THE GREEK ANOMALY: THREE BAILOUTS AND A CONTINUING CRISIS

by

MARKOS BEYS PAPACHRISTOU

Submitted in partial fulfillment of the requirements for the degree of Master of Arts

Thesis Adviser: Professor Elliot Posner

Department of Political Science

CASE WESTERN RESERVE UNIVERSITY

January, 2017 CASE WESTERN RESERVE UNIVERSITY

SCHOOL OF GRADUATE STUDIES

We hereby approve the thesis/dissertation of

Markos Beys Papachristou

candidate for the degree of Master of Arts *

Committee Chair: Elliot Posner

Committee Member: Peter Moore

Committee Member: Joseph White

Date of Defense: December 9, 2016

* We also certify that written approval has been obtained for any proprietary material contained therein. To my Parents

Christos and Patricia Papachristou Table of Contents

1. Introduction...... 1

2. Origins and Causes of the Greek Crisis...... 7 2.1 Issues with the Greek Politics and Economics...... 7 2.2 Economics of the Greek Debt...... 14

3. EU – ECB – IMF Bailouts of Greece...... 20

3.1 Bailouts and Austerity Measures...... 20 3.2 Cost of Austerity...... 28 3.3 Why Austerity Failed...... 33

4. Bailouts of Other EU Countries: Ireland, Portugal, Spain...... 42

4.1 Ireland and Greece...... 43 4.2 Portugal and Greece...... 48

5. Alternative Scenarios...... 52

5.1 Growth with Debt Reduction...... 52 5.2 Default and Grexit...... 57

6. Summary...... 63

References ……………………………………………………………………….…….67 List of Tables

Table 1. The Three Greek bailout Packages ...... 32 List of Figures

Figure 1. Evolution of Greek Debt ...... 15

Figure 2. Growth Rates of Greek GDP...... 16 Figure 3. Greek Trade Deficit ...... 17 Figure 4. Labor Productivity and Cost ...... 18

Figure 5. Unemployment in Greece and the EU...... 29

Figure 6. GNI per capita in Greece and OECD...... 30 Figure 7. Relative Unit Labor Cost in Eurozone...... 36 Figure 8. GDP Growth in Ireland and Greece ...... 44

Figure 9. Competitive Wages of Ireland and Greece ...... 45

Figure 10. Export Volumes of Ireland and Greece ...... 45

Figure 11. Portugal’s Competitiveness in terms of Labor Cost ...... 48 ACKNOWLEDGMENT

The author wishes to express his appreciation to his adviser Professor Elliot Posner for helping him during his research work. Thanks are also due to his thesis committee members and mentors, Professors Peter Moore and Joseph White. The Greek Anomaly: Three Bailouts and a Continuing Crisis

Abstract

by

MARKOS BEYS PAPACHRISTOU

This thesis explores the main aspects of the Greek economic and political crisis which was triggered by the increasing size of the Greek debt. By 2010 the debt has reached unsustainable levels impeding the country's access to financial markets. Many causes long preceded the crisis and obstructed modernization of the Greek economy. These included paternalistic, clientelist and rent-seeking politics. Accession to the European Union (EU) and later the Eurozone, despite early successes, accelerated Greece's deficit spending and its debt. The EU responded with a succession of three bailouts under increasingly strict austerity measures. A perfect storm of causes combined to yield disappointing results compared to austerity programs of other Eurozone countries. There has been a major austerity cost in economic, political and human terms, severely affecting the social fabric of the Greek society. In addition, the Euro currency has created trade imbalances between stronger and weaker states with the latter being unable to devalue. According to many experts, only a substantial debt reduction may help Greece's recovery. 1

1. Introduction

The Greek economic crisis at the start of 2010 rocked the stability of the European

Union (EU). To make matters worse, several more economic crises in Ireland, Portugal, and Spain occurred about the same time. Reluctantly, the EU had to respond by providing financial support to the stricken countries by bailout contracts under strict conditions. In the aftermath of these EU crises, two key questions are raised: first, why three bailouts have not worked in Greece in contrast to singular bailouts given to Ireland, Portugal and

Spain, which have seen positive albeit modest economic improvement. Second, how is it possible for a member of the EU that was considered to be a successful, growing economy in Europe for more than a decade prior to 2010, could end up in such a deep economic crisis that has resulted in the loss of at least 25% of it’s GDP from 2010-2015?

A number of factors both of internal and external origins have contributed to a

“perfect storm” situation in Greece. However, the causes of the crisis are not only fiscal and economic, but have also had deep political and cultural roots.1 The primary reason which is mainly cited for the crisis is the rise of the Greek debt which was accumulated over the years since Greece joined the European Union and then the Eurozone in 2002.2

Traditionally, Greece would borrow money from financial institutions to cover budgetary needs (gaps in the budget) and some funds would then be allocated for projects.

This borrowing (this money was easily available between 2000-2009) increased with

Greece's entry in the EU and the Eurozone. The EU membership was used by the Greek 2 governments as "collateral" cover to keep obtaining funding at low interest rates from central banks and sustain a financial equilibrium in the country. In fact, during this period

Greece actually achieved significant economic growth (at least 5% on average). However, this growth was partially driven by special funds (with some strings attached) which were allocated by the EU to help sectors of the Greek economy.

Of course, the Greek debt kept on growing as well during this economic growth period. Nonetheless, it seemed manageable as the country appeared to be a low risk for international investors and financial institutions.3 This was unwisely facilitated by the greed of creditors to lend more money to Greece without consideration and thorough testing (the so-called stress test) of Greece’s long term ability to maintain a reasonable debt to GDP ratio.4

The EU response to the Greek crisis, especially in Germany, was very slow during the early stages; it focused mostly on arguing about legalistic issues and treaties. However, the markets took this inaction as a lack of EU guarantee on the Greek debt which led to a degrading of Greek bonds and a rise on their interest rates. This was the official position of the EU prior to 2010: no bailouts. Then the EU, concerned about contagion effects, moved together with the IMF, to bailout Greece at first in 2010. Subsequent bailouts in

2012 and 2015 were needed and made under increasingly severe austerity measures.

However, these bailouts which were conditional on austerity have not been effective. On the contrary they have caused economic collapse in Greece which is evident by numerous indicators such as unemployment rate of over 25% and at least a 25% decline 3 in its’ GDP.5 Moreover, the social, human cost and politics of the austerity have been very high, breaking the mainstream two party system with radical political forces from both the hard left and the far right gaining in power and influence.

Alternative economic rescue plans have been proposed ranging from pro growth policies and reforms with heavy debt haircuts, to defaults and exit from the Euro (Grexit).

Many of these ideas and plans appeared in widely read articles and were promoted by some international experts in economics, finance and political science. However, none of these plans have been implemented as they were all resisted one way or another by the bureaucracy of the European Commission (EC) which influences the Eurogroup, i.e. the

Eurozone Working Group.6

Generally, there has been a failure from the Eurozone institutions in dealing with a crisis of this magnitude. The main reason for this is that the architecture of the whole EU was envisioned as an economic union but, despite such rhetoric, was not based on federal political structures, instead treating its members like separate entities.

It should be noted that other Eurozone countries with weak economies were also impacted by crisis during this period and also had to go through bailout plans. Ireland,

Portugal and Spain needed bailout support to survive their crises whereas Italy came under stress but remains without a bailout thus far. All these countries were able to recover and exit their bailout stage. Although there are similarities, nonetheless there are significant differences between Greece and the situation of the other so called PIIGS countries

(Portugal, Ireland, Italy, Greece, Spain), making the Greek crisis more acute and 4 exceptional.

Certainly, there were a number of pre-existing conditions and peculiarities in the

Greek economy, political structure and culture prior to its accession to the EU and the

Eurozone. The Greek economy was traditionally family oriented with strong roots in agriculture, small businesses and self employment. There were many small, family run businesses that were protected and closed to outsiders. The Greek economy was severely lacking in modernization when it ascended into the EU, lagging well behind its northern

EU counterparts.

The political system in Greece has been paternalistic and clientele oriented as practiced by both the center-left and the center-right parties that ruled Greece for decades.

The system was based on rent seeking favoritism extended to party members in form of political appointments in the government and the state sectors. Traditionally, the state sector in Greece has been among the largest in Europe with state employees having relatively modest salaries but enjoying benefits and job security. The bloated government size contributed to budgetary shortages which were exacerbated by corruption and a notorious tax evasion culture practiced in Greece for decades.

It is without doubt that Greece was unprepared to join the Eurozone in 2002.

Although these facts were well known, they were nonetheless disregarded by the EU authorities. By joining the Euro, Greece attained top credit ratings which facilitated access to easily borrowed money at low interest rates, despite its budgetary deficits and rapidly accumulating debts. This seemed great for the country during its period of growth from 5

2000-2009, however in 2010, the economy began to collapse like a house of cards.7

The EU institutions, when attempting to come to the rescue, proved inadequate to handle the Greek crisis and those of the other PIIG countries, except by the imposition of strict austerity measures. The Eurozone by treaty, provides for common currency and economic union, however, it was not built as a political union of its members.8 There are no federal structures in the EU and the Eurozone to share the burden and absorb the shocks of its member states in economic trouble. In fact the inadequacy of the EU institutions became glaringly apparent during the still evolving immigration crisis which is currently ongoing in Europe. Unfortunately, for Greece, it finds itself at the frontline of this immigration crisis as well.

Outline. This research paper is organized as follows. In Section 2, as necessary background, we analyze the origins and causes of the Greek crisis. We cover the main issues and peculiarities of the Greek economics, politics and culture which predated the country's accession to the EU. We discuss how the Greek debt grew to reach unsustainable heights.

