how the above factors evolved during the period from 1996 to 2008, Fig. 5 shows that, despite some improvement in the first years of EMU, there was a noticeable decline thereafter.

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 5

Quality indicators affecting the economic climate. Notes: Indicators are measured in various units with higher values corresponding to better outcomes; to ease comparison all are here indexed at 100 in 1996 (Source: World Bank, WGI various editions)

These developments were pivotal to the poor performance of Greece in attracting foreign direct investment in spite of the substantial fall in interest rates and the facilitation of capital flows within the Eurozone. As depicted in Fig. 6, FDI expressed as percent of GDP hardly improves during the last decade relative to the 1980s. The composition has also changed, as most of the FDI inflows were directed to non-manufacturing sectors and, pointedly, with an increasing allocation to real estate that further aggravates the strain in the Current Account.

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 6

FDI inflows to Greece expressed as percent of GDP. Note: Missing observations are due to non-availability and do not necessarily imply poor flows (Source: OECD, FDI statistics)

It is a well established fact that when new investments are directed mainly to the tradeable sectors this leads to substantial productivity improvements and favours net exports. In contrast, investments going mostly into the real-estate sector boost aggregate demand, raise prices, cause the real exchange rate to appreciate and hinder competitiveness. These developments manifest a major failure of Greece – and for that matter of other Eurozone countries – to exploit the post-EMU capital flows in order to upgrade and expand production; for details see a study by Christodoulakis and Sarantides (2011) who use the differentiation in composition and the asymmetry in the volumes of FDI to explain the diverging patterns of external balances in the Eurozone countries.

Unprepared for the 2008 Crisis

The fiscal decline started with the disappearance of primary surpluses after 2003 and culminated with rocketing public expenditure and the collapse of revenues in 2009, as shown in Fig. 2. Revenues declined as a result of a major cut in corporate tax rate from 35% to 25% in 2005 and extensive inattention to the collection of revenues.

Such decisions were making increasingly evident that stabilizing the economy was not a policy priority of the Government, and further actions soon confirmed the assumption: concerned over the rising deficits in 2007, it sought a fresh mandate to redress public finances but – despite securing a clear victory – no such action was taken after the election whatsoever. Only a few months before the global crisis actually erupted, the Government claimed that the Greek economy was “sufficiently fortressed” and would stay immune to the reverberations of international shocks. Even after September 2008, the Government was for a long time ambivalent as to whether implement a harsh program to stem fiscal deterioration or to expand public spending to fight off the prospect of recession. A final compromise at the end of the year included a consumption stimulus combined with a bank rescue plan of Euro 5 bn and a pledge to raise extra revenues. The first two were quickly implemented, whilst the latter was forgotten.

Weakened by internal divisions, the Government continued to be indecisive on what exactly to do and, after a defeat in the European elections in June 2009, it opted for yet another general election in October 2009 asking for a fresh mandate to address the mounting economic problems. In practice, the election period turned to be an opportunity for further largesse rather than of preparation on how to contain it. The fiscal consequences were stunning: total public expenditure was pumped up by more than 5 percentage points exceeding 31% of GDP at the end of 2009. (In levels, it exceeded Euro 62 bn, i.e., twice the size in 2003). The rise was entirely due to consumption as public investment remained the same at 4.1% of GDP; details on how public spending was ballooned are given in Christodoulakis (2010).

Total receipts in 2009 collapsed by another 4% of GDP as a result of widespread neglect in collection and the fact that privatization proceeds turned negative since the Government had to finance the emergency capitalization of Greek banks. The deficit of General Government spiraled and its figure was serially revised from an estimated 6.7% of GDP before the elections to 12.4% in October 2009, and finally widening to 15.4% of GDP by the end of the year. It was only then that European authorities stopped their onlooking attitude and issued a number of warnings against the spending.

Post-Election Inaction

In spite of the gathering storm in the Autumn 2009, the newly elected Government was far from being determined to achieve immediate fiscal consolidation, constrained as it was by its pre-electoral rhetoric that “money exists” and its ideological aversion to controlling trade union demands in public enterprises. Trapped in such unrealistic mentalities, the December Budget for 2010 surprised everybody by including an expansion of public expenditure and completely excluding privatizations, rather than the other way around. Seeing that no appropriate action had been taken to deal with the situation, rating agencies downgraded the economy, this sparked massive credit default swaps in international markets and the crisis loomed.

