European Economic Crisis Greek Government

European Economic Crisis -- Greek Government

This paper provides a deep insight into the European economic crisis and the events which eventually lead up to Greece debt crisis. It explains the causes which were responsible for the chaotic and poor financial situation currently prevalent in Europe. It also analyses the current tools used for stabilizing the situation in Greece and the shortcomings in them. It also highlights certain steps and measures which can be taken in improving the current scenario.

Occurrence of Greek Debt Crisis

Core Causes of Financial Crisis in Greece

Extensive Money Borrowing at Low Interest Rates

Misrepresentation of Public Records

Inappropriate Business Environment

Inefficiencies in the Public Sector

Greek Domestic Policy Responses to Debt Crisis

Austerity Measures

Structural Reforms

Financial Assistance from Eurozone Member States

Financial Assistance from IMF

5. Pros and Cons of the Greek Debt Crisis Issue 12

Prospective Solutions for Dealing with the Debt Crisis in Greece 14

6.1 Growing the Economy out of Debt 14

6.2 Monetizing of Debt 15

6.3 Restructuring or Defaulting of Debt 15

6.4 Detachment from Eurozone 16

6.5 Issuance of Eurobonds 16

6.6 Fighting off Corruption 16

6.7 Establishment of a Credible Tax Audit System 16

6.8 Establishment of a Credible National Agency 17

6.9 Policy Requirements 17

7. Bibliography 20

European Financial Crisis -- Greek Government

The debt crisis engulfing the European Union (EU) is immensely threatening to the economic and political conditions in Europe. The economic and financial crisis has shaken the foundations of European construction, more precisely; it's most visible and successful symbol -- the common currency, Euro. Debt crisis in EU attributes to the inability of some countries in gaining control over the growing debt, which has pressurized the stability and survival of the European currency, Euro (Todorivic and Bogdanovic 2012). The mounting debt and budget deficits of some countries of European Monetary Union caused the reaction of financial markets that punish countries with high debts by increasing prices of their additional borrowing. The inability of adjusting with exchange rates forces pressure in labour market and unemployment which further alleviates pressures with fiscal slippage (Adrain 2012). Minescu (2011) believed that the core reasons behind the current European financial crisis are low risk premiums, strong leveraging, elongated time periods of rapid growth of credit, abundant availability of liquidity and the soaring prices of assets. European banks lent billions to financially struggling nations and are now at the stake of facing huge losses, which could in turn cause the crisis to spread to more stable nations and the United States. All the EU countries thus adopted austerity measures for improving the fiscal strength and competitiveness. EU leaders adopted Euro Plus Act which included the commitment of each country to introduce a balanced budget amendment as a part of their national law. The debt crisis in European Union clarified the fact that an economic model based on the financing of consumption through borrowing would not bore fruit in the future (Todorivic and Bogdanovic 2012).

Occurrence of Debt Crisis in Greece

The economy of Greece has functioned as a relatively closed economy for decades bearing a characteristic large public sector. Tourism and ship building are the core sources of state revenue, yet the state faced a downfall in the industrial production. The reliability of Greek economic indicators has been questioned by the European Union and its position was quite curious even before the European crisis. Greece got an easy-access to longer-term borrowing due to the under-pricing of default risk. Statistics indicated that the general government revenue as a percentage of GDP has consistently remained lower than government expenditure in Greece (Taylor 2011). Greece was engulfed in the flames of large budget deficit, public debt, current account deficit and the decline in competitiveness. One of the fundamental reasons for the occurrence of crisis in Greece was the large amount of borrowing in international capital market for financing the current account deficit and the budget deficit. The delay in implementation of structural tax reforms and pension systems was also a contributing factor towards Greece's debt crisis. Poor collection of budget revenues, tax evasion and high government spending were the significant internal factors of the debt crisis. The accumulation of foreign debt mounted up drastically due to the external factors comprising of easy access to external capital markets at a lower rate after joining the EMU, and poor application of EU rules concerning public debt and budget deficits (Todorivic and Bogdanovic 2012). Greece faced the prospect of sovereign debt default due to the downgrading of Greece debt rating and non-zero economic growth. The European Union and the IMF worked out rescue loan plans to assist Greece. The loan bailouts may alleviate short-term liquidity problems, yet Greece is still at the stake of encountering the long-term debt obligations (Abboushi 2012). The following section will now cover a detailed analysis of the causes leading towards the financial crisis in Greece.

