After the Second World War, astute European leaders worked for gradual economic and political union in an effort to end centuries of animosity and conflict. That vision is currently seriously threatened by the ongoing economic crisis in Greece, which has important lessons for the future of international economic cooperation.
The post-World War II push for European unification started with the elimination of trade restrictions and continued with the harmonization of laws and the facilitation of cross-border travel. In 1992, the European Union (EU), a loose confederation that permitted the free flow of people, capital, products, and services, was established.
However, the adoption of a single currency, the euro, in 1999 turned out to be Europe’s most dangerous move. (Of the 27 EU members, 19 use the euro as their official currency.)
A sudden financial crisis hit Europe a decade after the euro’s launch. After Lehman Brothers failed, it manifested as a worldwide financial shock that began in the United States. Major European economies and banks were harmed.
Greece was one of the nations that virtually declared bankruptcy. Its leaders threatened to leave the euro in 2015. That action might have completely dismantled the unified currency and destroyed the “European project,” which took decades to construct. Nationalist tensions in Europe that had been dormant were rekindled by the discussion surrounding Greece’s threat.
The Greek economy is now stable and recovering gradually. However, the Greek government’s massive obligations to the rest of the euro zone cast a pall over both its future and the viability of the European project. Grievous budget cuts, tax increases, rising unemployment, declining living conditions, and cuts to social services have been inflicted on the Greek people. Many still worry about the future.
The Greek government and its European and International Monetary Fund (IMF) creditors made difficult, sometimes brave decisions during the crisis. However, there have also been errors in judgment that have left a legacy of mistrust and terror. Every stage of the crisis shows why there was never a simple solution.
PHASE ONE: THE PROBLEMATIC BORN OF THE EURO
Members of the eurozone had ratified the Stability and Growth Pact in the 1990s to strengthen the currency union. The agreement was created to impose budgetary restraint and regulate national borrowing. Countries with deficits can occasionally create money and cause inflation to relieve their financial problems, but becoming a part of the eurozone eliminated that possibility.
Despite the Pact, the Greek government adopted the euro in 2001 and piled up years of deficits and unsustainable borrowing. Bond interest rates, which typically increase when a nation has a deficit, have remained low.
Financial institutions may have believed that any nation experiencing a borrowing issue would receive financial assistance. They were apathetic toward the Greek deficits. The government’s borrowing binge supported the financing of social spending, wage hikes for public employees, and other public services. Budget deception was used to conceal its indebtedness. Its condition was generally ignored despite warnings.
In 2009, everything failed. Then, a new administration revealed that Greece’s fiscal deficit had exceeded everyone’s expectations and had reached 15.6 percent of GDP in 2011.
Bond markets began to have less faith in the Greek economy. There are no plans in place inside the European Union or the eurozone to assist the Greek government in addressing its budgetary issues. Athens needed assistance from the IMF and countries in the euro region since it was unable to refinance its obligations.
PHASE TWO: “TROIKA” TO THE RESCUE
A number of players intervened to prevent the Greek government from going into default. The European Commission, ECB, and IMF—collectively known as “the Troika”—had to balance three demands.
The European banking system’s “contagion” fear came first. Many of Greece’s debts were held by French and German banks. They were worried about bearing the additional cost of granting debt relief to Greece because their finances were already strained from losses resulting from the global financial crisis.
Banks had incorrectly believed that all public debt carries no risk. They had made loans to the Greek government under the dubious presumption that it had enough capital to withstand a default by Greece. Greek debt relief was believed to create a precedent by all European banks. Other European nations’ bonds suddenly became riskier, raising the cost of borrowing for these states. The whole European financial system was afflicted by a decline in investor confidence.
Europeans outside of Greece exerted a second amount of pressure. They opposed defending the Greek government’s disregard for domestic order. Many analysts were concerned that imposing strict austerity on Greece would choke off its economy and make it much more difficult for the government to pay off its obligations. Germans and other Europeans, meanwhile, believed that Greece should pay the price for its alleged wrongdoing.
Greek citizens exerted a third pressure, accusing their government and Greek creditors of misled them. Should innocent young Greeks, workers, and retirees pay the price for the errors of careless political figures and bankers?
Would Greek people penalize any political figures who voted in favor of a set of tax increases and budget cuts that lowered living standards? They questioned: Without a strong economy, how could the Greek government pay off its debts?
PHASE THREE: THE DEMANDS OF “MORAL HAZARD”
In May 2010, Greek authorities and their rescuers developed a three-year bailout plan. To minimize the Greek budget deficit, the plan enforced strict austerity on the Greek government and its citizens. In order to restore competition and growth, the retrenchment comprised tax rises, lowered pensions, public sector wage cuts, and loosened restrictions.
The government received loans totaling up to €110 billion from the IMF and European nations in exchange. Additionally, the ECB intervened to purchase Greek bonds on the secondary market.
At first, the strategy seemed to work. Greece’s bond yields decreased. Greece reduced its GDP-based deficit to 5%. But the economic cost of the fiscal consolidation was high. The Greek economy suffered.