The problem Greece faced at that time was an acute shortage of financing for the deficit, not yet one of debt sustainability as it later turned out to be. In this regard, a significant opportunity to diffuse the crisis was missed by the Government and European authorities alike. In order to reduce the risk of spillovers to other markets after the credit crunch in 2008, the ECB had invited private banks of Euro member states to obtain low-cost liquidity by using sovereign bonds from their asset portfolio as collateral securitization; see De Grauwe (2010) for a positive assessment of this policy. As a result of this credit facilitation, yields on Treasury bills remained exceptionally low. But instead of borrowing cheaply in the short term as a means of gaining time to redress the fiscal situation, the Government kept on issuing long maturities despite the escalation of costs. This had dramatic consequences on the perception of the crisis by international markets. Commenting on the cost of confusion, Feldstein (2012) aptly notes that:

“What started as a concern about a Greek liquidity problem – in other words, about the ability of Greece to have the cash to meet its next interest payments – became a solvency problem, a fear that Greece would never be able to repay its existing and accumulating debt”, (my emphases).

Adding injury to misjugment, the situation was further undermined when the ECB threatened to refuse collateral status for downgraded Greek bonds, hence fuelling fears that domestic liquidity would shrink and precipitating a capital flight from Greek banks. Three months later the rating requirement was dropped for all Eurozone countries, but the damage was no longer reversible. In early 2010, borrowing costs started to increase for both short and long term maturities, Greece had become a front page story worldwide and the count-down began. Despite the belated ECB generosity, the Government was financially exhausted and in April 2010 sought a bailout.

The Role of External Deficits

The global financial crisis in 2008 revealed that countries with sizeable Current Account deficits are vulnerable to international market pressures because they risk having a “sudden stoppage” of liquidity. Recent studies show that highly indebted EMU countries with large external deficits are found to experience the highest sovereign bond yield spreads. Along this line, Krugman (2011) recently suggested that the crisis in the southern Eurozone countries had rather little to do with fiscal imbalances and rather more to do with the sudden shortage of capital inflows required to finance their huge external deficits.

This explains why immediately after the crisis sovereign spreads peaked mainly in economies with large external imbalances, such as Ireland, Spain, Portugal and the Baltic countries, which were under little or no pressure from fiscal deficits; for a discussion of the effects of credit crunch in emerging markets with large Current Account deficits see Shelburne (2008). In contrast, countries with substantially higher debt burdens but without external imbalances, such as Belgium and Italy, experienced only a small increase in their borrowing costs at that time.

Greece happened to have a dismal record on both deficits and its exposure to the international credit stoppage was soon transplanted into a debt crisis. The Current Account went in free-fall after 2006 when three factors intensified: domestic credit expansion accelerated and disposable incomes were enhanced by the tax cuts, while capital inflows from the Greek shipping sector peaked as a result of the global glut and the huge rise in Chinese freight. The external deficit exceeded 14% of GDP in 2007 and 2008 and still no warning was voiced by any authority, domestic or European. In fact quite the opposite happened: Responding to pleas of car dealers, the Greek Government decided to reduce surcharges on imported vehicles in an attempt to revive the market, while other fellow Governments – at least those from car-making countries – failed to notice the pro-cyclical character of the measure. Replicating history back in 1989, the unfortunate act to facilitate car purchases in order to favour particular groups caused again a significant deterioration of both the external and the public deficit. Additionally, nobody missed the signalling about the true priorities of the Government and the pre-electoral spree followed as described above.

Two Important Policy Facts

Two stylized facts emerge from the historical account of fiscal developments in Greece. One is the fact that in periods of recession counter-cyclical activism usually takes the form of increased consumption, not public investment and this has detrimental effects on public and external deficits without contributing to higher growth. Another recurring characteristic is the propensity of Governments to increase public spending and to tolerate lower revenues in election years.

Cyclicality of Public Spending

As an indication of how the two main components of Government spending behave over the economic cycle, public consumption and public investment expressed as proportions of GDP are correlated with the growth rate; see Fig. 7. Public consumption is found to have a strong negative correlation with growth rates, suggesting a counter-cyclical pattern. This finding implies that periods of economic downturn are likely to be associated with higher public consumption due to increased benefits and programs to contain unemployment. In a situation of fixed public employment and nominal wage resistance, public consumption is expected to rise further relative to GDP.

