Why Greece still matters

In late January, it was leaked that a proposal was circulating in the German government that there should be a resident EU mission to oversee Greece’s implementation of austerity measures agreed in exchange for continuing loans from its euro zone partners and the writing into the Greek constitution of a commitment to give priority to servicing debts over any other form of expenditure. Eveangelos Venizelos, the Greek finance minister, remarked that those who made these proposals had failed to learn the lessons of history. As there had been many references in the Greek press to the occupation of Greece during the Second World War by Germany it was assumed that the remark referred to this. However, it is not clear what lessons could be learnt from this other than not to use military force to subdue other nations, a lesson which Germany clearly has learnt. A more relevant comparison can be made between  the enforcement of reparations by Germany’s enemies in the First World War following the Treaty of Versailles. Of course, there are many differences between Germany’s economy in the 1920s and Greece’s economic prospects in the 2010s. The motivation of politicians in Germany, which, by circumstance rather than choice, has to take the lead role in the EU’s harsh policy towards Greece, is mainly to avoid pouring money into what they see as a bottomless pit, rather than to punish the Greeks; in the case of the Treaty of Versailles, punishing Germany for its aggression in 1914 was part of the motivation of the victorious allies, although another part was compensation for the financial costs of the war. However, the effects on a country’s economy of having to pay financial reparations and having to service debt, are precisely the same. They both mean that a section of the country’s tax revenue has to be paid outside the country rather than on public services or social benefits. There is also a strong element of national humiliation in both cases, even if the causes of that humiliation are very different.

Although it cannot be proven, many historians do think that the combination of national humiliation and economic deprivation suffered by Germany in the 1920s contributed to creating favourable circumstances for the rise of the National Socialists in the 1933 election and in retrospect that the policies of the Western allies in the 1920s are seen as short-sighted. It can be pointed out that Greece is a small country without much recent history of military success so there is little danger that it could be a threat to peace or political stability in Europe as a whole. However, to treat a small, weak country much more harshly than a large, strong country would be treated, would not only be immoral but would fatally undermine the principles of solidarity and shared interests on which the forerunners of the EU were created in the 1950s and which have held, though sometimes under stress, in the subsequent half century. Moreover the impact of a politically unstable Greece on south-east Europe, which has been Europe’s most politically unstable region in the last 20 years, would be unpredictable.

To make a comparison between Greece’s economic situation and prospects now and that of European countries in the interwar years is not entirely hyperbolic. Five years of continual severe economic decline, with no prospect of a reversal of the trend, cuts of 20% and more in nominal wages, including the minimum wage and unemployment rising above 20% and nearly reaching 50% for young people are statistics comparable with those of European countries in the interwar period.

Having pointed to the gravity of the situation, it has to be admitted that there are no easy answers. The combination of rapid integration into the global economy, including free movement of capital, and participation in the euro, led to a level of consumption by 2007 which was way beyond what could be supported by the Greek economy’s productive capacity. After five years of rapidly declining domestic demand, there was still in 2011 a current account deficit of almost 10% of GDP, implying that Greece was paying much more for its imports than it was earning from exports of both goods and services, while a combination of fierce cuts in public sector salaries and pensions and tax rises, there was still a primary government deficit, implying that the government was still dependent on financial inflows and was nowhere near paying the interest, let alone the principal, of its debt. Germany and the other richer euro zone countries has always made clear that there would not agree to be party of a a “transfer union” that provides ongoing subsidies between the different participating states of the monetary union, beyond what was already provided for in the EU budget. However, the question of who is responsible for paying off Greece’s accumulated debt is a different one. Following the 53.5% write down of private sector debt agreed by a majority of such creditors on March 5th, over 80% of Greek debt will be official debt, which is essentially provided by other governments, mainly other euro zone participants. This debt still amounts to about 150% of Greece’s declining GDP. Given that the Greek economy is already on its knees, there is little chance that the debt can be serviced even if further painful measures are imposed and such measures would have a devastating effect on Greek society.

