The Economic Consequences of the Greek Debt Crisis
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Draco, the seventh-century BC Athenian legislator from whom we get the word “draconian” replaced the system of blood feud and oral law with a harsh, but transparent, written legal code. One of the provisions of Draco’s code was that any debtor whose status was lower than that of his creditor was forced into slavery. It’s hard not to think of Draco when contemplating the current to and fro between the Greek government and the “troika” of the European Central Bank, the European Commission, and the International Monetary Fund, representing Greece’s creditors, trying to avert a sovereign default and keep Greece from leaving, or being ejected from, the European monetary union. These discussions are more properly considered a dictation of terms rather than negotiations.

My friend Elena Panaritis was interviewed the other day on the BBC to talk about the crisis. Elena and I worked together as consultants for the World Bank, and she is now a Socialist member of the Greek Parliament. She pointed out that it took Margaret Thatcher 17 years to restructure the British economy, and that Britain had started out in a much better position than Greece today. No one doubts the need for fundamental structural reform of the Greek economy, but it is untenable for Greece to be forced to suffer 17 years worth of pain all at once. What Elena didn’t point out, though she might have if she had been given more than a 30-second sound bite, is that Greece reduced its primary budget deficit by eight percentage points from 2009 to 2011, in what the Financial Times has called “a radical austerity effort,” and in April 2010 announced a three-year, $40 billion package of tax increases and spending cuts. The U.S, equivalent would be about $1.9 trillion, unattainable in our current political climate.

Greece’s creditors are far from satisfied, however. Led by Germany, they have demanded, and the current Greek government is trying to win Parliamentary approval for, a new set of austerity measures that would reduce the minimum wage by 22% – which would effectively reduce most private sector salaries by an equivalent amount, since they are benchmarked against the minimum wage – and cut state pensions by 10%. Unspecified, but large, reductions in government payrolls are also demanded. All this on top of previous cuts of 15 to 30% in both wages and pensions.

It is hard to see a happy ending. Greece’s official unemployment rate is already 21% and youth unemployment is estimated at around 50%. GDP has shrunk by 11% in the past three years. The new cuts can only shrink demand further, leading to greater job losses and reduced tax revenues, which reduce the funds available for debt service and will, no doubt, spark renewed calls from the Eurozone’s leaders for new rounds of spending cuts and tax increases. You don’t have to be an orthodox follower of Keynes to recognize that such radical austerity, by choking economic growth, creates a vicious circle from which no one can benefit. The Greeks will suffer yet greater misery, while the country’s creditors go unpaid. Everyone pretends that this latest set of screw tightening will solve the problem once and for all, but it’s not clear that anyone really believes it.

The consequences of Greece’s exit from the Euro would, arguably, be far worse for Germany and the other Euro-zone members than for Greece itself. After a wrenching period of adjustment, Greece would be left to devalue its new currency, a far less painful way to restore prosperity than the alternative of bleak and interminable austerity. A default would shut Greece out of international credit markets for some time, but since the Greek budget is already in balance once debt service is excluded, it would not be long before it could borrow again.

Angela Merkel, on the other hand, has said that if Greece leaves the Euro the Euro itself will collapse, and with it the entire European project. Perhaps she has adopted such an apocalyptic tone to frighten everyone into submission, but it could become a self-fulfilling prophecy.

John Maynard Keynes, who represented Britain at the 1919 Paris Peace Conference, wrote, in The Economic Consequences of the Peace:

“Very few of us realize with conviction the intensely unusual, unstable, complicated, unreliable, temporary nature of the economic organization by which Western Europe has lived for the last half century. We assume some of the most peculiar and temporary of our late advantages as natural, permanent, and to be depended on, and we lay our plans accordingly. On this sandy and false foundation we scheme for social improvement and dress our political platforms, pursue our animosities and particular ambitions, and feel ourselves with enough margin in hand to foster, not assuage, civil conflict in the European family.”

He was referring to the imposition of war reparations on Germany so onerous that “Germany has in effect engaged herself to hand over to the Allies the whole of her surplus production in perpetuity.” Like the Allies in 1919, the Eurozone leaders, rather than fixing a definite settlement with which Greece might be able to comply, seem to be trying to “skin her alive year by year in perpetuity,” in Keynes’s words

The German financial delegation to the conference yelped with indignation: “Germany is no longer a people and a State, but becomes a mere trade concern placed by its creditors in the hands of a receiver, without its being granted so much as the opportunity to prove its willingness to meet its obligations of its own accord.”

Keynes did not exactly predict the German hyper-inflation of the 1920s or the Second World War, though he strongly hinted at both: “Wilted Flowerho can say how much is endurable, or in what direction men will seek at last to escape from their misfortunes?”

Just as the Allies in 1919 overestimated Germany’s ability to pay reparations, so too, I fear, have the Eurozone leaders overestimated the pain the Greeks are able to accept. Greece, a small country on the fringes of Europe, lacks the capacity for disruption that Germany had after the First World War. But the suffering already inflicted on Greek society is hardly consistent with the promised benefits of EU membership, and could sound a cautionary note in other small, peripheral EU members that when the time comes they too could be thrown to the wolves.

The saddest thing is that none of this is necessary. Unless the bankers and European leaders panic, a Greek default and even its exit from the Euro need not be a cataclysmic event. Rather than pushing Greece to the wall to preserve the Euro at all costs, the troika could instead develop a mechanism for Greece – and, potentially, other countries like Portugal and Ireland – to exit the Euro in an orderly way that threatens neither their survival nor that of the European project. But I wouldn’t bet on it.

Posted 03-05-2012 10:53 AM by Charles Krakoff