The public debt crisis in Greece

Roots, Policies, Outlook and Alternatives
07 October 2011

Every story needs a narrative, an explanation of why things happened the way they did. In such a narrative lie the answers of how to avoid/correct similar developments in the future and how to propagate positive ones.


Every story needs a narrative, an explanation of why things happened the way they did. In such a narrative lie the answers of how to avoid/correct similar developments in the future and how to propagate positive ones. Understandably, there may be different narratives to any particular case, depending on one’s standpoint, ie, on one’s individual and especially group or class interests, the information available, etc.

The narrative of the Greek public debt crisis is on many levels -domestic, the particular characteristics of Greek capitalism; European, the narrow basis of European integration and of the monetary union; global, the dominant role of finance, shifting its share of responsibility for the crisis to ordinary taxpayers. We shall explore each of these levels in the first part of our presentation.

The policies implemented in Greece, ostensibly in the interest of its people, are a test-case for the deepening of the neoliberal paradigm in Europe, favouring finance and more generally the privileged social classes. For example, the EU/IMF package is openly supporting privatization as a means of dealing with the public debt crisis, thus violating the Treaty’s neutrality towards ownership. Further, the setting up of a Task Force to provide technical assistance to the Greek government, quarterly reporting to the European Commission President and to the Commissioner for Economic Affairs and by-passing the Greek government compromises Greece’s political sovereignty. The policies implemented in Greece at present will be reviewed in the second part of our presentation.

Deflation has already taken hold of the Greek economy, while the prospect of a long-drawn depression is more real than not. Social discontent is turning into unrest, while society is gripped by the fear that the light at the end of the tunnel is that of the on-coming train! The government is mobilising ever increasing numbers of police, in order to quell the protests in the streets. So, what is to be done?

Desperate as the situation appears, we need to bear in mind that there is no shortage of alternative proposals. It is the political will to table and implement them that is in short supply. It is at this point that social mobilisations may bear on the situation. The broader, more informed, better coordinated and organised, the more likely they are to halt and even reverse the tide of events we are faced with. The outlook and possible alternatives will be discussed in the third part of our presentation.

1. The Greek narrative - Roots of the crisis

The orthodox account of Greece’s public debt crisis is one of fiscal profligacy, a country living beyond its means. This is not surprising, since Greece’s public deficit and debt, as well as its current account deficit have been persistently high in the past ten years. However, it is a superficial reading of the crisis, to the extent that it does not take into account the process that has led Greece to its present state. It is only through  understanding this process, that one can attempt to change it.

Domestic factors

By ‘domestic’ are meant the particular features of the capitalist formation in Greece, as it developed in the past half-century, which help explain the present state of its public finances. In the early 1950s, the Greek economy was in tatters, following a devastating WWII and an equally destructive civil war. The period 1950-1973 was dominated by the authoritarian Right (1950-1967) and the dictatorship (1967-1973). During this period, economic policy, which had little concern for a social agenda, aimed at ‘growth at any cost’, on the basis of a particular type of ‘social compromise’, which tolerated various tax digressions, such as favourable tax arrangements for the industrial sector, exemption of farmers from income tax, tax evasion by small businesses and professionals, etc. So much so, that there emerged the idea of ‘legal tax evasion’, which holds to this date (Stathakis, 2010).

The beginnings of the welfare state date back to the 1980s, during which a number of former national champions were nationalised, with the state taking over their liabilities. The problems facing the economy were compounded by sluggish growth and high inflation, resulting in a severe worsening of public finances.

Joining the eurozone was the strategic goal of the 1990s and of the 2000s. The productive sectors - manufacturing and agriculture- fell further behind, while privatization and market liberalisation helped deepen the financialisation of the economy. While the state of public finances worsened, these were ‘massaged’ through the use of derivatives and with the help of such revered financial institutions, as Goldman Sachs, a point we shall come back to shortly. Further, the inflow of portfolio investment made up much of the shortfall in the current account.

Throughout the sixty year period 1950-2010, the question of boosting state finances through the elimination of tax evasion remained outside the political agenda. This is a salient feature of the chronic fiscal problems of Greece. The fact that it is not bordered upon even today, is indicative of the prevailing group interests in Greek society. For example, it is estimated that the richest 20% of the population pay the least amount of income tax!