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 7

Growth rate correlations with public consumption (Lhs) and public investment (Rhs) expressed as percent of GDP (Source: Government budget, various editions)

On the other hand public investment shows a strong positive correlation with growth. This implies that, in a downturn, public investment is likely to fall, thus hindering the resumption of growth and causing more recession in the economy.

A clear manifestation of such behaviour over the cycle took place in recent years. With recession deepening year after year, the Government rather than curtailing the public sector found it more expedient to cut public investment in order to control the deficit. As a result, recession was made worse.

Electoral Cycles

The Greek economy was often subject to the electoral cycle, as incumbent Governments tried to appeal to voters by a variety of opportunistic policies, thus inflicting non-trivial fiscal losses. Practices included extra appointments of party affiliates, grants to favorable groups and allocation of petty projects to local constituencies, all of which affect current or next period expenditure.

It can readily be seen from Fig. 2 that spending rises during the election years in the 1980s and, as deficits widened, the economy had to enter a period of stabilization that was usually terminated before the next election. During the debt escalation in 1980–93 there were four stabilization programs and ten Finance Ministers – usually one to pursue the program and then a successor to denounce it and prepare for the next period of spending rise. Though the electoral cycle subsided in the period before and after EMU membership, it returned full-steam in the elections of 2009.

Apart from direct actions on the expenditure side, the empirical evidence suggests that slacker tax auditing around elections causes further fiscal deterioration. An extensive investigation by Skouras and Christodoulakis (2011) found that flaws in tax collection arise either as a result of deliberate relaxation of audits as a signal to political supporters or as an indirect consequence of the slackness prevailing in public administration around elections.

Considering that a typical pre-election period has duration of circa 40 days, Fig. 8 compares the revenue in the two months of the election period in each electoral year with the same two months in adjacent years. Simple inspection shows that in most of the elections held between 1974 and 2009, average bimonthly revenues expressed as percent of GDP were lower than the average of the respective figures in the two adjacent years, (with only two slight exceptions in 2000 that coincided with the entry to EMU and 2007 because it is compared with another – and a lot worse – electoral period in 2009). In the same study it is estimated that pre-electoral misgovernance causes a loss in revenues equal to 0.18% of GDP in each election year. For the 13 elections taken place in the period 1974–2009, this amounts to more than 5 billion Euros at 2010 prices.

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 8

Comparison of bimonthly tax revues in pre-election periods. Revenues are calculated for the period of two months before each election as % of annual GDP. Each election year (N) is denoted by black and compared with revenues collected over the same period during the previous (N − 2, N − 1) and the following years (N+1, N+2) denoted by grey. Frequency is bimonthly to account for the fact that the pre-election period lasts for 30–40 days, thus it extends over the prior as well as the poll month. Data are not seasonally adjusted, thus they reflect within year variations (Source: Skouras and Christodoulakis (2011) where further details are available)

An Ex Post Assessment of the Memorandum

EU authorities seemed to be unprepared to react promptly and concertedly to the Greek problem and undertook action only when they recognized the risks it posed for the banking systems of other European states. After difficult negotiations, a joint loan of Euro 110 bn was finally agreed in May 2010 by the EU and the IMF to substitute for inaccessible market borrowing. The condition was that Greece follows a Memorandum of fiscal adjustments to stabilize the deficit and structural reforms to restore competitiveness. More details are given in the Appendix. In the eventuality of success, Greece would be ready to tap markets in 2012 and then follow a path of lowering deficits and higher growth. More than two years after implementation, the record remains poor and the economy is fiercely contracting. An explanation is attempted below.

The Failure in Fiscal Adjustment

The decline of revenues as a share to GDP after 2007 and the collapse of the collection mechanism in 2009 in particular were instrumental for the explosion of public debt and deficit thereafter. Strangely enough, no serious effort was undertaken to remedy the situation after the elections. The ministerial post in the Inland Revenue remained empty for more than a year and two top executives resigned in protest that their proposals to beat tax evasion were turned down. The Government opted for an increase in the VAT rate from 19% to 23% in the spring 2010 and, as a result, CPI inflation jumped to 4.5%, further cutting purchasing power amid recession. The only result was that activity was reduced and revenues did not rise.

The Government continued to act in a positive feedback loop, with lower revenues prompting higher taxation and this in turn causing further evasion. Unable to raise efficiency and under pressure to collect revenues, it imposed a heavy increase in fuel tax, substantial consumption surcharges and finally a lump-sum tax in exchange for settling previous arrears. Once again tax revenues ended up far below the target in a typical manifestation of elementary Laffer-curve predictions.

