Jun 022010

An in-depth look at the Greek debt crisis and its international implications. How did it get in such a mess? What role was and is played by its use of the Euro? And what are its options?



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LIVE: Greek crisis dominates G20 Cannes summit


    Greek crisis dominates G20 Cannes summit

Overview of the day’s events:

– The G20 summit is being largely dominated by the Greek crisis, despite the country not being a member.
– Nicolas Sarkozy has said that Greece will not receive “one cent” if it breaks away from the eurozone via PM Papandreou’s planned bailout referendum.
– The Greek prime minister rejected pressure to resign, warning that early elections would lead to an exit from the euro, and instead pledging to negotiate with the opposition conservatives.


Greece suffers from unsustainable public-sector debt, low productivity, and an overall uncompetitive economy. In 2009, the government’s fiscal deficit was 13.6 percent of Greece’s gross domestic product (GDP) and its outstanding debt stood at 115 percent of its GDP. Lenders were losing confidence in Greece’s ability to repay them. Before the loan agreement with the International Monetary Fund (IMF) and the EU announced on May 2, they were demanding an almost 10 percentage points premium over lending rates to Germany, which worsened Greece’s deficit. Even with the large corrective measures Greece has agreed to undertake, its debt is projected to increase to 149 percent of GDP in 2012 before beginning to shrink in 2014.

Greece’s government must cut spending and improve tax revenue in order to greatly reduce or eliminate its need to borrow, reduce the cost of its output (via domestic deflation or leaving the Euro and depreciating a new currency) in order to restore the external balance between its imports and exports, and to reduce the impediments to economic efficiency and productivity growth so that its economy can grow more rapidly. How did it get in such a mess? What role was and is played by its use of the Euro? And what are its options?

How Did it Get There?

Americans like to think that we are responsible for our own well-being and turn to others for help only reluctantly and exceptionally. We do not generally think of others—whether through government or private organizations, other than our families—owing us anything but civil treatment and respect for our property. American’s are generally critical of Europeans for their entitlement attitude and the large state welfare systems that result from and/or feed it. Surprisingly, European per-capita income grew a bit more rapidly than it did in the U.S. over the 10 years since 1997 (67 percent vs. 55 percent), however this outcome reflects the unusually rapid growth in those Old European countries that reformed their welfare systems and markets the most (such as Ireland and Sweden), the broadly favorable effect of the Euro on competition and improved productivity, and the fact that population is stagnating in Europe while growing rapidly (via immigration) in the U.S, thus sharing the income growth among fewer people.

But following the retrenchment of entitlement spending resulting from Clinton’s welfare reforms in late 1996, the U.S. has more recently joined Europe in an ever-expanding welfare budget. Two factors were particularly important for the growth in such expenditures: the aging of the population and a global abundance of saving and hence low interest rates. Commitments were made (unfunded social security promises, medicare, etc) in the U.S. and elsewhere that generated future rather than current costs. Thus today’s politicians could gain credit for increased benefits that future generations would have to pay for out of (hopefully) larger incomes. Unfortunately, the future work force will be smaller relative to the retired workers they must support, greatly compounding the burden. In addition, borrowing costs have been unusually low making short term deficit financing particularly tempting. Low interest rates encouraged the shortsighted expansion of government programs financed with money borrowed from present and future generations. The result is a growing debt burden and a slowdown in the growth in output with which to pay it. But the future is now at hand and adjustments MUST be made in the U.S. and in Europe.

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