The Greek debt crisis originated from heavy government spending and problems escalated over the years due to slowdown in global economic growth. When Greece became the 10th member of the European Union on Jan. 1, 1981, the country's economy and finances were in good shape, with a debt-to-GDP ratio of 28% and a budget deficit below 3% of GDP. But the situation deteriorated dramatically over the next 30 years because fiscal profligacy, which is defined as wasteful and excessive expenditure, caused deficits and debt levels to explode.
The Road to Debt
In Oct. 1981, the Panhellenic Socialist Movement (PASOK), a party founded by Andreas Papandreou in 1974, came into power on a populist platform. Over the next three decades, PASOK alternated in power with the New Democracy Party that was also founded in 1974. In a continuing bid to keep Greek voters happy, both parties lavished liberal welfare policies on their electorates, creating a bloated, inefficient, and protectionist economy.
- The Greek debt crisis is due to the government's fiscal policies that included too much spending.
- Greece's financial situation was sound when it entered the EU in the early 1980s, but deteriorated substantially over the next thirty years.
- While the economy boomed from 2001-2008, higher spending and mounting debt loads accompanied the growth.
- By the time of the 2007-2008 financial crisis, the jig was up and Greece's debt loads became too big to handle—austerity measures were put in place shortly thereafter.
The government sent the country on an unsustainable fiscal path. For example, salaries for workers in the public sector rose automatically every year, instead of being based on factors like performance and productivity. Pensions were also generous. A Greek man with 35 years of public-sector service could retire at the ripe old age of 58, and a Greek woman (under certain circumstances) could retire with a pension as early as 50.
Perhaps the most infamous example of undue generosity was the prevalence of 13th-month and 14th-month payments to Greek workers. That is, workers were entitled to an additional month's pay in December to help with holiday expenses and also received one-half month's pay at Easter as well as one-half when they took their vacation.
As a result of low productivity, eroding competitiveness, and rampant tax evasion, the government had to resort to a massive debt binge to keep the party going. Greece's admission into the Eurozone in Jan. 2001 and its adoption of the euro made it much easier for the government to borrow. This was because Greek bond yields and interest rates declined as they converged with those of strong European Union (EU) members like Germany.
For instance, the yield spread between 10-year Greek and German government bonds plunged from more than 600 basis points in 1998 to about 50 basis points in 2001. As a result, the Greek economy boomed, with real GDP growth averaged 3.9% per year between 2001 and 2008, the second fastest after Ireland in the Eurozone.
But that growth came at a steep price in the form of rising deficits and a burgeoning debt load. This was exacerbated by the fact that these measures for Greece had already exceeded the limits mandated by the EU's Stability and Growth Pact when it was admitted into the Eurozone. For example, Greece's debt-to-GDP ratio was at 103% in 2000, well above the Eurozone's maximum permitted level of 60%. Greece's fiscal deficit as a proportion of GDP was 3.7% in 2000, also above the Eurozone's limit of 3%.
The jig was up shortly after the financial crisis of 2007-08, as investors and creditors focused on the colossal sovereign debt loads of the U.S. and Europe. With default a real possibility, investors began demanding much higher yields for sovereign debt issued by Portugal, Ireland, Italy, Greece, and Spain as compensation for this added risk.
Up until then, the sovereign debt risk for those countries had been camouflaged by their wealthy neighbors in the north, such as Germany. By Jan. 2012, however, the yield spread between 10-year Greek and German sovereign bonds has widened by a whopping 3,300 basis points, according to research by the Federal Reserve Bank of St. Louis.
As Greece's economy contracted in the aftermath of the crisis, the debt-to-GDP ratio skyrocketed, peaking at 180% in 2011. The final nail in the coffin came in 2009, when a new Greek government led by Papandreou's son George came into power and revealed that the fiscal deficit was 12.7%, more than twice the previously disclosed figure, sending the debt crisis into a higher gear.
The Bottom Line
The Greek debt crisis had its origins in the fiscal profligacy of previous governments, proving that, like individuals, nations cannot afford to live way beyond their means. As a result, Greeks may have to live with stiff austerity measures for years, if not decades.