Only by the end of 2011 it was recognized that further tax measures are no longer viable and attention should shift on collection efficiency. In its assessment of progress, the European Commission task force warned that “… tax and expenditure measures … substantially compress the households’ disposable income and significantly tighten their liquidity constraints”, (European Commission 2011, p. 2).

But that was no more than a void warning, because at the same time the Government was forced by the very same task force to retroactively raise the tax rate on the self-employed and impose a new levy on property in order to make up for the falling revenues.

Regarding public expenditure, a more optimistic picture emerged but at a huge cost in terms of growth and efficiency. Soon after the elections, the Government made clear signals that it had no real intention of containing the oversized public sector. Numerous appointments that were made before elections through a highly disputed process were nevertheless approved by the new incumbent, and a widely publicized operation to abolish and merge outdated public entities has made no real progress, to date. A novel scheme to push older staff onto a stand-by status with a fraction of their salary misfired as it was soon discovered that most on the list were exploiting the incentives of the system for an early retirement. After the fiasco the Government announced a lengthy process of evaluation in the public sector as a precondition for staff redundancies, but without setting a time limit it proved to be only an excuse to avoid actual decisionmaking.

In the absence of any structural adjustment in the public sector, the reduction of spending was achieved by imposing universal cuts in salaries and this led to widespread shirking practices. Another unusual tool for keeping expenditure low was to cut the budgetary co-financing of the European Community Support Framework, thus reducing public investment at a time when it was mostly needed to induce some growth in the economy. After the Decision by the European summit in July 2011, Greece was freed from the co-financing obligation, but when the new practice started to be implemented at the end of 2011 it was already too late to rectify the damage done to economic activity.

The Limits of Structural Adjustment

In order to rebalance the economy onto a more competitive path, the Memorandum agreement envisaged a long list of structural reforms ranging from reforming the social security system to removing closed-shop vocational practices, and from cutting red tape to liberalizing the licensing process for lorry and taxi drivers. The pension reforms initially succeeded in harnessing the deficits in the social security funds, but soon they reappeared when a wave of retirement took place in anticipation of imposing further age extensions in the future.

Most of the reforms were either abandoned or backfired. For example, the opening-up of lorry licenses failed to reduce transportation costs and enhance competitiveness in practice despite the severity of clashes with trade union hardliners. The reason for this was that insiders took advantage of a two year postponement and decided to maximize rent-seeking by withdrawing previous price concessions. Besides, the economic gloom was thwarting potential investors by making the upfront cost of setting up a new business too high.

A similar attempt to open-up the taxi licensing system was abandoned after a protracted clash with insiders in the summer 2011 that seriously damaged tourism in its period of peak. In other professions, such as lawyers and pharmacists, there was only a token liberalization without any reduction in consumer prices. Recognizing this failure, the new conditionality program imposed a regressive mechanism with the aim of reducing the overall profit margin to below 15%, (see Memorandum II 2012, para 2.8, “Pricing of medicines”). The results of this are still to be seen.

Seeing that the structural adjustment program was derailed, the Memorandum sought for alternatives. To enhance competitiveness in the labour market, liberalization measures extended part-time employment, imposed wage cuts across the board and removed collective bargaining agreements. Despite lowering labour costs by 12%, enterprises were overwhelmed by recession and unemployment became rampant, exceeding 17% of the labour force by the end of 2011. As with the positive feedback mechanism on the tax front, the rise in unemployment invited a new round of wage cuts in the private sector, shrinking further disposable income and fuelling new waves of social protest. Though the IMF mission in the autumn 2011 was explicit that “accelerated private sector adjustment … would likely lead to a downward spiral of fiscal austerity, falling incomes and depressed sentiment”, it nevertheless urged for further such measures in order to achieve a “… critical of reforms needed to transform the investment climate”, (IMF 2011). Bringing-up some growth to the real economy is still not a top priority for the program overseers.

The Failure of Privatizations

The failure of the privatization program is worth commenting on, as it reveals an unusual combination of strong rhetoric in theory with complete apathy in practice. Immediately after the elections in 2009, the Government showed that it had no intention of curbing the wider public sector. Its lack of resolve to tackle the excessive demands of public trade unions was made manifest in a dispute with a newly arrived investor in the Piraeus Port Company. The Government succumbed to paying enormous compensation for early retirement as a condition that the investment goes ahead. No privatization target was included in the 2010 Budget and none was actually implemented.

