Greece Economic Crisis of 2011 and its Prospects in the EU as its Member - Essay Example

Greece Staying in the Euro The Euro Zone is composed of a single monetary market and heterogeneous countries (Lapavitsas et al. 22). These countries diverge in fiscal policies and productivity levels. Their public debt levels diverge as well. Greece is an example of a country that failed to control its public debt levels. The Greek crisis became a crisis of the entire Euro Zone, as Greek exit would signal to external investors and EU partners that Euro is not as strong as first estimated. However, help to Greece has not been as generous as some think it should have been. Since 2009, Greece has not overcome the debt problems. The question most economists and Greek government still ponder about is whether Greece should exit or remain in the Euro Zone. However, a more important question is under which conditions help can be profitable to the Greek economy. So far, the answer requires deep institutional changes in the Greek economy. Origins of the crisis lie in the Greek public debt. According to Akram et al., in the 1980’s and early 1990’s, interest payment on public debt comprised a large share of the state deficit (307). Until the end of the 1990’s, despite high levels of public debt, Greece had managed to maintain fiscal control and debt regulation largely because of the EU membership and lower interest rates it had to pay on its debt (Akram et al. 307). Greece was unable to finance its deficit without indebting itself because of low levels of public saving since the 1980’s (Akram et al. 307). Since the 1990’s the average saving rate stood at 11 percent (Akram et al. 307). As a result, most of the Greek public debt, 80 percent, ended up being owned by 2010 by foreign banks (Akram et al. 307). The debt owned abroad amounted to 224 billion Euros by 2009 (Akram et al. 307). Greece failed to uphold the EU criteria. In 2001, Greece joined the EU. Its public debt to GDP ratio amounted to 101.5 percent (Akram et al 307). According to the Maastricht Criteria, Greece needed to have the ratio at 60 percent (Akram et al. 307). The crisis escalated in 2009, when the new finance minister revealed that the Greek economy performed much worse than previously claimed. By 2010, Greek public debt amounted to 290 billion Euros (Akram et al. 306). The deficit stood at 12.8 percent of GDP instead of 3.6 percent of GDP (Akram et al. 307). Inflation also was higher than the EU average (Xafa). Greece also accumulated a large current account deficit. Consumers demanded foreign goods, which resulted in a current account deficit of $51.5 billion in 2008 (Akram et al. 309). Private debt as a result accumulated too. By the end of 2009, Greece was downgraded by most rating agencies. According to Akram et al., “in October 2009, Fitch had down shifted the Greek credibility to A- and further degraded to BBB+ by the end of December 2009. Standards & Poor’s and Moody also downgraded the Greece on the same grounds” (306). The prognosis by many was that Greece needed to leave the Euro zone (Akram et al. 306). Some even recommended that the Euro Zone should be partitioned on a north – south basis (Akram et al. 306). The trust of investors was destroyed. The government failed to impose reforms. Administration also failed to properly assess the situation in Greece prior to 2009 (Akram et al. 308). Corruption levels were high too, which placed Greece at the bottom of South Europe (Akram et al. 308). Tax evasion stood at 30 percent of GDP (Akram et al. 308). Instead of flowing into government pockets, and then being used to repay the debt, this money stayed in private hands. As a result, investors fled as Greece was downgraded. The Euro Zone was supposed to decrease exchange rate fluctuations of its member – countries. According to Mishkin, large exchange rate fluctuations damage the economy (319). They damage financial institutions and banks as fluctuations generate losses (Mishkin 319). A single, strong currency can decrease these fluctuations. The single currency is still overwhelmingly a theoretically unknown phenomenon. Money supply of a single currency union can be targeted, but the allocation within countries inside of the union cannot (Lane 586). If the central bank of the union sets the monetary policy so the losses of all national central banks would be minimized, then the best policy when an asymmetric demand shock occurs is to do nothing (Lane 587). There is a difference between a currency union and a fixed exchange rate system: “monetary policy in a currency union does