Core Causes of the Financial Crisis in Greece

The worsening economic conditions in Greece made it the victim of a tremendous debt crisis. A number of factors are responsible for the fiscal crisis experienced by Greece since 2008. Some of these factors are endogenous, and are linked with the internal structure of Greek economy. The prolonged macroeconomics imbalances encountered by the Greek economy and the credibility issues of the macroeconomic policies are core contributing factors towards the Greek debt crisis. On the other hand some factors are exogenous and are linked with the financial turmoil encountered by entire Europe (Kouretas, Georgios, and Vlamis 2010). This section closely focusses on the domestic factors leading towards the Greece debt crisis.

Extensive Money Borrowing at Low Interest Rates

The high growth rate of real GDP during the period of 2001-2008 was the result of growth of personal consumption and public investments financed from public funds and funds from the European Union. The public debt of Greece increased drastically due to the extensive borrowing from international capital markets for financing the Greek's government deficit (Gibson, Hall and Tavlas 2012). The reliance on external borrowing to cover budget deficit and current balance of the country's economy led to a situation of high sensitivity of the capital markets (Todorivic and Bogdanovic 2012). The extensive borrowing was aimed at inducing the income of average household in Greece. This borrowing was completely streamlined to higher consumption levels in an effort to raise the standard of living of households. This process was also fuelled by the incoming capital flows from the EU which were accumulated in the form of agricultural subsidies. Moreover, the financing of infrastructure within the broader framework of the convergence and cohesion policies of the EU were also a source of capital inflows (Kouretas, Georgios and Vlamis 2010). The Greek economy lacked a will to maintain fiscal discipline, and possessed a wasteful and inefficient state administration. Immensely expensive pension and welfare system and tax evasion further aggravated the situation of public debt in Greece. Poor collection of tax revenues generated drastically high budget deficits.

The industrial structure of Greece and low competitiveness further contributed towards the debt crisis. Low productivity and relatively high earnings played a major role in affecting the declining competitiveness of Greek products abroad, which ultimately affected the decrease in exports and current account deficits.

Misrepresentation of Public Records

Greece encountered another massive hurdle in covering up its existing debts when it was discovered that the government misrepresented and falsified the data it disclosed about its public finances. This was done by the Greek government to make an attempt to stay within the monetary guidelines of the Eurozone. Abboushi (2012) declares the fact that Greece has had particularly precarious debt dynamics and was the only member state that cheated with its statistics for a long period of time. The statistics indicate that the Greek government revised its deficit for 2008 from 5.0% to 7.7% of GDP and revised the 2009 deficit from 3.7% to 12.5%, which was further more revised to 13.6%. Thus Greece not only reported incorrect data, yet it also committed acts of non-transparency, improper documented bookkeeping, and lacked a sense of responsibility of the statistics agency. The disclosure of these facts and figures spooked the bond markets and the credit rating agencies. These decided in considering that Greece was not trustworthy and not credit worthy. Bond yield spread rapidly like a fire and Greek government credit rating dropped severely. Greece eventually encountered the prospect of not being able to raise new debt to pay off existing debt.

Inappropriate Business Environment

Another factor inhibiting Greek economic success was the fact that Greece has not been a particularly business-friendly country and seems to hinder entrepreneurship and capital investment. The World Bank surveys countries all over the world by evaluating them in terms of their business environment. The countries are then ranked accordingly. The dimensions evaluated by them comprise of "starting a business," "employing workers," "protecting investors," and "registering property." The unfriendly business environment scares away foreign entrepreneurship and reduces foreign direct investments, which tend to be a primary source of capital. Recent OECD data show that Greece is among the least recipient of foreign direct investment capital in Europe. The cold attitude of Greece in its business dealings with countries all over the world reduces their chances of receiving foreign aid for paying out the debts (Abboushi 2012).

Inefficiencies in the Public Sector

The real appreciation of wages in the public sector and the increase of employees in the public sector of Government and municipalities led to a reallocation of capital and labour away from the private sector and especially from export oriented sectors leading to the loss in competitiveness and the increase in the current account deficit (Kouretas, Georgios and Vlamis 2010). The private sector received a setback, as it was immensely dependent on government projects and less on its own efforts for research, development and innovation. High level wage offered to government employees made the average person to search for a job in the public sector where payment is not related to productivity. This eventually deteriorated the competitiveness of Greek economy. Kouretas, Georgios and Vlamis (2010) provide an evidence of the fact that Greece experienced the highest growth increase in public spending and public administration employment which lead to a gigantic public sector during the period of 1999-2005.

