The political crisis in Europe revolving around Greece’s economy is currently on hold. While the Greek people continue to endure Great Depression-level suffering, the months-long standoff between the government of Greece and Europe’s leaders was temporarily resolved by an agreement to negotiate further—an agreement to possibly agree at some point in the future, but only if the Greek government imposes further austerity on its people immediately.
Unfortunately, this latest gambit will almost surely end badly—not just for the Greek people, but for Europe and the rest of the world as well. The American people, too, have much at stake.
As I will explain below, the situation in Greece is economically simple, but politically nasty. Europe’s economic and political institutions—very much dominated by the German government—have willfully made the Greek situation worse. Rather than treating the problems in Greece as a manageable economic challenge, Germany’s leaders (only slightly hindered by some useful resistance from the International Monetary Fund) have instead turned the crisis into a matter of nationalistic scapegoating.
Europe’s political and financial leaders have, in short, used the “European project”—an admirable effort that was based on the idea of making Europe’s diverse peoples a unified whole—to sow bigotry and chauvinistic discord aimed at the Greek people. That is clearly bad for Greece. It could also set back European political unity for decades.
The Simple (Yet Difficult) Economics of a Common Currency
As I noted above, the economic situation in Greece is actually rather easy to understand. More to the point, it is also clear that there is one least-bad path forward, along with one most-bad path to disaster. To this point, the leaders of Europe have made it clear that they are determined to take the wrong path.
Sovereign nations with their own currencies have more options for dealing with economic setbacks than do countries that have no direct control over their monetary systems. When an economically independent country faces a downturn, that country can count on the value of its currency weakening, which tends to reduce imports and to increase exports. That, in turn, puts people at home back to work. But, with some exceptions that are not relevant here, this happens only when the country has a central bank that allows it to happen (and, usually, one that tries to expedite the process).
Joining a currency union, like the euro, changes everything. An individual member of the Eurozone cannot independently decide to allow its currency to lose value because it is tied to other countries that use the same currency, and the European Central Bank might well decide that it does not want to allow the currency’s value to change. Moreover, even if the euro’s value were to change, that would not help a struggling country as much as it otherwise would, because most of the country’s most important trading partners use the same currency.
This means that a country like Greece, when faced with a particularly harsh economic downturn, cannot count on exporting its way out of the slump (as Germany did in the 1990s when its economy was in crisis). Moreover, because its debts are denominated in the euro, Greece cannot use expansionary fiscal policy to end the depression. Its only available policy option is to push down wages domestically, in order to be able to sell goods at lower prices. Decades of research and experience, however, have shown that reducing domestic wages is extremely difficult, and it can only happen (even imperfectly and incompletely) if the country experiences an extremely deep recession or depression.
In the case of a country like Greece, that downturn makes its debt situation ever more difficult to manage, because the country’s GDP continues to decline dramatically in response to the austerity measures. In fact, even though Greece’s government has been collecting more in taxes than it has spent for the past several years (a so-called primary surplus, which excludes interest payments on existing debt), the country’s ratio of debt to GDP has gone up dramatically. This, however, is absolutely not a matter of Greece’s leaders having been fiscally profligate. The debt-to-GDP ratio is up because the denominator (GDP) has plummeted, not because the numerator (debt) has risen.
Europe’s leaders have stepped in over the past few years with a series of financial packages that have required Greece’s government to run large primary surpluses—that is, ever more stringent austerity measures. This has real effects directly on real people, who do not receive payments that they otherwise could have received from their government. Even more importantly, it has real effects indirectly on other people, who suffer because the economy’s downward spiral inflicts pain on everyone.
Greece’s unemployment rates have been in the 25-30 percent range for several years. That is not a typo. Over one-fourth of the people in Greece who seek work have not been able to find it. (In fact, this number is almost certainly understated, because people living through depressions know that seeking work is fruitless.) More shockingly, unemployment among young people in Greece has exceeded 50 percent throughout this disaster.
Debt Renegotiations and German Moralizing Based on Mythical Notions of Inviolable Rules
The least-bad path forward for Greece would be for everyone to admit that the country will never be able to pay its current debts in full, and to renegotiate those loans in a way that would allow the Greek economy to recover, putting its people back to work, and again becoming a positive force in an integrated European economy.
The IMF—which is one of Greece’s most important lenders—openly stated during the worst of the recent political crisis that the only way forward for Greece—and for Europe—was to reduce the country’s debt principal. There would normally be nothing surprising or especially complicated about such a process. Debts are renegotiated all the time. Indeed, the West German government negotiated with its creditors to reduce its debt by one-half shortly after World War II, to allow their country to start over.
The idea of a “fresh start” through bankruptcy is hardly a novel concept, in any modern economy. Even large, successful corporations sometimes renegotiate debts with their creditors, often through bankruptcy proceedings. For example, the remaining U.S. airlines have all used bankruptcy protections (sometimes more than once) to emerge as profitable companies. Although the specifics of bankruptcy laws need to be responsive to different contexts—preventing “deadbeat dads” from using bankruptcy to avoid paying child support, for example—there is no doubt that debt principal is often written down (which is to say, never paid back).
More importantly, everyone knows that loan contracts are not inviolable. Borrowers know it, and lenders know it, too. That is why debt is “rated” by analysts as being more or less likely to be paid off. As a matter of aspiration, loan contracts express what both sides expect to happen, but the idea that any deviation from the strict letter of those contracts is somehow an unheard-of attempt to cheat other people is simply absurd.