In Section 3, we discuss the three EU and IMF successive bailouts of Greece under conditions of increasingly stricter reforms and austerity rules. We describe why the EU imposed austerity has not worked in Greece while plunging the country into severe recession with high financial and human cost. The objective of this section is to analyze the reasons of this failure, which are both internal to Greece and external, beyond the country's control. 6

In Section 4, we describe the case of other Eurozone countries in crisis that required bailouts. Specifically, we compare Greece to Ireland and Portugal discussing the similarities and differences and why these Eurozone countries managed to recover and avoid – so far at least – the acute situation of Greece. The objective of this section is to provide a general perspective of the bailout processes pursued on other distressed

Eurozone states in comparison to Greece, and through comparative methods to highlight what made Greek programs and circumstances different.

In Section 5, we describe a number of alternative scenarios that Greece could have taken in lieu of the austerity imposed measures. The reason is there has been much criticism from serious observers concerning the inflexibility of the Eurozone austerity approach.9 We mention proposals on growth strategies with targeted reforms Greece could have taken instead of the austerity. We also discuss the issue of drastic debt reduction that could have improved Greece's international credit ratings. Admittedly, some of these proposals would require at least consent from Eurozone authorities and the IMF, which has not been clearly articulated so far. We also discuss the extreme choice of outright Greek default on its loans followed most likely by a Grexit, that is, exit from the Eurozone and possibly from the EU itself.

In Section 6, we summarize our work and provide concluding remarks. 7

2. Origins and Causes of the Greek Crisis

In this section we analyze various internal features and peculiarities of modern

Greek politics and economics and how they interacted one on another. We will then discuss the economic issues affecting the rise and rise of the Greek debt.

2.1 Issues Related to Greek Politics and Economics

There are several factors that have largely contributed to the crisis that emerged in

Greece since 2010. Many of these factors are internal and can be primarily attributed to misguided policies and actions prior to and during the crisis.10 However, there are many other external factors which were beyond Greek control – caused first by inaction and then exacerbated by the harsh responses of the international institutions that came to rescue

Greece, most notably the EU/Eurozone, the European Central Bank (ECB) and the IMF as well as other financial creditors.11

The internal causes and origins of the Greek crisis go back two centuries after the

Greece gained independence from the Ottoman Empire. Early Greek communities had a long history of running their own affairs using local organizations and this self-government system worked well for a long time until at least the early parts of the 20th century. From there, Greece went through long periods of political turmoil, from right wing dictatorships, to World War II and then leftist insurgencies, and even a civil war. Finally after a military coup which ended in 1974, Greece finally settled on a stable democratic state.12 8

During this long period of political instability, the various Greek regimes displaced the local elites, undercutting old traditions of community administration. The new groups of administrators were beholden to the regime in power by rent-seeking relationships to their mutual benefit. The democratic state which finally emerged in 1974 maintained and further politicized these arrangements by promoting their own party members to fill local positions.13 The country ended up being ruled by a “paternalistic illiberal" democracy.14

An important element for consolidating the new regime in power was state expansionism and nationalization of selected industries. This was accompanied through political patronage which was disbursed through increases in public sector employment, government spending, regulations that limit competition and the imposition of levies on transactions that benefit third parties. Nonetheless, Greece easily gained accession to the

EU in 1981 despite these shortcomings.15

Two political parties, center-left and center-right, controlled the government and dominated Greek politics and Greece’s electoral laws, creating a polarized two party system. The parties have been ruling Greece alternately over the last decades (this pattern was broken by the recent hard-left win). When in power, the parties promoted a patronage system based on favoritism to their own members offering large number of political appointments in the government and state sectors. Both political parties acted according to their political interests and competed for populist policies.

Although the two parties originally had ideological differences, over time they converged on major policies. Both parties, broadly speaking, agreed on the goals of 9 economic policies and policy instruments to achieve those goals. They reached agreement on the country’s entrance to the Eurozone, becoming pro-EU, pro-free trade and open markets, pro-public health and public education, pro-higher pensions, yet maintaining low taxes.16 Despite rhetoric and rivalry, the parties were very close in terms of political context, but were fiercely competing for populism and political gains.

Populism, which contributed to the mismanagement of public finances and the economy, has become one important characteristic of the Greek political system.17 Populist policies were promoted by both political parties. Public spending is popular for politicians because "it buys votes in the short-term." It is also popular with the voters because they tend to see "government benefits as a windfall." They do not see the money as coming from their own pockets, but from “the government,” or at least from someone else’s pockets.

The resulting system has encouraged corruption, discouraged wealth creation and affected popular ideological narratives. The view that "the state is good and that markets are bad" is widely held across the political spectrum and is understandable in a rent- seeking society where all activities, including market transactions, are seen as redistribution.18 But the realization of “putting people above markets,” although seemingly noble, has deepened clientelism and produced the current national crisis. The state became the instrument for creating and distributing rents or benefits among various client groups. In this situation, rent seeking, that is, the attempts by groups and individuals to influence the political allocation of benefits, becomes paramount.19 10

A major driver of corruption came from the parties and their constituencies. Each of the major parties tried to return favors to its respective clientele after gaining or regaining power. They designed and implemented policies according to electoral and narrow party interests, rather than adopting policies that would best serve the country.20

Both parties built patronage networks through the use and abuse of their mass party organizations which were exploited in order to penetrate the state machine as well as interest groups and parts of civil society. Thus, political parties penetrated all areas of public life, including NGOs, universities, civil service, and local and regional authorities.21

The local leaders built up party machines by distributing state funds. The interaction between local and national elites produced a highly dysfunctional system. Appointments to key institutions – hospitals, museums, universities and even port authorities – were political, not meritocratic.22

Greek politicians saw the provision of public sector jobs and benefits as an important way to grant favors and thereby secure electoral support. Thus, they filled public institutions such as state universities, hospitals, public utility organizations and administrative services with their supporters which caused a massive growth of the public sector. As of 2009, Greek government expenditures accounted for 50% of GDP, with 75% of (non-interest) public spending going to public sector wages and social benefits.23 Just prior to the crisis, the state sector in the Greek economy was among the largest in the

Eurozone with state employees having relatively modest salaries but enjoying benefits and job security. Of course the bloated government size contributed to budgetary shortages 11 which needed to be filled by perpetual loaning.24

According to the Organization for Economic Co-operation and Development

(OECD), while the Greek spending on public administration as a percentage of total public expenditure has been the highest in the OECD, there has been “no evidence that the quantity or quality of the services are superior.” 25

Greece joined the Eurozone in 2002. The adoption of the Euro currency made easy for Greece to get cheap and plentiful credit. This enabled Greek politicians to finance deficit spending along with current account deficits.26 Being part of the Euro, they did not have to worry about inflation or a devaluation of the currency. Much of the borrowed money was used to pay back interests from previous loans and, unwisely, to finance consumption instead of investment, infrastructure and institutional development. There were questions about how effectively the government funds acquired from abroad were used in the Greek economy. There have been serious allegations that large sums of money were either wasted or disappeared (stolen) to offshore tax havens.

As government expenditures were increasing, tax revenues were not increasing at the same rate. Tax evasion has been a chronic problem in Greece. Part of the problem is that Greece’s complex tax code grants exemptions to numerous professions and income brackets. However, clientelism could also have been an important factor behind pervasive tax evasion. Before the crisis, the Greek state taxed only one third of officially declared incomes, at an average tax rate of 30%.27 Low tax revenues were offset by access to cheap credit by the Greek governments resulting to huge budget deficits. Instead of addressing 12 tax evasion and other structural deficiencies, the governments kept on borrowing money much of which went to fund current consumption and not to undertake productive investments that would generate growth. 28

There has been a notorious tax evasion pattern going on in Greece for decades prior to the EU. This is almost a cultural and habitual trait as many Greeks go to considerable lengths to conceive schemes avoiding taxes.29 Tax evasion crosses all economic strata from the rich, to the middle and lower classes. Of course massive tax evasion, has been widely practiced by the rich who manipulate the system using connections, money, gifts or even bribes made to the ruling parties.30

To compound tax evasion, Greece has a huge unrecorded or shadow economy – at least 25% of the official GDP according to some estimates – that is not taxed.31 Although shadow and barter economy was widespread earlier in Greece, it still exists even today.

Greek people still engage in small transactions with each other exchanging or bartering their services to avoid taxes. The size of the shadow economy and the levels of corruption in Greece have been and still are particularly high with respect to other developed EU countries. The politics of the Greek crisis, reflected by clientelism and rent-seeking dependencies, had an impact on the size of the shadow economy and corruption levels.

Experts have suggested that policies targeting the shadow economy may lead to alternate sources of government revenues that would lessen the requirement of fiscal austerity and provide relief from the current economic depression.32

Most analysts see political and bureaucratic clientelism “as emblematic of a 13 broader distrust of state institutions” and as the root cause of widespread tax evasion.

“Bureaucratic clientelism" are used to describe the functioning of the Greek political system. That is, creating patronage networks, inefficient public sectors and a weak civil society. The image of the country started to be associated with graft, bribery, corruption and scandals. Greece’s clientelist system with socialist elements in it, significantly contributed to the extension of the welfare state and inefficient industrial policies.33

A side effect of a clientelist system is that the party in power avoids any politically risky policy or reforms. They prefer to kick “the can down the road” to the next government. Each party used their government powers and control of the public funds to stay in power as long as they could; not for reforms and fixing the public finance imbalances. The lack of party political consensus for reform and strong opposition of powerful interest groups also contributed to the failures of reform attempts. Many reforms that were actually attempted failed when they became unpopular and the party leaders noticed that their re-election was at stake.34

An example of failed reforms, the governments were under pressure from the EU to reform their pension and welfare system which was responsible for half the cost of public deficit and absorbed 15% of the country’s GDP. The Greek pension system has a low retirement age with unequal coverage and benefits making it unsustainable, "a ticking bomb," according to the bank of Greece. However, both parties failed to address the structural deficiencies of the pension system due to strong opposition from various interest groups including public sector trade unions and the party traditionalists.35 14

About unions, well organized labor and trade unions in Greece prevent reforms, keeping real wages high, thus hurting the country’s international competitiveness. The unions care only about protecting their members, rejecting even sensible policy solutions.