Not only this, the Greek had low entrepreneurship motives and the entrepreneurs' encountered difficulties in starting up their business due to bureaucratic obstacles that further inflate corruption.

Greek Domestic Policy Responses to Debt Crisis

Austerity Measures

In order to avoid bankruptcy and bring down the deficit, the European Union and the International Monetary Fund expected the Greece government to take strict measures of austerity. The Adjustment Programme implemented by the European Union aimed at cutting down the expenditures of the Greek Government. Greek Government planned for budget cuts, freezing of wages of public sector, lifting up retirement age, putting higher VAT taxes, cutting down of pension and social service payments. The Greek pension system itself was on the brink of insolvency before the EU's implementation of the Adjustment Programme. Thus, the Programme removed the incentives for retirement before the statutory age (Taylor 2012). The austerity measures catered two core economic issues being encountered by Greece. One is the cutting down of large government budget deficits and the other being stabilization of the economy in cyclical economic downturn. However, it always remained a matter of question that how long could the Greek government count on public support for the austerity measures in this era of sharp recession.

Structural Reforms

Greek Prime Minister named Papandreou introduced long-term structural reforms for the Greek economy. These reforms cover the domains of healthcare, pension systems and public administration. His plans aimed at boosting competitiveness by fostering enhanced development in the private sector, supporting research, development and innovation and enhancing employment and economic growth. The measures included calculating pensions on the basis of lifetime contributions as opposed to the last five years of earnings. His efforts aimed at tightening public regulation and increasing accountability in Greek healthcare systems. The reforms target the increase of attracting new foreign investment in Greece by boosting export of goods and services. It intends to increase investment and development in sectors which had strong comparative advantages for trade and investment, like renewable energy sector and transportation networks. However, these structural reforms encountered the substantial challenge of maintaining public and political support for austerity measures and economic development reforms.

Financial Assistance from Eurozone Member States

France and Germany are willing to render loans of $11.2 billion and $8.4 billion respectively to Greece, if Greece sticks to its austerity plan and layout detailed deficit reduction measures for the upcoming years. The instability in Greek economy can have considerable consequences for the EU. It is expected that might spread across European bond markets and draw in countries like Italy, Spain, Portugal and Ireland as the crisis has contributed to a weakening of the euro's foreign exchange value. Germany tends to be the most influential state of the Eurozone and possesses the largest economy as well. However, it lies amongst the sceptical member states. Some statistics indicate that majority of the Germans are unwilling to render help to Greece. A major reason for this is the fact that major EU countries are also encountering financial hardships and have failed in modernising their own economies (Nelson, Belkin and Mix 2010).

Financial Assistance from IMF

In 2010, Greece asked for financial assistance from the IMF. Many viewed the outside intervention by IMF as a potential humiliation for the Eurozone, as the Eurozone failed in demonstrating its credibility and strength in taking care of its own problems. However, gradually all the member states favoured the twin-track approach of combining the assistance and aids of Eurozone states and the IMF. The IMF also stands in catering Greece with technical assistance along with provision of financial assistance. Some economists opined that the level of assistance provided to Greece by IMF would be far much smaller than the broader package of financial assistance catered by the Eurozone member states (Nelson, Belkin and Mix 2010).

Pros and Cons of the Greek Debt Crisis Issue

The European Union and its member nations, the International Monetary Fund and the European Central Bank played their roles in catering the Greek debt crisis by relying on bailouts and austerity measures. The austerity plans have contributed little on fiscal woes and have only stirred up anti-governmental tension among the Greek population (Vickstrom 2012). On one hand the European officials accepted the Greek plan for resolving the debt crisis through fiscal consolidation process, yet they were unaware of the potential hazards that were encountered on the other side of the picture. The increase in taxes and drastic reduction in government spending paved the way for major declines in economic activity and increased illiquidity in the economy. This led Greece towards unemployment and pushed the country into an era of recession. Due to declining economic activity, the budget revenues won't be increased by charging of higher taxes. Now the Greek government was attacked by two sides. On one side it has to reduce its deficit via restrictive fiscal policy, while on the other side it had to maintain its economy for sustained growth which can be achieved by expansionary fiscal policy. The instruments of fiscal policy are the only tool on which the Greek government could rely, as Greece is a part of the Eurozone and it is not possible for it to have an independent monetary policy. Moreover, there doesn't exist any possibility for currency devaluation for solving the current problem of stabilizing the economy (Todorivic and Bogdanovic 2012). Although the Greek state and its citizens have sacrificed a great deal to cope up with the EU/IMF bailout requirements, yet it seems that Greece may be even closer to default than before the intervention of the European Central Bank and the IMF. Greek citizens are now much concerned about the worsening economic conditions. As the Greek citizens watch their pensions diminish and their benefits disappear, they are becoming less supportive of the severe austerity measures being implemented. Austerity measures have been instrumental in identifying areas of wasteful spending and have made the financial institutions in Greece more transparent. As the situation aggravates in Greece, it continues to receive additional funding but with the requirement of implementation of much severe austerity measures for curtailing the excessive government spending. The continuous need of Greece for bailout referendums has increased uncertainty pertaining to Greece's ability of covering up all its debts.