Thus it was viewed as a major shift of policy when the Government agreed in March 2011 to adopt a large-scale privatization plan of Euro 50 bn during the period 2011–2015, or roughly 4% of GDP per annum. The plan included extensive sales of public real-estate, privatizations of public enterprises in the energy sector and private partnerships in the operation of airports and ports throughout Greece.

After months of procrastination a market-friendly Privatization Fund was finally set up to replace the ineffectual authority that was in charge before, but its determination was this time hindered by adverse market conditions. With asset prices falling to abysmal levels, privatizations would be probably embarrassing in political terms and inadequate in terms of revenue, but in practice there was no real demand, as capital flight continued to be fuelled by fears of abandoning the Eurozone and funds from abroad were not coming for the same reason. Despite initial ambitions, the program achieved little in 2011, selling only an option on Greek Telecom, future rights to the National Lottery and publishing a preliminary tender for the redevelopment of the old Athens airport. In 2012 the program was downscaled to a meager Euro 2.8 bn, just a quarter of the amount initially announced.

The New Memorandum Conditionalities and Ways-Out of the Crisis

Faced with a deepening recession and a failure to produce fiscal surpluses sufficient to guarantee the sustainability of Greek debt, the European Union intervened twice to revise the terms of the Memorandum. In the first major intervention in July 2011, the amount of aid was increased substantially by Euro 130 bn and repayment was extended over a longer period of time. To implement the Private Sector Involvement (PSI) in debt restructuring, a cut of 21% of the nominal value of Greek bonds and re-profiling of maturities was decided upon with the tacit agreement of major European banks.

Crucially, the EU authorities this time fully recognized the perils of recession and allowed Greece to withdraw a total amount of Euro 17 bn from Structural Funds without applying the fiscal brake of national co-financing. The plan looked powerful, except for the typical implementation lags. The Agreement was only voted through by all member-state Parliaments only in late September 2011 and the release of structural funds was approved by European Parliament in late November. Participation in the PSI had reached only 70% of institutional holders amid speculation that post-agreement buyers of Greek debt from the heavily discounted secondary market were expecting a huge profit through their offer to cut it!

Thus, a new intervention looked inevitable and in October 2011 a revised restructuring (the so called PSI+) was authorized, envisaging cuts of 50% of nominal bond value that would eventually reduce Greek debt by Euro 120 bn and would allow it to be stabilized at around 120% of GDP by year 2020. In exchange, Greece would undertake further fiscal cuts of around 6% of GDP. Greek bonds held by public institutions (i.e. by the bail-out providers) will be fully honored, though social security funds and domestic public entities were forced to participate in the scheme.

The agreement was hailed as the definite solution to the debt conundrum, but euphoria turned sour a few days later when the Greek Government surprised everybody by seeking a referendum for its approval. Many feared that the outcome could in all probability be negative as an expression of current misgivings, and this would be quickly interpreted as opting for exiting the Eurozone. In the ensuing furore, the decision was annulled, the Prime Minister resigned and a coalition Government was formed in November 2011 to implement the restructuring of debt and negotiate the terms for the new round of EU-IMF loans. The Government acted quickly and concluded the PSI agreement in May 2012, but the extra fiscal package was not finalized as new elections were called for by the coalition partners, anxious to refresh their mandate before the political cost of further cuts becomes too inhibitive for them to remain in power. A caretaker Government followed and pre-electoral inaction adjourned privatizations so as not to excite opposition from the unions, and made collection authorities to slacken the processing of income tax statements so as not to infuriate the voters with an increased tax burden. Revenues dropped significantly, sadly confirming the cycle described in Section 4.

The situation was further aggravated after the first election round proved inconclusive, with the two mainstream parties saw their share of the vote collapse from around 80% of the electorate in 2009 to just one third of the total in 2012, while leftwing and rightwing parties, with a strong rhetoric against the bail-out agreements, saw their share of the vote soar; this prompted a new wave of speculation that Greece is likely to exit the Eurozone and capital flight drained significant amounts from the Greek banking system.

The second round was polarized by the Euro dilemma, thus helping to increase mobilization of voters and finally resulting in a tripartite coalition that vowed to take all necessary measures to safeguard Greece in the Eurozone.