German Chancellor Angela Merkel vowed to safeguard the single currency by aiding Greece out of concern that Greece might leave the euro, sparking a financial disaster. “If the euro fails, Europe will fail,” she declared.
But she also demanded a strict stance against “notorious deficit-sinners” and careless lenders, specifically European banks. President Nicolas Sarkozy of France and I pledged to help euro area nations in need during a crucial summit in Deauville in 2010. Additionally, they demanded “adequate participation of the private sector” – debt relief where banks would take less than full returns on their bonds.
The Deauville news further shook the bond markets. Banks dreaded having to take “haircuts” on the value of their loans. Bond yields increased, making the likelihood of a prompt return of Greek borrowing to the market even more improbable.
Greece restructured its debt at the beginning of 2012. Supposedly, it was voluntary. Due to the possibility of default, the majority of bond holders agreed. In exchange, the Greek government received a fresh package of official emergency loans that would be disbursed over a three-year period in installments, allowing it to cover bills while maintaining budget restraints.
Again, the combination of hair cuts and financial hardship was effective—up to a point. Greece’s main fiscal balance, which is the fiscal balance without interest payments, had a modest surplus in 2013. But once more, the medication only made the patient sicker.
The economy of Greece fell apart. From 2010 levels, its economic production fell by 25%. Pensions and wages decreased. The unemployment rate rose to 27%. by 180 percent of GDP by the end of 2014, Greece’s debt-to-GDP ratio, which had risen from 130 percent of GDP in 2009, was not even reduced by the medication.
It was more difficult to accomplish that goal due to forced austerity intended to help the Greek government pay its debts.
PHASE THREE: The Can is Thrown Down the Road in Phase Four
The majority of Greek loans are no longer in the control of private bondholders as a result of the restructuring of private debt and European intervention. Instead, these loans were retained by a number of public European and international organizations, including the European Central Bank, the European Financial Stability Facility, and the European Stability Mechanism. Most of these obligations had longer maturities of 20 to 30 years and low funding costs.
The political dynamics of the Greek crisis were altered by the transfer of debt from the private sector to official European creditors. Many European nations experienced an upsurge in nationalist feeling. At the same time, the Greek populace began to oppose Europe and the country’s imposed economic contraction.
Greeks chose a new anti-austerity administration in early 2015, led by left-wing Syriza party leader Alexis Tsipras. They opposed the Troika and wanted a reduction in budgetary discipline, increased debt relief, and a reversal of some of the earlier measures. The club of euro area finance ministers, the Eurogroup, opposed. Before talking about a new plan, they insisted that Greek authorities “finish” their current one.
The problem was reignited by the altercation. To prevent Athens from choosing to leave the euro, European authorities intended to increase lending to the country. Leaders in Europe, however, did not want to yield to what they believed to be extortion by the Greek government. They worried that the collapse of the euro due to a Greek default would set off a fresh financial and economic crisis.
Greek officials rejected a Eurogroup offer for more aid in June 2015 that was contingent on maintaining fiscal restraint. In response, the ECB decided against providing Greek banks with more emergency funding.
The Greek government implemented capital controls and cash withdrawal limitations in order to prevent a run on deposits. Additionally, the government failed to make a €1.5 billion payment to the IMF. Greece would have been forced to launch its own currency, effectively leaving the euro, had the impasse continued.
But once more, compromise was forced by the crisis’s menace. Greek officials agreed to a new reform plan in August 2015 in exchange for money now and the promise of up to €86 billion over the following three years.
The new program expected a little less austerity than the prior one did. September saw the reelection of Tsipras. Greece outperformed expectations in 2016 by reporting a sizable primary surplus of about 4%. In 2017, growth went back to being positive, unemployment started to slowly drop, and.
The EU-imposed austerity was still hurting Greek voters despite these indications of stability in the summer of 2019. They were also angry that the European Union had put pressure on Tsipras to allow Greece’s northern neighbor to use the titles “Macedonia” and “Macedonian,” which many Greeks believed belonged exclusively to their country. The electoral setback of Syriza and the resignation of Tsipras as prime minister were caused by a confluence of economic, political, and cultural resentments. The center-right coalition led by the new prime minister, Kyriakos Mitsotakis, has pledged to slash taxes, a move that would undoubtedly raise doubts in the eyes of Europe’s creditors.
At 180 percent of GDP, the Greek government’s debt level is still extremely high yet stable. Midway through 2018, Greece’s official European creditors made some additional maturity extensions and interest deferrals available to the Greek government. The Greek government agreed to maintain a primary surplus of at least 3.5 percent of GDP through 2022 and an average surplus of more than 2 percent of GDP until 2060 in exchange.
No nation has ever maintained such large surpluses for such a long time. In actuality, Athens cut its surplus goals in May 2019. It will only be a matter of time until Greece has another debt crisis unless private borrowing costs for the Greek government continue to be historically low for decades.