2 Greece in the Euro Area: Odd Man Out, or Precursor of Things to Come? LOUKAS TSOUKALIS Greece has acted as a catalyst for the outbreak of the crisis of the euro area, following the bursting of the big bubble in the Western financial system. It remains today the most vulnerable link of the euro chain, even as the crisis has extended to other countries. Greece has also served as a test case for national and European policies in response to the crisis—more precisely, as a stress test for the domestic political system and the economy and society at large in the context of economic austerity, recession, and reform-induced change, as well as for the capacity of European institutions to devise new policies to deal with problems they had clearly not been prepared for. Some believe that Greece is the odd man out among the beleaguered countries of the European periphery. If that is true, there is a wide variety of policy options that may follow, ranging all the way from special treatment and patience for a country expected to go through little less than a peaceful revolution amid punishing conditions, to orderly or less orderly default and/ or forced exit from the euro area. There are others who suspect or fear that Greece may be the precursor of things to come—as it has already been to some extent—or possibly the first in a series of domino effects that could eventually lead to the disintegration of the euro area. The stakes are high, indeed. Hence Loukas Tsoukalis is professor of European integration at the University of Athens, president of the Hellenic Foundation for European and Foreign Policy (ELIAMEP), and visiting professor at the College of Europe in Bruges. 19 © Peterson Institute for International Economics | www.piie.com Figure 2.1 Holdings of Greek government debt, December 2007– March 2011 billions of euros 400 350 300 250 200 150 100 50 0 June June June March March March December December December September September September March 2011 December 2007 2008 2009 2010 Domestic banks Other domestic entities Foreign banks Other foreign entitiesa Euro area and International Monetary Fund a. Including the European Central Bank. Source: European Commission, The Economic Adjustment Programme for Greece, Fifth Review Draft, October 2011, p. 22, graph 21. the disproportionate amount of international attention paid to Greece in comparison to its modest size, although admittedly the size of its public debt is less modest. As of June 2011, its public debt had risen to €354 billion, held in large part by foreigners, notably banks, other financial institutions, and in- creasingly European governments and the European Central Bank (ECB). The debt held by private institutions exceeded €200 billion (figure 2.1). The Outbreak of the Crisis It all began in October 2009, when the newly elected government of Greece, led by George Papandreou of the socialist party (PASOK), announced that the Greek budget deficit of 2009 was going to be much bigger than previously claimed by the outgoing center-right (New Democracy) government, well into double-digit figures. The announcement was not followed by serious 20 RESOLVING THE EUROPEAN DEBT CRISIS © Peterson Institute for International Economics | www.piie.com Figure 2.2 10-year interest rate spreads over German bunds, September 1992–June 2011 basis points 1,100 1,000 900 800 700 600 500 400 300 200 100 0 2 March 1993March 1994March 1995March 1996March 1997March 1998March 1999March 2000March 2001March 2002March 2003March 2004March 2005March 2006March 2007March 2008March 2009March 2010March 2011 SeptemberSeptember 199 September 1993 September 1994 September 1995 September 1996 September 1997 September 1998 September 1999 September 2000 September 2001 September 2002 September 2003 September 2004 September 2005 September 2006 September 2007 September 2008 September 2009 2010 Greece Ireland Italy Portugal Spain Source: Europe at a Crossroads, speech by Gikas Hardouvelis, Eurobank EFG, Belgrade, October 24, 2011, www.eurobankefg.rs. measures to deal with the problem. Jittery markets, still under the spell of the Lehman effect, suddenly focussed on the prospect that the financial crisis could transform itself into a crisis of sovereign debt, as governments increased their borrowing to deal with the adverse effects on banks and the real econ- omy. Spreads on Greek state borrowing rose fast as the Greek government and EU institutions dithered (figure 2.2). Greece was the catalyst for the outbreak of the crisis of the euro area because it had the worst combination of three different deficits. First, it had a large budget deficit, which reached 15.4 percent of GDP in 2009 after a num- ber of revisions (figure 2.3), on top of an already big public debt (at 127 percent of GDP in 2009, it was already the highest in the euro area). Second, it had an