respond to aggregate productivity shocks and it is this responsiveness that distinguishes a currency union from a symmetric fixed exchange rate arrangement” (Lane 587). Aggregate demand shocks are absorbed by the changes in the real interest rate. Price levels and employment remain unaffected (Lane 587). When an asymmetric demand shock occurs, currency union can increase its performance if the countries within are already integrated in terms of consumption patterns or the markets are specialized (Lane 603). However, this was not the case with Greece and the EU. Moreover, the more weight is placed by a union on the price stability versus employment stability, the more stable and attractive will be the currency union (Lane 603). A single currency has affected Greece adversely. Skeptics before the crisis claimed that a single currency would leave less developed markets at a disadvantage (Mishkin 49). Since in the EU there are no tax transfers from richer to poorer regions the way they are done in the US, poor regions would not be able to obtain adequate funds needed for development (Mishkin 49). Yet, because these countries needed to compete in the same overarching market, in the same currency, they were left at a disadvantage. They could not depreciate their currency to become more competitive. For Greece, joining the Euro Zone had a similar effect to one that pegging the exchange rate to the Euro would have had. Shambaugh discovered that fixed exchange rates, domestic monetary autonomy and open capital markets cannot coexist (304). Fixed exchange rates eliminate monetary autonomy and only the base country, the country against which the currency is pegged, has this autonomy (Shambaugh 304). In the EU, the economically strongest countries had the autonomy (Mishkin 49). However, in absence of such factors, flexible exchange rate systems adjust better to asymmetric demand shocks (Lane 597). Some argue that exit out of the Euro Zone would be good for Greece. Theoretically, a return to drachma would enable Greece to affect the economy through its monetary policy (Lama & Medina 6). With large levels of current account deficit, Greece would be able to offset this by depreciating its currency. Its goods would become cheaper relative to foreign goods, which should increase exports. Foreign goods would also become more expensive, which should decrease imports. Once out of the EU, the EU could bail out Greece at a much lower interest rate (Chibber). In reality, Greece cannot exit the Euro Zone. Greece is a signatory to the Stability and Growth Pact of 1997 (Akram et al. 310). Every signatory must maintain steady fiscal deficit and debt levels (Akram et al. 310). In order to join the Euro Zone, according to the Constitution of the Economic and Monetary Union, a country must fulfill certain Maastricht criteria: The inflation rate of the applicant state should not be more than 1.5 percent, in comparison with the average of three EU member states who pertains the lowest inflation rates during the previous year. The long term interest rates of the applicant state should not be more than 2 percent, in comparison EU member states with the lowest inflation rates. The applicant state, before joining Euro-Zone, has to adopt exchange-rate mechanism (ERM II) for successive two years and during this period it is not allowed to devalue the currency. At the end of foregoing fiscal period, the government budget of the applicant state should not be more than 3 percent of each member state’s GDP. At the end of foregoing fiscal period, the gross to GDP ratio should not be more than 60 percent (Akram et al. 310). Every member state is obliged to follow the rules. The targets stated above were stretched over the 2012-2013 period (Akram et al. 310). However, analyses showed Greece had not improved its fiscal position (Akram et al. 310). Greece indulged in excessive spending in capital expenditures and labor compensation (Akram et al. 310). Though it would be best for Greece to exit, Greece cannot be expelled. Greece can only exit if it voluntarily chooses to do so (Akram et al. 313). Greece can only exit the Euro Zone if it exits the EU. According to a European Commission spokeswoman, “the treaties indeed confirm what we have been saying here: the treaty doesn't foresee an exit from the eurozone without exiting the EU” (Chibber). The Maastricht treaty from 1992 and the Lisbon treaty from 2007 do not offer any guidelines on how a member country of the Euro Zone could step out (Chibber). As Chiber argues, “under its current obligations, for Greece to exit the euro, it