The Crisis in Greece

Greece wants to stay put in Europe. Many, including the German finance minister want them out – Grexit is the term that has been coined for their departure. Greece however, has too much to lose if it does. Greece was a founding member of the Organization for Economic Cooperation and Development and joined the European Community in 1981. With a common currency, fixed exchange rate for a member's currency and a European Central Bank, members were expected to follow certain macroeconomic disciplines, especially in relation to deficits and debt. But, Greece chose not to as internal reforms would mean that the retirement age would have to go up to European standards and universal state pensions would have to go.

If a country borrows, it should have the means to repay its obligations of principal and interest through money collected internally through taxes. However, in Greece the service sector contributes close to 85 per cent to Greece's gross domestic product and consists mostly of small enterprises. Taxes are difficult to collect, and tax increases are not effective. Greece has been "socialist", against labor reforms, in favor of state ownership and of generous social benefits, including pensions. Support from the ECB and the International Monetary Fund prevented the Greek economy from collapse during the global financial crisis of 2008-09. It was EU-support that led Greece onto years of unrestrained spending, cheap lending, generous social programs and no financial reforms. Greece also underreported its debts. Greek balance of payments and budget deficits rose from below five per cent of the GDP in 1999 to around 15 per cent of GDP in 2008-09. Greece was the classic case of a chronic borrower and defaulter who was protected because the EU did not want a Greek exit.

Has Greece always been a developed, first world, industrialized country that many believe it is? Greece became eligible to borrow from the EU as soon as it became an EU member and its per capita income started rising in line with the debt that the country took. Greek per capita income was somewhere between $500-$1000 per year in the 1960's-70s. It started borrowing as soon as it became a member of the EU. Their per capita income crossed $10,000 in the 90's. In 2007 it was over $ 28,000 just before the financial crisis and today it is $21,600 having come down somewhat. The trends are exactly in line with the debt that the country has taken. What we see in Greece from 2002 is successive Greek governments borrowing at low interest rates and redistributing it to the populace, without any productive GDP growth. This is normally a goal of the far left. The growth in Greek GDP has come through money inflows not via the real economy.

Its entire GDP growth is debt fueled and this has risen sharply after joining the Eurozone. With every bailout they have agreed to necessary public sector and welfare reforms that have never been implemented. Everyone acknowledges that they have been living way beyond their means. With 85% of GDP coming from the service industry (read tourism) it is not the first world industrialized country that people have been touting. Its debt after the current bailouts will cross $450 billion shortly. This, by the way, is greater than the debt of Britain. There is no way that Greece is going to repay all of its debt. The entire emotional referendum (the leftists always do this well) and its aftermath was designed to ultimately write of its debt. Unfortunately, it seems that the free lunches at other people's expense are over.

If Greece was not in the EU its currency the Drachma could have been devalued and this could have been a corrective to a mismanaged economy. The GDP has declined by over 25 per cent, and unemployment and debt ballooned. Since May 2010, EU member-states and the IMF had an 'economic adjustment program' to stop the deterioration of Greece's finances and restore its fiscal health. The program required Greece to implement structural reforms for improving the competitiveness of the economy to sustain economic growth. But Greece cheated on its debt statistics and the international lenders did not have a sound monitoring mechanism. Its deficit actually exceeded Eurozone limits. Greece's national debt - at 300 billion euros ($413.6 billion) - was bigger than the economy, and it was growing. High deficit to the GDP, its downgraded credit-rating - to the lowest in the Eurozone - made Greece a financial black hole for foreign investors and everyone noted that rarely do governments borrow to enable people live an unaffordable lifestyle.

The loan adjustments and fresh advances that Greece has now agreed with the EU also have a tough program of pension cuts, privatization and higher taxation. Given the Greek preference for a soft life, no elected government can persist for long with lax welfare policies. Greece could possibly be headed for another spate of military junta rule. That will set the economy right till the Greeks can go back to their soft ways.

Many intellectuals argue that the Greeks should not be made to suffer more austerity and reduced living standards. But Greeks prospered on funds from Europe, mainly from Germany. Either Greece goes its own way or follows strict discipline in servicing its borrowings. A Greek bailout (by lenders such as the IMF and European banks) could lead to other countries asking creditors to take a haircut, i.e. write off a part of the debt. They could refuse reforms to live within their means within a given period. Lenders like the IMF are there to help during an emergency. Without the possibility of repayment, international financial transactions could become very risky.

Greece is a serious serial economic offender. It needed to be compelled to correct itself. Europe undeniably faces a dilemma. Greece is the home of European civilization and must remain in Europe. The EU is a dream that requires all members to stand by a common currency and take the first steps towards political union. One exit could trigger other exits. The EU will do a lot to help Greece but Greeks must face hardships it has brought on itself. It is impossible that Europe should have a central bank and a common currency but not the powers to rectify a member-state's macroeconomic imbalance. That requires both political union and steadfast central fiscal and monetary management. The problem is that the EU is a monetary union and not a political union like the United States for instance. How to do all this will be the central debate of this decade.

There are now many intellectuals who look at the plight of the suffering Greek common man and are trying to get some sympathy. When I read the Nobel prize winning economist Joseph Stiglitz in the New York Times, I was amazed at the emotional arguments being used. Hearing these arguments my heart starts to bleed. The carpet turns red. All the sentimental posturing completely ignores the fact that Greece is a defaulter nation and there are serious consequences for default. We all know Greek debt is unsustainable and it will never be given back. But, when you default on a loan, unpalatable terms are normal. And, we are seeing the consequences of multiple borrowing and default. We also know that Greeks themselves are solely responsible for being where they are. They might blame their Greek Oligarchs, but that is part of internal democratic politics. They have enjoyed higher per capita and extensive welfare benefits including universal early retirement and state pensions. Now retirement age is being raised to equalize with the rest of Europe.

So, the basic Greek strategy for successive governments has been to borrow and redistribute to its citizens - the standard far-left solution - basically living far beyond its means.

The bubble had burst long before the first major loans 5 years ago. What is happening now are the unsavory consequences of doing nothing (unlike Ireland, Portugal, Spain and Italy who have reformed) for so long.

We all know the consequences of default. Lenders will dictate tough terms. This is nothing new, and comparing this with the East Asian crisis as Stiglitz has done, is not very valid because in all cases the borrower is negotiating from a position of weakness. After the financial crisis, the US Govt. did everything the opposite of what the IMF had recommended for East Asia. That's what a global power does. Greece is a minnow. Stiglitz is making a point about terms such as selling Dutch milk in Greece as opposed to local 'fresh milk' that the Greeks love. If the Dutch are making conditions about their milk being sold in Greece, it is because the Dutch have lent hugely to Greece who have not paid back. This is like the old concept of 'tied aid' that most developing countries are familiar with.

All the emotional pyrotechnics that we have seen, including protests ( if you have been to Syntagma Square in Athens - you would have seen Greeks protesting for almost anything to get a buck of welfare), these are all designed with one thing in mind, debt-write-off. No- can-pay! That is what the negotiations are all about. The Greek referendum should really have asked the people --" Do you want to stay in Europe, Yes, No. But they chickened out and didn't ask the right question. Greece should stay out of Europe for its own long term good.