equally large, indeed unsustainable, deficit in its current account that was almost 15 percent of GDP in 2008 (figure 2.4)—a deficit of competitiveness, in other words. Finally, it had a serious credibility deficit, as people realized that Greek politicians had repeatedly been economical with the truth and creative with the use of statistics. Greece was surely not unique with respect to any of those three deficits among members of the euro area and the wider world. But GREECE IN THE EURO AREA 21 © Peterson Institute for International Economics | www.piie.com Figure 2.3 General government revenues and expenditures, 1988–2010 percent of GDP 55 50 45 40 35 30 Revenues Expenditures 25 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Europe at a Crossroads, speech by Gikas Hardouvelis, Eurobank EFG, Belgrade, October 24, 2011, www.eurobankefg.rs. Figure 2.4 Current account balance, 1995–2010 percent of GDP 0 –2 –4 –6 –8 –10 –12 –14 –16 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 200920082010 Source: Europe at a Crossroads, speech by Gikas Hardouvelis, Eurobank EFG, Belgrade, October 24, 2011, www.eurobankefg.rs. 22 RESOLVING THE EUROPEAN DEBT CRISIS © Peterson Institute for International Economics | www.piie.com Figure 2.5 Real GDP growth, 2003–12 percent change, year-over-year percent change, quarter-over-quarter 10 5.0 4.0 3.0 5 2.0 1.0 0 0.0 –1.0 –2.0 –5 Actual (LHS) Actual (RHS) –3.0 Forecast (LHS) Forecast (RHS) –4.0 Previous forecast (LHS) –10 –5.0 2003 2004 2005 2006 20072008 2009 2010 2011 2012 Sources: Hellenic Statistical Authority (EL.STAT.), www.statistics.gr; European Commission Services. it had, undoubtedly, the worst combination of deficits when markets began to panic again, while governments, and notably Greece’s own government, took their time in trying to get a grip on an admittedly very difficult situation. The mess in which the country found itself stemmed from huge failures of government and political responsibility. Since Greece joined the euro in 2001, budget deficits have always exceeded the 3 percent Maastricht limit (fig- ure 2.3), partly camouflaged through creative accounting but seen as manage- able as long as nominal and real growth rates remained high (figure 2.5). They seemed manageable no longer when the international crisis hit. At the time, Greece had a weak government that, facing the prospect of early elections, allowed public finances to get completely out of control in 2008–09. Greek politics is clientele politics par excellence: Political parties distrib- ute money and favors to voters/clients. Greece is, of course, not unique in this respect. But the problem grew bigger with time: The quality of the Greek polit- ical class steadily deteriorated, the “enrichissez-vous” culture became dominant after many years of rapidly rising prosperity, and membership in the European Union, and the euro in particular, came to be perceived as an all-protective umbrella against adversity, as well as a provider of free or cheap money, rather than an agent for reform. The state became increasingly corrupt and dysfunc- tional, an instrument of parties in power and a victim of the clientele system which, if anything, grew stronger over the years. There was cheap money to spend. Organized interests and the forces of inertia in a basically conservative society that does not much like change combined to kill any attempt at struc- GREECE IN THE EURO AREA 23 © Peterson Institute for International Economics | www.piie.com tural reform. The result was a deadlocked country in many ways, although one still enjoying a steadily rising standard of living. It had not always been like this. Greece is a country that underwent a remarkable transformation during the second half of the 20th century, from economic underdevelopment and deeply flawed democratic institutions, in- terrupted by a spell of dictatorial rule, to high standards of living (Greece was classified before the outbreak of the crisis among the top 25 countries of the world according to United Nations indicators) and a full-fledged democracy. It is the country that organized the highly successful, albeit extremely costly, Olympic Games of 2004, the only country of its size to do so for several dec- ades, and the one that played an important stabilization role in the Balkan region after the collapse of communist regimes, with Greek banks and enter- prises acquiring in the process an important foothold in the area. It could be argued that Greece has often tried to punch above its weight. This tendency has largely to do with history going back a long way. But there is something else contributing to it: a Greek elite, consisting largely of expatriates, with a strong global presence in the arts and sciences, in finance, and in shipping, but not directly participating in the running of the country.