Unfortunately, many of Europe’s leaders have decided to turn the current crisis into an attempt to describe the Greek people as a whole as opportunistic leeches. As one American professor recently explained in the pages of The New York Times, Germany’s leaders in particular insist on viewing the situation as a matter of morality. After giving a talk at conference in which he explained why Greece’s situation is so dire, he wrote, “German attendees circled me to explain how the Greeks were robbing the Germans. They [the Germans] did not want to be victims anymore.”
This is especially galling, because the German economy’s current strength is largely based on the weakness of the economies of Greece, Italy, Spain, and others. How can that be? Because, as I described above, the common currency combines the economic fortunes of both rich and poor nations. Had Germany still been using the deutsche mark, normal forces of supply and demand would have strengthened the mark, making Germany less competitive, while allowing the poorer countries to take away some of Germany’s export market share.
Skeptical? This is hardly some far-out theory, and I am by no means the only economist to have made the point over the last few years. In fact, the economist Ben Bernanke stated the point quite clearly just last week: “Germany has benefited from having a currency, the euro, with an international value that is significantly weaker than a hypothetical German-only currency would be. Germany’s membership in the euro area has thus proved a major boost to German exports, relative to what they would be with an independent currency.”
Professor Bernanke is, moreover, hardly a bomb-thrower. He was President George W. Bush’s choice to be the chairman of the Federal Reserve Board, our central bank, a position in which he served from 2006 through last year. His economic work, both as an academic and a policymaker, has been thoroughly mainstream. Bernanke is saying what is obvious to anyone who understands the basic economics here: The Greek situation is not a result of fecklessness by the Greek people. Saying that they should stop “robbing” their creditors is dangerous nonsense.
Greece’s Governments, Like All Governments, Have Made Mistakes. When Is That Relevant?
As clear as the economic story is, however, it turns out that it is always possible to point to actions by Greek politicians as a way to distract people from the larger story. Because the current government of Greece is openly leftist, Europe’s conservative political and financial leaders feel especially free to claim—against all logic—that the situation only got out of hand because the new Greek government (which took office barely six months ago) insisted upon rolling back some of the austerity measures that have immiserated the Greek people for all these years.
It is essential to note that the current government did not try to end the austerity measures under which Greece has been laboring. It agreed up front to continue to run primary surpluses essentially ad infinitum, but it tried to moderate the severity of the austerity measures as a way to break the self-reinforcing downward spiral that the current situation had created. Yet, the all-too-common meme from Greece’s critics was to describe the new government’s negotiating stance as “political blackmail.”
Saying, as Greece’s government did, that the current arrangement needed to change, because it was hurting Greece, but also because it was not actually increasing the likelihood that European lenders would ever be paid in full, was thus somehow viewed as political grandstanding. (Again, what the Greek government was saying has since been confirmed by the very staid IMF.) That it was also the clearly stated will of the Greek people, who had put up with years of suffering that voters elsewhere (certainly including American voters) would never have tolerated, made no difference to Europe’s political and financial leaders.
Beyond blaming of the current government, Greece’s creditors also rolled out a series of other accusations about the supposed dishonesty of Greece’s politicians. Greece supposedly, for example, lied to enter the Eurozone in the first place, providing fake numbers to make its finances appear stronger than they were.
What that story fails to acknowledge is that everyone, very much including the German and French leaders of the European Union at the time, were in on the scheme. Everyone knew that Greece was being allowed into the EU for political reasons, and everyone was willing to avert their eyes. Using that episode now as a reason to punish the Greek people is eerily reminiscent of the famous line in “Casablanca,” where Captain Renault shouts, “I’m shocked, shocked to find that gambling is going on in here!”
Similarly, another claim is that generations of Greek governments have failed to put in place a modern system for collecting taxes. This, again, is true as far as it goes. But again, it is irrelevant to the current situation. Everyone knows that every country’s tax collections will be lower than the amount that would be collected if compliance with the tax laws were perfect. This is called the “tax gap.” In the United States, that gap has been estimated at about 10 percent of the total tax revenue that the federal government collects annually. For most other countries, it is much higher.
The point here, however, is that the countries and institutions that loaned money to Greece knew all of this. They knew that Greece’s tax gap is large, and that it has been for generations. It is perfectly valid, of course, to say that a country could try to collect more tax revenue, as a matter of reinforcing respect for the rule of law, or for other reasons. That, however, is not what is happening here.
Ultimately, current calls for “better tax collection efforts” in Greece are simply a different way to call for intensified austerity. Unless the Greek government can come up with a way quickly to collect large amounts of unpaid taxes from wealthy Greeks—because only wealthy citizens would be unlikely to reduce their spending on Greek goods and services, which would further harm Greece’s economy and increase its unemployment rate—calling on the country to increase taxes now (or, even worse, to cut spending further) is simply to try to force the Greeks to endure deeper austerity. That the excuse for doing so is given a moralistic gloss—“If only you had not tolerated such a large tax gap for all these years, you’d be fine now.”—does not change the underlying reality.
In short, even if one views the current and former governments of Greece as dishonest and uncooperative—charges that have some element of truth, but are being deliberately overblown—that is not currently relevant. Such claims are, instead, largely excuses for refusing to deal forthrightly with the problems at hand. They would, in fact, push the situation in precisely the wrong direction. If Greece is to stay in the Eurozone, it must receive debt reductions. And if it leaves the Eurozone, it will surely default on its own. Greece’s creditors are not going to be repaid in full, either way. The sooner they accept that, the better it will be for everyone, including the creditors themselves.
In my next Verdict column, the second in this two-part series, I will explain how the mismanagement of the Greek crisis harms not only the Greek people, but people everywhere. I will also explain a disturbing parallel between the moralizing that Europe’s leaders have used to condemn Greece’s people to years of pain and ideologically similar victim-blaming in the United States.