The Greek Economic Crisis

Case Study: The Greek Economic Crisis – Debt, Default, Deflation and Social Breakdown

Macroeconomic indicators for Greece – negative growth and mass unemployment

1. Greece has been a member of the single European currency since it was launched in 2001
2. 2013 will be the sixth year in succession that Greece has been in recession
3. Cumulatively the economy will have lost more than 20% of national output before a recovery starts
4. Private sector demand has collapsed, there have been deep falls in consumer spending on goods and services and even great reductions in real private sector capital spending
5. Government consumption on state-provided goods and services is now shrinking rapidly too as the fiscal austerity measures take effect.
6. This combination of weak private sector demand and a contracting public sector makes it inevitable that the Greek economy stays in recession
7. Net trade (X-M) is making a small contribution to positive growth and the current account deficit is likely to dip below 5% of GDP for the first time in several years. But this on its own is insufficient to provide Greece with the means to achieve a sustainable recovery
8. Greek national output is vastly below potential – there is a huge margin of spare capacity
9. This is one reason why the Greek economy remain at risk of price deflation – which given the scale of national and private sector debt could be catastrophic. Low positive inflation is good news for Greece if it helps to restore price competitiveness, deflation would be a different story.
10. Unemployment has reached historic highs, more than 25% of the working population is out of work and youth unemployment has soared to nearly 60%
11. Despite austerity measures the fiscal deficit remains high and national debt will move higher – towards 190% of GDP. IMF aims to bring this down to 120% of GDP in 2020 look fanciful.
12. The OECD estimates that the trend rate of growth for Greece is zero or perhaps slightly negative – this is highly unusual and reflects the depth of the economic and fiscal crisis facing the country. The IMF does not see Greece returning to growth until 2015 by which time its economy is forecast to be 25% smaller than at the start of the crisis.

The Greek Debt Crisis

The Greek economy became embroiled in a huge debt crisis in the aftermath of the global financial crisis from 2007 onwards. Having struggled to keep public sector spending under control and tackle widespread tax evasion, it became clear a few years ago that the annual Greek budget deficit was much higher than expected. About €30bn annually of tax revenues go uncollected in Greece.

The tipping point for Greece was the immediate and short-run fall-out from the Global Financial Crisis (GFC). Students ought to be familiar with the background here. The sub-prime mortgage crisis in the United States quickly turned into a major global financial meltdown affecting most countries but especially those with highly leveraged financial systems i.e. banking systems and other lenders that had created too much credit to private sector businesses and individuals.

The Greek economy was hit by a fierce demand-side shock and this was made worse because the economy was already suffering from structural competitiveness problems inside the single currency system.

As a direct consequence of the GFC:

• Most of Greece’s main trading partners went into a deep recession – cutting exports
• There was a 2% fall in world output (unusual) but worse, a 12% fall in global trade

Greece suffered badly because her economy was heavily dependent on tourism and construction, two sectors badly hit by the sharp fall in demand and production.

In 2009 Greek exports collapsed by nearly a fifth (causing a large inward shift of AD) and the Greek fiscal deficit grew from 5% of her national income in 2007 to nearly 14% in 2009. A decade of progress in reducing unemployment was reversed within the space of two harsh years.

The Greek government has run a budget deficit in every year of at least 4% of GDP. Even during the first half of the last decade there was a sizeable deficit although corruption and fraud meant that the official figures hid this. The deficit peaked at over 15% of GDP in 2009 and in 2011 the budget deficit was nearly 10%. Strong growth in Greece helped to keep the government debt to GDP ratio at or around 115% during the years from 2001 to 2008 but a combination of huge annual deficits and six years of recession has brought about a huge rise in the scale of the national debt.

The OECD is forecasting that this will reach 200% of GDP in 2014 despite attempts to cut the deficit. The reason is simple – even though the Greek budget deficit is coming down, their economy is shrinking so the base level of real GDP is falling. In December 2012, the 'troika' of the IMF, the EU and the European Central Bank reached a new funding agreement for which will cut Greece's long term debt burden. And Greece has made some progress in cutting the annual budget deficit. Greece reduced its fiscal deficit before interest payments by 13.4% of GDP between 2009 and 2012.

The European Union, International Monetary Fund and the European Central Bank are the main creditors to the Greek government. They are known as the EU-IMF-ECB troika

Fiscal austerity means contractionary fiscal policy measures in the form of higher taxes and/or cuts in planned government (public) spending. In Greece in 2010, the country was forced to agree a Euro 110bn emergency bailout and introduce an austerity budget. These measures included a VAT rise from 19% to 23%, higher duties on fuel, alcohol and cigarettes, an increase in the retirement age, a public sector pay freeze and a freeze on the size of the basic state pension.

There is a fierce debate in economics about the most effective ways to address the problems caused by high levels of government debt. Many economists including Nobel-winner Joseph Stiglitz argue that contractionary policies make the debt problem worse and that sustained growth is the best pathway out of a debt crisis.

Greece is also seeking to implement structural economic reforms as part of their bail-out package. Structural economic reforms have included:

• Pension reforms including raising the official state retirement age
• Privatisation of state assets both to raise revenue and to increase competition
• Cuts in the national minimum wage
• Measures to reduce entry barriers to certain occupations / professions including transport
• Cutting taxes on employing workers to boost employment
• Making the Greek judicial system more efficient
• Cutting red tape for businesses to promote investment
• Stronger measures to tackle tax evasion by individuals and businesses

The key issue is whether these structural supply-side reforms will be sufficient to improve competitiveness and generate the minimum growth that Greece needs to break out of their debt trap?