Other features of the profile of the Greek economy and its fiscal basis can also be explained by taking a longer-term view of the development of capitalism. For example, the existence of ‘closed professions’ and high public sector employment denote the attempts of capitalists to tie in the interests of the middle class and sections of the working class to their own (Tsakalotos, 2010). In this sense, the resulting social and economic configuration is a component of contemporary Greece, rather than just the symptom of a ‘clientelistic state’.

Only radical social and economic transformation, starting with the tax system and public administration, can make a lasting impact. The EU/IMF package does not address the social nature of Greece’s fiscal problems, while the deepening crisis makes institutional change more difficult.

European factors

It has been said that Greece faces a triple constraint (a) the inability to devalue its currency; (b) global downturn and (c) a powerful partner determined to run a current account surplus (Papadimitriou et al, 2010).

Indeed, in adopting the single currency, the eurozone members solved the problem of exchangerate speculation. However, the lack of a government banker - ie, a central bank that can stabilise the sovereign bond market through open market operations, in the way the Federal Reserve and other central banks are able to do- exposed them to speculation in the bond market, to the extent that the ECB is forbidden by the Treaty from acting in that capacity.

At the same time, the fiscal arrangements of the monetary union rely on discipline and peer pressure, while the Union budget is minimal (less than 1% of EU GDP), excluding by definition the notion of a transfer union. Thus countries like Greece stand defenceless at a time of crisis.

The increase in the public deficit of Greece is largely endogenous. Ie, it is mainly the result of the global and European recession and the coming into play of the automatic stabilisers. Thus a chronically high public deficit and debt shot upwards in 2009-2010. Financial engineering exacerbated the situation.

The third constraint facing Greece, as well as other indebted eurozone countries, is the growing divergence in the performance of different countries. In particular, a persistent and growing trade imbalance between Germany and certain other mainly N. European countries, on the one hand, and most S. European countries, amongst which Greece, on the other, is indicative of the competitiveness problems faced by the latter even in normal times, let alone at a time of crisis. The macroeconomic stance chosen by a major economy in the eurozone, such as Germany, undermines any attempt at convergence.

Thus, although the Greeks work longer hours than the Germans on an annual basis, have one of the lowest per capita incomes in Europe, a very unequal distribution of income and a high level of poverty, especially among the working poor (OECD, 2010), they are less competitive than their German counterparts, because Germany is pursuing a low-wage growth strategy, which is consistent with its export-led model. On a long-term basis, such divergences are not compatible within a monetary union, unless the difference in the current account balance between surplus and deficit member states is compensated for by transfers. This however is precluded by design.

Overall, the restrictive institutional arrangements of the European Monetary Union and the diverging wage policies of its member states account not only for much of the predicament Greece finds itself in, but also for its inability to overcome it.

Global factors

As mentioned above, much of the increase in the Greek public debt was originally triggered by the global downturn. In addition, global finance played a significant part in exacerbating the crisis in its different stages.

Starting at the beginning, for nearly fifteen years, Goldman Sachs created currency swaps that enabled Greek government debt issued in dollars and yen to be swapped for euro-denominated bonds that would be paid back at a later date. The bond maturities range between 10-15 years. GS received a hefty commission and sold the swaps to a Greek bank in 2005. The Greek government kept its eurozone partners happy and the state of the Greek public finances was expertly and legally disguised!

As Greece’s financial condition worsened in 2009, GS, JP Morgan and certain other banks backed an obscure company - the Markit Group of London-  to introduce a new index - the iTraxx SovX Western Europe- made up of the 15 most heavily traded credit-default swaps in Europe and covering troubled economies such as that of Greece. This enables market players to bet on whether Greece, amongst others, will default or not. Trading in such swaps drives up the cost of insuring Greek sovereign debt and in turn what Athens has to pay to borrow funds. Hence the phenomenon of banks betting Greece will default on debt they helped hide!

As mentioned above, the monetary arrangements of the eurozone leave its members vulnerable to bond market speculation. As the Greek crisis demonstrated, such countries can be held hostage by financial markets and credit rating agencies alike. The multiple downgrades of Greek sovereign bonds are illustrative in this respect. In the first half of 2011 alone, the three big CRAs downgraded them 7 times! Not surprisingly, by July 2011, the spreads on these bonds exploded, as did the CDS.

