abcd a POLICY INSIGHT No.51 OCTOBER 2010 Greece and the fiscal crisis in the Eurozone Willem Buiter and Ebrahim Rahbari Citigroup and CEPR; Citigroup Introduction the Eurozone than outside it with an independent national monetary and/or exchange rate policy. The saga of the Greek public finances continues. We also believe that the Eurozone as a whole But this time, Greece is not the only country that could come out of this crisis stronger than it suffers from doubts about the sustainability of went in if it uses this opportunity to remedy the its fiscal position. Quite the contrary. The public design flaw at the heart of it – the absence of a finances of most countries in the Eurozone are minimal ‘fiscal Europe’. in a worse state today than at any time since the industrial revolution, except for wartime The dimensions of the fiscal problem episodes and their immediate aftermaths. And the problems are not confined even to the Eurozone, Table 1 shows that the fiscal troubles are but extend to other EU member states, like the widespread. In fact, only a limited number of UK and Hungary, and to Japan and the US. This small industrial countries are in reasonable essay explains how and why this situation came fiscal-financial shape, i.e. Australia, New about and how it is likely to evolve during the Zealand, Denmark, Norway, Sweden, Finland rest of this decade. and Switzerland. Canada, Germany and the Netherlands, which are widely considered (and In fact, only a limited number of small consider themselves) to be in reasonably good industrial countries are in reasonable fiscal-financial condition, are so only compared fiscal-financial shape. to the truly dire conditions experienced by most of their peers. The origins of this widespread loss of fiscal At almost 115% and 14%, respectively, Greece’s control are shared by most countries and can (gross) government debt and budget deficit are be traced to pro-cyclical fiscal policy during the certainly of great concern. But these numbers boom period preceding the financial crisis that are somewhat less staggering, even in peace started in August 2007, the fiscal cost of the time, when set against a Eurozone average of financial rescue operations, the revenue losses almost 82% for gross debt and 6% for the budget caused by the recession and the discretionary deficit. And on the whole, the fiscal situation of fiscal measures taken to stimulate economic the Eurozone as a whole still appears to be more activity. But the uniquely serious situation in sustainable than that of the US, the UK, or Japan. Greece owes much to country-specific features of its economy, its political institutions and The roots of the fiscal unsustainability its policies. Fiscal sustainability in Greece and problems in Eurozone and Greece elsewhere can only be restored via fiscal pain (tax increases and/or public spending cuts), by The fiscal unsustainability problems in most inflating away the real burden of the public debt, advanced economies have four common roots: by economic growth, by sovereign default or by First, strongly pro-cyclical behaviour by a bailout, and the balance of costs and benefits the fiscal authorities during the boom period of these options can vary between different between the bursting of the tech bubble at the countries and over time. end of 2000 and the onset of the financial crisis For countries that are part of the Eurozone, this of the North Atlantic region in August 2007. cost-benefit analysis is complicated by the legal Second, the direct fiscal costs of the financial and institutional constraints of membership. crisis, that is, the bailouts and other budgetary Nevertheless, we are convinced that any fiscally- rescue measures directed at propping up the challenged Eurozone member is better off within financial system, starting with the collapse of CEPR POLICY INSIGHT No. 51 CEPR POLICY INSIGHT No. To download this and other Policy Insights, visit www.cepr.org OCTOBER 2010 2 Table 1. Fiscal troubles around the world % of 2009 nominal GDP Cyclically Gross debt Net debt Budget balance Sturctural balance adjusted primary balance Australia 15.9 -5.7 -3.9 -3.3 -2.5 Canada 82.8 28.6 -5.1 -3.2 -2.3 Czech Republic 42.0 -1.0 -5.9 -4.6 -3.7 Denmark 51.8 -5.1 -2.8 0.1 0.7 Euro area 78.7 51.7 -6.3 -3.6 -1.2 Austria 66.5 37.2 -3.5 -2.5 -0.4 Belgium 96.7 80.7 -6.1 -2.8 0.4 Finland 44.0 -63.2 -2.7 1.1 0.6 France 77.6 50.6 -7.6 -5.7 -3.7 Germany 73.2 48.3 -3.3 -1.4 0.8 Greece 115.1 87.0 -13.5 -11.7 -7.1 Ireland 64.0 27.2 -14.3 -9.9 -8.2 Italy 115.8 101.0 -5.2 -2.7 1.5 