Monday, August 29, 2011

...but how did Greece get itself into the financial mess?

A lot has been said about the financial crisis in Greece in recent months, speculation about the future, but little about how Greece got itself into the position its now in. A lot of what has been said has been inflamatory and in some cases down right racist.

Which is why i was pleased to read an article on Economia titled The Greek deficit and debt crisis: an end or a beginning? written by the esteemed foreign correspondant for the Economist Robert McDonald.

The first part of a series, Mr McDonald traces the root of the crisis back to the burgeoning public sector debt of the 80s and explains the various attempts at economic reform that have taken place since then.

The following is an excerpt from the article.

At this juncture it is worth a brief historical review to see how Greece arrived at the present impasse. The country has, since WWII, been aid-dependent. In the early days – during the Civil War of the late 1940s and the Cold War of the 1950s, 60s and 70s -- this was military aid provided by the United States but it freed national resources for domestic development programmes.

Since Greece’s entry into the European Economic Community, in 1981, Europe has taken over where America left off with various civilian aid programmes. Through the Integrated Mediterranean Programmes and three Community Support Frameworks, Greece has received to date some €55bn in structural fund aid and, under the fourth community support framework, Greece stands to receive a further €24bn by 2015. That is to say, by the middle of this decade Greece should have received nearly €80bn in development aid from the EU.

Despite such assistance, successive Greek governments have continued to run up massive debts -- particularly under the socialist governments of the 1980s under the Panhellenic Socialist Movement (Pasok) headed by the party’s founder Andreas Papandreou (the late father of the current prime minister).

A fact on which the present government tends not to dwell is that in 1980, the year before the socialists first came to office, the Greek debt to GDP ratio stood at just 39%. Nine years later, when Pasok was voted from office, the debt stood at 104% of GDP. The level has never since fallen below 100%.

The servicing of this debt has been a huge drain on budget resources cutting deeply into the potential for development investment. So long as the economy was growing, the cost was sustainable, albeit with difficulty. Today, interest payments absorb one in every four euros of net ordinary budget revenues and there is a primary deficit.
The primary balance is the budget balance less interest payments. Once there is a primary surplus the government will be in a position to begin to pay back some of the debt. As it is, the aggregate level keeps mounting.

Ordinarily the government would be able to keep ticking over by borrowing small amounts to cover new debt and large amounts to roll over old debt as it matures. But, in present circumstances, the cost of doing this is prohibitive and, because of recent changes in EU accounting procedures, the aggregate debt level has been mounting rapidly. It is officially forecast to reach nearly 160% of GDP by next year. That’s a little under €30,000 in debt for every man, woman and child in the country.

The present recourse to the European Union is not the first time that Greece has been helped by Brussels with loans as well as with aid. In 1985, the public sector borrowing requirement had risen to 17.9% of GDP and national reserves had dwindled to the equivalent of just five weeks of imports. The government could only obtain expensive, medium-term credit and so turned to the Community for a cheaper loan. It was granted Ecu1.75bn but under the strict condition that it should reduce the public sector borrowing requirement and cut the current account deficit to a level that would be sustainable by non-debt inflows of foreign capital.
The economy and finance minister of the day was Costas Simitis, a reformer who in the mid-1990s succeeded Andreas Papandreou as prime minister. Simitis implemented policies which met the Community’s conditions through a15% devaluation of the drachma and an incomes policy that produced a real reduction in the earnings of salaried employees of 11% over two years. Simitis wanted to extend such measures for several more years to try to restore skewed economic fundamentals. However, Andreas Papandreou, with an eye to the possibility of early elections, forced Simitis to resign and appointed a more tractable successor who oversaw a return to laxity.
The conservative New Democracy government elected in 1990 found itself confronted with an even higher public sector borrowing requirement equivalent to 21% of GDP. It too turned to Brussels for assistance. It was granted an Ecu2.2bn loan facility in exchange for a rigorous consolidation programme which included many proposals that sound familiar today such as, for example, a) a 10% reduction in public sector employment, b) caps on public sector wages and c) a halving in subsidies for public sector enterprises. This was to be coupled with an extensive programme of privatisation.

The EEC loan was to be disbursed in three tranches: the first of Ecu1bn and a second and third -- each of Ecu 600mn. Release of the latter two was contingent on implementation of the consolidation programme. At the end of the first year, the government was quietly advised by Brussels that its performance had been so abysmal that, if it applied for the second tranche, its application would be rejected. The government did not apply and instead tried to muddle through with domestic programmes until it fell in an early election in 1993.

In 1992, the ND government had signed up to the Treaty of Maastricht which transformed the European Economic Community into the European Union and set the framework for a common currency with a unitary monetary policy to be administered by a European Central Bank (ECB). Those countries who wished – and were able – to subscribe to conditions laid down in the Economic and Monetary Union (EMU) were eventually to be allowed to deploy the Euro.

The criteria for the EMU included basic rules that deficits should be no more than 3% of GDP and debt should be equivalent to, or headed towards, 60% of GDP. In addition, there were other criteria related to exchange rate stability, inflation, and long term interest rates. In 1998, when the European Council decided which countries were entitled to become members, Greece was the only one of the twelve that wished to join, that did not qualify. The Greek deficit stood at 4.6% of GDP and its debt at 108.5% of GDP while its inflation rate was more than double the reference rate and its long-term interest rates were nearly 2 percentage points higher than the reference rate as well as being unstable.

The Pasok government of the day – by this time headed by Costas Simitis – devoted all its political energies for the years 1999 and 2000 to meeting the criteria to join the Economic and Monetary Union. To do this it used accounting practices which it claimed were sanctioned by Eurostat. These reduced the estimated general government budget deficit for 2000 to less than 1% of GDP (0.8%) and brought down the general government debt to 104% of GDP. Inflation was squeezed through a series of administrative measures and interest rates fell below the reference level. In March 2000 Greece was declared to have met the membership targets and on January 1, 2001 it became the 12th member of the EMU.

Member states of the Economic and Monetary Union are required each year to present a so-called Stability and Growth Programme to the European Commission detailing the policies that they will follow in the medium term in order to continue to adhere to EMU membership criteria.

For three years, the country produced programmes which appeared to show that it was abiding by the rules. I say appeared, however, because when the New Democracy party was restored to government in March 2004 it undertook what it styled a “fiscal audit” which claimed that Pasok had only achieved the target numbers through creative accounting. Among other things, ND contended that the socialists had kept down deficits by keeping off-balance-sheet many items of expenditure. By ND’s calculations, the 2004 deficit, which had been officially forecast to be 1.2% of GDP, was actually 3.2% of GDP and debt levels, which were supposedly contracting, were actually on the rise.

The full text including annotations can be read here

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