What Is the Story Behind Greece's Downfall?
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) was the first time in history a developed nation has missed such a payment. Greece joined the Eurozone in 2001, and some consider that the Eurozone partly to blame for Greece's downfall. However, the Greek economy was suffering structural problems prior to adopting the single currency, and the economy was left to collapse—although not without its reasons.
- Greece defaulted in the amount of €1.6 billion to the IMF in 2015.
- The financial crisis was largely the result of structural problems that ignored the loss of tax revenues due to systematic tax evasion.
- Greece's productivity was much less productive than other EU nations making Greek goods and services less competitive and plunging the nation into insurmountable debt during the 2007 global financial crisis.
Understanding Greece Before the Euro
Before acceptance into the Eurozone in 2001, Greece’s economy was plagued by several problems. During the 1980s, the Greek government had pursued expansionary fiscal and monetary policies. However, rather than strengthening the economy, the country suffered soaring inflation rates, high fiscal and trade deficits, low growth rates, and 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, help to lower nominal interest rates, encourage private investment, and spur economic growth. Further, the single currency would eliminate many transaction costs, leaving more money for the deficit and debt reduction.
However, acceptance into the Eurozone was conditional. 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 remainder 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 within the Maastricht limits. In 2004, the Greek government openly admitted that its budget figures had been doctored to meet the entry requirements for the Eurozone's single currency. Greece was hoping that despite its premature entrance, membership to the EMU would boost the economy, allowing the country to deal with its fiscal problems.
In 2004, the Greek government admitted that it had fudged its budget figures in order to join the Eurozone and boost its economy.
Greece’s acceptance into the Eurozone had symbolic significance as many banks and investors believed that the single currency effaced the differences among 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 indeed spurring 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 stemmed 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 the same periods 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 was 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 was actually more of a social norm that was not remedied in time.
The Greek Economy vs. Other European Countries
The adoption of the euro only highlighted the competitiveness gap as it made German goods and services relatively cheaper than those in Greece. Having given up independent monetary policy Greece could no longer 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 benefited from increased exports to Greece, banks, including German banks, benefited from Greek borrowing to finance cheap imported German goods and services. As long as borrowing costs remained relatively cheap and the Greek economy was still growing, such issues continued to be ignored.
Eurozone membership helped the Greek government to borrow cheaply and to finance its operations in the absence of sufficient tax revenues. However, 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.
The Global Financial Crisis
The global financial crisis that began in 2007 exposed the true nature of Greece’s financial strife. The recession weakened 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 to dry up, Greece faced a liquidity crisis, forcing the government to seek bailout funding, which they eventually received with staunch conditions.
Bailouts from the International Monetary Fund and other European creditors were conditional on Greek budget reforms, specifically, spending cuts and higher tax revenues. These austerity measures created a vicious cycle of recession with unemployment reaching 25.4% in August 2012. Tax revenues weakened, which made Greece’s fiscal position worse. Austerity measures created a humanitarian crisis, homelessness increased, suicides hit record highs, and public health significantly deteriorated. The measures, applied amidst the worst financial crisis since the Great Depression, proved to be one of the largest factors attributing to Greece's economic implosion.
Special Considerations—Greece's Bailout
Far from helping the Greek economy to get back on its feet, bailouts only served to ensure that Greece’s creditors were 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 created an economic straitjacket and an insurmountable debt crisis evidenced by the country's massive default.