The responsibility for this situation of unsustainable debt cannot by any means be placed entirely on Greece. A contract to lend money requires the voluntary agreement of both borrower and lender. Neither should enter such contract without a realistic perspective on the feasibility of repayment. (Private contracts in market economies are usually limited by bankruptcy law which means that adverse consequences have to be suffered by both borrower and lender if repayment cannot be managed.) In the case of Greece, severe adverse consequences have already been suffered by the Greek population, and now also by some private sector lenders. What about the governments (meaning taxpayers and electorate) of other countries that now hold most of Greek debt? They have taken on this debt as a result of two programmes of financial intervention, one of €110bn in May 2010 and one of €130bn just agreed. These programmes are commonly referred to as “bail-outs” of Greece. However, they were not primarily motivated by a desire to help the Greek people but rather to maintain financial stability throughout the euro zone. There was a huge and well-founded fear that a financial collapse of Greece could have similar effects on the rest of the euro zone to that of Lehman Brothers in 2008 on the US and Europe. The responsibility for the financial instability of the euro zone as a whole cannot credibly be placed on one small member state. The euro zone is beset by imbalances between many other countries and by the poor condition of banks even in otherwise stronger economies. Greece should not have been allowed to join the euro zone but again it is not appropriate to place responsibility for this sevent primarily on Greece. Just as any elite institution such as a university wants to attract a wide range of applicants but then has the responsibility to choose amongst those applicants those which it thinks would benefit from being admitted, so the euro zone cannot complain that it has attracted a range of applicants not all of whom were suitable. It was the task of the European Commission, the ECB and the then existing 11 euro zone member states to decide whether Greece was a suitable applicant. It is claimed that Greece “cheated” but it should have been obvious that it hired Goldman Sachs to use its financial knowhow to present Greek statistics in the most favourable possible light. It should have been evident that Greece’s weak economy already burdened by a huge public sector debt was not a suitable candidate.

Moreover the problem with Greece is not just its membership of the euro zone. There are also imbalances in other parts of the world, fuelled by easily mobile capital, in which some countries, like Greece, Spain, the UK and the US, have had economies inclined to borrow, whether through the public or private sectors, while others, such as Germany, the Netherlands and China, have had economies inclined to save. Those with surplus savings have to look to place those savings abroad, if they cannot be spent domestically. They have to recognize that, if they fail to invest the money wisely, they do no have an automatic right to be repaid. The main reasons that euro zone countries have ended up with a lot of worthless Greek debt relate to their own mistakes: the decision to admit Greece, their failure to supervise their banking sectors, the failure to enforce the euro zone’s instrument of fiscal discipline, the Stability and Growth Pact, and the failure to recognize that large external current account imbalances were bound to cause instability.

If Greece’s partners grind it ever further into penury to get their “pound of flesh”, they will present a dismal spectacle to the world, and betray the inheritance of the EU’s founding fathers. The first spur to the Marshall Plan which, as described in Jean Monet’s Memoirs, provided the background for the integration of west European economies, was the desperate economic plight of Greece and Turkey in 1947 when the UK withdrew aid it had in the immediate post-war years provided to these countries.  The US intervened to help Greece and Turkey and then recognized that it was not just these countries that needed economic support. It would be ironic and tragic if Greece proved both the starting and ending point of a unique period of solidarity between European countries.

However, even if Greece’s euro zone partners recognize that they will have to accept the loss of most of their holdings of Greek sovereign debt, the Greek economy will still be in a dire situation with no clear prospect of a way out.

What Greece’s partners and the EU institutions can do to help Greece recover is limited by a number of constraints, one of which is the size of the EU budget. In practice this is limited to only 1% of EU GDP. However, given that the Greek economy accounts for only about 2% of EU GDP and that is the country most in need of help at present there should be scope within this limit to do more. Even under existing provisions, there is €20.4bn provided for as grant aid to Greece in the 2007-13 budgetary framework, most of which after five of the seven years remains unspent. One of the main reasons for failure to use the funds is the condition provision that matching funds must be provided by the recipient government. In the circumstances in which the Greek government is being told by the EU authorities to reduce its expenditure, the requirement that it increase its expenditure in order to benefit from these funds, has become absurd. Although the proportion of matching funds has belatedly been reduced, it should be eliminated. Much of this funding is intended to go to small and medium businesses, whose expansion potential could be substantially enhanced by a combination of subsidies by the structural funds and loans by the European Investment Bank, at a time when Greek banks are having to cut back on their exposure.

On September 1st, 2011, an EU Task Force for Greece was established, one of whose primary purposes was to oversee the spending of EU structural funds in Greece; another objective was that of seeking to use the funds for training and work experience of young people. In these objectives, the Task Force could play a major role but its potential is weakened by the multiplicity of its objectives, including “advising” the Greek government on administrative “reform”. Since advising is a euphemism for arm-twisting and reform a euphemism for severe cuts, this objective has prevented the Task Force from being seen in Greece as benign. Instead it is seen as a symbol of Greek subjection with the portrayal of its head, Horst Reichenbach, in Nazi uniform in one Greek newspaper, being the most extreme example.  It would be much better if there were a Task Force for promoting growth and employment opportunities which was completely separate from the pressure being exerted for brutal fiscal tightening and create a positive image. This would not of course be anything near a full answer to the Greek economy’s predicament, but it could provide a small dose of the desperately needed and lacking ingredient of hope.