The relations between them and the political class had been a patron-client relationship. In addition to the unions, there are many other powerful interest groups that influence political and economic stability and development negatively. These rent-seeking groups curtail competition in the product and services markets, increase red tape and administrative burdens, and seek to establish opacity in the legal processes to defend their accumulated privileges.36

2.2 Economics of the Greek Debt

The main reason for the Greek crisis as cited by many observers is the rise of the

Greek debt both public and private accumulated over the years since Greece’s joining the

EU, and especially the Eurozone in 2002. The party in power could not satisfy the demands of its clientele – jobs, salaries, social benefits – from the budget and so would need to cover the deficits by perpetually borrowing from financial institutions. This was feasible during the easy-money period 2000-2009, as Greece would use the EU/Eurozone membership for loan guarantees. Of course, the Greek debt kept on growing as well during this period but the country was still considered to be low risk.

Shown in Figure 1 is the evolution of the debt and the debt/GDP ratio from the 15

Figure 1: Evolution of Greek Debt and Debt/GDP ratio: Source: AMECO 2014 beginning of the modern two party system period of Greek politics to the present time. We can observe that the Greek debt kept on growing and growing until the 2010 crisis – the small dip of debt around 2012 is attributed to the first two bailouts which occurred at that time. However, the debt to GDP ratio was rather stable until well into late 2000's (2008).

The reason is because the Greek economy was growing during the time, after its accession to the Eurozone, despite all budgetary deficits.

This growth was fueled by consumption as a result of government policies to increase spending for salaries, social benefits, and public projects. The declared objective was to raise the living standards of the Greek households. This process was also fueled by the incoming capital flows from the EU in the form of agricultural subsidies, and also from the financing of infrastructure. However, it was crucial to aggressively obtain loans at low interest rates from financial institutions in order to cover the annual budget deficits – 16 expenses including debt payments –and pay the interest for all previous loans that kept accumulating.

The Greek GDP growth rate during this period is illustrated in Figure 2. As shown, the GDP rate was increasing till 2006, then started declining but was still positive until the crisis in 2009 and beyond. Shown also in Figure 2 is the IMF projected Greek GDP growth

Figure 2: Growth Rates of the Greek GDP projected beyond 2015. Source: EL STAT and Commission Services

rate which is still in the negative ranges till at least 2016 and beyond.

One of the reasons that the crisis was so severe is related to basic features of the

Greek economics. The fundamental units of the Greek production system consists of many small and some medium size businesses that are not scalable with limited competitiveness.

The average small business size is 4 to 5 employees, while in the EU countries is over 15 17 employees per firm.37 This business fragmentation is inward-looking exhibiting

Figure 3: Greek Trade Deficit. Source: STATISTA protectionist attitudes.38

An important aspect of this environment is that most businesses deal with non- tradable sectors of the economy, such as the public sector, retail, construction and consumer services. The manufacturing sector has decreased significantly during the last 2 decades from about 25% to 8% of GDP in 2012, mainly serving the domestic market. The trade sector of the economy is limited and includes mainly tourism and a small part of the manufacturing and agricultural products.39

The lack of export orientation in the economy has resulted in perennial trade deficits as shown in Figure 3 which illustrates the Greek trade balance over the last decade and so the low competitiveness of the Greek economy. Undoubtedly, the intensification of 18 competition in the EU market, especially after the accession to the Eurozone, generated a spiral of defensive adjustments and the concentration of economic activity in the non tradable sectors.40

Figure 4. Labor productivity, compensation and labor cost in Greece. Source: Macroeconomic Database

As shown in Figure 4, the labor productivity and labor compensation in Greece, although rising in the years prior to 2009, suffered substantially with the beginning of the crisis. Emerging economies under weak productive structures and strong pressure from international markets need to adopt a proactive development model using a growth strategy based on attracting investment and exploiting their local competitive advantages. This mode of development is not consumer oriented and may be unpopular in the short term but has been proven to work in some success cases of emerging economies (South Korea, 19

Taiwan, even Poland in Europe).41 This model was never seriously adopted by Greece during its entire membership period in the EU.42

The Greek authorities took the easy way out and pursued a development model based on consumption and imports instead of investment, production and exports. The existence of low interest rates in the post Euro period, facilitated the public and private borrowing, increasing employment in the public sector, while the tradable sector was shrinking. Most new jobs in the private sector were in retail, consumer services and construction which depended on domestic demand and banking loans.43 Emphasis was mainly on infrastructure projects while development of human capital, entrepreneurship and R&D were under funded.

The Greek development model was based on a political strategy to create dependencies of a large segment of the population on the state and public sector. This included significant rent seeking activities from numerous interest groups.44 The model underestimated the tradable sector of the economy which is the basis of international competitiveness. The weakness of this model was revealed during the ongoing Greek crisis. 20

3. EU – ECB – IMF Bailouts of Greece

In this section we discuss the three Greek bailouts between 2010 to 2015 which were made by the Troika – the Eurozone, the ECB (European Central Bank) and the IMF.

Each bailout consisted of a package of financial loans together with increasingly strict austerity measures imposed on Greece.

3.1 Bailouts and Austerity Measures

With its accession into the Eurozone, Greece experienced stable growth in the 2000's which was primarily fueled by deficit spending. The government engaged in wild public sector spending instead of sensible investment while simultaneously covering budget deficits with easily obtained credit and financial loans.45 As shown earlier, Figure 1, the debt to GDP ratio was about steady prior to 2009, however, the Greek debt was going up during the same period. Throughout the 2000’s, Greece was able to roll over its budget deficits easily, however after the 2008 global economic crisis, financial institutions began to cut credits and sharply increase interest rates, which made borrowing much more costly.46 By the end of 2009, Greece and some other Eurozone economies had much more difficulty financing their budget deficits.

Despite its growth during the 2000's, Greece’s external debt also kept on growing reaching aproximately115% of GDP by 2009.47 Also, the budget deficit reached about

13% of GDP while government spending was rising and revenues falling due to the global 21 recession and a decline in the tourist market and shipping sectors. In 2010 Greece entered recession with deficit rising to over 12% and debt estimated at 125% of its GDP. The government was no longer able to roll over its debt without outside help.48

Things started getting out of control as the rating agencies lowered Greek debt scores and the market’s trust in the Greek government’s ability to pay plummeted. By mid

2010, the Standard & Poor's downgraded Greek debt to BB+, and later to junk bond status, crashing the Greek stock market.

The EU leaders were late to respond but finally realized that they needed to act soon. A Greek default could have led to a banking crisis in the EU since many banks, especially those in France and Germany, had a high exposure to Greek debt. The danger of contagion to other highly indebted countries in the Eurozone was becoming real.

First Bailout: After lengthy negotiations, the Eurozone countries agreed to provide

€80 billion and the IMF agreed to give €30 billion under a stand-by agreement. The total bailout package of some €110 billion was supposed to be disbursed over three years.

However, the loans were conditional on implementation of several austerity measures with the intent to restore the fiscal balance, and the privatization of government assets worth

€50 billion by 2015, as well as following structural programs to increase competitiveness and economic growth prospects. The EU demands for austerity increased in 2011 with further budget cuts and more privatization, through which the government was expected to raise €50bn by 2015.49 The government did make an effort to apply some of these austerity measures without much success because the political cost was high with intensified street 22 protests, which were often turning violent.

Second Bailout: The EU finance ministers and political leaders continued with their discussion of restructuring the Greek debt while realizing that a second bailout under more austerity measures would be needed as early as 2012. In February 2012, the

Eurozone finance ministers approved the second bailout package of €130 billion, prepared by the Troika.50 It included a 53.5% write down or “haircut” for investors in Greek bonds and the program became active a month later. The writing down involved exchanging existing holdings for new, more liquid and secure bonds. As a result, Greece’s debt-to-

GDP ratio also declined, then from a forecast of 198% in 2012 to about 160%. This bailout package was also conditional on the implementation of an additional austerity package as well as the continuation of structural reforms, labor market reforms, and privatization as outlined in the first bailout program.

Despite the bailout program the recession deepened causing a continuing political instability in Greece. Due to the adverse public reaction to the austerity measures, the government offered to resolve the bailout agreement in a referendum, but later backed off under pressure from the Eurozone and especially Germany. Subsequently, Greece faced a severe political crisis, which led to the resignation of the government in November 2011. A technocratic government of national unity under the premiership of a central banker was formed to pave the way for the implementation of the new bailout under the supervision of the Troika.

The technocratic administration lasted only four months failing to implement the 23 new bailout while the economic and political crisis worsened. Greece had a parliamentary election in May 2012 which produced a weak centrist coalition government against a strengthened hard left opposition advocating an anti-bailout and anti-austerity platform.

The struggle between the Troika and the new Greek government continued as the bailout disbursements were held on delays of implementation of the austerity measures. A more realistic new plan was negotiated late 2012 which actually imposed new bailout demands. It required Greece to bring its debt-to-GDP ratio to 124% by 2020, and

“substantially below” 110% by 2022. 51 Furthermore, Greece was supposed to achieve a

124% of debt-to-GDP ratio by “cutting the interest rate on existing rescue loans,” returning profits earned by the European Central Bank on Greek debts it owns and helping Greece buy back its private-sector debts at their currently depressed market prices. Unfortunately, the plan did not involve any write-off of the bailout loans owed by Greece which would help with the burden of the Greek debt.

As the country’s economic and fiscal challenges continued to deteriorate, Greece had another parliamentary election in January 2015, and this time the hard left party won the majority and formed the government.

The second bailout package was supplemented with some additional financial relief measures from the Eurozone, in early 2013, while the IMF extended its support with an extra €8.2 billion of loans till March 2015 maturity. All together the packages seem to alleviate the economic crisis in Greece during 2013. Actually, a review of the bailout program revealed some encouraging developments such as a modest economic growth and 24 some decline in unemployment rate. It was anticipated that the country would regain access to the private lending markets for the first time since eruption of its debt crisis.