Greece made the decision of remaining a member in the Eurozone and taking assistance from other EU states and the IMF. The decision of remaining a member of the Eurozone and as a result having other states make explicit decisions about national economic conditions is crucial for Greek government. Greece has had the option of financing its own budget deficit and increasing the competitiveness of its exports, if it had quitted the Eurozone and adopted and devalued a new national currency. However, exiting the Eurozone possesses the danger of future borrowing costs to be much higher for Greece (Mitsoupoulos and Pelagidis 2012).

Prospective Solutions for Dealing with the Debt Crisis in Greece

At present Greek has a negative outlook, possessing a limited number of possible outcomes. Despite the aid and loans from the EU and IMF, Greece is encountering immense difficulties in coping up with its debts. This dilemma requires proper management of the excessive debts. Following are some of the prospective solutions, which can serve instrumental in dealing with Greece debt crisis.

Growing the Economy out of Debt

The most effective method in resolving the issue of excessive debts would be to grow GDP at a much faster rate than the debt. The reduction in Debt-to-GDP ratio would accompany fewer pains. This however necessitates the need for identifying the sources of economic growth. Due to lack of competitiveness described previously, Greece could count on miraculous trade aversions or internal devaluation for boosting up the exports sectors. Internal devaluation calls for low labour costs, with low working wages, less benefits yet longer working hours. This measure has received fairly reasonable success, as the Greek labour cost declined by 3.4% in 2010 and further more by 4.2% in the year 2011 (Kondeas, Alexander and Karagiannis 2012).

Monetizing of Debt

Creating inflation results in the reduction of real debt value and facilitates the debtors in paying their debts, putting the domestic consumers at the stake of lowering their living standards. Japan, U.S. And UK coped up with their debts by monetizing the government debt through the Quantitative Easing (QE) schemes (Kondeas, Alexander and Karagiannis 2012). As Greece does not have its own currency, it does not have this option available. Monetizing of debts will certainly reduce the burden on Greek government. Monetization is prohibited strictly by the laws of EU.

Restructuring or Defaulting of Debt

It is a vivid fact that Greece will not able to pay out all its debts despite the severe austerity measures and reductions in government spending. The current measures being adopted by the Greek government did not serve instrumental in reducing the debts, yet they only delayed the repayment. Greece has the option on defaulting on its debts which will ultimately relieve Greece from the mountain of debt which it cannot afford to pay despite its intense austerity measures. Greece's economy has already begun to shrink, and the longer the inevitable is prolonged, Greece's economy would aggravate badly in the future. In fact, Greece defaulting is beginning to look like a better alternative than keeping it barely afloat (Vickstrom 2012). In the wake of a default, Greece will have the opportunity to protect the depositors and banks and guarantee payment of pensions and certificate deposit payments. Vickstrom (2012) believes that in the situation of Greece's default, the real losers would be foreign banks and credit investors, while Greek national banks would be the potential winners.

Detachment from Eurozone

Greece also has the option of leaving the Eurozone, and returning back to the drachma as its national currency. This idea possesses good economic potentials for Greece. If Greece decided upon leaving the Eurozone and re-adopting the drachma, it would have the opportunity of devaluating its currency and becoming more competitive economically. This will boost up the exports sector as more nations and companies would be interested in doing business ultimately yielding high amounts of cash towards the Greek nation. An example of this can be seen in the history of Argentina, whose new president's first action was to de-peg the peso from the dollar, and then devalue peso for eliminating hyperinflation and stabilization of the economy (Vickstrom 2012).

Issuance of Eurobonds

The ECB can buy or sell issues of new bonds at lower rates in order to cater Greece with an opportunity of borrowing money without large rate spreads. This however, is not a long-term solution, yet Greek economy could benefit from it until it stabilizes well (Michelis 2012).