Grexit: There is a good reason why the world's going nuts over Greece

The bailout money helps keep the Greek economy going and at the same time helps repay the debt that is falling due.

Vivek Kaul June 29, 2015 14:41:27 IST
Grexit: There is a good reason why the world's going nuts over Greece

Greece is a very small country which makes up for less than 0.5 percent of the world's gross domestic product (GDP). Given this, why is the world going bonkers over it? In this column I will try and answer this question.

Greece is in the process of repaying the massive debt that it has taken on and by the end of this month needs to pay €1.6 billion to the International Monetary Fund (IMF). The trouble is that the country is practically bankrupt and needs bailout funds. If Greece does not pay the IMF by June 30, it will be declared to be in a default. It may also have to leave the Euro Zone (the countries which use euro as their currency).

Grexit There is a good reason why the worlds going nuts over Greece

Greek Prime Minister Alexis Tsipras. Reuters

The country owes around €240 billion to the European Commission, the European Central Bank(ECB) and the IMF, together referred to as the troika. The troika has been lending money to Greece for a while now. As Mark Blyth writes in Austerity—The History of a Dangerous Idea: "In May 2010, Greece received a 110-billion-euro loan in exchange for a 20 percent cut in public-sector-pay, a 10 percent pension cut, and tax increases."

Every time the troika lends money it demands more austerity measures from Greece. The idea is to ensure that the Greek budget enters into a positive territory so that the country is finally able to start repaying the debt it owes, instead of borrowing more to repay what it owes. The troika wants the Greek government to run a surplus i.e. its revenues should be more than its expenditure.

The Greek Prime Minister Alexis Tsipras in return for more bailout money has offered to achieve a budget surplus of 1 percent during this year. He further offered to achieve a surplus of 2 percent in 2016 and 3 percent in 2017. As Blyth writes that the idea seems to be to: "Cut spending, raise taxes—but cut spending more than you raise taxes—and all will be well." That's what the troika seems to believe in.
Over and above this Tsipras has also promised to raise an additional €2.7 billion this year along with pension cuts and an increase in value added tax. The Greek prime minister has also promised to take steps to curtail early retirement.

Greece has a very generous welfare system. Some jobs which are categorised as arduous allow men to retire at 55 and women at 50. As John Mauldin and Jonathan Tepper write in their 2011 book Endgame—The End of the Debt Supercycle and How it Changes Everything: "As this is also the moment when the state begins to shovel out generous pensions, more than 600 Greek professions somehow managed to get themselves classified as arduous: hairdressers, radio announcers, musicians." After retirement these people are paid a government pension.

Tsipras has promised to raise the retirement age gradually to 67 and in the process increase the retirement age, so that the pension bill of the government comes down.

Over and above this what pushes up government expenditure further is the fact the average Greek government employee is paid significantly more than a private sector employee. As Mauldin and Tepper write: "The national railroad has annual revenues of €100 million against an annual wage bill of 400 million, plus €300 million in other expenses. The average state railroad employee earns €65,000 a year. Twenty years ago a successful businessman turned finance minister named Stefanos Manos pointed out that it would be cheaper to put all Greece’s rail passengers into taxicabs."

In fact, the Greeks working for the government were paid for fourteen months in a year. As Neil Irwin writes in The Alchemists—Inside the World of Central Bankers: "Greek workers, in addition to monthly paychecks, received so-called thirteenth and fourteenth month's checks to cover their holiday spending and summer vacations."

Also, the Greeks do not like paying tax, making things even more difficult for the government. Tsipras, the Greek prime minister, has also promised to implement higher taxes on business as well as the wealthy Greeks. These measures are expected to ensure that Greece will be bailed out again and that it will not be forced to exit the euro zone and stop using euro as its currency. Hence, Grexit i.e. Greece exiting the euro, will not happen, at least not in the near-term.

Having said that the question one needs to ask here is if more austerity is the way to go for Greece? When the troika lent €110 billion to Greece in May 2010, it expected Greece to follow austerity measures by cutting spending in order to be able to repay the money that was being lent.

But the results were disastrous. As Blyth writes: “The lenders, the so-called troika of the ECB, the European Commission and the IMF, forecast growth returning by 2012. Instead unemployment in Greece reached 21 percent in late 2011, and the economy continued to contract."

The economic numbers continue to be weak in case of Greece. As The Guardian reports: "[The] country...has lost a quarter of its national income since the financial crash, has to cope with an unemployment rate of 26% and is owed 76 billion euros in unpaid taxes...An estimated 8,500 small and medium-sized businesses have closed since the start of the year." The unemployment rate among the youth is over 50 percent. In this scenario, austerity measures can only lead to further contraction of the economy.

Also, a lot of money is moving out of Greek banks. The Guardian points out that "a further €1.6bn was pulled out of the banking system on Monday[June 22, 2015]."

Getting back to the original question as to why is the world so worried about Greece? Greece owes a lot of money to European banks. As Satyajit Das, the author of Extreme Money, points out in a February 2015 column: "Bailouts benefited banks, particularly from Germany and France, with less that 10% of the €240 billion bailout going to Greece." So, the money that Greece got from the troika was used to pay off European banks. Hence, if Greece defaults European banks will end up in trouble.

Further, no one really expects Greece to be in a position to be able to repay all the debt that it has taken on. As Das points out: "Greece is unlikely to be ever able to pay back its current borrowings. No amount of semantics and pettifoggery can disguise that fact which has not changed since the start of the crisis. What cannot be paid back will not be paid back."

So why is it that Greece is likely to be bailed out again? The bailout money helps keep the Greek economy going and at the same time helps repay the debt that is falling due. Any move where Greece decides to go for an outright default on its debt, might inspire the likes of Spain, Italy, Portugal etc., to do the same. Then there will be real trouble because the amount of debt owed by these countries is bigger than that of Greece.

The problems in Greece highlight similar problems in other countries in the Euro Zone as well as some Eastern European countries. If these countries decide to default on their debts, then the entire concept of "euro" might be history. As Das writes: "Once Greece defaults and/or leaves the Euro, it would be difficult to stop speculation about other peripheral nations, undermining the entire basis for the common currency. Even without a full Grexit, any concessions to Greece would result in other countries such as Ireland, Portugal, Spain, Italy and France seeking relaxation on budgets and reform. Debt and fiscal sustainability within the Euro-zone would become unachievable."

Also, any hint of Greece exiting the euro will lead to the Greeks withdrawing their euros from their banks (which they are already doing in fact). This would happen primarily because the new currency (probably drachma in Greece’s case) would be less valuable than the euro. Hence, Greek banks would face bank runs.

This could lead to citizens of other weak countries in the Euro Zone withdrawing their euros from banks, leading to bank runs in these countries as well. They would do this in anticipation of their countries leaving the Euro Zone as well, after Greece.

For the euro to continue existing it is important for the European Union led by the likes of Germany and supported by the stronger countries like Finland, Norway etc., to keep bailing out Greece and the weaker economies.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

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