Unfortunately, the infusion of capital produced only temporary relief as recession returned strongly in later 2014. The bailout terms did not provide for medium or long term investments which would have driven growth. The spending cuts retarded the economy increasing drastically unemployment. Political uncertainty, continuing strikes and labor turmoil led to government deadlocks and a snap election that was won by the hard left, for the first time in recent Greek history.

Third Bailout: The new leftist government refused to respect the austerity measures asking for a substantial review of its terms. This caused the Troika to suspend all scheduled long term aid to Greece granting only a four-month technical extension of the bailout program. The Troika demanded that either the Greek government would accept the previously negotiated terms, or alternately could reach a new agreement on some updated terms with its public creditors.52 This rift caused an increasingly growing liquidity crisis

(both for the Greek government and Greek banks), resulting in plummeting stock prices while interest rates for Greece at the financial markets spiked.

Negotiations between the Greeks and Troika were dragging for five months in

2015. Faced by the threat of sovereign default, the Greeks made a final attempt to reach an agreement with Troika on revised terms than the previous strict austerity measures.

Default would inevitably entail enforcement of recessionary capital controls to avoid a collapse of the banking sector – and potentially could lead to exit from the Eurozone, due 25 to growing liquidity constraints making continued payment of public pension and salaries impossible in Euro. However, the Troika offered a bailout with conditions and terms basically similar to the ones in the previous packages. 53 The Greeks rejected this offer because they took it as a take-it-or-leave-it ultimatum. In desperation from the looming default, the Greek government called a referendum for public approval or disapproval of the new agreement.

The Greek people voted by 61% against the bailout agreement in the July 5, 2015 referendum. Immediately after, the Greek government was put under extreme pressure by the Eurozone, meaning basically Germany, to either accept the agreement or exit from the

Eurozone, by initiating the so called Grexit process.54 There was a last attempt to find a solution in a long, overnight negotiation session involving all Eurozone heads of state.

Under severe German pressure, Greece capitulated accepting almost all the terms of the new bailout, which turned out to be worse than the ones offered a month earlier. In summary, the deal means new loans of up to € 86 billion will be made available over the next three years paid in tranches first to recapitalize the banks and for Greece to repay their debts to the ECB. Note this program is not burdening the Eurozone countries as it is supposed to be funded by the European Stability Mechanism (ESM).55 – ESM is an institution established in 2012 and operates as a permanent bailout fund for Eurozone countries with economic difficulties. ESM raises funds by limited loans and debt bonds backed by an €80 billion capital, provided by the Eurozone governments, in accordance with the contribution key annexed to the ESM Treaty.56 26

3.2 Cost of Austerity

The key austerity measures imposed by the Troika were:57 Increased taxation, including VAT (sales tax) up to 23%, elimination of tourist discounts; an increased pension age of 67 years as well as reform of labor laws concerning collective bargaining, layoffs and other benefits; deregulate the health system and pricing for medicines; reduce social benefits to save 0.5% of GDP and privatization of state assets, including seaports, airports, power companies. Proceeds from these sales would be concentrated in a special fund controlled by the ECB. The details of these measures together with performance metrics and deadlines were to be negotiated soon after the Greek parliament had approved these austerity principles in advance. The Greek parliament did vote for approval despite the humiliating experience of loss of sovereignty.

The immediate impact of these measures was severe on the society. Millions of

Greeks have already been affected by tough budget cuts by the previous bailout deals.58

The government imposed new drastic spending cuts across the board. There were salary reductions on state and civil employees badly hitting the lower incomes. The salary cuts were extended to the private sector as well. Pensions were also significantly reduced incurring many humanitarian problems. Taxation including VAT was increased with more effort to fight perennial tax evasion. Greece was already suffering from a badly designed debt haircut provided by the second bailout terms. This undermined the banking sector with large loss of liquidity which was exacerbated by the time of the third rescue plan.

Capital controls were introduced restricting withdrawals from bank accounts to € 420 per 27 week.59 This was very inconvenient to the Greeks, who still deal with cash on a daily basis and they now have to wait on long lines out of the banks and the ATMs.60

Of course, Greece badly needed economic reforms, however, the imposition of all these drastic measures, at a fast pace, was very painful and devastating to the Greek society. The objective of this fiscal consolidation and austerity was to reduce the government budget deficits which eventually would improve the economy. However, the short term economic effect has been negative, at least thus far. Salary and pension cuts reduced tax revenues. There was much less money in circulation because of capital controls. Many small businesses were closed and larger businesses shrank by layoffs or even failed. Unemployment went up to 25% and youth unemployment over 40-45%.61

Strict adherence to austerity in Greece produced economic decline and severe recession with loss of GDP amounting to about 25% during the period of the three bailout plans. There was no investment to create jobs and stimulate growth. Because of the junk level rating of the Greek bonds, investors have been reluctant to do business in Greece.

The bailout money was just enough to recapitalize the banks and keep them working on life support every month. There was no provision in the rescue package for job creation and investments in Greece. A major part of the loaned money was allocated under restrictions to ensure that Greece will keep its obligations by making scheduled interest payments to its creditors.

There are also elements in the new program that are a clear outcome of bad planning. To meet its 2015 liquidity needs Greece has already received at least €21 billion 28 bridge loan from ESM. Greece also received another bridge loan of about €15 billion to pay back a maturing bond to the ECB and to recapitalize the country’s banking sector.62

According to rough EU estimations, banks would need an injection of more than €25 billion in 2015-16 to remain functioning. The essence of the new rescue plan is that these sums will come from privatizations of state assets. On the basis of past experience, this target is unrealistic. Under the terms of the first two bailouts, privatization receipts for

2011-2014 were only €5.4 billion. Although now Greece has been forced to release many more state assets, it will take years to collect the recapitalization funds, which are urgently needed now.63

Moreover, the plan will also meet increasing resistance from Greeks – the majority of whom will not benefit from the fire-selling of public property, because the proceeds of all state assets sold will be transferred to a new fund controlled by the ECB and the

Eurozone. The requirement for asset privatizations and parliamentary pre-approval were two major aspects of the new agreement that lacked democratic legitimacy and degraded

Greek sovereignty.

Humanitarian Cost: The household disposable income has been decreasing in

Greece from 2010 to 2015 primarily due to unemployment as opposed to falling salaries.

Unemployment has continued to rise steadily throughout 2015. Eurostat indicates that the greatest rise in unemployment in the EU, between January 2012 and January 2013, was in

Greece, from 21.5% to 27.2%.64 This is clearly illustrated in Figure 5.

Poverty and inequality has also been increasing during the same period. Figure 6 29 shows how the parallel progression of Greece’s per capita gross national income (GNI) diverged from that of the OECD65 average around the time the first rescue deal was approved in 2010. Since 2011, Greece had the highest rate of those at risk of poverty or social exclusion in the Eurozone (31% compared to an average of 24.2% across the EU as a whole). In 2011 alone, this increased by 3.3%, meaning that 372,000 more people were at risk of poverty or social exclusion.

Figure 5: Unemployment in Greece and the EU, 2000-2012 Source: EUROSTAT

More than one in three Greeks fell below the poverty line in 2012.66 The middle class has shrunk and is closer to the poverty line, while the poor are getting poorer and inequality is increasing. Moreover, the suicide rate in Greece has increased by 26.5% from

377 in 2010 to 477 in 2011, and has increased by 104.4% for women.67

The number of people aged between 18 and 60 living in households with no 30 income since the beginning of the crisis, and particularly since the introduction of the rescue measures, has risen to over one million in 2012, equal to 17.5% of the population.

The public health system is increasingly less accessible, especially for poor and marginalized groups. Close to one in three Greeks have no public medical insurance, most often due to long-term unemployment.68

Figure 6: GNI per capita in Greece and OECD average. Source: OECD

Political Cost: The austerity process has contributed to the collapse of the two- party system, center-right and center-left, which had long dominated the politics in Greece.

At the same time, the crisis has triggered the rise of extremism from the fringes of the hard left and far right. Their successes can be attributed to the country’s grave economic situation and a drop in confidence in traditional parties. In the 2015 elections the far left 31 got the majority to form a government. This produced a deadlock for several months with the Eurozone as the leftist were refusing the bailout terms due to pre-election promises.

However, after the referendum, the leftist government compromised with the Eurozone which led to the split of the party in pro and anti-bailout factions. A second election took place later in 2015 which was still won by the pro-bailout faction of the left. However, political instability has now returned to Greece which will certainly increase as the third bailout impacts deeper the society.69

A more worrisome political aspect is the rise of the far right Golden Dawn party.

Although it achieved about 7% in the 2015 elections, it is the third political party in

Greece. The main strength of Golden Dawn is the role it plays standing against illegal immigration, blaming the crisis on government policies that have allowed of hundreds of thousands of immigrants to flood into Greece. The party has formed militant groups to patrol some Athens neighborhoods with a particularly high percentage of immigrants. It has provided personal safety services and food distribution for hungry pensioners who feel neglected and too frightened to go outside.

However, Golden Dawn has been involved in many incidents of violence against immigrants and political refugees in Athens and across the country. Many consider Golden

Dawn to be a xenophobic and violent organization with some borderline fascist tendencies.