would have to leave the EU. This option was only added in Article 50 of the Lisbon treaty.” An exit would not imply an end to all ties with the EU. Once out of the EU, Greece would still be connected to the EU. According to Chibber: “The key part of Article 50 involves "setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union.” Chibber names examples of Liechtenstein, Norway and Iceland, all of which are not in the EU but are economically stable and have access to the single market through the European Economic Area. Greece too would have this option, but without the constraints on its monetary and fiscal policy. It could devalue its currency when needed and restructure debt at its own will. Objectives of the central bank could be designed to better serve the needs of the Greek economy. However, instead of choosing to leave, Greece has been pleading for help from the EU. The EU approached the crisis from a neoliberal point of view. The Euro Zone member countries responded by decreasing public expenditure, increasing indirect taxes, reducing wages and further liberalizing markets and while privatizing public property (Lapavitsas et al. 5). Germany benefitted from the crisis, as did other core countries, with large capital stocks (Lapavitsas et al. 5). Labor is left out of the neoliberal policies, as capital is protected. However, such policies, according to Lapavitsas et al., only deepen the crisis. The European Central Bank (ECB) lacks proper structure that a national central bank would have. The primary objective of ECB is price stability (Lapavitsas et al. 25). The objectives of the economic policy of the Economic Community, on the other hand, are high level of unemployment and stable, non – inflationary growth (Lapavitsas et al. 25). A central bank as a lender of last resort would bail out the Greek economy. However, ECB is not able to do this (Lapavitsas et al. 24). There is no Ministry of Finance in the EU that would handle the Greek crisis (Lapavitsas et al. 24).Moreover, the periphery, which includes Greece, has been seen as underproductive and too indebted. As a result, a total bail out from the point of view of ECB would be inefficient. ECB is overly controlled by a few countries. Though it is independent in its policies from other countries, ECB is largely financed by only a few EU member countries. These are: Germany with 25.9 percent of contribution, France with 19.4 percent, Italy with 17.1 percent, Spain with 11.3 percent and then other countries contributing the rest (Lapavitsas et al. 28). Greece contributes only 2.7 percent of ECB capital (Lapavitsas et al. 28). Greece was provided with the first bailout in 2010. On 2 May 2010, Greece was given a bailout of 100 billion Euros (Akram et al. 313). EU provided 80 billion Euros. Of that amount, 27.9 percent was provided by Germany, 21 percent by France, 18.4 percent by Italy and the rest was contributed by other Euro Zone member – countries (Akram et al. 313). However, it is hard to imagine how Greece could survive without a default. Standard and Poor forecasted that by 2015, Greek debt will amount to 144 percent of GDP (Akram et al. 314). By 2016, it should amount to 165-189 percent of GDP. Other analysts predict “a real possibility of default risk” (Akram et al. 314). In 2012, Greece received additional financial help. So far, Greece has not managed to improve economic performance, for the fifth year since the start of the crisis (Xafa). In March of 2012, Greece “concluded an agreement with the EU and the IMF on a second rescue package and a write-down of the debt due to private bondholders” (Xafa). Such default is called orderly default (Lapavitsas et al. 6). Private bondholders should be forced to bear the brunt of the crisis as well, according to the Economist. Though the EU has been trying to prevent the credit – default swaps crisis that occurred in the USA, such a policy should stabilize the economy, so restructuring of Greek bonds could be executed (Economist). However, Greece could lose control over domestic banks. Workers might end up bearing the brunt of the reforms. Fiscal policy would be controlled overwhelmingly by the core countries (Lapavitsas et al. 6). Exit out of the Euro Zone will not benefit Greece. Greece lost access to capital markets and so since 2010 it has been forced to borrow from other EU member countries to cover the gap between consumption and production (Xafa). Exit would leave Greece without that market as well. A return to the drachma would only exacerbate the problem, as Greece is in shortage of foreign exchange needed to