The Case for Greek Austerity

The early and mid 2000’s was a time of economic prosperity for Greece. Following their adoption of the euro, Greece gained access to inexpensive credit, allowing them to achieve one of the fastest economic growth rates between 2000 and 2007. Greece saw record high GDP levels, even higher than the Eurozone average of 2.5%, at 5.9% in 2003 and 5.5% in 2006. It was expected that middle and lower income countries would borrow funds to finance their growing economies. By joining the Eurozone, Greece and other peripheral countries could now borrow money to fund investment in their private and public sectors. Greece instead redirected the majority of investment towards the public sector, which employs roughly 30% of the working population (Weisenthal 2015). The net effect was a significant increase in the standard of living as real GDP per capita went up by roughly 30%.  This resulted in an increase in the government budget deficit from 3% of GDP in 1999 to 15% in 2009 and an increase in the current account deficit from 3.4% of GDP in 1999 to 14.4% in 2008.  A low retirement age, a generous pension system and an outdated tax structure only served to increase Greece’s public debt this past decade.

From 2004 to 2006, Greek pension spending increased by 11%; over the same period, Germany’s experienced no growth (White 2015). An individual can work a minimum of 35 years to earn a full pension in Greece, whereas an individual must work a minimum of 45 years in Germany to see that money. Greek citizens have seen an increase in their standard of living as a result of joining the Euro; they are afraid that austerity measures will result in this new standards loss. The Greek government could have mitigated this had they reformed their tax structure. When the global financial crisis occurred and analysts began reexamining the riskiness of Greek debt, several things became clear. First, Greece was found to have fabricated its macroeconomic and financial statistics, making the country’s performance look better than it really was. Second, tax evasion was rampant and ingrained in Greek culture.

Despite the fact that tax rates in Greece mimic rates elsewhere in the Eurozone, Greek citizens have displayed an aversion to making these payments. Recent evidence suggests that Greece is the worst country in Europe at collecting taxes, bringing in only 10.5% of undisputed tax debt (Klein 2015). “Alleged corruption among politicians only strengthens Greeks’ conviction that evading taxes in their own everyday lives isn’t a serious crime, and little is attached to getting caught, unlike in other European countries or even the U.S.” (Stamouli 2015). Like many developing countries, corruption is an open secret.  To get things done, from arranging a doctor’s appointment to obtaining a business license, one pays a bribe. Amnesty International’s Corruption Perceptions Index ranks Greece tied for last in the EU (Transparency 2015).

Greece has been consuming beyond its means. Greece neglected to use loans obtained during the early years for productive investment, instead politicians opted to pander to their citizens in order to gain political popularity. Many citizens and leaders of member Eurozone countries fail to see the reason they should support Greece’s current standard of living. Austerity measures would allow for Greece to stay in the Eurozone, improve their strained relationships, and allow for them to make significant and needed structural reforms. Opponents of austerity measures argue that these policies actually worsen a country’s economic health; by decreasing public spending and increasing taxes, governments may decrease their tax base and cause their economy to stagnate. Austerity can theoretically be expansionary if its policies lead to a sharp decline in interest rates and are implemented properly, but this is rare in practice.

Following the 2008 global economic crisis, Estonia plunged into a severe economic downturn and unemployment initially increased to 18.8%. The government responded by decreasing public sector wages by 10% and passing laws to gradually raise the retirement age from 61 to 65 (Tanner 2012). While their value added tax was increased by 2% (18% to 20%), they deliberately kept taxes low on “businesses, investors, and entrepreneurs” (Tanner 2012).  Currently, unemployment is at a much lower 7% while GDP has stabilized from 4.7% in 2012 to 2.1% in 2014 (CIA World Factbook).

If Greece left the Eurozone, it would be a consequence of running out of money. This would indicate that they have refused any of the deals the Eurozone has offered them in an attempt to save a member EU nation. Greece would be forced to regain their monetary policy in order to print their own money for use in their transactions. They would be required to print a substantial amount of money in a short time, causing the Drachma (or another version of their  new currency) to initially experience a substantial devaluation. The Euro would be more valuable than the new Drachma, causing some members of the Greek population to hoard their Euros. Depositors would withdraw their Euros from the banks resulting in severe bank runs; if the government could not print money fast enough, the banks would fail due to their lack of funds. Antonio Samaras, the former Greek Prime Minister, alerts that Greek living standards could decrease by 80% in the short run of a Grexit (BBC News). Since Greek debt is valued in Euros, a considerable devaluation of the Drachma would also cause Greek debt to be much more expensive due to the skewed exchange rate between the two currencies. While it may appear that a devalued currency would allow for cheaper exports, Greece could have trouble trading with the EU due to likely trade barriers arising after a Grexit. The new sovereign nation would suddenly be faced with no individual foreign policy and a lack of allies and foreign investors willing to trust them.

Greek citizens and politicians have been placing the blame for their economic woes upon austerity measures and have repeatedly refused bailout deals that require structural reform. They fail to recognize that any deal is more beneficial than the potential consequences of a Grexit. Instead the blame should be placed upon their failure to recognize that they have been living beyond their means, and for their lack of effort in implementing policy changes to correct for their broken tax structure and overly generous pension system. Accepting any deal the Eurozone places before them allows Greece to continue their credit binge and maintain their standards of living, albeit at a lower level. Correct austerity measures and reforms will leave Greece with a stronger and more competitive economy. Markets will be reassured by credible, long-term plans to reduce debt and structural reforms to prevent similar market collapses in the future. Austerity measures will appease the fiscally responsible countries that have assisted Greece in their economic misfortune, along with encouraging confidence regarding sovereign risk.