Table 1 provides a compact review of the main aspects of the three Greek bailout packages, including time-frames, austerity measures, implementation deadlines, impact and the austerity cost. 32

Package 1 Package 2 Package 3 Time May 2010 – June 2013 Feb 2012 – Dec 2014 August 2015 – August 2018 Frame & Overlapped Package 1; Extensions Extended to June 2015 € 110 billion loan € 130 billion loan € 86 billion new loans: Financial (additional to 1st 1st tranche of € 26 billion, Terms package, remaining tranches in & Troika: including € 48 billion installments after reviews Creditors bank capitalization) ECB - European Central ESM: European Stability Bank Troika Mechanism EC – European Commission Private creditors agreed IMF – International Monetary Fund to extend bond maturities, and possibly a 50% haircut Reduce gov spending; Continuation of 1st Prior bailout conditions plus: Austerity Structural reforms; package conditions: - Reduced social benefits and Measures Privatization of some spending cuts, structural pensions; & state assets reforms, privatizations. - Reformed health care; - Increased VAT (sales) taxes; Conditions Additionally, it - Tough laws on insolvency; imposed labor reforms, - Eliminating price controls for eliminating collective drugs and hospital supplies; bargaining to facilitate - Relaunch privatization of state layoffs and plant assets through an a fund closing controlled by the Troika;

The Greek government The new government The leftist government was very slow to was partially wanted to radically change Implementa implement most of the successful in the bailout terms but the tion and measures as there was implementing several Troika resisted. The Perform- strong resistance from its bailout conditions. economy was fast ance own clientele and the Some macroeconomic deteriorating bringing Greece public. indicators, deficits and to the edge of default. Strong pressure from even growth, improved After the 3rd bailout agreement, the Troika was all together temporarily. Because of the Government has too much for the weak political pressure from implemented many measures government to bear, so it fringe forces, the within the deadlines, stabilizing the economy by late 2016. collapsed. government fell. Impact and Deterioration of Persisting crisis, with Serious deterioration of Austerity economy, recession, temporary improvement multiple sectors of society, Cost rising unemployment, not leading to recovery. economic, social and and labor unrest. Debt/GDP highest in political. Capital controls EU. imposed. Day to day life and Political turmoil with stability disrupted. rising fringe forces.

Table 1: The Three Greek Bailouts: Summary of Details 33

3.3 Why Austerity Failed

There is little doubt that the austerity measures imposed by the Eurozone over the last 5 years have failed to improve the Greek economy. In fact, each bailout package compounded the failure level of the previous bailout. By indicators such as high unemployment, GDP loss, high trade deficits and so on, the economic crisis went from bad to worse with an unsustainable debt and high human cost.70 The hope of the Eurozone technocrats, backed by Germany, that austerity would eventually work in Greece has not been fulfilled with little prospect of improvement in the foreseeable future. But what went wrong? What are the reasons of failure?

In Sections 1 and 2, we mentioned that there have been several causes which led to the Greek crisis, both internal and external. Here, we will explore the reasons that led the austerity measures to fail in Greece. In the next Section 4, we will discuss the cases of other bailout countries where austerity has been more successful that in Greece. Here we explore if there are any Greece specific conditions that contributed to the exacerbation of this crisis.

According to experts,71 there are two reasons that are peculiar to Greece which contributed to the failure of austerity in this country. Additionally, there are other reasons, which are not dependent on Greece, but are due to the way the Eurozone project has been designed, meaning its structure, policies, and institutions. In what follows, we discuss all these reasons in some detail. 34

Greek Extended Families: One major difference between Greece and other

Eurozone economies is the extended families rather than individuals constitute the fundamental core of the Greek society. Every extended family was touched by the severe recession measures be it salary reductions, pension cuts, layoffs, or taxes. Greek extended families respond to crisis collectively in ways that individuals cannot. The families defend themselves against the austerity by division of labor among themselves, meaning spreading economic activities, sharing expenses and resources, which may include living space. They may often perform some transactions within a core of trusted families avoiding taxes.

Although not legally, but still traditionally, the role of the extended Greek family supersedes the role of the individual towards the state. Of course the austerity measures hit all family members but the pain is shared by supporting each other, and may feel more tolerable than individual pain.72

Although Greek extended family-based businesses provide a buffer in times of austerity, yet in some way they contribute to sustaining the shadow economy in Greece.

Thus as shadow economy is difficult to measure, the extended family business style does not seem to improve Greece's macroeconomic indicators such as government revenue, tax evasion, and the GDP.

Unfortunately, the Eurozone technocrats and policymakers have not understood the role of the extended families in Greece, their influence in the society and their reaction and resistance against the austerity measures.

Greek Defense Expenditures: Greece's defense spending (by GDP) is very high 35 and is probably the highest in the EU. Before the austerity process, Greek defense amounted to about 4% of its GDP, annually (now it has been cut to about 2.6%). In comparison, Germany's defense cost is only 1.2-1.3% of its GDP.73 For decades, prior to the crisis, Greece's defense budget has been even higher. Surprisingly, the relation of the high defense spending to the Greek deficits, and the Greek debt, has been little discussed.

However, there is little doubt that the high defense cost over a period of many decades has contributed significantly to the Greek debt.74

Greece has been facing many disputes with neighboring Turkey over Cyprus, and more recently the Greek islands in the Aegean. Greek sovereignty of the continental shelf and the airspace of the Greek islands in the Aegean is internationally recognized. However,

Turkey questions the status quo in the Aegean, frequently violating the Greek airspace with military over flights. Tensions have been high between the two countries with several near misses from confrontation. Ironically, both Greece and Turkey are members of the NATO alliance which is supposed to protect member states, especially the weaker ones, from such pressures. However, neither the EU nor NATO, nor the US for that matter, have provided guarantees of Greece’s territorial sovereignty. The reason is attributed to the geopolitics of the general area, that is, the Southeast of Europe and the Middle East, which is beyond the scope of this work.

Membership in the EU should carry with it a peace dividend. To date, Greece has not seen it. Although the EU bureaucrats will not admit it, Greek tensions with Turkey benefit the armaments industries in France and Germany. It is no accident that the Troika 36 has rejected suggestions that Greece cuts back on weapons purchases and defense spending.

Eurozone Policies and Issues: It is arguable that the Eurozone project was not well designed at its inception. The idea was to allow free cross border commerce by avoiding currency exchanges and speculation. In addition to economic benefits, breaking currency barriers would contribute to the ultimate EU goal of “ever closer union” of its members.75

The Eurozone monetary union treaty was based on a common currency, the Euro, for all its members. However, to control the debt, the member states were obligated to limit their annual spending to a deficit level about 3% of their GDP. Although this rule was violated repeatedly, it did not matter so much during the growth years of the Eurozone, from 2000 to 2009.

Figure 7: Relative Unit Labor Cost in Eurozone. Note year 2000 is assumed the base with no differences then. Source: European Commission. 37

In the first decade of the Eurozone, there was increased divergence in the competitive positions among its members, with Germany clearly standing out. Due to its export oriented economy, Germany has enjoyed a strong competitive edge over the rest of the Eurozone. In fact, the majority of the German exports are imported by the other

Eurozone states.76 Figure 7 clearly shows the competitive advantage of Germany, in terms of relative labor cost, over several other Eurozone states, especially those in the South.77

Normally, countries that control their currency, when faced with loss of competitiveness, they can devalue to make imports more expensive and curtail inflation.

However, because of the common currency, the Eurozone states do not have any other means to control their lower competitiveness except by letting inflation rise. That, in turn, requires a period of low growth and sustained unemployment which makes budget deficits under control much more difficult.

This is what actually happened to Greece and some other Eurozone countries such as, Ireland, Portugal, Spain. Greece was loosing more and more competitiveness in comparison to Germany and other Northern Eurozone states while importing more goods from theses states. This may have not mattered when credit was plentiful, but after the credit lines dried up budget deficits led to recession with high unemployment.

Another factor that makes the debt problem in the Eurozone much more acute is that individual governments cannot resort to the printing press if they run out of money.

When a non-Eurozone country has budget shortfalls, its central bank can be a “lender of last resort”78 to cover the deficit, at least for a short time. The Euro is controlled by ECB 38 which, by treaty, does not act like a central bank lender for each Euro state. So Greece in

2010 and later could not do what Argentina has done repeatedly – that is, devalue and borrow money from its central bank.

It has been pointed out by experts79 that Eurozone governments can be subject to the equivalent of a bank run. If no one buys their debt, they will be forced to default.

Lenders may decline to buy their debt because they believe that ultimately those governments do not have the political will to raise the taxes to cover their spending in a sustainable way: this is the equivalent of an insolvent bank. This is exactly what has been happening to Greece all these years.

However, lenders may also forsake a country’s debt if they believe no one else will buy that debt, even though that debt may be sustainable in the long run. A government may be subject to a self-fulfilling belief in the market that no one will lend to them. This situation is close to Spain's bailout where the Spanish debt was not really unmanageable, actually in better shape than the UK's debt. Nonetheless, Spain faced significant financial difficulties as there were no lenders for the Spanish debt at reasonable interest rates.

By contrast, a country that can print its own currency is not so vulnerable because it can fund any shortfall. Its own central bank can be the lender of last resort and existing lenders will get their money back. The European Central Bank (ECB) could be a lender of last resort for a Eurozone country, but ECB was not designed for this purpose and is very reluctant lending money to governments in crisis 39

The designers of the Eurozone did worry about the debt problem but for different reasons. Their concern was that the market would not discipline individual profligate governments, who would free-ride on low Eurozone interest rates. They set up mechanisms to control deficits which ultimately failed.80 In practice, the critical problem has turned out to be almost the reverse – without a central bank that is prepared to be the lender of last resort, governments are too vulnerable to market discipline. This has certainly been the case of Greece and the other so called PIIGS Eurozone states.

So the Eurozone has design problems that could emerge even if all its governments were solvent in a long-run sense. Yet most EU bureaucrats are in denial of this fact insisting that the problem lies with excessive debt levels in individual countries. This view relies more on Eurozone politics rather than economics.

