Greece caught in death spiral

Greece caught in death spiral
Pensioners wait outside a National Bank branch in Thessaloniki in the hope that it might open. Greece has closed banks and imposed capital controls in an attempt to avert the collapse of its financial system.

Greek banks are shut down and the people of Greece can withdraw only €60 (S$90) at ATM machines. The referendum on Sunday will decide whether Greece should say "yes" or "no" to bailout conditions imposed by the troika of the European Union, the European Central Bank and the International Monetary Fund.

What will be the consequences of the vote for Greece, Europe and the global economy? Will there be a geopolitical impact? How did Greece get into this quagmire? What lessons can we learn from the Greek tragedy?


Greece has been in a Great Depression since 2009, with gross domestic product falling 25 per cent and unemployment at 28 per cent. Youth unemployment is easily double the national average. The Depression is comparable to what the United States experienced in the 1930s.

In October 2009 when the Greek economic/financial crisis began, the Greek government had a budget deficit of 15.7 per cent of gross domestic product (greatly exceeding the 3 per cent allowed in the EU Stability and Growth Pact) and a debt-GDP ratio of nearly 130 per cent (more than twice allowed).

Externally, the current account deficit (foreign borrowing) had been rising to nearly 9 per cent of GDP, resulting in a cumulative debt of more than 70 per cent of GDP.

What were the root causes?

Firstly, entry into the euro zone was achieved at too favourable an exchange rate, causing Greece, which was already lagging behind in productivity, to become uncompetitive.

Secondly, Greece's higher wage increases and higher inflation, combined with low productivity, worsened its competitiveness: Greece's unit labour cost rose to nearly 30 percentage points higher than Germany's.

Thirdly, after joining the euro zone, Greece's borrowing costs fell substantially from nearly 25 per cent in 1991 to below 6 per cent. This must have encouraged a borrowing binge by the public and private sectors.

Fourthly, the financial crisis of 2007-2008 resulted in a sudden stoppage/reversal of external financing. Those who had borrowed at short term were the most vulnerable because of the maturity - and, in some cases, currency - mismatches.

Bad governance was also an issue.

Finances were fudged: To enter the euro zone, Greece lied about its public finances.

Its deficits were well in excess of the Maastricht norm of 3 per cent of GDP and its public debt well above the limit of 60 per cent of GDP.

Profligacy: Successive governments promised more and more largesse in order to win votes. The result was ballooning Budget deficits that had to be financed by borrowing because Greece cannot print euros.

Bloated bureaucracy: After democracy was restored in 1974, successive populist governments padded the civil service. By 1980, over 500,000 were civil servants. Until recently, the number exceeded one million (out of a work force of over four million). Most of these employees cannot be fired. Generous perks, benefits, bonuses and pensions were the lure for government jobs.

Poor tax collection: Revenues lost to tax evasion are estimated to be 3 per cent to 4 per cent of GDP, enough to reduce the government deficit by half.

Ineffective governance and corruption: According to World Bank indices, Greece's indices for effectiveness of governance and corruption had fallen way below the rest of the EU/euro zone.


Despite the massive bailout funds extended by the troika and substantial haircuts on bond redemptions, Greece is in the throes of a Great Depression with high unemployment, heavy retrenchments, severe cuts in government expenditure, especially on pensions and entitlements, and an exploding debt-GDP ratio of 175 per cent.

The problem is Greece has to find the euros to pay its creditors but it cannot find enough. It needs more bailout and debt restructuring but the troika insists on onerous conditions which spell more austerity and painful reforms.

Greece is in the hapless death spiral described by the noted economist Irving Fisher in his article "The debt-deflation theory of Great Depressions", where austerity results in exploding debt-GDP ratios. The current government was elected by a disenchanted electorate who do not like austerity. Being a member of the euro zone means Greece has no control over the exchange rate and monetary policy, both of which are set by the ECB. It has to live with a euro too strong for its weak competitiveness. Staying with the euro means that the only way forward is to cut wages and prices - what economists call internal devaluation. In addition, of course, it has to produce a primary surplus in the Budget to pay its creditors. This entails further painful cuts in government expenditure and increases in taxes. Greek standards of living must fall further.

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