Overall, global finance affected the emergence and the development of the Greek public debt crisis both directly and indirectly. The particular instances mentioned above are examples of direct involvement. Indirectly, global finance has been instrumental in fostering the ¡¥profligacy of the Greeks’ narrative, in an attempt to divert attention from its own part in the crisis and to secure fresh bail-out funds. Furthermore, as pointed out by Walden Bello, by throwing the spotlight on the high and rising government spending as the key problem of the economy worldwide, global finance is trying to deflect the pressures for tighter financial regulation demanded by citizens and governments since the start of the global crisis.

2. EU/IMF bail-outs -The cure killing the patient?

The run-up to the first bail-out

The saga of the Greek public debt crisis began in October 2009, when the newly elected socialist government announced that the public deficit for 2009 would reach 12.5% of GDP, instead of 3.7%, as projected in that year¡¦s budget. The 10-year bond spread (over the German bond), which was equal to 134 b.p. on 22 October 2010, started rising.

In early 2010, Greece announced a series of austerity measures, which were ‘welcomed’ by the European Council (at its meeting of 25 March 2010). However, the 10-year bond spread reached 586 bp on 22 April. On 23 April 2010, the Greek government formally applied for financial assistance from the eurozone and the IMF. This was agreed in early May 2010, while the ECB announced that it will accept Greek government bonds as collateral irrespective of their rating.

Even so, by 7 May, the 10-year bond spread reached 1038 bp, around which it hovered throughout 2010 and which it has by now exceeded.

The 2010 bail-out

This amounts to Euro 110 bn, of which Euro 80 bn are intergovernmental loans pledged by the eurozone countries and Euro 30 bn by the IMF. The projected disbursement of the loans is designed to meet the financing needs of Greece up to the first half of 2013. The loans carry a 3.5% interest rate and have maturities of 15-30 years, including a grace period of 10 years. The bail-out package is strictly conditional on the implementation of severe austerity measures, as well as of extensive liberalisation and privatization reforms.

More specifically, the austerity measures are based more on expenditure cuts (over 60% of the reduction of the deficit) than on tax increases. They are designed to reduce the public deficit from 15.4% of GDP in 2009 to 2.6% by 2014. Further, thorough-going and detailed reforms of the pension system, of healthcare and of education constitute explicit conditions of the bail-out package. Progress in all of these areas is checked at regular intervals by EU and IMF officials, determining whether whether the next tranche of the loans will be disbursed or not. In this way, additional pressure is exerted, leading to further austerity measures, in case of the targets not being reached.

The bail-out fiscal projections are based on a crucial assumption, that growth resumes not only in Greece, but also globally. As the experience of the past year has shown, this is a bold assumption, almost certain to fail in the short term. Greece is already in a downward spiral of falling wages, prices and production and rising unemployment (17% from 10% in 2009 and expected to exceed 20% shortly), poverty and inequality. As the Fourth Review of the ‘Economic Adjustment Programme for Greece’  notes, the recession is deeper and longer than initially expected. This results in the non-attainment of the bail-out fiscal targets, which leads to new measures, taken in a near-panic by the Greek government, perpetually chasing its own shadow!

The 2011 bail-out

This was decided in July 2011 and it marks a departure from the previous one, insofar as it contains a clause regarding the involvement of the banking sector, which is being asked to take on a loss of approximately 21% of their Greek government bond holdings. The actual form and rate of participation of the banks has not yet been finalised.

A cornerstone of both bail-outs is the fast-track privatization of the state’s holdings throughout the economy. In spite of the EU¡¦s presumed neutrality towards ownership (art. 345 of the Treaty), the European Commission takes a clear position in favour of privatization, as a means of reducing the public debt, as well as of promoting economic activity. Furthermore, the privatization process is to be monitored by an independent board, following the example of the TREUHAND agency, which was responsible for the privatization of the E. German economy, after unification. Obviously, it is considered to have been successful, even though 2,5 million jobs were lost in the process, while the whole exercise cost more than DM 300 billion, as compared with the privatization revenues, which did not exceed DM 60 billion.

Overall, the EU/IMF bail-outs fail to recognise the nature of the Greek debt crisis, be it domestic, European or global. In this way, they overlook not only the deeper aspects of the shortcomings of the Greek economy, but also the structural weaknesses and inadequacies of the euro construction, as well as the role of finance.

