In 2015 Greece defaulted on its debt. While some said Greece simply fell into ‘arrears’, its missed payment of €1.6 billion to the International Monetary Fund (IMF) signaled for the first time in history a developed nation has missed such a payment. While some may think that Greece would have been better off never having joined the Eurozone, the fact of the matter is that the Greek economy was suffering structural problems prior to adopting the single currency. Greece could have benefited from a better designed Eurozone, but instead, the economy was left to collapse – though not without its reasons.
Greece Before the Euro
Before acceptance into the Eurozone in 2001, Greece’s economy was plagued by several issues. During the 1980s the Greek government pursued expansionary fiscal and monetary policies. But, rather than strengthening the economy, the country suffered soaring inflation rates, high fiscal and trade deficits, low growth rates and several exchange rate crises.
In this dismal economic environment, joining the European Monetary Union (EMU) appeared to offer a glimmer of hope. The belief was that the monetary union backed by the European Central Bank (ECB) would dampen inflation, helping to lower nominal interest rates, thereby encouraging private investment and spurring economic growth. Further, the single currency would eliminate many transaction costs, leaving more money for deficit and debt reduction.
However, acceptance into the Eurozone was conditional, and of all the European Union (EU) member countries, Greece needed the most structural adjustment to comply with the 1992 Maastricht Treaty guidelines. The treaty limits government deficits to 3% of GDP and public debt to 60% of GDP. For the rest of the 1990s Greece attempted to get its fiscal house in order to meet these criteria.
While Greece was accepted to the EMU in 2001, it did so under false pretenses, as its deficit and debt were nowhere near being within the Maastricht limits. In 2004, the Greek government openly admitted that its budget figures had been doctored in order to join the Eurozone. Greece’s hopes were that, despite premature entrance, membership to the EMU would help boost the economy, allowing the country to deal with its fiscal problems once they were "in." (See also, When Global Economies Converge.)
Greece’s acceptance into the Eurozone had symbolic significance as many banks and investors believed that the single currency effaced differences between European countries. Suddenly, Greece was perceived as a safe place to invest, which significantly lowered the interest rates the Greek government was required to pay. For most of the 2000s, the interest rates that Greece faced were similar to those faced by Germany.
These lower interest rates allowed Greece to borrow at a much cheaper rate than before 2001, fueling an increase in spending. While helping to spur economic growth for a number of years, the country still had not dealt with its deep-seated fiscal problems which, contrary to what some might think, were not primarily the result of excessive spending.
At root, Greece’s fiscal problems stem from a lack of revenue. As a percentage of GDP, Greece’s social spending expenditures were 10.3% in 1980, 19.3% in 2000 and 23.5% in 2011, whereas Germany’s social expenditures during these same times were 22.1%, 26.6% and 26.2%, respectively. In 2011, Greece was below the EU average of 24.9% in social expenditure.
Much of this lack of revenue is the result of systematic tax evasion. Generally self-employed, wealthier workers tended to under-report income while over-reporting debt payments. The prevalence of this behavior reveals that, rather than being a behind the scenes problem, it is actually more of a social norm, one that wasn't remedied in time.
Greek Economy vs. Other European Countries
The adoption of the euro only served to highlight this competitiveness gap as it made German goods and services relatively cheaper than those in Greece. Giving up independent monetary policy meant that Greece lost the ability to devalue its currency relative to that of Germany’s. This served to worsen Greece’s trade balance, increasing its current account deficit. While the German economy benefits from increased exports to Greece, banks, including German ones, benefit from Greek borrowing to finance the importation of these cheap German goods and services. But, as long as borrowing costs remained relatively cheap and the Greek economy was still growing, such issues continued to be ignored.
While Eurozone membership helped the Greek government to borrow cheaply – helping to finance its operations in the absence of sufficient tax revenues – the use of a single currency highlighted a structural difference between Greece and other member countries, notably Germany, and exacerbated the government’s fiscal problems. Compared to Germany, Greece had a much lower rate of productivity, making Greek goods and services far less competitive. (See also, What's the difference between monetary policy and fiscal policy?)
The Global Financial Crisis
The global financial crisis that began in 2007 would see the true nature of Greece’s problems brought to the surface. The recession served to weaken Greece’s already paltry tax revenues which caused the deficit to worsen. In 2010, U.S. financial rating agencies stamped Greek bonds with a 'junk' grade. As capital began drying up, Greece was facing a liquidity crisis, forcing the government to begin to seek bailout funding which they eventually received, albeit with staunch conditions.
Bailouts from the IMF and other European creditors were conditional on Greek budget reforms, namely cuts to spending and increasing tax revenues. These austerity measures created a vicious cycle of recession, with unemployment reaching 25.4% in August 2012. Not only did this weaken tax revenues which made Greece’s fiscal position worse, but it created a humanitarian crisis; homelessness increased, suicides hit record highs, and public health significantly deteriorated. Such severe austerity measures amidst the worst financial crisis since the Great Depression, proved to be one of the largest factors attributing their economic implosion.
The Bottom Line
Far from helping the Greek economy back on its feet, bailouts only served to ensure that Greece’s creditors are paid while the government was forced to scrape together paltry tax collections. While Greece had structural issues in the form of corrupt tax evasion practices, Eurozone membership allowed the country to hide from these problems for a time, but ultimately served to be an economic straitjacket, creating an insurmountable debt crisis as evidenced by their massive default. The only thing Greece knows for sure is that difficult times are ahead.