The financial crisis in Greece has implications far beyond a $200 billion economy that represents only 2.6% of the euro zone, which is far less than many country economies shrank during the global recession. It has become a critical test of the ability of the euro currency and the euro countries to address fiscal flaws and restore investor confidence. And it has raised the question of whether this is merely the first sign of financial markets’ frustration with government deficit spending from which no country, including the US, will be immune.
Greece’s problems are largely attributable to rampant spending on public employee wages, a dysfunctional tax system and a rapid loss of investor confidence (a deficit from the 2004 Olympics estimated as high as $11 billion doesn’t help either). Government spending is 40% of gross domestic product (the total value of economic output), public employee wages are as high as 25% of federal spending and pension benefits are far more generous than in the private sector. Resistance to changes is fierce, despite the government’s passing of an austerity plan, and there have been at least three deaths due to violent protests. The tax system has changed so frequently and drastically, often retroactively, that evading taxes is not only culturally acceptable but is seen as a matter of survival. Up to 25% of Greece’s economy is made up of unreported income and Greece is last on Transparency International’s index of perceived corruption index largely because of tax officials accepting bribes to look the other way.
As a result, Greece’s budget deficit this year is as high as 13.6% of GDP and the accumulated debt is as much as 124% of GDP. The problems in Greece are not new, but fear that Greece would default (that is, refuse to pay its debts) grew rapidly when the new government disclosed that prior estimates of Greek deficits were grossly understated. The cost of borrowing soared, making Greece’s budget hole even deeper. Finally, the International Monetary Fund and the other euro zone countries created a $147 billion rescue fund. In return, Greece will be forced to cut public wages and pensions, raise the retirement age, deregulate and privatize certain industries, raise taxes, crack down on tax evasion and even reduce military spending.
These cutbacks will actually reduce economic growth for several years, and Greece does not have a large amount of exports, making it more difficult for growth to help solve the deficit problems. And because Greece uses the euro, it does not have any of the options associated with a sovereign currency; one common remedy is to “devalue” the currency, or make it worth less compared to other currencies. This allows the country in trouble to repay its debts with cheaper currency and makes its exports less expensive, although often at the cost of inflation.
The European Union adopted measures in 1997 to maintain and enforce fiscal discipline by countries using the euro. The criteria included annual budget deficits no higher than 3% of GDP (including all public budgets, not just federal) and total debt of less than 60% of GDP. Although punitive proceedings were started against Portugal in 2002 and Greece in 2005, no fines were ever applied, and the criteria proved to be unenforceable against bigger countries such as France and Germany. As a result, the criteria have been significantly relaxed and often ignored. Even before the recent global recession, nine of the 16 euro zone countries, as well as the combined euro zone, had violated the criteria. In 2009, all but two of the 16 Euro countries had deficits greater than 3% of GDP and Ireland’s deficit is larger than Greece’s. It’s no surprise, then, that in addition to the Greek bailout fund the euro zone has agreed to create a $1 trillion bailout fund to combat any future crises, avoid increased borrowing costs for all the euro countries if investors lose confidence and address speculation that the euro will fail as a regional currency. (The UK, although not a euro country, also has a deficit of over 13%. And Japan, even though widely regarded as one of the world’s soundest economies, defies logic with a total debt of over 220% of GDP.)
Of course, Greece is hardly the first country to teeter on the brink of default. Defaults, or agreements to restructure sovereign debt to avoid default, have been caused by war, revolution and civil conflicts. Nearly all of the sixty-four sovereign defaults and restructurings since the late 1970’s, however, have been due to domestic economic policies, shocks to local economies and political upheavals (as reported by Federico Sturzenegger and Jeromin Zettelmeyer in their 2007 book Debt Defaults and Lessons from a Decade of Crises). These include economies such as Brazil and Argentina that are far larger than Greece and “clusters” of countries in Latin America and Africa with similar economic problems in the 1980’s, which was a debt crisis that rivals today’s.
Where does this leave the US? Our current deficit is over 10% of GDP and total debt is over 92% of GDP, fast approaching $9 trillion (and forecast to rise to as high as 140% of GDP in coming years). While interest rates are historically low, it is a simple mathematical truth that growing debt increases interest costs which in turn adds to deficits. The federal government has assumed over $2 trillion in private debt with no plan to unwind from it. Projections of the cost of social insurance and medical programs are widely criticized as woefully understated, which could greatly add to budget pressure. Tax increases are seen as inevitable, but there is a debate as to the point at which an increased tax burden slows growth. Many states, which are technically required to balance their budgets, are looking at significant deficits, and bloated public pensions are under fire. (Arizona, whose public pension benefits are fairly reasonable, did increase benefits in 2001 and those increased benefits are constitutionally guaranteed.)
But the US is not Greece. Despite growing government involvement, our federal spending is half of Greece’s as a percentage of GDP and our spending on federal civilian employees is a fraction of Greece’s. Our “shadow economy” of unreported income is around 7% of GDP. Our economy is by far the world’s largest and one of the most diversified. The dollar is still the world’s reserve currency and the warnings of just a year ago that the Euro would replace the dollar now seem highly unlikely. The dollar could gradually lose value against other currencies, helping the US debt burden by creating inflation and easing repayment. And there are signs that even the economic recovery to this point has led to higher tax revenue and lower expenditures, with the government recently reducing its quarterly borrowing for the first time in three years.
Despite our great advantages, deficit spending simply cannot go on forever. The real lesson of Greece is that a crisis can develop very quickly and can’t necessarily be solved quickly or easily. And any default crisis in the US would likely be much more painful because, unlike Greece, it is hard to imagine who could bail us out.