The political argument is both simple and powerful. Government promises of austerity in the longer run will not be trusted and will not be credible, unless they are accompanied by austerity taking place shortly. Governments that ignore the debt problem today will, it is argued, forget their promises on long-term austerity once the recovery has happened and they will go back to spending too much and taxing too little. The presumption is that governments are subject to a deficit spending addiction thus increasing their debt relative to their GDP over time.81

Based on this argument, Eurozone policymakers have formulated strict austerity measures to address recessions in Eurozone states. The basic rule is "austerity today"82 meaning the process of reducing debt has to be unconditional and rapid. In the Greek case, 40

"austerity today" has been particularly harsh, a kind of shock therapy, but has not succeeded so far. In the case of the other PIIGS, "austerity today" has been softer with some success to allow exiting their bailout stage, but they are still vulnerable.

Many experts have advocated an entirely opposite approach: fiscal stimulus today followed by austerity when the recovery is assured.83 They argue that debt should be allowed to respond to macroeconomic shocks and debt correction should be gradual and context sensitive (depending on the conditions of a particular country). The problem of deficit bias is that governments spend too much, or tax too little, in the good times. When economies grow rapidly, government deficits fall and may even become surpluses, so it appears as if government debt is not a problem. But this is an illusion, as becomes apparent when the boom comes to an end.

To summarize, countries in the Eurozone have lost control of their own currency and cannot issue debt or devalue to improve their competitiveness. They are vulnerable to financial shocks and dependent on investors. Lack of market confidence may exacerbate their interest rates without a lender of last resort.84

On the contrary, countries that are not in monetary union can issue debt and devalue their own currency to mitigate their competitiveness. These countries are less vulnerable to a crisis as their central bank can always provide the liquidity needed to avoid a default forced by the market.

These features of a monetary union have not sufficiently been taken into account in 41 the design of the economic governance of the Eurozone. The basic rule is that when a country experiences budget deficits and increasing debts, it should be punished by high interest rates and tough austerity programs. These austerity programs and bailouts have failed in Greece. Although there has been limited success of austerity with some other

Eurozone states in trouble, still these countries remain vulnerable.

A monetary union can only function if there is a collective mechanism of mutual support and control. Such a collective mechanism exists in a political union. Since the EU is not a political union, the Eurozone bureaucrats have responded not in collective unison but by imposing harsh austerity measures on the debt stricken member states. However, these measures do not address the imbalances and vulnerabilities of members to market shocks and are far from sufficient to guarantee the long term survival of the Eurozone. 42

4. Bailouts of Other EU Countries: Ireland, Portugal, Spain

Since 2009, several Eurozone states particularly Portugal, Ireland, Italy, Greece and

Spain (the so called PIIGS countries) have experienced severe economic difficulties in their budget deficits and problems securing loans from financial markets. All these countries applied austerity measures on their own to reduce expenses contracting the economy. However, since these measures were not enough they had to seek support (with the exception being Italy thus far) from the EU Troika through bailout packages.

The Troika rescue packages and terms were different because the crisis environment in each country had different characteristics. The Greek crisis was caused by a seemingly unsustainable public debt. In Ireland the private debt was very high which led to its banking insolvency. This insolvency would in turn lead to its own sovereign debt crisis. The Portuguese crisis came from a combination of external debt and balance of payments issues rather than by the sovereign debt. The Spanish has more similarities to the

Irish crisis as it was also fueled by property expansion during the early Euro years while the labor cost was also rising. The bubble burst caused a fiscal and banking crisis in Spain with very high unemployment rates (approximately 25-27% in 2013). Finally, in Italy, all the ingredients of a fiscal debt crisis had been there for nearly a decade. Yet the country has managed to muddle through with half baked reform measures without a bailout so far.

Italy is too large for its European partners to save, but also too big to fail.85

In what follows we compare the Greek crisis to the crisis in two other Eurozone 43 states, Ireland and Portugal. These countries were chosen because of the size of their economies and other indicators which are somewhat comparable. It is worth noting that these countries are not completely analogous to each other as they have significant differences in multiple ways.

4.1 Ireland and Greece The Irish financial and sovereign debt crisis is directly related to the government’s decision in September 2008 to guarantee all private liabilities of its principal national banks. This decision was made without a full array of information and under severe pressure from domestic banking interests. These liabilities were caused from questionable bank loans in the housing market during the growth years of 2000-2008.86 In the aftermath of this government decision, the public debt-to-GDP ratio increased from less than 40% to about 100%. (The ratio ultimately capped out at 120% in 2014 and currently sits at the sub

100% mark.) Ireland asked for EU support in 2009 and accepted the austerity terms of the

Troika bailout in 2010 which was set on reducing the fiscal deficit to 3% of GDP by 2015, with major implications for economic performance. Under the bailout terms, the Irish economy has experienced a severe downturn since 2008 and by 2013 was flat-lining; living standards have fallen, unemployment rose to about 15% and since 2008 net emigration has increased rapidly (82,000 in 2012). The political and social costs of managing austerity have been rising.87

Nonetheless, projections were that the situation will improve after 2014 with growth actually expected in the 2015 time frame. Actually the economic indicators have 44 turned, becoming much better for Ireland, to the extent that Eurozone austerity proponents claim that Ireland validates how austerity is supposed to work: "A permanent reduction in government spending or higher taxes will increase unemployment, which will reduce wages and prices. This will improve competitiveness, leading to higher external demand for Ireland’s products (and less imports) which will eventually replace the lost demand due to austerity. However, because wages and prices are ‘sticky’, this adjustment will not happen quickly." 88

The fact is that Ireland is now experiencing growth and that unemployment is falling. According to OECD estimates the growth in 2015 was nearly 5%, and this was greatly helped by a 12% increase in exports. The question is why Greece has been so different. Figure 8 shows the growth rates of the two economies. Due to the 2009 recession, Ireland did poorly, but Greece performed much more poorly.

Figure 8: GDP growth of Ireland and Greece: Source OECD

The most important reason for the economic difference is that Greece experienced a much harsher austerity than Ireland did. In fact, the fiscal contraction between 2009 and 45

2013 in Greece has been 2.7 times greater than in Ireland. Figure 9 shows the fall of wages in both countries. Clearly, the fall in wages in Ireland produced a significant improvement in competitiveness of Ireland.

Figure 9: Competitive Wages of Ireland and Greece. Source: OECD

Figure 10 shows the much higher volume exports of Ireland in comparison to Greece. One would expect that Greece, which sustained a much larger unemployment and a more persistent fall in wages would show some improvement in competitiveness and exports.

The question is why this has not happened.

Figure 10: Export Volumes of Ireland and Greece. Source: OECD 46

To begin with, there are special aspects pertaining to the Greek extended families and Greek defense spending which do not exist in Ireland. Irish society is based more on individual values akin to the UK and the US.89 Ireland is also not a member of NATO and its defense spending has been far less than Greece’s. Moreover, Ireland is far away from the migration flows from the Middle East and North Africa that have more recently overwhelmed Greece and Italy.

There are other reasons more systemic to the Irish and Greek political economy.

The Greek and the Irish political systems and ideologies diverge considerably, explaining why Greek and Irish responses to the austerity measures have been so different.90 Actually, the Irish economy is far more open than the Greek economy.91 Over the last twenty years or so the Irish political economy has been restructured on neoliberal models and practices similar to the ones in the US and the UK.92 The Irish political system has relied on the social partnership approach which brought about a relatively peaceful coexistence and agreement between Irish trade unions and employers organizations.93

However, the Greek political economy has evolved as mixed economy similar to the one in Italy with strong socialist tendencies. Some might even argue that Greece practices a state capitalist model of development. The Greek political system has not ever encompassed the principles of the social partnership. Since the times of the civil war in the

1940's, the Greek trade unions have been formed much along class lines in perennial confrontation with their more neoliberal oriented employers. Of course many such labor meetings end up without any agreement or resolution of the conflicts despite the gravity of 47 the situation.

Another reason is the export oriented Irish economy. It has been built over the last thirty years by huge multi-billion dollar investments from major multi-national corporations, mostly from the US.94 Recently companies like IBM, Microsoft, Google,

Facebook, Apple, all have moved into Ireland. These companies invest in high tech areas such as software, data bases and web applications. Such investments are based on intellectual property value, not on heavy industry and expensive infrastructures, which makes it easy for them to take hold in a new location. The various Irish governments have consistently supported these investments with legislation and tax friendly regimes to attract and maintain investors.95 Of course these Irish policies have paid off over the years with healthy trade surpluses, with the exception of a few of the years during the recession.

In contrast, Greece has not had any significant investments in high tech areas.

Although Greece has a highly educated population, Greek government policies have not been attractive for high tech investments. Most investments in Greece come from

Germany, France and recently from China. With the exception of tourism, the investments are in energy intensive industries such as textiles, coal mining, ship building.96

To summarize, the Irish social actors have incorporated neoliberal policies similar to the ones in the US and the UK, in a course of twenty years of neoliberal restructuring.

However, in Greece, with more ideologically divided politics and the legacy of a mixed market economy, the shock therapy nature of the reforms have produced a much more contested and politicized reaction to the austerity. 48

4.2 Portugal and Greece The Portuguese economic crisis is primarily a crisis of external debt and a balance of payments rather than a sovereign debt crisis. Portugal experienced a marked deterioration in its financial investment position after joining Euro – a result of the current import/export deficits. A straightforward explanation is that with the Euro, Portugal lost

“competitiveness”, shown in Figure 11. Portugal over the last 235 years has almost always reported trade deficits. Nonetheless the recurring devaluation of the Portuguese escudo kept the country's income accounts in balance and the net worth of its import/export volumes under control. With the adoption of Euro, Portugal can no longer rely on currency devaluation to cover its deficits and liabilities. This point was covered in some detail previously. Thus a deeper reason Portugal presently faces this crisis is that the common

Euro currency removed the automatic stabilizers that helped with the balancing of external debt and income deficits.97

Figure 11: Portugal’s Competitiveness in terms of Labor Cost. Source: OECD 49

Portugal requested financial assistance from the Eurozone and in 2011 negotiated for a €78 billion bailout program with Troika. This bailout program came with strict conditions that required severe retractions in the public and private sectors as well as state- funded bank recapitalization. After two years of austerity, the unemployment rate jumped to approximately 15% and the well being of Portuguese families, businesses and government had regressed by further than the gains made in the previous 13 years, and by

2015 Portugal will have already lost two decades of gains before it even starts paying down its debt.

The Eurozone endorsed Portugal's progress in 2015 in implementing bailout terms at the time Greece needed a third bailout program. In Portugal the recession was less acute than in Greece since the fall in domestic demand was offset by an increase in net exports from 31% to 41% by 2015. Moreover, there was a noticeable a shift of resources from the non-tradable to the tradable sector. The worse-than expected recession in Greece can be attributed, to some extent, to the lack of a speedy recovery in the export sector. Exports in

Greece have not shown a consistent positive trend since the beginning of the sovereign debt crisis. In Greece, during the pre-crisis period, 2000-2010, the resources allocated to the non-tradable sector had increased from 38% to 44% and this trend has not yet reversed.