maintain the current level of imports (Xafa). Xafa argues that what Greece needs is: “some form of rationing of essential imports would need to be imposed, as well as a freeze on bank deposits to avoid a run on the banks.” Moreover, exit out of the Euro Zone will not change the fact that Greece is uncompetitive. A return to a devalued drachma would not increase exports. The reason behind it is that Greece is the most heavily regulated OECD country. Moreover, Xafa claims that “its competitiveness ranking would probably slip further due to the inevitable restrictions on imports and bank deposits.” Greek history of currency crises before joining the Euro Zone in 2001 does not exhibit any improvement in competitiveness after each of these crises (Xafa). Lack of reforms indicates that the government has been historically reluctant to impose strict reforms. Xafa argues that Greek companies are inefficient, by using the example of Greece’s railroad company. This company has more employees than passengers, with its revenues amounting to 10% of the payroll (Xafa). Thus, Xafa argues that Greece needs restructuring and privatization. If Greece exits the Euro Zone, inflation will increase. According to Xafa, Greece only has a choice between “negative growth with inflation or negative growth without inflation.” Inflation will increase if Greece exits the Euro Zone, as its currency will devalue. A devaluation of currency will imply that drachma will become less valuable than before. Moreover, drachma is no longer a valid currency. According to Xafa, Greek economy will reject drachmas. Only Euro will be used as a currency. Nobody will believe in stability of drachma as a currency. What would eventually happen is that the government would be the only user of drachmas. Contracts so far have all been made in Euros. A switch to drachmas would produce confusion as contracts would need to be converted to the new currency. The Economist argues that it would take years to sort out the mess, especially as the contracts could not be converted at once since drachmas would need to get devalued, but due to the unstable condition of the Greek economy, devaluation could continue for some time. If Greece leaves the Euro Zone or defaults, other countries will suffer. If Greece defaults, the EU will be seen by investors and credit rating agencies as unstable. Its actions will create a view that the EU will not bail out its member countries. However, several countries also face the same situation as Greece (Akram et al. 314). Spain, Portugal and Ireland need to increase their public spending until they will recover and GDP will start growing again. Until then, deficit budgets and high public debts will need to increase (Akram et al. 314). In 2009, the public deficit for Portugal stood at 8 percent, for Ireland at 12.5 percent, France at 8.3 percent and Spain at 12.7 percent (Akram et al. 314). Public debt to GDP ratio for Portugal stood at 77.4 percent, France at 76.1 percent, Ireland at 65.8 percent and Italy at 114.6 percent (Akram et al. 314). Even older member countries such as France and Italy are not stable. Any run on the banks or flow of investment out of these countries could cause instability. Greek success is thus important to the entire Euro Zone. Instead, some argue that Greece should not be given an option to choose between exit or no exit, but between what type of a default it wants to undergo. Lapavitsas et al. argue that default should be “debtor-led, sovereign and democratic, leading to deep cancellation of debt” (7). Creditors should not be given the upper hand in determining how to help Greece. Lapavitsas et al. criticize the ordered default scenario as the public: the common citizens suffer the most in such defaults. If executed properly, “a broad economic and social program including capital controls, redistribution, industrial policy, and thorough restructuring of the state” would prevent a social catastrophe (Lapavitsas et al. 6). Though with more options, debtor-led default would most likely precipitate exit from the Euro Zone. Once out of the Euro Zone, Greece would have additional options. Greece would be able to “re-denominate its entire debt in the new currency” (Lapavitsas et al. 6). The government would be allowed to nationalize banks in order to rescue them, and domestic currency could provide additional liquidity (Lapavitsas et al. 6). Problems indicated by Xafa would still remain. Assets and liabilities of banks would remain denominated in Euros (Lapavitsas et al. 6). New problems would arise: Greek banks would shrink over time. New