Though the new Government exhibits some of the weaknesses typical of party coalitions, it strives to persuade domestic and European opinion that it means business. As a signal, it reaffirmed that privatization of several public companies will go ahead and announced that the state will abolish minimum holding rights in utilities as an incentive to potential buyers. The Agricultural Bank was swiftly privatized and other state-owned credit organizations are to follow suit. The fiscal package is expected to be voted on in Autumn 2012, though a new round of social tensions and political breakaways cannot be ruled out.

In the meantime, two factors have adversely affected the situation of Greece versus the Eurozone and the bail-out authorities: On the European front, the market pressure is currently directed towards the economies of Spain and Italy, and the concomitant threat to the very existence of the Euro has pushed the Greek problem to the sidelines. Although European authorities responded to the challenge by designing a new defense mechanism in the banking system and the European Central Bank decided to intervene in the bond markets to stave off speculative attacks against member-states, European public opinion is characterized by a “rescue fatigue” and appears to be increasingly hostile towards granting any further support for Greece. However, Greece itself is overstressed: unemployment has rocketed above 24% of the labour force; recession has further deepened with the contraction of real GDP expected to exceed 7% in 2012, an awesome deterioration from milder estimates just a few months ago.

If this trend continues, debt stabilization will be jeopardized and a new cycle of futility and desperation will emerge. Since the dynamics of the debt-to-GDP ratio are sensitive to the prospects of growth, it is worth examining alternative debt paths that correspond to lower and higher growth profiles.

Three Alternative Scenarios: Walking on a Tight Rope

The alternatives revolve around a medium growth path, as has been calculated by European authorities in March (EC 2012, Table p 30) to ensure sustainability of public debt. This is based on real growth resuming in 2014 and staying above 2% thereafter, while inflation of GDP deflator is consistently kept below 2%. A primary budget surplus is achieved in 2013 and stays above 4% of GDP for the next of the period. Privatizations are to follow the revised schedule shown in Fig. 9, and the cost of borrowing is set at 4% per annum.

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 9

Proceeds from privatizations. Note: Proceeds are net of capitalizations in state-owned enterprises. For 2008, 2009 and 2010 figures of proceeds are net of bank shares purchases, thus the negative sign (Source: Privatization Report, Ministry of Finance, 2008. Data for 1996 and 1997 are taken from Budget Reports. Planned figures were set in May 2011, but then they were revised in 2012) (Memorandum II, para 2.1)

The lower and higher growth scenarios are devised by assuming two nominal growth paths cut or augmented by two percentage units respectively, as depicted in Fig. 10. All other assumptions remain the same as in the EC scenario to facilitate comparisons. Debt profiles are shown in Fig. 11.

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 10

The three alternatives for recovery. Growth rates of nominal GDP are taken as the sum of real growth and the projected rates of GDP deflator. The medium growth rate is taken from European Economy (2012, Table p. 30), The strong and low growth profiles are obtained by simply assuming plus and minus two percentage units per year over the medium path

Greek Crisis in Perspective: Origins, Effects and Ways-Out, Fig. 11

Alternative paths for public debt as % of GDP. Note: Each scenario corresponds to an assumption of nominal growth in 2012–2020 shown in Fig. 10. All other assumptions remain the same. The medium growth scenario replicates EC (2012)

The low-growth case leads to a debt to output ratio in 2020 above the level it had in 2010 when the country initially asked for a bailout. Most probably, the economy will collapse before the end of the period as generating primary budget surpluses of above 4% of GDP or collecting privatization proceeds of more than 2% of GDP for six consecutive years is utterly unrealistic under anemic growth. The low growth scenario is not out of context though, and, for a start, it replicates what actuall happened in 2012 with real growth rate plummeting at − 7% rather than the − 4.7% rate envisaged in the official scenario. If this gloomy trend continues, markets will pick up the conundrum and the situation will soon get out of control. There is no political force in Greece eager to undertake new painful cuts on top of the current ones, and the country will be forced to abandon the stabilization program. European Governments – unable to ignore indignant public opinion – will insist on no more bailout aid without honoring previous obligations, and then Greece will be left impotent and unwilling to continue any further. End of game.

