When most people think of Greece, they imagine warm ocean breezes and tranquil seaside fishing towns. But these days, when European leaders talk about Greece, the mood is anything but calm.
After years of imbalanced budgets, government corruption and widespread tax evasion, Greece is now on the brink of a full-on financial crisis.
The country’s debt totals 110 percent of gross domestic product. This year’s deficit is expected to clock in at about 12.7 percent of gross domestic product, significantly higher than the original estimate of 6 percent. Its credit ratings were recently downgraded to the lowest level in the eurozone.
But, rather than face up to its budget shortfalls, the Greek government has a tradition of masking them. The only time since the introduction of the euro that the Greeks managed a budget deficit under the 3 percent required by European Monetary Union rules was in 2006 when officials included the black market and prostitution in their calculations of economic output.
Corruption also adds a large chunk to the real debt figures. Recently elected Prime Minister George Papandreou estimated that bureaucracy costs his country 7 percent of its gross domestic product and that half of that could be eliminated by aggressively combating red tape and corruption.
Given the government’s less than stellar example, it is perhaps not surprising that tax evasion is common in Greece. According to Finance Minister George Papaconstantinou, only 0.03% of Greeks reported earning €200,000, about $287,000, or more, last year. By contrast, the highest-earning 2 percent of Americans all earned over $261,166 in 2007. While Greece does not have the same level of wealth as the United States, Papaconstantinou said that the earnings reported on tax forms are “out of step with the wealth that we see around us.”
The state of the country’s finances has naturally sparked worries within its borders. Its citizens are used to receiving ample benefits from the government, which employs about a quarter of Greeks. The newly elected socialist government is not eager to earn a reputation for making budget cuts, particularly given that, in Greece, cuts and strikes go hand in hand. A New York Times reporter, on his way to interview Papaconstantinou about the budget difficulties, had to first venture past heaps of garbage that had accumulated in Athens’ Syntagma Square as a result of a two-week strike by trash collectors.
But, if Greece doesn’t pull itself out of debt, Greeks won’t be the only ones to suffer. In 2001 Greece gained entry into the European Monetary Union using figures that have since been questioned. As a result, the country’s finances are deeply intertwined with those of the rest of the EMU countries, meaning that a potential default on debt, or, worse, declaration of bankruptcy, by Greece would have repercussions for all the member countries.
The Greek government has announced a new austerity budget and broad tax reform to help mend its budget problems, but the measures may not go far enough. The government has said that it will reduce its budget deficit to 9.1 percent next year. It will take another four years to hit the 3 percent mark “without jeopardizing the economic recovery,” according to Papaconstantinou.
The problem is that, given Greece’s diminishing credibility, no one is interested in financing all the debt produced by those deficits. Already, in order to attract bond investors, Greece must pay interest that is 2.5 percentage points higher than Germany pays. With the credit rating agencies slashing their assessments of Greece’s stability, buyers are likely to become even harder to find.
In fact, soon Greece may become ineligible for loans from the European Central Bank. The bank regularly gives loans to European Union countries, which in return generally offer their own government bonds as collateral. The ECB relies on the ratings assigned by Standard & Poor’s, Fitch Ratings and Moody’s to determine the creditworthiness of countries issuing bonds. Based on its present standards, temporarily relaxed in light of the global financial crisis, Greece still qualifies. But, if the ECB puts its regular requirements back in place next year, as it intends, then Greece may no longer be eligible to receive loans in exchange for its bonds.
This puts the ECB in a difficult position. If it maintains its plan to resume stricter standards, rendering Greece ineligible, then Greece may fall into complete financial collapse. The country may end up with no choice but to declare insolvency, which could trigger a domino effect, threatening the entire currency union. According to BusinessWeek, economists at UBS have said that they believe that, because of the potential risk to the euro, the ECB will do everything in its power to help Greece. “We believe that if a country is facing a problem with debt repayment or issuance, it will be supported,” they said.
On the other hand, if the ECB gives in and maintains its relaxed standards or lowers them even further in order to continue to support Greece, it might end up handing out its money in exchange for worthless Greek bonds. Such a move would send a message to other financially struggling EU member countries, like Ireland and Spain, that it’s okay to run up lots of debt because the ECB will always come to the rescue. One member of the executive board of Germany’s central bank cautioned against any rescue efforts on the part of the ECB, saying that if Brussels comes to Greece’s aid, “then the currency union will turn into an inflation union.”
Ireland or Spain might follow in Greece’s footsteps. Ireland recently unveiled dramatic cuts in an attempt to curb its deficit, which is expected to reach 13 percent of GDP next year. In Spain, the unemployment rate hit a startling 19.3 percent in October. Spain and Ireland both top Greece on the “misery index” generated by Moody’s Investors Service, which ranks countries based on a combination of unemployment rates and budget deficits.
As the ECB weighs its options, Americans should heed Greece’s example. In the long run, it doesn’t work to spend more than you make. Whether you are an individual living beyond your means or the major superpower racking up debt in order to buy the public’s favor, eventually lenders, and the populace, will question your full faith and credit.