Luxembourg 14.5 -0.7 1.1 -0.2 Netherlands 60.9 28.5 -5.3 -4.6 -3.0 Norway 43.7 -153.4 9.7 -0.8 -3.8 Portugal 76.8 57.9 -9.4 -7.4 -4.7 Slovak Republic 35.7 12.4 -6.8 Slovenia 35.9 -5.5 Spain 53.2 34.8 -11.2 -8.3 -7.1 Hungary 84.0 58.0 -3.9 -1.6 2.2 Iceland 122.7 41.0 -9.1 -7.4 -5.0 Japan 189.3 96.5 -7.2 -5.5 -4.5 Korea 34.9 -31.0 0.0 New Zealand 35.0 -8.1 -3.5 -1.4 -2.3 Poland 58.4 22.3 -7.1 -7.3 -5.3 Sweden 51.8 -23.4 -1.1 2.3 2.6 Switzerland 5.5 0.7 1.3 1.7 United Kingdom 72.3 43.5 -11.3 -8.6 -7.0 Unites States 83.9 56.4 -11.0 -9.1 -7.6 Notes: Gross Debt: "General Government Gross Financial Liabilites", OECD EO and "General Government Debt", Eurostat; Net Debt: "General Government Net Financial Liabilites", OECD EO; Budget Balance: "Government Net Lending", OECD EO and "General Government: Net Lending/Borrowing", Eurostat; Structural Balance: "General Government Cyclically Adjusted Balances", OECD EO; Cyclically Adjusted Primary Balance: "Cyclically Adjusted Government Primary Balance", OECD EO. Source: Gross Debt and Budget Balance for Euro Area (and countries in Euro Area) from Eurostat, otherwise OECD Economic Outlook (EO). Northern Rock in September 2007, and expanding Fourth, the end of asset booms and bubbles, massively with the rescue of Fannie and Freddie especially in real estate markets, plus the by the Federal government on September 7, 2008, normalisation, from extraordinary heights, of the Lehman Brothers insolvency on September profits and pay in the financial sector, are likely 15, 2008, and the last-minute rescue by the to produce a lasting reduction in the buoyancy Federal government and the Fed of AIG and its of government revenues with respect to GDP counterparties in a number of interventions that in countries with significant construction and started on September 16, 2008. financial sectors, resulting in an increase in the Third, the worldwide recession that started structural primary (non-interest) deficit of the in 2008 and lasted in most of the advanced sovereign. industrial countries until the end of 2009.1 The Together, these four developments caused recession weakened many government revenue an unprecedented peacetime deterioration in sources and boosted certain public expenditure the public finances of most of the advanced categories (like unemployment benefits) for industrial countries.2 the usual cyclical or automatic fiscal stabiliser In Greece, a number of country-specific factors reasons. 2 They also caused a sharp deterioration in the public 1 According to the NBER Business Cycle Dating Committee, finances of a number of emerging market economies – the latest US recession started in December 2007 and mainly in Central and Eastern Europe and the countries of reached a trough in June 2009. The recovery in the US is the Commonwealth of Independent States ( the successor therefore 15 months old at the time of writing (September states of the former Soviet Union minus the three Baltic CEPR POLICY INSIGHT No. 51 CEPR POLICY INSIGHT No. 27, 2010). nations). To download this and other Policy Insights, visit www.cepr.org OCTOBER 2010 3 Figure 1 Public debt in emerging economies and 20 added to these common causes of the fiscal developed economies troubles. In October 2009, following the Greek general election and change of government, Greece’s general government budget deficit was 140 Emerging Markets revealed by the new government to be 12.7% 120 Developed Economies of GDP rather than the 6.0% reported by the old government, and the 3.7% promised to the 100 European Commission at the beginning of 2009. 80 The most recent estimate from Eurostat puts the 60 2009 general government deficit of Greece at Debt % of GDP 13.6% of GDP. And, while the finances of many 40 sovereigns deteriorated strongly as a result of the 20 recent crisis, Greece entered the downturn with a 0 large underlying public deficit already. 2009 2014 Source: IMF The deterioration in the fiscal positions of most industrialised countries has been spectacular, even more so when set against is only one emerging market amongst the high- the remarkable fiscal restraint demonstrated government deficit countries in 2009 – India. by most emerging markets And India, with a gross general government debt to GDP ratio of over 80% during 2009 (see IMF (2010)), is much better able to manage a 10% Greece’s budgetary problems owe much to high of GDP general government deficit, because entitlement and age-related spending, poor tax during 2009 it had a growth rate of nominal administration and a bloated public sector.