Understanding the Greek Debt Crisis
A Modern Odyssey
You may have heard of the ancient Greek tragedy called, “The Persians”, written by Aeschylus. It is a play that unconventionally gives a voice to the “enemy” (the Persians) after their defeat in the Greco-Persian War. It is a piece that evokes sympathy and heartache in the face of the loss, pain, and withered pride left like a shrapnel lodged in the characters’ expression and speech. Perhaps the modern Greek financial crisis is today’s version of the “The Persians”. A story of grand plans gone sour, over-indulgence, suffering, mismanagement, empty promises, and populistic trials of a country that is often seen as the black sheep of Europe.
In the late 2000s, the European Union provided the bankrupt country of Greece with a multibillion euro financial bailout to prevent the country from collapsing under its heavy debt burden. Greece, in particular, had a long history of economic mismanagement, and now other nations were on the hook for paying the large bill to get the country out of a problem of its own making. Fiscally responsible countries like Germany had to take responsibility for economically failing countries like Greece. How did we reach this point? How did Greece transform from one of the fastest growing economies in the 1950s, to the most heavily indebted EU country of the 2010s? The answer to that question would entail a trip to the past, a time before the introduction of Greece to the euro, and membership in the European Union.
This article will examine how the Greek financial crisis came to be, including its causes, long-term consequences, and lessons for the future.
1950s-1970s: The Greek Economic Miracle
Following the civil war, Greece’s economic growth averaged 7.7% between 1960 and 1973. GDP doubled in one decade, taxes were low, and the exchange rate allowed for cheap exports. Funding from the Marshall Plan, the growth of the services industry, and currency devaluation all worked towards attracting investment in the Greek economy. Infrastructure spending also grew through the “antiparochi system”.
Junta Era (1967-1974)
Like Pinochet would later do in Chile, the Greek Junta embraced free markets. Government expenditure was increased to finance “civil security” spending, residential housing expansion, and the naval industry. Deregulation of markets were accelerated, with considerable taxes on personal incomes, but decreased taxes on corporations. Farmers’ loans were written off while financial scandals like Thalassodania broke out. External debt increased, but this was concealed as public debt through a complex system between the government, banks, and infrastructure contractors.
After the Junta: Metapolitefsi
In 1974, the Turkish invasion of Cyprus served as the catalyst for the collapse of the military junta, with the center-right “New Democracy” party winning the democratic elections of the same year. The collapse of the Brenton Woods Agreement, and the oil prices hikes during the petroleum embargoes of the 1970s strained Greece’s economic growth. Inflation spiked, reaching over 25% in 1974. Applying to join the European Economic Community (EEC) in 1975, economic policies were applied to constrain inflation and balance budget payments. Despite this, stagflation plagued the economy as inflation crept up again, while productivity plunged due to increased labor costs and inadequate technological investment.
With growing economic malaise, Greeks voted for PASOK, a socialist party in the 1981 elections. A welfare state was established, with increased social benefit transfer payments. Wages for the public sector and pensions rose, while unions became more powerful and the labor market became more rigid with regulations. Banks lent at negative nominal interest rates and subsidies were given to mid-sized companies, not considering their business outlook and productivity. Rising taxes and an intricate bureaucratic system encouraged tax evasion, while the budget deficit increased rapidly. Contractionary measures, such as tax increases, were implemented in 1985 to fight off inflation, limit the budget deficit, and create a more friendly business environment. The Koskotas-Bank of Crete scandal tarnished PASOK’s reputation, triggering a political crisis. The party lost the election of 1990 to the New Democracy party.
1992: Maastricht Treaty
In 1992, twelve EEC member-states signed the Maastricht Treaty, transforming the EEC into the European Union. The treaty set the foundation for the European Monetary System, which specified the convergence criteria towards adopting the new currency, the euro. This included maintaining a government deficit below 3% of GDP, government debt below 60% of GDP, and an inflation rate that does not exceed 1.5 percentage points of the best performing members in price stability. In 1999, Greece’s national debt-to-GDP ratio touched almost 99%, with a 5% budget deficit and an inflation rate of 2.64% (far above the criteria specified for the smooth transition towards the euro). In the 1990s, economic policy was designed towards bringing in more government revenue, which increased from 31% of GDP in 1989 to 39% in 1992. This was done instead of making significant cut-backs in spending, which fell from 52% to 49% of GDP during the same period.