The higher growth scenario, on the other hand, leads to a debt to output constantly declining and reaching a level of around 95% at the end of the period, substantially below the medium scenario. The growth path is not unrealistic and real growth rates have just to be close to those that prevailed in the previous decade, though now based on deep market reforms and without the fiscal extravaganza. Other assumptions, such as those of substantial primary surpluses and uninterrupted privatizations, also become more realistic with higher growth. Sustainability may be further assisted if the bail-out funds currently allocated for the recapitalization of Greek banks are taken out of public debt accounts and become liabilities of the new banking authority that is scheduled to operate next year on a Eurozone-wide basis. This will mean a further reduction of the debt to output ratio by more than twentyfive percentage units and will firmly anchor Greece in the Eurozone.

Is Exit from the Euro an Option?

The crisis in Greece had profound ramifications for the Eurozone, both in political as well as in economic terms. In the Euro area, Greece is routinely considered not only as devouring European taxpayers, but also as the habitual wrongdoer especially when compared with the other two countries (Ireland and Portugal) which are undergoing similar adjustment programs with more efficacy. In such a politically unyielding and increasingly suspicious framework, a Greek exit from the Eurozone started to attract attention both at home and abroad.

Though complications and costs that would ensue in the banking sector will be enormous, the exit of Greece could prove opportunistically attractive to some European politicians who get angrier every time a new round of aid is discussed. However, they overlook the fact that a Greek exit would reverberate around other states and lead to an aggravation of the crisis; for how contagion will spread see Vehrkamp (2011). It may also serve as the convenient argument for consolidating and enforcing a two-tier model of Economic Governance, as has been advocated before the creation of EMU (e.g. Bayoumi and Eichengreen 1992) and is recently suggested again by commentators and politicians betting on the “Grexit scenario” and assuming that other countries may follow suit. Based on an inner core of surplus economies in the north and a weaker periphery in the south, competitiveness in this model will be restored through the so called “internal devaluation” of labour costs, thus perpetuating the gap that is already widening between the Eurozone countries; for a description of divergences within the common currency see Christodoulakis (2009).

For Greece, exit would trigger a prolonged economic catastrophe. As the entire Greek debt will remain denominated in Euros, the rapid depreciation of the new national currency will make its servicing unbearable and the next move will be a disorderly default. Isolation from international markets would drive investors even further away, while the financial panic would drain domestic liquidity at a massive scale. The creditor countries of the EU would start demanding repayment of their aid loans, and this would soon deprive Greece of its claim on the EU cohesion funds. Tensions are likely to produce further conflicts with EU agencies and the pressure to consider complete disengagement from the European Union will gain momentum both domestically and abroad.

Stay in the Eurozone and Grow More

The cost would be so immense that the single available option for Greece is to complete the fiscal adjustment and become reintegrated into the Eurozone as a normal partner. This requires Greece to undertake concrete actions that produce visible results within a short timeframe, so that society becomes more confident to pursue further reforms. Some policy suggestions for this direction are as follows:

First, Greece needs to acquire credibility while also being properly understood abroad. The continuing fiscal shortfall is easily translated as reluctance, causing continual friction with the European Union and demands for a new battery of austerity measures. To escape this cycle, Greece must adopt a front-loaded policy as a matter of urgency to achieve key fiscal targets quickly and to change the impression of being a tactical waverer. This seems to be the line adopted by the new Government. If Greece succeeds in this front-loaded policy, it may be in a position to revise some of the pressing – although so far unattainable – schedules and ensure greater social approval and tolerance. To ensure that there will be no spending spree in future elections, the best option for Greece is to adopt a constitutional amendment on debt and deficit ceilings, just as Spain did in 2011, alleviating market pressures, at least for the time being.

Second, Greece desperately needs a fast-track policy for exiting the long recession. An amount of Euro 17 billion could be disbursed and routed immediately to support major infrastructural projects and private investment in export-oriented companies. The growth-bazooka should then be followed by structural reforms and privatizations that can attract significant private investment as market sentiment is restored. In addition, instilling growth will help to control the debt dynamics and reduce public deficits without ever-rising taxes that thwart private investment and make economic recovery and sustainability even more unattainable. Feldstein (2012) leaves no doubt about the mechanics of stabilisation when he warns that “(t)o achieve a sustainable path, Greece must start reducing the ratio of its national debt to GDP. This will be virtually impossible as long as Greece’s real GDP is declining”, (my emphasis).