Furthermore, the same logic and political one-sidedness is displayed in relation not only to other indebted countries seeking financial assistance, such as Ireland and Portugal, but also with regard to the main policy guidelines for the eurozone as a whole. Pursuing fiscal consolidation simultaneously across an area of 17 member states (not to mention 27!) at a time of crisis is simply spreading ‘contagious austerity’ at the risk of provoking the ‘contagious downturn’ of the eurozone as a whole, in effect risking its very survival (Munchau, FT, 4/9/2011).

3. Outlook and alternatives

The austerity measures and the labour market reforms carried out in Greece are a form of internal devaluation, ie, a way of lowering the real effective exchange rate in terms of unit labour cost. This is a long-drawn process, with a heavy social cost, made even heavier by the current global and European uncertainties. Furthermore, it cannot go on for very much longer, not only because the economy will eventually collapse, but also because, in a society with diversified interest groups, those bearing the greatest share of the burden will reach the limit of their capacity to do so. Already, there are signs of political alienation and anger directed against the two major political parties, which have alternated in power in the post-WWII period. The extreme Right is also registering a rise in electoral preferences.

Overall, the situation in Greece is no longer economically or socially sustainable. The experience of the past year has demonstrated that fiscal consolidation without growth is not possible and that the continuation of the austerity and reform programme of the EU/IMF in fact deepens the recession, making a disorderly default more imminent. So, what is to be done?

The orthodox answer to this question is ‘more of the same’. Germany’s federal minister of finance, Wolfgang Schauble, maintains that ‘Governments in and beyond the eurozone need not just to commit to fiscal consolidation and improved competitiveness, they need to start delivering on these now. The recipe is as simple, as it is hard to implement in practice: western democracies and other countries faced with high levels of debt and deficits need to cut expenditures, increase revenues and remove the structural hindrances in their economies, however politically painful’ (FT, 5/9/2011). A plain message, in clear neoliberal language, which unfortunately cannot work at a time of crisis. But what is the alternative?

The idea of issuing ‘eurobonds’ -ie, bonds collectively guaranteed by the eurozone member states- has been floated by various proponents and in a variety of forms. For example, according to the’ blue’ bond proposal, countries would have the right to issue blue bonds, collectively guaranteed up to 60% of their GDP, thus significantly lowering their borrowing costs.

Another ‘eurobond’ proposal would have the ECB issue bonds and buy up to 60% of the existing debt of the eurozone countries, while individual countries would be responsible for their share of the interest on the Eurobonds.

Both of these proposals could offer some relief to the current crisis of confidence in the eurozone and help indebted countries like Greece out of their current impasse. However, the ‘blue’ bond proposal implies a transfer from stronger to weaker countries, in the form of guarantees, while the’ eurobond’ proposal comes up against the ‘ no bail-out’ clause of the Treaty and of the ECB statute.

More proposals, not necessarily requiring the revision of the Treaty of the Union, have also been forthcoming. For example, Thomas Palley has proposed the establishment of a European Public Finance Authority, that would act as a treasury for the eurozone, in conjunction with the ECB, which in turn would assist budget financing by managing bond interest rates, as a government banker would normally do (Palley in FT, 31-8-2011).

All of the above proposals towards a more meaningful financial, if not fiscal, union of the eurozone have two things in common: (i) they require the political will to adopt and implement them and (ii) they are medium to long-term measures. In the best of cases, they cannot deal with the immediate issues facing Greece or the eurozone.

Most analysts agree on the need to provide breathing space for Greece. The continuation of austerity policies does not only dampen aggregate demand. It also increases the real value of the outstanding debt, which will lead to bank failures and to bankruptcies of businesses. Hence, the need to reverse gear; ie, to reflate the economy by promoting economic growth. Since the private sector cannot do this, it will have to be the government.

Furthermore, there is an urgent need to restart growth in the eurozone and in the EU more generally. Surplus countries like Germany can boost consumer spending in co-ordination with the rest of the eurozone. The European Investment Bank can also contribute to reflation by financing public works. Needless to say, such reflation should take into account environmental and climate considerations and it should be designed so as to reduce inequality and poverty.

Lastly, it is essential that the reform of financial regulation policy in the EU, as well as globally, is concluded soon, after more than two years of deliberations. The attempts by the banks and other financial institutions to tailor the new regulations to their own interests has to be resisted. After all, growth and stability are prerequisites for a successful exit from the current crisis on the national, European and global level.

Photo by mkhalili.