2001: Adopting the Euro
In 2001, Greece adopted the euro, enjoying increased capital inflows and low borrowing costs— similar to the interest rates of fiscally responsible countries like Germany. While exports grew, imports increased twice as fast. Instead of exercising fiscal control, Greece continued to finance domestic consumption, wages, public pensions, and social transfers through increased debt, which substantially increased budget deficits. With Greece put under financial supervision through Eurostat, it was revealed that the country had not complied with the Maastricht criteria upon its entry to the Eurozone (which was also true for Germany and France). With this system, Greece was able to convert part of its liabilities to other currencies based on a fictional exchange-rate. Eurostat at the time did not have specific requirements for these elements to be included in financial statistics, with other European countries, such as Italy, taking advantage of this loophole as well.
2000s: The Financial Crisis
The 2000s were marked by widening deficits and dangerously loose fiscal policies. Government spending fluctuated above 50% of GDP in 2008 and 2009, with the majority channeled towards social welfare transfer payments. Pensions, taxes, and unemployment benefits were weaponized as political tools during election campaigns to persuade voters. Tax evasion also was rampant.
The eurozone debt crisis that was triggered by the Great Recession pushed Greece towards budget deficits of over 10% between 2008-2011. Consequently, the GDP-to-debt ratio of Greece leapt from the relatively steady 100% of GDP to around 127% in 2010, and 176% in 2015. In contrast, Italy, which followed a similar debt-to-GDP course, experienced a budget deficit of 4.6% in 2010, being able to normalize it below 3% by 2012. Historically, during periods of high budget deficits and spiking debt, countries had been able to devaluate their currency. This strategy worked at making exports cheaper and more competitive, thus increasing export revenues. In this case, however, Eurozone nations (including Greece) had no control over their monetary policy.
2008-2009: Great Recession and Balance of Payments Crisis
In September 2008, the collapse of Lehman Brothers triggered a worldwide financial panic. The effects of extreme deregulation, securitization of mortgage-backed-securities with subprime loans, and credit default swaps backed by a strong belief in rising housing prices, all led to the burst of a housing bubble that infected the entire financial system. The U.S. and E.U. governments attempted to stem the crisis through multiple bailouts as borrowing costs skyrocketed. The majority of Eurozone countries, including Greece, financed their deficits through inflows of foreign capital. At the time, increased interest rates and exhaustion of capital resources during the crisis caused a credit crunch and balance of payment crisis, which immobilized Greece’s finances. In response, credit agencies Fitch, Moody's, and Standard & Poor's downgraded Greek bonds to junk status, freezing markets and eventually leading to 10-year bond yields surpassing 35%.
In 2010, Greece agreed to adopt strict austerity measures, and in exchange, the EU and the IMF provided a loan of 110 billion euros in emergency funds. The Greek government was asked to increase taxes (including VAT and corporate taxes), establish an independent statistics and tax collection committee, cut red-tape, reform the pension system, cut wages, and increase privatization. Later that year, the first version of quantitative easing was introduced by the European Central Bank (ECB), with the Securities Market Program being launched to buy bonds in order to assure liquidity in struggling markets. An additional rescue program of 750 billion euros was also pledged to prevent sovereign default of any Eurozone economy. Prime Minister George Papandreou requested and then later cancelled a national referendum regarding the second bailout that was under consideration. He ended up resigning, with a temporary government formed under Lucas Papademos to carry out the austerity measures and proceed with bailout negotiations.
In 2012, Greece received a second bailout amounting to 172 billion euros, alongside more austerity measures. More than 50% of debt reductions were included in the deal, constituting the largest debt restructuring program in history. The debt reductions resulted in deep losses for private bond holders, as well as Greek pension and social security funds that were also large holders of Greek debt.
What About Grexit?
