On August 20, the bailout program that saved Greece from financial collapse ended. After eight years of reforms and austerity, Greece can again “stand on its own” and attract funding from private sources alone. The evolution of this decade-old Greek financial tragedy provides insights into the development of the Eurozone and its flaws, as well as lessons about financial crises.

Our observations

  • The Greek crisis has been much more severe than the American Great Depression that started in 1929. The U.S. economy, boosted by the 1933-1936 New Deal, managed to return to its pre-crisis level within 7 years. In contrast, Greece’s GDP is still 43% lower after a decade of contraction and austerity. Furthermore, compared to the other “PIIGS” (Portugal, Italy, Ireland, Greece, Spain) of the Eurozone sovereign debt crisis, Greece performs badly: while only Ireland’s GDP is above its 2008 level, GDP levels in Spain, Italy and Portugal are “only” 17-20% below their 2008 levels.
  • Greece received three bailouts in the past eight years, totaling €287 billion, the world’s largest financial rescue ever. Between 2010 and now, Greece has had four governments and unemployment skyrocketed from 8.4% to 27.5% in 2013, down to 2% in June 2018 (youth unemployment grew from 21.8% to 58.2% in 2013, and had reduced to 42.8% last year).
  • In his book “Waagstuk Europa”, historian Mathieu Segers argues that the emergence of the European Union (EU) and the European Monetary Union (EMU) was driven by political rather than economic ambitions. We have written before that the Eurozone is not an “optimum currency area”, hence that member states sharing a single currency, monetary policy and exchange rate bears significant risks and disadvantages.
  • Germany is on course to have the largest current account surplus in the world for the third consecutive year, set to hit $300 billion or 8% of its GDP. Christine Lagarde, boss of the IMF, warned at the beginning of this year that the build-up of large current account surpluses threatens to destabilize the global trade system and fuels protectionism across the world.
  • In June 2016, the International Monetary Fund published a paper called “Neoliberalism: Oversold?” criticizing the “neoliberal approach” of providing loans and bailout program on the condition of tough reform and fiscal austerity programs. The publication suggests that there is a robust debate within the IMF over how to deal with financial and credit crises, as IMF has long been considered a proponent of this neoliberal approach (including in the case of Greece).

Connecting the dots

Two weeks ago, Fitch upgraded Greece’s long-term foreign currency rating by two notches, citing improvements in public finances, debt sustainability and its relations with European creditors. That can be considered a small miracle, as only three and a half year ago, Alexis Tsipras was elected Prime Minister of Greece with the promise to “restore Greek democracy” and end austerity and reform programs that were laid down by foreign interveners, dubbed the “troika” and consisting of the ECB, IMF and European Commission. His alternative was withdrawing Greece from the Eurozone and returning to the Drachma, a “Grexit”, thereby almost singlehandedly destabilizing the Eurozone and undermining confidence in the Euro. Although Tsipras backed down on his promises, this Greek financial tragedy remains an interesting case to study.
In the years after Greece’s accession to the European Exchange Rate Mechanism in 1999 (a system to reduce monetary instability and exchange rate volatility), Greece’s fiscal conditions structurally violated the conditions of the European Stability and Growth Pact, the purpose of which is to guarantee the monetary stability of the Eurozone. This is illustrated by Greece’s high budget deficits (persistently above 5% of GDP) and government debt (increasing from 97.8% in 1995 to 115.3% in 2015). Nonetheless, Greece adopted the Euro in 2002, showing that its inclusion was driven by political ambitions rather than solely economic fundamentals.
Greece’s problems emerged because it acquired artificially low interest rates that enabled it to borrow money and finance its government’s budget deficit, and current account surpluses in other, more productive Eurozone member states (e.g. Germany, the Netherlands). These in turn created large imbalances within the Eurozone, as reflected in the large TARGET2 imbalances. When the Global Financial Crisis (GFC) hit in 2008 and the Eurozone experienced a subsequent sovereign debt crisis, long-term interest rates on “PIIGS” debt exploded, reaching an all-time high of 29.2% on 10-year Greek government bonds. It was only after the European Central

Bank (ECB) announced an unlimited support for all Eurozone economies in July 2012 (Draghi’s famous “whatever it takes” speech) and Eurozone bailout programs were established, that the problems began to resolve. Bailout programs were proposed, on the condition of tough reforms and fiscal discipline, creating tensions between Southern and Northern Eurozone member states and fueling debates about the break-up of the Eurozone. However, almost a decade after the GFC, it is increasingly acknowledged that the austerity and reform program have worsened the crises in Greece and other economies. The strong anti-neoliberal sentiment in economics and public opinion after the GFC further discredit these policies and the institutions that implemented them (e.g. the European Commission, IMF).
The Eurozone’s more fundamental or structural problem is that it is a monetary union without being a political union (the political EU is different from the monetary EMU). This hinders swift action in times of crisis, in comparison to, for example, the U.S. Federal Reserve, which reacted earlier and with a stronger package of monetary stimulus to the GFC. Furthermore, European institutions (e.g. the ECB) suffer from a democratic deficit to legitimize its actions and regulation. This further erodes trust in European institutions that must come up with solutions (e.g. Greece accusing the troika for imposing too tough austerity measures, while Germans and Dutch are fed up with the ultra-low interest rates that hurt their thrifty consumers). Furthermore, on a socio-cultural level, member states lack the solidarity to help solve problems elsewhere in the Eurozone, like there is in the U.S. where large states have been net-payers for decades to other American states. As a result, their national governments have a fragile mandate to come up with pan-European solutions for financial crises. The Greek financial tragedy show that its problems and solutions run deeper than a financial crisis and economic response.

Implications

  • As neoliberal policy and economics is discredited across the world after the GFC, new models of economic development and growth are being tested and developed. This might explain the “Keynesian resurgence” in economics, the increased popularity of socialist policies in the West or even the appeal of “Chinese” or authoritarian economic model across the world.
  • The model of growth funded on cheap credit and capital inflows is not unique to Greece or to broader Eurozone debt crisis. Turkey, for example, has recently enjoyed years of growth based on fiscal spending without improving the structural, long-term competitiveness of its economy. As monetary conditions tighten across the world, in tandem with a strong U.S. Dollar, capital outflows and increased funding costs are now putting strong pressure on the Turkish Lira.
  • The problems of the Eurozone sovereign debt crisis, and Greece in particular, show that a monetary union should be backed by a political union and the corresponding institutions to mediate shocks and implement adequate transmission mechanisms. On its turn, a political union should be founded upon a shared socio-cultural unity among member states and citizens to inject the sufficient trust and legitimacy to make these institutions function well. For example, the proposed East African Monetary Union or possible Asian Monetary Union, which might have a predecessor in the Asian Monetary Unit, might suffer from these problems given the political and socio-cultural differences within these regions.