The inevitability of the above thesis cannot be ignored anymore. Nor can it be circumvented by sermons on the necessity of front-loaded reforms on the assumption that will automatically restore growth and competitiveness. In fact, the need for further growth spreads fast to other countries either in or outside the Eurozone; for example, the UK Government recently decided to inject BPS 50 bn on infrastructural projects to speed economic recovery and one just hopes that the Eurozone will be equally responsive to the need.

Conclusions

Exactly three decades after becoming a fully-fledged member of the European Union and ten years after joining the Eurozone, Greece sought a bail-out agreement in 2010 to avoid bankruptcy. A long history of stabilization programs proved incapable of achieving a lasting fiscal correction and adequately raising competitiveness, as fundamental weaknesses in the economic and political system continue to play a corrosive role. The oversized public sector and the frequent indulgence in pre-electoral spending sprees in exchange for political support led to protracted fiscal deficits and the accumulation of a large public debt. Equally, the chronic deterrence of productive investment by a multitude of regulatory inefficiencies resulted in a thin tradeable sector and large Current Account deficits. The economy remains vulnerable to political developments which are often dictated by short-term partisan considerations with far reaching fiscal implications. This explains why, in spite of substantial reforms taking place over the last two decades and achieving high growth rates, EMU participation and moderate debt stabilization, the situation went once more out of control.

Regarding the current crisis, the article described how prolonged external and fiscal deficits were allowed to reach uncontrollable levels and, in the aftermath of the credit crunch, led to a further escalation of debt and the subsequent bail-out. Two and a half years later, fiscal consolidation is still far from being sustainable in spite of augmenting the bail-out loans and implementing a substantial debt reduction on private holders.

The economy has contracted by nearly 20% since 2008, social tensions are multiplying and the future of Greece in the Eurozone is in jeopardy. Some consider such an outcome as a due punishment for past excesses, while others see it as an escape from further unemployment and recession. The article finds both angles of view as illusory, and argues that the only viable way out of the current crisis is to restore growth and then adopt a realistic plan for privatizations and reforms. The lesson of the past two years is that deep recession will otherwise continue to hinder any existing possibility for exiting the crisis. Greece, and other Eurozone countries too, are desperate for a “corridor of confidence”, to use Keynes’ famous phrase, to put things in order before it is too late.

See Also

• European Central Bank

• European Central Bank and Monetary Policy in the Euro Area

• European Cohesion Policy

• European Monetary Integration

• European Monetary Union

• European Union Budget

• European Union (EU) Trade Policy

• Euro Zone Crisis 2010

Appendix: A Brief Description of the Conditionality Programs for Greece

The adjustment program for Greece was laid out in three phases. The first Memorandum was signed in May 2010 and aimed at reducing the fiscal deficit to 3% in 2013. Specific measures that were actually implemented included universal cuts in public salaries and all pensions, a rise in VAT from 19% to 23% and similarly in other consumption surcharges, the abolition of collective agreements in favor of firm-level contracts, the lowering of private sector wages by 12% and a reform in the Social Security system. It also included the liberalization of red-tape practices in the transport sector, pharmacists and lawyers, but the outcome was heavily compromised through a series of delays and back offs. Fiscal deficit for 2010 ended up close to 11% of GDP, substantially lower than the horrendous 15.4% in the year before but still away from the initially set target.

Thus, in early 2011 a new round of negotiations resulted in a second round of measures voted by Parliament in June 2011. They included further taxation on past incomes, a lump-sum tax on professionals, further rises in indirect taxes and a new property levy that was imposed two months later. The program demanded the abolition of outdated public entities, the reduction in the number of civil servants and a further curtailment in their salaries. It also envisaged ambitious privatizations on utilities and public real-estate that could trim down public debt by Euro 50 bn within a four-year period. Fiscal deficit for 2011 is provisionally estimated to be 9.8% of GDP, revealing a major difficulty in further adjustment in the absence of growth.

The third round of adjustments was voted for in February 2012 as Memorandum II. (For the full text see “Memorandum of Understanding on Specific Economic Policy Conditionality”, 9 February 2012, available at http://www.hellenicparliament.gr).

This time it was approved by the two major parties, but only after a line-up was imposed to avoid desertions and rising internal protest. Measures included a reduction of minimum wages in the private sector by 22%, an additional cut by 10% to new entrants as a means to beat youth unemployment, 15% cuts in various pensions, the abolition of several tax credits and explicit targets for cutting employment and entities in the wider public sector. Policies will start to be implemented in the final quarter of 2012.