Apart from the loans that were granted by the IMF and the EU, many European banks were major private holders of Greek bonds. Grexit and the return to the Greek drachma would coincide with significant currency devaluation. This would incur huge losses of holders of Greek debt, whether it would be EU institutions, private entities or sovereign governments. Currency devaluation would also carry a substantial risk of hyperinflation, since Greece imports 40% of its food and pharmaceuticals, and 80% of its energy. The loss of financial credibility would be accompanied by a large drop of foreign direct investment and the difficulty in acquiring new debt at low interest rates.
By 2014, Greece returned successfully to international bond markets, with yields being initially below 5%. The country achieved a positive economic growth of 0.7%, while achieving a budget deficit below 3%. Austerity measures that included increases in taxes, job cuts in the public sector, reductions in government spending on health care and education, pensions cuts, and a rise in the minimum retirement age all worked to fuel public dissatisfaction. As a result, the anti-austerity left-wing party Syriza, under the leadership of Alexis Tsipras, won victory in the snap elections and pledged to renegotiate terms with Troika. In June, Greece missed its 1.6 billion euro payment to the IMF, with some describing it as defaulting on its debt. A referendum was held, giving the choice to Greek voters to decide whether the government should accept the new austerity measures and proceed with a new bailout. The outcome was a panic-driven rejection of the proposed austerity measures, which induced the government to impose emergency capital controls to prevent a run on the bank. This allowed daily money withdrawals no higher than 60 euros. Despite the referendum, a third bailout was approved of 86 billion euros from the EU, with additional austerity policies that become more lenient in 2017 to accommodate growth more rapidly. Among the measures would be an increase of VAT to 24%, increases in property and income taxes, as well as the privatization of Greece's PPC electricity utility, railways, Athens International Airport and the Thessaloniki Port.
In 2018, Greece left the bailout program after receiving the last payment of 6-7 billion euros in exchange for stricter austerity measures that would allow Greece to run a budget surplus from 2016 to 2019. In July 2019, the New Democracy party won the national elections, with Kyriakos Mitsotakis becoming the new Prime Minister. The positive outlook on Greece’s budget surplus, debt-to-GDP ratio, unemployment and growth was derailed by the COVID-19 pandemic. Despite the deterioration of macroeconomic indicators, Greece managed to stifle the spread of the virus through an effective lockdown, more quickly and with lower mortality rates compared to other EU members, hailing the country as an unexpected success story.
Aftermath: Unemployment, Brain Drain, and Disillusionment
Through substantial sacrifices, Greece was able to reduce its unemployment rate from 27.5% in 2013 to 17.2% in 2019. The government debt-to-GDP fell from 181.2% in 2018 to 176.6% in 2019. Foreign direct investment increased by 33.3% in the same period, while exports reached record highs in 2019. Despite the optimistic progress of the economy, Greece continues to follow strict austerity measures. The population has been traumatized by years of unemployment, uncertainty, and failed promises. Even though it has fallen rapidly, youth unemployment was still 35.11% in 2019, having reached its peak at 55% in 2013. GDP lost a quarter of its value since the beginning of the crisis. Limited career prospects, low wages, sparse R&D projects, inefficiencies in the education and health care sector, have chronically forced students and skilled professionals to seek better opportunities outside of Greece. Various projects starting in 2020, such as ‘Rebrain Greece’ began to offer competitive salaries to talented individuals who left the country during the crisis.
Isolation Moderation describes the idea of classical realism, which is an international relations theory that transposes the inherent drive of self-preservation to the behavior of political entities. Expressed by the philosophical positions of Niccolo Machiavelli, Thomas Hobbes, and Hans Morgenthau, the theory suggests that state actions are motivated by survivalist national interest, creating inevitably distinct hierarchies due to intense power competition. What we could extract from classical realism, and the financial saga of Greece, is that countries should perhaps ensure first that they are independent, in every sense of the word. This would include being able to survive in extreme conditions without requiring constant life-line injections of liquidity or aid. As each individual has to exercise discipline and assume responsibility in their own lives, governments and politicians should look beyond short-term benefits and work towards sustaining a healthy economy in order to benefit future generations.
If you are interested in learning about more of these ideas, please order your own copy of Isolation Moderation.