Greece and Portugal were the two countries hit the hardest by the crisis, yet the internal political reactions within each nation was notably different. While in Greece there were difficulties among political actors agreeing to austerity policies, the Portuguese parties negotiated a broad political consensus over reforms. Moreover, the Greek party 50 system underwent substantial change, with the hard left and far right gaining against the center while in Portugal the mainstream parties largely retained their support base.98

A key reason relates to the different level of clientelism in each country, where political ‘patrons’ provide goods or services to their backers in return for political support.

There is a greater prevalence of clientelistic linkages in Greece than in Portugal, as measured by a number of indicators: the extent of political party patronage, the organizational form of parties and their relationships with influential organized interests, especially public sector unions. In Portugal, the looser connections with unions, a smaller reliance on clientelistic linkages and the smaller party memberships have created fewer obstacles to implementing austerity reforms, allowing for extensive pro-retrenchment compromises.99

Portuguese parties have agreed on a number of fiscal retrenchment measures at the onset of the crisis, reforms have been mostly negotiated, and existing patterns of party competition have persisted throughout the crisis. By contrast Greece has the need to satisfy tightly connected clienteles exchanging their electoral support for public spending – something that has ruled out open support for austerity from the main parties and therefore delayed cross-party agreements. Hence, adversarial politics has been the leading feature of fiscal retrenchment reforms. There were other alternatives for Greece to pursue, however they would not be in cooperation with the Eurozone. These include the feared Grexit and or a default on its international debt.

To summarize, this significant divergence between two similar countries can be 51 explained by the extent of clientelistic links, which tend to be both tighter and more volatile than ideological links. Portugal's lower levels of clientelism before the crisis ensured that Portuguese parties were more capable of backing austerity policies without alienating their supporters. Mass clientelism led Greek parties to systematically over- promise and voters to over-expect, which led to brutal sanctions and anger when these promises had to be betrayed. In contrast, Portuguese parties did not promise as much and voters did not expect much from them either. 52

5. Alternative Scenarios

There were several alternative actions that the Greek government could have taken during the highlights of the crisis instead of the Troika austerity program. However, many of the alternative actions required policy changes and help from the Troika itself.

Nonetheless, there were options, even if they would have created conflict with the

Eurozone authorities.

5.1 Growth with Debt Reduction Growth and Targeted Reforms. Many observers have argued that fiscal contraction under austerity measures is counter productive.100 This has been proven in

Greece where austerity resulted in a 30% loss of GDP, a 25% unemployment rate and a debt to GDP ratio of 180%. Even other crisis stricken states which were able to more successfully implement their bailout programs remain vulnerable to market shocks and suffer from high debts. There is some speculation that Portugal may ultimately need a second bailout.

As mentioned in Section 3, the origins of the "hard and fast" austerity programs were political. The EU elite believes that if austerity is slow then profligate governments will forget about reforms and go back to their usual spending habits. Although it is correct that governments have a propensity to deficit spending, the theory of a “shock therapy” style of austerity has yet to be substantiated in practice. On the contrary, it has been seriously argued that debt should be allowed to respond to macroeconomic shocks and that 53 debt correction should be gradual and cognizant of a country’s circumstances.101

The Eurozone situation is not bright in 2016 after the political shock of the recent

Brexit, the UK exit from the EU.102 The Brexit undermined the confidence of the entirety of the European Union. European leaders have realized that this is the time to rethink the whole EU project and now they have to decide which way to go. Prior to Brexit, there was a tendency to push for "more Europe". However, now with the political rise of Euroskeptic parties, there are voices for "less Europe" or Europe of the nations.103 Maybe this is a good time for the EU to change course and introduce different policies towards its debt crippled states.

So what if the Eurozone allowed a policy supporting more growth coupled with targeted reforms. How this would affect a country like Greece? Assuming that this Greek growth could only come from external investments, the obvious question is where this funding would come from. Let us defer this point for the next subsection and consider where these investments could be made in Greece. There are many potential growth areas in Greece where carefully controlled investment could pay off:104

– Mineral resources: Although Greece is small in area, it boasts significant deposits in coal, gold, aluminum and even hydrocarbons under the sea. Modern mineral extraction methods and technology would go a long way to improve efficiency and output.

– Agriculture. The Greek climate and soil is ideal for many plants such as vegetables, grapes, grains, citrus, nuts, even bananas. More efficient cultivation methods and tools 54 would help, but even more help would come from improved planning. Greek agriculture has been set back by misguided allocation policies and micromanagement by the EU, despite the funds they disbursed.

– Shipbuilding industry. Greece has a long tradition of being a marine nation with a large commercial and merchant fleet. Greek shipyards were doing well but after the adoption of the Euro their output has been falling noticeably. Lack of investment and unsound policies are destroying a bright spot of the Greek economy.

– Textiles. This was another productive part of the Greek economy which unfortunately declined in recent years. Investment to renovate the textile industry could help its recovery.

- Tourism. This is still doing well in Greece, but it can be expanded to all year round as the climate of Greek islands is mild even during the winter. Tourism expansion would need investments in hotels and transportation infrastructure as well as sufficient marketing and advertising.

– Small business. Last but not least, investments should be made to support small businesses which are still the backbone of the Greek economy.

All the above investment areas would help exports in particular the tradeable Greek exports and improve the imbalances in the current account deficits. Of course more investments in human resources, health and training should be made as Greece has a highly educated population. Again, investments should be carefully chosen for the long time but made under supervision and auditing.105 55

Greece of course needs reforms which should be targeted and synchronized with the investments. Reforms have already been made but more are needed to modernize labor, unions, pension funds and healthcare. Privatizations should be made at a slow pace to avoid fire sale auctions. Reforms to reduce tax evasion, clientelism and corruption should also be made with the understanding that these types of reforms will take much longer time to implement.

Debt Reduction. The Greek debt, in 2016 sits at about 170% of the GDP which is unsustainable under any austerity or bailout scheme. This was reported by the IMF in the summer of 2015. Simply put Greece can not pay this kind of money. The debt burden is painful as it reduces the Greek credit worthiness and the ability of the Greek banks to borrow money from financial institutions at reasonable interest rates. Because of its high debt, Greece has been cut off from international financing.

The IMF has suggested a drastic Greek debt reduction: the so called debt haircut.106

Any substantial forgiveness of the Greek debt will have a significant beneficial effect on the economy. It will make the Greek credit worthy again, substantially reducing interest rates so that the country could go back to the markets and borrow again without need for bailouts. It is likely that debt reduction together with investments will lead the country to recovery and growth with positive influence on most economic indicators.

The Paris Club is a voluntary, informal group of creditor nations who meet several times per year, to provide debt relief to developing countries, in collaboration with the

IMF. The Paris Club has a model for rescheduling of sovereign debts over a defined period 56 or fixed period, depending on financing.107 Usually, the Club’s operations have been geared to low-income countries, and thus would seem ill-designed for the larger complex industrial economies of Europe. However, the Paris club framework and rules may apply to the case of Greece. Fortunately, there is some new thinking which has appeared recently. According to a press release, the representatives of the Paris Club have decided in principle to abolish the debt of its biggest debtor: Greece. Although this is very encouraging, it is too soon to evaluate any followup implementation procedures and plans for the Greek debt relief effort.108

Unfortunately, there are several concerns. The Eurozone leadership adamantly has resisted any suggestions even talk about a Greek debt haircut. Their fear is that a debt haircut benefiting Greece would be unfair to other bailout stricken countries. Despite differences in each country's case to Greece as discussed earlier, the perception of unfairness is apparent.

There is also concern that a debt haircut would reward Greece’s bad behavior taking the country off the hook without reforms. Moreover, there is concern that Greece, after a debt relief and some initial growth, may again revert to its old habits borrowing heavily as did previously before 2010, creating a new debt crisis.109

Another approach would be not to forgive a large part of the Greek debt, just to extend it with very long time payment terms, essentially over a "century" long. Although this idea may not be that much different from a debt haircut, still it may calm the markets to ease lending terms for Greece.110 57

There is still a question about who is going to finance the Greek investments for growth. Under the present austerity terms, much of the bailout funds should be used by

Greece to pay back interests to its lenders, every year or so. However, if there is a debt haircuts, then maybe the country's credit will improve to stand on its own for borrowing.

Then some of these bailout funds could be well used for investments in growth areas of

Greece. Of course this requires new thinking and farsighted policy changes in the

Eurozone but may be worth of consideration since the current austerity has not really worked.

5.2 Default and Grexit.

Of other alternatives, some of them are not in the spirit of being European but might be viable if Greece was willing to go it alone or at least be a bit of a pariah. These alternatives come down to a Greek default on its international debt with a very possible exit from the Eurozone.

Negotiating Tactics. Greece actually had significant bargaining power to negotiate for better terms in paying back its loans and to moderate the Troika’s austerity demands.