currency would depreciate, as also claimed by Xafa. However, unlike Xafa, Lapavitsas et al. argue that depreciation would create opportunities to the decreasing competitiveness among Greek companies (6). In any case, Greek economy will need to recover for years to return to its pre – 2009 levels. So far, taxes have been raised, but the economy has not been made more competitive (Economist). As a result, the economy became even more burdened by the debt. The EU is set on not letting Greece leave the EU. However, Greece is not like Argentina or Iceland. Both countries defaulted on their debt. However, they also recovered relatively quickly. The reason behind their quick recovery is that they had their own currency at the start of the crisis (Chibber). Argentina had peso linked to the US dollar. It defaulted on $102 billion of its debt during a financial crisis in 2001-02 (Chibber). However, in 2005 it managed to swap debt to 76 percent of its creditors, which reduced the value of bond holdings by two thirds (Chibber). Another example is Iceland. In 2008, Iceland had a run on its currency as banks failed. By summer, its currency depreciated by 50 percent. Inflation rose to 14 percent and interest rates to 15 percent (Chibber). Similarly, the splitting of Czechoslovakia in 1993 could be used as an example of a country that exited a monetary union. However, this divorce was successful as citizens and investors had time to adjust to the idea of two currencies (Chibber). Moreover, neither country faced a default the way Greece does. Most recommendations suggest that Greece should leave the Euro. Exit also implies leaving the EU. However, it does not imply isolation from other EU member countries. Exit, on the other hand, enables Greece to impose a flexible currency system in the markets and a possibility to increase exports. Debt contracts would be damaged, as the parties would refuse to convert them to drachmas in the presence of devaluations and insecurity about where the devaluation would stop. Without an exit, Greece is dependent on the monetary policy of ECB, which is controlled by the largest and wealthiest EU member countries, especially Germany. Germany, however, is not willing to bail out Greek debtors, unless Greece improves its performance. Moreover, even with a bail out, the Greek economy is so uncompetitive that it would further continue down the road of current account deficit and public debt. Politically, an exit by Greece could imply a disaster. The EU would not be viewed as a strong union. Investors might view it unfavorably as well, since failure to keep Greece could be viewed as a forecast for future crises among the EU member countries. Moreover, if Greece exits and is bailed out at a lower interest rate, other countries would find it profitable to leave as well. Such countries are Ireland, Portugal and Spain. In short, this crisis is a big test for the EU. Greece mustn’t leave, though it would be the best policy for Greece. A unitary monetary policy and market have failed to work for Greece, which was left unchecked with regard to its fiscal policy. So far, remedies have been slow to come, as ECB is faces its own institutional weaknesses. Greek government also has a history of unexecuted reforms. Without an exit out of the EU, Greece needs to find a different way to increase competitiveness and resolve the retaining debt problems. Works Cited Akram, Muhammad et al. “The Greek Sovereign Debt Crisis: Antecedents, Consequences and Reforms Capacity.” Journal of Economics and Behavioral Studies 2.6 (2011): 306-318. Print. Chibber, Kabir. “How Might Greece Leave the Euro? BBC, 3 Nov 2011. Web. 23 Apr. 2012. Economist. “What to Do About Greece.” The Economist. 28 Jan 2012. Web. 23 Apr. 2012. Lama, Ruy and Medina, Juan Pablo. “Is Exchange Rate Stabilization Appropriate Cure for the Dutch Disease?” International Journal of Central Banking 8.1 (2012): 5 – 46. Print. Lane, Phillip. “Asymmetric Shocks and Monetary Policy in a Currency Union.” The Scandinavia Journal of Economics 102.4 (2000): 585 – 604. Print. Lapavitsas, Costas et al. Breaking Up? A Route Out of the Euro Zone Crisis. RMF Occasional Report 3, 3 Nov. 2011. Web. 22 Apr. 2012. Mishkin, Frederic. The Economics of Money, Banking, and Financial Markets. Boston: Pearson/Addison Wesley, 2004. Web. 22 Apr. 2012. Shamaugh, Jay. “The Effect of Fixed Exchange Rates on Monetary Stability.” The Quarterly Journal of Economics 119.1 (2004): 301 – 352. Xafa, Miranda. “Greece’s Exit from the Euro Zone Would Be All Pain, No Gain.” VOX, 18 Mar. 2012. Web. 23 Apr. 2012. Read More