The mere fact that Greece owed so much money actually gave the debtor country bargaining clout through the threat of debt default. There was a fear back 2010-12 that such a default would have exposed French and German bank loans to big losses. Moreover, there was the threat of contagion to the bonds of other sovereigns as well as the uncertainty that would have emerged after a Greek default.111 58

However, no such threat was invoked or even remotely implied by the Greek governments that were involved in the 2010 and 2012 agreement. Successful negotiators, first need to believe that their interests differ from those of the other side, making sure that the other side knows this fact. Second, negotiators need to prepare their own side for the ultimate threat so that the other side has the reasonable fear that the threat is real.

But the Greek governments apparently did not fulfill either of the two important conditions for successful negotiations. Naively, they got carried away by the rhetoric about

“European solidarity” and “we are all in this together.” This rhetoric is not useful to seriously prepare and create a strong Greek bargaining position. Instead of being an independent actor one becomes cognitively captured by the other side.

About the default: The question is, wouldn't default bring bankruptcy to the Greek state? There are differences between default and bankruptcy concerning public and private loans. Sovereign states do not literally go bankrupt. This means there are no supranational ultimate authority that will decide and enforce how the country’s assets will be allocated between the different creditors and what will remain with the country’s state. Instead, bonds and loans are issued according to the laws of specific jurisdictions, but the ultimate enforcement can be difficult since states are sovereign.112

Legally, the majority of Greek debt issued before 2010 was governed by Greek law.

After the 2nd bailout 2012, Greek debt came under British law and defaulting on that debt would be considerably more difficult than that issued under Greek law.113 Then it would appear that Greek default prior to 2012 would not have been difficult. Why not? 114 59

Well, prior to 2012, Greece still had a chance to borrow, if not from the markets, from other sovereign states such as China, the US, Russia and maybe Japan. If Greece had defaulted in early 2010 its debt could have become sustainable in the long run with write offs on bondholders considerably below 50% of total debt. The country would have had to borrow internally, perhaps issue IOU's and impose a few modest cuts. The effect of such a policy would have been mildly recessionary.

Instead, the Troika provided Greece with loans as to cover its budget deficit without default in exchange for increasingly draconian austerity measures. The effect of this policy was a fast downward economic spiral. Greece was getting poorer faster; debt was becoming ever less sustainable.

Now, default has become considerably more difficult both because Greek public debt is under English law and because 80% of it is official and owed to official sources – the IMF, the ECB, and the Eurozone. Quite likely, the default will be followed by the dreaded Grexit.

The Grexit Reality. Grexit means for Greece getting out of the Euro and re- introducing its old currency. First, there is little doubt among economists that the easiest mechanism for a country to gain international competitiveness is to have its currency depreciate. The main benefit comes from the flexibility the country has to adjust to market shocks and international competitiveness. Moreover, using its own currency, Greece could tailor monetary policy to its needs, instead of having it determined by the needs of bureaucrats in Brussels or Berlin. 60

Most of those who object to exit from the Eurozone are mainly concerned with the costs of transition. There are several important questions. Won’t the foreign debt burden increase even more due to devaluation? How will the banks adjust to the change in currencies? How will the country import essential items like petroleum and pharmaceuticals? What will happen to bank deposits? Won’t all this create total chaos?

What is important is the competency of those who manage the transition: are they honest, competent and ready to defend Greek interests? Will they be speedy and flexible in adjusting when unforeseen problems pop up? How skilled at articulating their actions to the Greek people will they be as to stymie negative reactions. A completely uncontrolled and unplanned exit from the Eurozone will be chaotic and a lot more painful than a controlled and well-planned one.

Capital Economics provided detailed guides for the process of exiting the Eurozone and answers to the above questions.115 Because of its long recession, exit from the

Eurozone would have been much easier earlier. Now the main problem is political, especially regarding protracted negations for restructuring or forgiving the debt.

In terms of short and medium term after Grexit, the adjustment of the banking system will take some time. Naturally, capital controls will need to be imposed and other measures will have to be taken to ration foreign exchange for the importation of essential items.

Bank deposits will automatically be adjusted to the new currency as will be all domestic debts. Inevitably, net creditors will lose some and net debtors will gain in the 61 short run. But even net creditors might gain in the long run since the economy can be expected to grow faster.

The transition will be difficult and painful but, if managed properly the pain will be short term. With its own currency the Bank of Greece and the government will be able to inject much needed liquidity in a currently dying domestic market. Liquidity along with depreciation, import substitution, reduced imports, and possibly increased exports will bring the economy back to life and increase employment.

In contrast to Brexit, Grexit does not mean exit from the EU, but rather an exit from the Eurozone. Actually, there is no legal way to expel Greece from either the

Eurozone or the EU, it can only occur by voluntary departure.116 This means Greece would still have access to the large EU market under preferential tariffs, just as other EU members that are not in the Eurozone. Further, a default and Grexit would not have to be done in an overtly adversarial fashion with Germany and other Eurozone countries. There are many economic and political constituencies within Germany that would find such a possibility welcome and mutually advantageous for Greece, Germany and for the future of a more cohesive and sustainable Eurozone. Of course, a counter argument to the above is that a successful Grexit may be an attractive example to other debt stricken Eurozone periphery countries.

To summarize, there are two key difficulties facing the Greek leadership if they were to pursue the aforementioned Grexit: First they need to thoroughly prepare the details of an implementation plan, and secondly they would need to convince and lead the 62

Greeks through difficulties such a transition would entail. None of the Greek governments, including the hard leftist one, have seriously considered this task. 63

6. Summary

Many factors that have largely contributed to the Greek crisis have internal origins.

Some of them are historical – the long Ottoman occupation of Greece – and traditional – the dominance of small (often family oriented) businesses in the economy. These factors significantly delayed modernization of the Greek economy. Further, Greece expends a large sum of money on defense expenditures; the cause of this is rooted in the geopolitics of the Aegean and fear of military aggression from Turkey. The most important internal cause is the political system in Greece which has evolved into a paternalistic and clientele oriented system over the last 50 years. Both major parties practice populism promoting favoritism, corruption and rent seeking actors. This resulted in a large state sector, encouraging inefficiencies and increased government spending. A notorious tax evasion exacerbated deficits which required perennial external borrowing while increasing the debt. In retrospect it is clear that Greece did not qualify for membership in terms of economic criteria.

There was a sluggish EU response during the early stages of the crisis when it was still manageable. Moreover, there has been a failure of the part of Eurozone institutions in dealing with a crisis of this magnitude. The European institutions proved inadequate to handle the Greek crisis except by the imposition of strict austerity. The entirety of the EU architecture was envisioned as an economic union, but despite the rhetoric, was not based on federal political structures, in many ways treating its members like separate entities.

There have not been any effective mechanisms in the EU and the Eurozone to share the 64 burden and absorb the shocks of its member states in economic trouble. The ECB was not really designed to bailout weak Eurozone states. The ESM was not established until 2012 and still is not fully developed. ESM may participate in later phases of the 3rd Greek bailout, hopefully will not be too little too late.

After 2010, Greece was unable to borrow money at reasonable interest rates from the markets. Things started getting out of control as the rating agencies lowered the Greek debt scores and trust in the country's ability to pay withered. The Troika agreed to provide

Greece with a €110 billion bailout package which was hinged on strict austerity measures.

These measures concerned fiscal consolidation, privatizations and reforms. The government made efforts to implement some of the measures, without much success because there was public resistance and implementing the measures came at a high political cost. Several more bailouts would be required.

The immediate impact of these measures was severe on the society. There were drastic cuts, salary and pension reductions, both on state and private sectors and also a reduction regarding social benefits. Taxation including VAT was increased as was the campaign against tax evasion. There were anti-union reforms affecting collective bargaining and layoffs. To avoid severe loss of liquidity, capital controls were introduced restricting withdrawals from bank accounts. Many businesses were closed or suffered severe layoffs, with unemployment topping the highest level in the Eurozone. Poverty and inequality has also increased during the same period with healthcare becoming less accessible, especially for marginalized groups. 65

The political cost of the bailout programs was also significant. It led to the collapse of the two-party system, with the subsequent rise of the hard left and the far right parties.

In the 2015 elections the hard left was able to form a majority government. There was a deadlock for several months with the Eurozone, with the eventual leftist split and capitulation incurring political instability.

When examining the series of bailouts that Greece needed versus the needs of other states, it becomes clear how the local intricacies (family businesses, pervasive shadow economy, tax evasion culture) of the unprepared Greek economy, coupled with a clientele oriented form of government that has a high defense spending ratio, could end up needing several rounds of bailouts. Greece’s outmoded economy was pressed too hard and its inability to address its debts via the traditional means of currency devaluation led to a bitter cycle of borrowing with higher and higher interest rates. The €110 billion first loaned to

Greece by the Trokia showed a sluggish EU response that was more or less unprepared to handle such a crisis.

When compared to other countries such as Ireland and Portugal, we see that

Ireland’s greatest difference was a strong export economy coupled with a more modernized economy and disciplined workforce. Hence, when bailed out Ireland was able to recover despite its high public debt. Portugal, which seems an even closer comparison to Greece in economic size, yet differed in that its debt was external and that it lacked the level of cronyism that Greece has. Moreover, the Portuguese unions are not as closely aligned with the Government as the Greek unions, allowing austerity measures to go through quickly. 66

Ultimately, Greece ended up being a proverbial “perfect storm” of preconditions when compared to other Eurozone countries that struggled with economic crises.

The choices for Greece are currently very limited. Exit from the Eurozone may be too late now to plan after the third bailout. Remaining in the Eurozone under conditions of strict austerity and limited investment may require additional bailouts with further economic deterioration and rising political tensions bringing the country to the edge. I hope, there will be changes in the EU policies to allow debt relief together with investments to flow in the country for recovery and growth. How realistic is this hope?

Well, perhaps the recent political turmoil in Europe with the rise of Euro-skepticism may finally awake the EU bureaucrats and especially the Eurozone leadership to change their debt policies and plans for the benefit of the weaker states, and ultimately save the

European project. 67 References

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